Thursday, February 28, 2008
Mint article on rethinking poverty eradication schemes
Here is my Mint article exploring a different approach to delivering anti-poverty scheme assistance. The full version of the same was posted earlier here.
Wednesday, February 27, 2008
MCX starts carbon trading
In January 2008, the Mumbai based Multi Commodity Exchange (MCX), in a tie-up with the Chicago Climate Exchange, became the first commodity exchange in Asia to launch futures trading in carbon credit contracts. Hitherto such contracts were traded only in the European Climate Exchange (ECX).
This comes in the aftermath of the Delhi Metro Railway Corporation (DMRC) recently becoming the first rail project in the world to qualify for carbon credits. The DMRC can claim 400,000 CERs for a 10-year crediting period beginning Dec 2007, which translates to Rs 1.2 crore per year for 10 years. The money from sale of CERs will be used to offset the additional investment and operation costs.
The international market for trading in carbon emissions is estimated to be in the range of $ 60-70 billion annually. India is among the global leaders having generated close to 30 million carbon credits and roughly another 140 million in the pipeline for sale. One-third of the total Clean Development Mechanism (CDM) projects registered with the United Nations under the Kyoto Protocol are from India. According to the World Bank, India is expected to rake in at least $100 million annually by trading in carbon credits. By ’12, Indian companies are expected to generate at least $8.5 billion at an average rate of $10 per tonne of CER.
As per the United Nations Framework Convention on Climate Change (UNFCC), a company is awarded a carbon emission reduction (CER) certificate for each reduced tonne of CO2 or its equivalent emission. This can be traded either immediately as an over the counter (OTC) product, or as a futures contract, like any other commodity derivative instrument. These credits are bought by companies in developed countries which exceed their permissible emission limits.
The trade is part of the Kyoto Protocol, which establishes a flexible mechanism of ‘cap and trade system’, where companies in industrialised countries (mostly in Europe and Japan) are allowed to meet their GHG emissions limits by purchasing GHG emission reductions from elsewhere. Companies which have reduced their emissions below their allowances, will be able to trade some part of their surplus allowances with other industrialised parties. Under the protocol, carbon credits or CER certificates are issued by the Clean Development Mechanism (CDM) Executive Board, the highest international body to register projects and issue credits.
The trading unit would be 200 tonnes, where each tonne of carbon credit being an entitlement to emit one tonne of carbon dioxide equivalent gases. A total of five contracts of carbon credits are available on its platform with expiry in December 2008, December 2009, December 2010, December 2011 and December 2012.
This comes in the aftermath of the Delhi Metro Railway Corporation (DMRC) recently becoming the first rail project in the world to qualify for carbon credits. The DMRC can claim 400,000 CERs for a 10-year crediting period beginning Dec 2007, which translates to Rs 1.2 crore per year for 10 years. The money from sale of CERs will be used to offset the additional investment and operation costs.
The international market for trading in carbon emissions is estimated to be in the range of $ 60-70 billion annually. India is among the global leaders having generated close to 30 million carbon credits and roughly another 140 million in the pipeline for sale. One-third of the total Clean Development Mechanism (CDM) projects registered with the United Nations under the Kyoto Protocol are from India. According to the World Bank, India is expected to rake in at least $100 million annually by trading in carbon credits. By ’12, Indian companies are expected to generate at least $8.5 billion at an average rate of $10 per tonne of CER.
As per the United Nations Framework Convention on Climate Change (UNFCC), a company is awarded a carbon emission reduction (CER) certificate for each reduced tonne of CO2 or its equivalent emission. This can be traded either immediately as an over the counter (OTC) product, or as a futures contract, like any other commodity derivative instrument. These credits are bought by companies in developed countries which exceed their permissible emission limits.
The trade is part of the Kyoto Protocol, which establishes a flexible mechanism of ‘cap and trade system’, where companies in industrialised countries (mostly in Europe and Japan) are allowed to meet their GHG emissions limits by purchasing GHG emission reductions from elsewhere. Companies which have reduced their emissions below their allowances, will be able to trade some part of their surplus allowances with other industrialised parties. Under the protocol, carbon credits or CER certificates are issued by the Clean Development Mechanism (CDM) Executive Board, the highest international body to register projects and issue credits.
The trading unit would be 200 tonnes, where each tonne of carbon credit being an entitlement to emit one tonne of carbon dioxide equivalent gases. A total of five contracts of carbon credits are available on its platform with expiry in December 2008, December 2009, December 2010, December 2011 and December 2012.
Sub-prime bailouts loom large
Bailout cries are growing louder. In the guise of removing powerful headwinds that may prevent a strong recovery from any slowdown, Princeton Professor, Alan Blinder has lent his considerable academic reputation to the growing calls for bailing out mortgage holders facing foreclosures. He feels that a "potential tsunami of home foreclosures" will throw families (he however acknowledges that only "some" of them are victims of deception) into the streets, cut consumer spending, and create a meltdown in the larger financial markets.
He therefore calls for the creation of a New Deal type Home Owners’ Loan Corporation (HOLC), financed by borrowing from capital markets and the Treasury, that would buy old mortgages from banks — most of which would be delighted to trade them in for safe government bonds — and then issue new loans to homeowners. He estimates that the new version of HOLC will need to lend to 1-2 million mortgages, thereby borrowing and lending $200-400 bn to the most vulnerable types of mortgage holders. His figures even suggests that the HOLC 2.0 could make a profit!
He writes, "The HOLC had received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages, thereby owning nearly one of every five mortgages in America. As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC’s borrowers defaulted anyway. So the corporation eventually acquired ownership of about 200,000 houses, nearly all of which were sold by 1944."
Alan Blinder's plan came even as a confidential proposal by the Bank of America warned that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes. In order to prevent this, it suggests creation of a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.
Such bailouts are in contradiction to the neo-classical arguments that "wounded financial markets are supposed to cure themselves: asset prices fall, bargain hunters rush in and markets return to normal", a standard prescription administered, often forcibly, on many developing countries and recently even Japan. The "moral hazard" possibilities of any bailout are enormous. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers. It is likely to encourage banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.
Proposals like that of Bank of America, envisages the government buying the mortgages at their true current value, perhaps through an auction, at probably a big discount from the original loan amount. The mortgage lenders, or the investors who bought mortgage-backed securities, would then be free of the bad loans but would still have to book their losses. They argue that if the government took control of the bad mortgages, it could restructure the loans on terms that borrowers could meet, keep most of them from losing their homes and avoid an even more catastrophic plunge in housing prices. Though the government might end up buying $80 billion to $100 billion in mortgages, it can recoup its money if it buys the mortgages at a proper discount, repackage them and sell them on the open market. But identification of the real needy beneficiaries will remain a major problem.
About 8.8 million homeowners, or 10.3 percent of the total, are facing the prospect of foreclosures. House prices are down 10% from the 2006 high and are likely to fall at least another 10%. Each 10% decline cuts household wealth by about $2 trillion, and this eventually reduces annual consumer spending by about $100 billion. Falling house prices also discourage home building, with housing starts down 38% over the past 12 months.
Update 1
On 11 March, 2008, the Federal Reserve offered to let the biggest investment banks on Wall Street borrow up to $200 billion in Treasury securities in exchange for hard-to-sell mortgage-backed securities as collateral. It also made clear that it was prepared to do more as needed. The move, which was coordinated with central banks in Europe and Canada, came on the heels of two similar actions last week, in which the Fed offered up to $200 billion in 28-day cash loans to banks and big financial institutions.
As Edmund Andrews writes, "The Federal Reserve, in effect, is trying to ease an acute credit squeeze by agreeing to hold large volumes of mortgage-backed bonds that Wall Street firms are struggling to sell and providing them with either cash or Treasury securities that they can immediately convert to cash." In recent days, market prices for seemingly safe debt had fallen so much that major financial institutions were being forced to put up more capital to secure their debt. The Fed appears to belive that the moral hazard dangers inherent in such bailouts are more than over-ridden by the much bigger danger of the credit squeeze dragging the whole economy into a deeper recession. The Fed’s hope is to relieve some of the pressure on institutions to sell at fire-sale prices, easing the strains on economic activity and making the credit markets feel more comfortable in buying mortgage bonds again.
The danger is that the central bank might make things worse in the long run by postponing the repricing of mortgage assets that financial institutions are holding, or by further weakening the value of the dollar and aggravating inflation.
He therefore calls for the creation of a New Deal type Home Owners’ Loan Corporation (HOLC), financed by borrowing from capital markets and the Treasury, that would buy old mortgages from banks — most of which would be delighted to trade them in for safe government bonds — and then issue new loans to homeowners. He estimates that the new version of HOLC will need to lend to 1-2 million mortgages, thereby borrowing and lending $200-400 bn to the most vulnerable types of mortgage holders. His figures even suggests that the HOLC 2.0 could make a profit!
He writes, "The HOLC had received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages, thereby owning nearly one of every five mortgages in America. As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC’s borrowers defaulted anyway. So the corporation eventually acquired ownership of about 200,000 houses, nearly all of which were sold by 1944."
Alan Blinder's plan came even as a confidential proposal by the Bank of America warned that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes. In order to prevent this, it suggests creation of a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.
Such bailouts are in contradiction to the neo-classical arguments that "wounded financial markets are supposed to cure themselves: asset prices fall, bargain hunters rush in and markets return to normal", a standard prescription administered, often forcibly, on many developing countries and recently even Japan. The "moral hazard" possibilities of any bailout are enormous. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers. It is likely to encourage banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.
Proposals like that of Bank of America, envisages the government buying the mortgages at their true current value, perhaps through an auction, at probably a big discount from the original loan amount. The mortgage lenders, or the investors who bought mortgage-backed securities, would then be free of the bad loans but would still have to book their losses. They argue that if the government took control of the bad mortgages, it could restructure the loans on terms that borrowers could meet, keep most of them from losing their homes and avoid an even more catastrophic plunge in housing prices. Though the government might end up buying $80 billion to $100 billion in mortgages, it can recoup its money if it buys the mortgages at a proper discount, repackage them and sell them on the open market. But identification of the real needy beneficiaries will remain a major problem.
About 8.8 million homeowners, or 10.3 percent of the total, are facing the prospect of foreclosures. House prices are down 10% from the 2006 high and are likely to fall at least another 10%. Each 10% decline cuts household wealth by about $2 trillion, and this eventually reduces annual consumer spending by about $100 billion. Falling house prices also discourage home building, with housing starts down 38% over the past 12 months.
Update 1
On 11 March, 2008, the Federal Reserve offered to let the biggest investment banks on Wall Street borrow up to $200 billion in Treasury securities in exchange for hard-to-sell mortgage-backed securities as collateral. It also made clear that it was prepared to do more as needed. The move, which was coordinated with central banks in Europe and Canada, came on the heels of two similar actions last week, in which the Fed offered up to $200 billion in 28-day cash loans to banks and big financial institutions.
As Edmund Andrews writes, "The Federal Reserve, in effect, is trying to ease an acute credit squeeze by agreeing to hold large volumes of mortgage-backed bonds that Wall Street firms are struggling to sell and providing them with either cash or Treasury securities that they can immediately convert to cash." In recent days, market prices for seemingly safe debt had fallen so much that major financial institutions were being forced to put up more capital to secure their debt. The Fed appears to belive that the moral hazard dangers inherent in such bailouts are more than over-ridden by the much bigger danger of the credit squeeze dragging the whole economy into a deeper recession. The Fed’s hope is to relieve some of the pressure on institutions to sell at fire-sale prices, easing the strains on economic activity and making the credit markets feel more comfortable in buying mortgage bonds again.
The danger is that the central bank might make things worse in the long run by postponing the repricing of mortgage assets that financial institutions are holding, or by further weakening the value of the dollar and aggravating inflation.
Tuesday, February 26, 2008
Trade and Inequality
Paul Krugman opened up an intense debate about the role of trade in generating inequality, by claiming in his NYT article, Trouble with Trade, that "it's hard to avoid the conclusion that growing U.S. trade with third world countries reduces the real wages of many and perhaps most workers in this country."
He argues that while "trade between high-wage countries tends to be a modest win for all, or almost all, concerned... trade between countries at very different levels of economic development tends to create large classes of losers as well as winners". Krugman goes on to say that outsourcing and trade benefits the highly educated American workers by improving their wages and expanding their job oppportunities. However, the less educated suffer because their jobs get shipped overseas and downward pressure on their wages, due to other workers with similar qualifications crowding into their industries and looking for employment to replace the jobs they lost to foreign competition.
In a conclusion that generated sufficient debate in the blogosphere, Krugman concludes, "It’s often claimed that limits on trade benefit only a small number of Americans, while hurting the vast majority. That’s still true of things like the import quota on sugar. But when it comes to manufactured goods, it’s at least arguable that the reverse is true. The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose."
Alan Blinder has written about the steps needed to be taken to mitigate the harmful effects of international trade. He argues in favor of a stronger saftey net to cushion those affected from trade related issues, by way of "expanding some existing programs, like making unemployment insurance more comprehensive, and vastly increasing — and improving — job retraining programs. It also means enacting new programs like universal health insurance, guaranteed pension portability and so-called 'wage insurance'. Wage insurance would replace a portion of the wages lost by workers who do find new jobs at lower rates of pay."
He also argues in favor of reasonable safeguards for the environment and labor without interfering much with trade. In what can be seen as a veiled call back for the days of workers Unions, he even says, "The government should be protecting, rather than undermining, American workers’ rights to organize and bargain collectively."
Dani Rodrik draws attention to the work of Robert Feenstra and Gordon Hanson, which claims that “global production sharing,” is a potentially
important explanation for the increase in the wage gap between skilled and unskilled workers in the U.S. and elsewhere. Feenstra and Hanson claim that "trade in inputs has much the same impact on labor demand as does skill-biased technical change: both of these will shift demand away from low-skilled activities, while raising relative demand and wages of the higher skilled."
Striking a different note, The Economist feels that consumption inequality is a more appropriate parameter to judge individual economic well-being. While acknowledging that income inequality has widened, it draws on the study of Dirk Krueger of the University of Pennsylvania and Fabrizio Perri of New York University to claim that consumption inequality has barely budged for several decades. It is argued that the innovations in production and distribution have improved the quality of goods at the lower range of prices faster than at the top, thereby narrowing the range of experience and further masking a closing of real or “utility-adjusted” consumption inequality. The article also draws on the findings of some "happiness" researchers, whose findings show that inequality in self-reported “life satisfaction” has been shrinking in wealthy market democracies, suggesting that the quality of lives across the income scale are becoming more similar, not less.
I have tried to list out a few arguements as to why the simple "life satisfaction" surveys conceal more than they reveal, and widening inequality carries within itself germs of further division.
1. Life satisfaction is a highly subjective concept, which cannot be quantified without a very high probability of distortions, that fail to capture the full dimension of the issue. It varies across income groups (witness numerous studies that show that the poor in India or people of some poor African countries are very happy), and betweeen countries.
2. Unlike in the previous times, most of the basic necessities for helping individuals realize their potential - health care and education - are increasingly becoming out of bounds of the poor. The capital investments required to achieve success are becoming ever more higher.
3. Widening income inequality itself has an effect on aligning the price of basic services like education, skills upgradation, and health care. As incomes at the top rise spectaculalry, we see the emergence of a two or multi-tier system of education.
4. The consumption data does not account for the dis-utility associated with widening of "relative incomes", which by itself contributes substantially towards "life-satisfaction".
5. There are numerous studies to show that economic mobility has slowed down considerably. The NYT quotes of a study by the Brookings Institution to warn that "widening gaps in higher education between rich and poor, whites and minorities, could soon lead to a downturn in opportunities for the poorest families"
6. Almost every determinant of income - education, health, credit, insurance - have experienced widening inequality.
He argues that while "trade between high-wage countries tends to be a modest win for all, or almost all, concerned... trade between countries at very different levels of economic development tends to create large classes of losers as well as winners". Krugman goes on to say that outsourcing and trade benefits the highly educated American workers by improving their wages and expanding their job oppportunities. However, the less educated suffer because their jobs get shipped overseas and downward pressure on their wages, due to other workers with similar qualifications crowding into their industries and looking for employment to replace the jobs they lost to foreign competition.
In a conclusion that generated sufficient debate in the blogosphere, Krugman concludes, "It’s often claimed that limits on trade benefit only a small number of Americans, while hurting the vast majority. That’s still true of things like the import quota on sugar. But when it comes to manufactured goods, it’s at least arguable that the reverse is true. The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose."
Alan Blinder has written about the steps needed to be taken to mitigate the harmful effects of international trade. He argues in favor of a stronger saftey net to cushion those affected from trade related issues, by way of "expanding some existing programs, like making unemployment insurance more comprehensive, and vastly increasing — and improving — job retraining programs. It also means enacting new programs like universal health insurance, guaranteed pension portability and so-called 'wage insurance'. Wage insurance would replace a portion of the wages lost by workers who do find new jobs at lower rates of pay."
He also argues in favor of reasonable safeguards for the environment and labor without interfering much with trade. In what can be seen as a veiled call back for the days of workers Unions, he even says, "The government should be protecting, rather than undermining, American workers’ rights to organize and bargain collectively."
Dani Rodrik draws attention to the work of Robert Feenstra and Gordon Hanson, which claims that “global production sharing,” is a potentially
important explanation for the increase in the wage gap between skilled and unskilled workers in the U.S. and elsewhere. Feenstra and Hanson claim that "trade in inputs has much the same impact on labor demand as does skill-biased technical change: both of these will shift demand away from low-skilled activities, while raising relative demand and wages of the higher skilled."
Striking a different note, The Economist feels that consumption inequality is a more appropriate parameter to judge individual economic well-being. While acknowledging that income inequality has widened, it draws on the study of Dirk Krueger of the University of Pennsylvania and Fabrizio Perri of New York University to claim that consumption inequality has barely budged for several decades. It is argued that the innovations in production and distribution have improved the quality of goods at the lower range of prices faster than at the top, thereby narrowing the range of experience and further masking a closing of real or “utility-adjusted” consumption inequality. The article also draws on the findings of some "happiness" researchers, whose findings show that inequality in self-reported “life satisfaction” has been shrinking in wealthy market democracies, suggesting that the quality of lives across the income scale are becoming more similar, not less.
I have tried to list out a few arguements as to why the simple "life satisfaction" surveys conceal more than they reveal, and widening inequality carries within itself germs of further division.
1. Life satisfaction is a highly subjective concept, which cannot be quantified without a very high probability of distortions, that fail to capture the full dimension of the issue. It varies across income groups (witness numerous studies that show that the poor in India or people of some poor African countries are very happy), and betweeen countries.
2. Unlike in the previous times, most of the basic necessities for helping individuals realize their potential - health care and education - are increasingly becoming out of bounds of the poor. The capital investments required to achieve success are becoming ever more higher.
3. Widening income inequality itself has an effect on aligning the price of basic services like education, skills upgradation, and health care. As incomes at the top rise spectaculalry, we see the emergence of a two or multi-tier system of education.
4. The consumption data does not account for the dis-utility associated with widening of "relative incomes", which by itself contributes substantially towards "life-satisfaction".
5. There are numerous studies to show that economic mobility has slowed down considerably. The NYT quotes of a study by the Brookings Institution to warn that "widening gaps in higher education between rich and poor, whites and minorities, could soon lead to a downturn in opportunities for the poorest families"
6. Almost every determinant of income - education, health, credit, insurance - have experienced widening inequality.
Regulating moneylenders
This post is about another illustration of the "second-best" approach to development. Standard explanations of poverty elimination and economic development has blamed the local moneylender for exploiting the locals and perpetuating deprivation. The stereotype of the usurious practices of the moneylender are part of development folklore. However, such simple explanations tend to gloss over important issues.
The moneylender is part of the massive unorganized sector and his activities are therefore not registered and regulated. Accordingly, governments across the world have taken steps to ban the moneylender or develop alternative mechanisms like thrift activities through the Self Help Groups (SHGs). But the moneylender continues to be as ubiquitous and resilient as ever.
We cannot wish away the reality that access to timely and assured credit for the poor remains a major deficiency in many developing countries. With the formal credit mechanisms failing to reach out to these poor, the demand is being met by the moneylender. Given the huge area and large numbers, it is not practical for even the most aggressive "financial inclusion" campaign to bring all the uncovered under the formal banking net. All the presently available alternative credit delivery initiatives involving micro-finance are too limited and have negligible reach.
Any effort to remove or immobilize the activities of the moneylender, without having in place a working formal credit mechanism, will not only fail, but also adversely affect the poor for whose benefit these steps are taken. It will starve them of much needed credit. As long as the demand and incentives that created the moneylender remains, even if the government successfully manages to wish away the moneylender, some other informal version will certainly emerge to occupy the vacated space.
So the only pragmatic solution to the problem appears to lie in co-opting the moneylender and formally recognizing his presence. A practical regulatory framework can be created, which registers them and regulates their activities. The mere recognition of their presence may be enough to contain and significantly reduce some of the problems.
The moneylender is part of the massive unorganized sector and his activities are therefore not registered and regulated. Accordingly, governments across the world have taken steps to ban the moneylender or develop alternative mechanisms like thrift activities through the Self Help Groups (SHGs). But the moneylender continues to be as ubiquitous and resilient as ever.
We cannot wish away the reality that access to timely and assured credit for the poor remains a major deficiency in many developing countries. With the formal credit mechanisms failing to reach out to these poor, the demand is being met by the moneylender. Given the huge area and large numbers, it is not practical for even the most aggressive "financial inclusion" campaign to bring all the uncovered under the formal banking net. All the presently available alternative credit delivery initiatives involving micro-finance are too limited and have negligible reach.
Any effort to remove or immobilize the activities of the moneylender, without having in place a working formal credit mechanism, will not only fail, but also adversely affect the poor for whose benefit these steps are taken. It will starve them of much needed credit. As long as the demand and incentives that created the moneylender remains, even if the government successfully manages to wish away the moneylender, some other informal version will certainly emerge to occupy the vacated space.
So the only pragmatic solution to the problem appears to lie in co-opting the moneylender and formally recognizing his presence. A practical regulatory framework can be created, which registers them and regulates their activities. The mere recognition of their presence may be enough to contain and significantly reduce some of the problems.
Sunday, February 24, 2008
Conditional cash transfers in poverty alleviation
The Brazilian government have been running an experiment with anti-poverty programs since 2003, called Bolsa familia (Family Fund). It has grown to be the largest single anti-poverty scheme in the world, covering some 11 m families or a quarter of Brazil's population. At just 0.8% of GDP, the Bolsa program delivers good bang for the buck. Its success raises questions about the traditional models of anti-poverty programs.
Traditionally anti-poverty programs have focussed on providing either skill training, or self-employment assistance, or subsidies for food and other essential items, or welfare payments to the old, disabled and some specific groups. Apart from the welfare payments, all the others are usually large programs that seeks to deliver a standard benefit(s) to a defined set of beneficiaries.
This commoditized and uni-dimensional approach to poverty eradication has many pitfalls. Besides being inflexible, it fails to take into account the differential needs and requirements of the target beneficiaries. Such top-down schemes open up ample opportunities for incentive distortions, that in turn manifests in poor targetting and numerous delivery channel leakages.
These traditional prescriptions to poverty alleviation manifests with many problems - black market in PDS foodgrains and kerosene, poor quality schools and hospitals, lack of choice for parents and patients, sales and illegal capture of government weaker section housing units, ineligible welfare pension beneficiaries, artificially depressed low prices for agriculture commodities, distortions in fertilizer production etc. In some ways atleast, the total long-term damage inflicted by way of market incentive distortions and eliminating choice may be much more than the expenditure itself.
In contrast, "conditional cash transfer" schemes like the Bolsa Familia seeks to incentivize individual families towards achieving certain important social goals, by making direct cash tansfers which are conditional on achieving those social goals. The fungibility of the cash transferred leaves the spending discretion to the beneficiary. This is in keeping with the by now widely acknowledged fact that each family knows what is best for them, what are their needs and wants, and how the money can be most effectively spent. The success or otherwise of such programs depend on the ability to monitor the fulfillment of the conditions and check any pilferage in the cash transfer.
Under the Brazilian Bolsa scheme, the mothers of a family which earns less than 120 reais ($68) per head per month, are paid a benefit of up to 95 reais on condition that their children go to school and take part in government vaccination programmes. Municipal governments do much of the collection of data on eligibility and compliance, but payments are made by the federal government. Each beneficiary receives a debit card which is charged up every month, unless the recipient has not met the necessary conditions, in which case (and after a couple of warnings) the payment is suspended. The involvement of women and the use of debit card ensures that the cash transferred is likely to be well spent and cash pilferages are minimized.
Another popular example of direct cash transfer is micro-credit financing. Here too women hold the accounts and receive the loans from banks and other micro-finance insitutions and they utilize the loan amount for their consumption and other requirements. It may be a good idea to make these loan transfers conditional to the group members striving to achieving certain social goals like sending children to school; immunizing their children; keeping their premises clean; undergoing family planning operations after say, two children etc. The self help groups can also be incentivized by way of interest subsidies on the loans, which can be transferred directly to the group account.
Other government anti-poverty schemes, like subsidies, self-employment assistance, welfare transfers can all be modelled as cash transfer schemes. Such schemes, by virtue of the fungibility of the benefit and the discretion given to the beneficiary, is likely to be more effective and have fewer incentive distortions. Besides, given the relative ease of transferring cash instead of various other benefits, it reduces the scope for pilferage and other leakages. Further, by imposing suitable conditions, it becomes possible to achieve important social goals.
Here is a list of how the most important government welfare and development programs can be redesigned to make it similar to a conditional cash transfer program.
1. Public Distribution Scheme (PDS)
The subsidy for the foodgrains distributed to the poor can be transferred directly as cash. They can purchase the foodgrain at the market price from any regular shop. The subsidy component can be variable, depending on the market price for the particular type of foodgrain. The eligible benenficiaries may be given the subsidy as a cash transfer into their accounts, subject to their achieving certain specified social goals. These goals may include sending children to school (in which case the subsidy can be transferred to an account on producing the attendance particulars) or being part of a good Self Help Group (the money can be transferred to the SHG account). For all those with social security pensions, the subsidy can be transferred into their pension accounts.
2. School Vouchers
Poor children can use school vouchers to get admission in private schools. The subsidy can be in the form of a voucher for a minimum amount, which can be topped up by the beneficiary to select any school of choice. Government run schools will also run, but in competition with the private schools.
3. Housing vouchers
Instead of giving ownership of houses, poor people, especially in urban areas, can be allotted rent vouchers which can be used to get accomodation in government housing estates or private houses. The rent vouchers, for a specified subsidy amount, can be topped up by the beneficiary to get an accommodation of their choice.
4. Health Care and Insurance
Basic health care can be delivered though Primary Health Centers (PHCs). A universal health insurance system should be put in place that provides for all tertiary and even some secondary care. The insurance benefits should be conditional again to certain social desirables like sending children to school, universal immunization, participation in adult literacy programs, and getting family planning operations done. The insurance subsidy can be transferred to the account of the individual or the SHG of which the individual is a member, as an insurance credit. The individual may be given the option of either joining a basic health insurance scheme which becomes available with the subsidy or purchasing a different scheme from the market by topping up the subsidy. Group insurance schemes with the SHG as the unit, can also be explored.
5. Agriculture subsidies
The major agriculture subsidies are for fertilizers, seeds, and as price support. Instead of artificially keeping the market prices of these items low, thereby distorting the market incentive structure, it is more efficient to provide the subsidy support as a cash transfer. The amount of subsidy can be pre-determined. The challenge with this approach would be in correctly targetting the beneficiaries. This assistance should be confined to farmers below the poverty line and having small landholdings. The subsidy support can be delivered directly to their accounts. Poor farmers can be encouraged to form Farmers Groups and members of good groups can be transferred the subsidy amounts. Another way of targetting is to transfer the subsidy to the kisan credit card, thereby incentivize farmers to take the same. All this will also go a long way into bringing farmers into the organized sector. The money can also be transferred to the wife's SHG account.
6. Employment Training assistance
The individuals wanting wage and self employment training and eligible for government assistance can be identified. They can then be given training vouchers, of a specified amount, which can be used to access training in private institutes. The individual can top up the voucher amount and go to an inistitute with a higher training cost, but perceived to offer him better prospects.
Apart from improving the effectiveness of these programs, the aforementioned methods will also reduce the incentive distortions inherent in government welfare programs. By insisting on bank accounts, such programs will go a long way in enabling access to formal channels of credit and bringing transparency to the administration of such schemes. The SHG based transfers can be made mandatory especially in the southern states, and others where the SHG movement is strong.
Administering such programs poses a major challenge in terms of managing databases and close co-odination between different government agencies. An integrated database, that links the individual databases of the different departments, can go a long way in addressing many operational problems. In any case, such a database is a necessary condition for effectively administering any large program. It is worth spending both the effort and the resources to achieving it. That this is achievable is borne out by the fact that both the NREG wages and now the Social Security Pensions are being delivered to the beenficiaries through bank (and post office) accounts in many places.
All these are only some illustrative examples of how we should look at re-modelling our anti-poverty programs. They will need to be implemented carefully, not as shock therapies, but with appropriate area-specific phasing and sequencing of activities, so as to ensure that the transition is trouble free. They attempt to address some of the major deficiencies associated with the traditional programs, and in the process achieve some critical social goals by incentivizing the beneficiaries. These strategies will give choice and discretion in decision making to the beneficiary, remove all market distortions and re-align incentives, minimize delivery channel leakages and pilferages, and also achieve important social goals. In other words, it seeks to achieve the full-bang for the development-buck!
Update
The proposed introduction of smart cards for PDS will considerably help in administering cash transfer programs.
Traditionally anti-poverty programs have focussed on providing either skill training, or self-employment assistance, or subsidies for food and other essential items, or welfare payments to the old, disabled and some specific groups. Apart from the welfare payments, all the others are usually large programs that seeks to deliver a standard benefit(s) to a defined set of beneficiaries.
This commoditized and uni-dimensional approach to poverty eradication has many pitfalls. Besides being inflexible, it fails to take into account the differential needs and requirements of the target beneficiaries. Such top-down schemes open up ample opportunities for incentive distortions, that in turn manifests in poor targetting and numerous delivery channel leakages.
These traditional prescriptions to poverty alleviation manifests with many problems - black market in PDS foodgrains and kerosene, poor quality schools and hospitals, lack of choice for parents and patients, sales and illegal capture of government weaker section housing units, ineligible welfare pension beneficiaries, artificially depressed low prices for agriculture commodities, distortions in fertilizer production etc. In some ways atleast, the total long-term damage inflicted by way of market incentive distortions and eliminating choice may be much more than the expenditure itself.
In contrast, "conditional cash transfer" schemes like the Bolsa Familia seeks to incentivize individual families towards achieving certain important social goals, by making direct cash tansfers which are conditional on achieving those social goals. The fungibility of the cash transferred leaves the spending discretion to the beneficiary. This is in keeping with the by now widely acknowledged fact that each family knows what is best for them, what are their needs and wants, and how the money can be most effectively spent. The success or otherwise of such programs depend on the ability to monitor the fulfillment of the conditions and check any pilferage in the cash transfer.
Under the Brazilian Bolsa scheme, the mothers of a family which earns less than 120 reais ($68) per head per month, are paid a benefit of up to 95 reais on condition that their children go to school and take part in government vaccination programmes. Municipal governments do much of the collection of data on eligibility and compliance, but payments are made by the federal government. Each beneficiary receives a debit card which is charged up every month, unless the recipient has not met the necessary conditions, in which case (and after a couple of warnings) the payment is suspended. The involvement of women and the use of debit card ensures that the cash transferred is likely to be well spent and cash pilferages are minimized.
Another popular example of direct cash transfer is micro-credit financing. Here too women hold the accounts and receive the loans from banks and other micro-finance insitutions and they utilize the loan amount for their consumption and other requirements. It may be a good idea to make these loan transfers conditional to the group members striving to achieving certain social goals like sending children to school; immunizing their children; keeping their premises clean; undergoing family planning operations after say, two children etc. The self help groups can also be incentivized by way of interest subsidies on the loans, which can be transferred directly to the group account.
Other government anti-poverty schemes, like subsidies, self-employment assistance, welfare transfers can all be modelled as cash transfer schemes. Such schemes, by virtue of the fungibility of the benefit and the discretion given to the beneficiary, is likely to be more effective and have fewer incentive distortions. Besides, given the relative ease of transferring cash instead of various other benefits, it reduces the scope for pilferage and other leakages. Further, by imposing suitable conditions, it becomes possible to achieve important social goals.
Here is a list of how the most important government welfare and development programs can be redesigned to make it similar to a conditional cash transfer program.
1. Public Distribution Scheme (PDS)
The subsidy for the foodgrains distributed to the poor can be transferred directly as cash. They can purchase the foodgrain at the market price from any regular shop. The subsidy component can be variable, depending on the market price for the particular type of foodgrain. The eligible benenficiaries may be given the subsidy as a cash transfer into their accounts, subject to their achieving certain specified social goals. These goals may include sending children to school (in which case the subsidy can be transferred to an account on producing the attendance particulars) or being part of a good Self Help Group (the money can be transferred to the SHG account). For all those with social security pensions, the subsidy can be transferred into their pension accounts.
2. School Vouchers
Poor children can use school vouchers to get admission in private schools. The subsidy can be in the form of a voucher for a minimum amount, which can be topped up by the beneficiary to select any school of choice. Government run schools will also run, but in competition with the private schools.
3. Housing vouchers
Instead of giving ownership of houses, poor people, especially in urban areas, can be allotted rent vouchers which can be used to get accomodation in government housing estates or private houses. The rent vouchers, for a specified subsidy amount, can be topped up by the beneficiary to get an accommodation of their choice.
4. Health Care and Insurance
Basic health care can be delivered though Primary Health Centers (PHCs). A universal health insurance system should be put in place that provides for all tertiary and even some secondary care. The insurance benefits should be conditional again to certain social desirables like sending children to school, universal immunization, participation in adult literacy programs, and getting family planning operations done. The insurance subsidy can be transferred to the account of the individual or the SHG of which the individual is a member, as an insurance credit. The individual may be given the option of either joining a basic health insurance scheme which becomes available with the subsidy or purchasing a different scheme from the market by topping up the subsidy. Group insurance schemes with the SHG as the unit, can also be explored.
5. Agriculture subsidies
The major agriculture subsidies are for fertilizers, seeds, and as price support. Instead of artificially keeping the market prices of these items low, thereby distorting the market incentive structure, it is more efficient to provide the subsidy support as a cash transfer. The amount of subsidy can be pre-determined. The challenge with this approach would be in correctly targetting the beneficiaries. This assistance should be confined to farmers below the poverty line and having small landholdings. The subsidy support can be delivered directly to their accounts. Poor farmers can be encouraged to form Farmers Groups and members of good groups can be transferred the subsidy amounts. Another way of targetting is to transfer the subsidy to the kisan credit card, thereby incentivize farmers to take the same. All this will also go a long way into bringing farmers into the organized sector. The money can also be transferred to the wife's SHG account.
6. Employment Training assistance
The individuals wanting wage and self employment training and eligible for government assistance can be identified. They can then be given training vouchers, of a specified amount, which can be used to access training in private institutes. The individual can top up the voucher amount and go to an inistitute with a higher training cost, but perceived to offer him better prospects.
Apart from improving the effectiveness of these programs, the aforementioned methods will also reduce the incentive distortions inherent in government welfare programs. By insisting on bank accounts, such programs will go a long way in enabling access to formal channels of credit and bringing transparency to the administration of such schemes. The SHG based transfers can be made mandatory especially in the southern states, and others where the SHG movement is strong.
Administering such programs poses a major challenge in terms of managing databases and close co-odination between different government agencies. An integrated database, that links the individual databases of the different departments, can go a long way in addressing many operational problems. In any case, such a database is a necessary condition for effectively administering any large program. It is worth spending both the effort and the resources to achieving it. That this is achievable is borne out by the fact that both the NREG wages and now the Social Security Pensions are being delivered to the beenficiaries through bank (and post office) accounts in many places.
All these are only some illustrative examples of how we should look at re-modelling our anti-poverty programs. They will need to be implemented carefully, not as shock therapies, but with appropriate area-specific phasing and sequencing of activities, so as to ensure that the transition is trouble free. They attempt to address some of the major deficiencies associated with the traditional programs, and in the process achieve some critical social goals by incentivizing the beneficiaries. These strategies will give choice and discretion in decision making to the beneficiary, remove all market distortions and re-align incentives, minimize delivery channel leakages and pilferages, and also achieve important social goals. In other words, it seeks to achieve the full-bang for the development-buck!
Update
The proposed introduction of smart cards for PDS will considerably help in administering cash transfer programs.
Saturday, February 23, 2008
Myths of Indian and Chinese growth
Pranab Bardhan lists out a few popular myths associated with the spectacular economic growth of India and China. China and India have become poster children for market reform and globalization in much of the financial press, even though both countries’ economic policies with regard to privatization, property rights, and deregulation have departed demonstrably from free-market orthodoxy in many ways.
Global integration and associated market reforms resulted in high growth, which in turn produced dramatic declines in extreme poverty. China grew at an impressive 9% in the 1978-93 period, well before it opened up its economy. About China's poverty reduction success he writes, "World Bank estimates suggest that two-thirds of the decline in extremely poor people (those living below the admittedly crude poverty line of one dollar a day per capita at 1993 international parity prices) between 1981 and 2004 had taken place by the mid-1980s. Much of the extreme poverty was concentrated in rural areas, and its large decline in the first half of the 1980s may have been principally the result of domestic factors that have little if anything to do with global integration: a spurt in agricultural growth following de-collectivization, in which output increased at 7.1% per year on average between 1979 and 1984, almost triple the 1970-78 rate; a land reform program, involving a highly egalitarian distribution of land-cultivation rights subject only to differences in regional average and family size, which provided a floor for rural income; and increased farm procurement prices."
He writes about the Indian story, "Reform has clearly made the Indian corporate sector more vibrant and competitive, but most of the Indian economy lies outside the corporate sector; for example, 93 percent of the labor force works outside the corporate sector, private or public. The world famous Indian IT-enabled services employs less than a quarter of one percent of the total Indian labor force. Service subsectors like finance, business services (including those IT-enabled services), and telecommunication, where reform may have made a significant difference, constitute only about a quarter of total service-sector output. Two-thirds of service output is in traditional or “unorganized” activities, in tiny enterprises often below the policy radar and unlikely to have been directly much affected by regulatory or foreign trade policy reforms. As for poverty, the latest Indian household survey data suggest that the rate of decline, if anything, slowed somewhat in 1993-2005—the period of global integration—compared with the ’70s and ’80s. Moreover, some non-income indicators of poverty such as those relating to child health, already rather dismal, have hardly improved in recent years. (For example, the percentage of underweight children in India is much larger than in sub-Saharan Africa and has not changed much in the past decade or so). Growth in agriculture, where much of the poverty is concentrated, has declined somewhat over the past decade, largely because of the decline of public investment in rural infrastructure such as irrigation. Little of this has much to do with globalization. Indeed, some disaggregated studies across districts in India have found trade liberalization slowing down the decline in rural poverty. Such results may indicate the difficulty displaced farmers and workers have had adjusting to new activities and sectors due to various constraints such as minimal access to credit, information, or infrastructural facilities like power and roads; the high-school-dropout rate; and labor market rigidities—even as new opportunities are opened up by globalization."
"China’s earlier socialist period arguably provided a good launching pad for market reform. That foundation provided wide access to education and health care; highly egalitarian land redistribution that created a rural safety net and thus eased the process of market reform, with all its wrenching disruptions and dislocations; increased female labor participation and education that enhanced women’s contribution to economic growth; and a system of regional economic decentralization (that linked the career paths of Communist Party officials to local area performance). County governments were in charge of production enterprises long before Deng Xiaoping’s economic reforms set in, and, even more significantly, the earlier commune system’s production brigades evolved into the highly successful township and village enterprises that led the later phenomenal rise of rural industrialization."
"Both China and India (but China more so) have succeeded in exporting more sophisticated products than is usual in countries in their respective per capita income ranges: China, in consumer electronics, including computers and other information- and communication-technology-related goods, and auto parts; India, in software, pharmaceuticals, vehicles, steel, and auto parts. This performance is remarkable (though more in gross value of exports than in value-added terms, as some of the components and technology used in production are acquired from abroad) and is due primarily to sizeable skill and technological bases, enriched over the years of “socialist slumbering” by indigenous learning-by-doing and nurtured by government policies of building domestic capability—sometimes at the expense of static resource allocation efficiency."
Global integration and associated market reforms resulted in high growth, which in turn produced dramatic declines in extreme poverty. China grew at an impressive 9% in the 1978-93 period, well before it opened up its economy. About China's poverty reduction success he writes, "World Bank estimates suggest that two-thirds of the decline in extremely poor people (those living below the admittedly crude poverty line of one dollar a day per capita at 1993 international parity prices) between 1981 and 2004 had taken place by the mid-1980s. Much of the extreme poverty was concentrated in rural areas, and its large decline in the first half of the 1980s may have been principally the result of domestic factors that have little if anything to do with global integration: a spurt in agricultural growth following de-collectivization, in which output increased at 7.1% per year on average between 1979 and 1984, almost triple the 1970-78 rate; a land reform program, involving a highly egalitarian distribution of land-cultivation rights subject only to differences in regional average and family size, which provided a floor for rural income; and increased farm procurement prices."
He writes about the Indian story, "Reform has clearly made the Indian corporate sector more vibrant and competitive, but most of the Indian economy lies outside the corporate sector; for example, 93 percent of the labor force works outside the corporate sector, private or public. The world famous Indian IT-enabled services employs less than a quarter of one percent of the total Indian labor force. Service subsectors like finance, business services (including those IT-enabled services), and telecommunication, where reform may have made a significant difference, constitute only about a quarter of total service-sector output. Two-thirds of service output is in traditional or “unorganized” activities, in tiny enterprises often below the policy radar and unlikely to have been directly much affected by regulatory or foreign trade policy reforms. As for poverty, the latest Indian household survey data suggest that the rate of decline, if anything, slowed somewhat in 1993-2005—the period of global integration—compared with the ’70s and ’80s. Moreover, some non-income indicators of poverty such as those relating to child health, already rather dismal, have hardly improved in recent years. (For example, the percentage of underweight children in India is much larger than in sub-Saharan Africa and has not changed much in the past decade or so). Growth in agriculture, where much of the poverty is concentrated, has declined somewhat over the past decade, largely because of the decline of public investment in rural infrastructure such as irrigation. Little of this has much to do with globalization. Indeed, some disaggregated studies across districts in India have found trade liberalization slowing down the decline in rural poverty. Such results may indicate the difficulty displaced farmers and workers have had adjusting to new activities and sectors due to various constraints such as minimal access to credit, information, or infrastructural facilities like power and roads; the high-school-dropout rate; and labor market rigidities—even as new opportunities are opened up by globalization."
"China’s earlier socialist period arguably provided a good launching pad for market reform. That foundation provided wide access to education and health care; highly egalitarian land redistribution that created a rural safety net and thus eased the process of market reform, with all its wrenching disruptions and dislocations; increased female labor participation and education that enhanced women’s contribution to economic growth; and a system of regional economic decentralization (that linked the career paths of Communist Party officials to local area performance). County governments were in charge of production enterprises long before Deng Xiaoping’s economic reforms set in, and, even more significantly, the earlier commune system’s production brigades evolved into the highly successful township and village enterprises that led the later phenomenal rise of rural industrialization."
"Both China and India (but China more so) have succeeded in exporting more sophisticated products than is usual in countries in their respective per capita income ranges: China, in consumer electronics, including computers and other information- and communication-technology-related goods, and auto parts; India, in software, pharmaceuticals, vehicles, steel, and auto parts. This performance is remarkable (though more in gross value of exports than in value-added terms, as some of the components and technology used in production are acquired from abroad) and is due primarily to sizeable skill and technological bases, enriched over the years of “socialist slumbering” by indigenous learning-by-doing and nurtured by government policies of building domestic capability—sometimes at the expense of static resource allocation efficiency."
Tips on reducing carbon footprint
Morgan Stanley have an excellent Little Green EBook, that gives 50 tips on how to make our lives greener and reduce our carbon footprint, and thereby help tackle climate change.
Friday, February 22, 2008
Equilibrium coalitions in the rent seeking economy
In this post, I will argue that corruption and rent seeking contributes significantly towards keeping prices low, thereby perpetuating a tenuous equilibium which suits all the major stakeholders in the dominant socio-economic and political coalition. Though this equilibrium keeps costs lower, the quality of services delivered suffer. But as will be seen, this balancing act that involves all stakeholders is often institutionalized and deeply embedded in the system, can persist for long and is not very easy to destabilize. It also partially explains why eliminating corruption is a formidable challenge.
Let me illustrate with three examples. First, the Vijayawada Municipal Corporation used to pay much less than the minimum wage to its sanitation workers, who are recruited as Self Help Groups (SHGs) and awarded sanitation contracts. Originally, the SHG was to be entrusted sanitation work in a certain locality and paid a specific sum for undertakling this task. Over the years, this has evolved into the VMC paying a fixed amount to each member of the SHG depending on the number of days they work, an effective daily wage.
But this system spawned corrupt practices in the form of workers periodically staying away from work, but claiming wages by colluding with their supervisors. The wages so claimed were shared between the workers, supervisors, municipal councillors, press and other stakeholders. In order to control this absenteeism and the resultant corruption, it was decided to introduce a more rigorous attendance monitoring system by taking the IRIS scan of each worker four times a day. The attendance figures soared, complaints dropped and sanitation services improved.
This new attendance monitoring system however met with stiff opposition from workers unions and local political representatives, who demanded scrapping it for very specious reasons. When it became clear that the new system was here to stay and everyone had reconciled to it, demand for raising wages made its appearance. This was surprising given that despite the daily wage being just Rs 58 for the past four years, wage revision was never a major demand. The workers share of the rents had more than made up for their lower wages. But this wage revision demand now was understandable given the fall in rents.
Second, the VMC have long been using hired water tankers for supplying water and tippers/tractors for transporting garbage. Such contracting is ususally done based on annual open tenders. But surprisingly enough, the old tenders were being extended since 2002 despite the Standard Schedule of Rates (SSR) tender rates and the diesel prices having gone up substantially. Since there were a number of allegations going around that these vehicles were not doing the full requirement of trips but were claiming the trip charges, it was decided to introduce GPS based monitoring technology.
Though the contractors and their drivers initially responded by deliberately tampering the installed GPS devices, it was soon controlled and the GPS monitoring system got standardized. Complaints fell and garbage lifting improved. Then the demands for recalling tenders based on the new rates started growing, and finally climaxed in fresh tenders being called and contracting done at the latest SSR rates. Hitherto, the trips evaded had more than made up for the loss suffered by way of lower trip charges. But now the GPS had reduced the trip evasion possibilities, thereby making the old rates unsustainable.
Third, the VMC executes engineering works worth about Rs 40 Cr every year through contractors under the supervision of the Engineering officials. There is a wonderfully balanced equilibrium in this long standing arrangement, which is widely acknowledged as being rampantly corrupt. The contractors boost their margins by diluting the quality of the works and shares it with the supervising engineers who are therefore incentivized to look the other direction on quality. The corporators and political representatives are also co-opted into this arrangement, and do not complain about the quality of works. Despite occasionally highlighting the lapses in quality, the media too generally prefer to turn a blind eye and take a share in the spoils. In order to improve quality and control this rent seeking, it was decided to introduce a system of Third Party Quality Control checks on all works, and computerize the entire work flow of recording, check measurements, bills preparation, bills sanction and payment.
Once the initial resistance, which involved all efforts to sabotage the new measures, had died down and the stakeholders had become reconciled to the changes, the underlying problems began to surface. The TPQC enhanced the quality and the work flow automation reduced rent seeking opportunities. The actual costs began to rise for the contractors, and the other stakeholders started facing declining rents. Works which were hitherto being tendered out at a discount to the estimated contract values, despite the rising construction costs, were now being finalized at the maximum permissible tender premium. The pool of contractors bidding for works shrunk, as those unqualified and fly-by-night contractors felt the quality side pressures and dropped out. Contractors associations started highlighting their genuine problems arising from fluctuating market rates for construction materials and the inadequate SSR. In fact, a crisis loomed with the contractors staying away from participating in engineering works and many bigger works could not be entrusted because of failure to attract bidders despite repeated tenders.
In all cases, the IRIS, GPS, TPQC and the work flow automation were exogeous interventions that disrupted the inefficient, but mutually beneficial equilibrium. The equilibrium was sustained by the strength of the coalition between the various stakeholders that thrived on the rent sharing. Interestingly in all the cases, the rent seeking was controlled in the process of improving quality of services and products delivered. But in the process, the expenditures increased as the agents started facing the real costs of the services. All this in trun sets in motion a spiral of efficiency and performance improvements.
These interventions were done more as a quality enhancement drive, than as a specific anti-corruption drive, thereby putting the rent coalition on the backfoot. Improving quality is widely acknowledged as a desirable, and steps taken to improve it does not face open opposition. In contrast, specific anti-corruption drives is more likely to face open opposition on many specious grounds.
But this success of IRIS or TPQC or GPS is not the final word. The rent seeking coalition will continuously explore the possibility of forming new alignments, that can overcome the obstacles posed by the external interventions. A new equilibrium develops and rent seeking continues, till another exogenous intervention comes. A robust civil society through say, a Residents Welfare Association, can play a critical role in quality oversight and check corruption. Ultimately this demand-driven, social audit is the only sustainable, long-term and most effective weapon against corruption.
Let me illustrate with three examples. First, the Vijayawada Municipal Corporation used to pay much less than the minimum wage to its sanitation workers, who are recruited as Self Help Groups (SHGs) and awarded sanitation contracts. Originally, the SHG was to be entrusted sanitation work in a certain locality and paid a specific sum for undertakling this task. Over the years, this has evolved into the VMC paying a fixed amount to each member of the SHG depending on the number of days they work, an effective daily wage.
But this system spawned corrupt practices in the form of workers periodically staying away from work, but claiming wages by colluding with their supervisors. The wages so claimed were shared between the workers, supervisors, municipal councillors, press and other stakeholders. In order to control this absenteeism and the resultant corruption, it was decided to introduce a more rigorous attendance monitoring system by taking the IRIS scan of each worker four times a day. The attendance figures soared, complaints dropped and sanitation services improved.
This new attendance monitoring system however met with stiff opposition from workers unions and local political representatives, who demanded scrapping it for very specious reasons. When it became clear that the new system was here to stay and everyone had reconciled to it, demand for raising wages made its appearance. This was surprising given that despite the daily wage being just Rs 58 for the past four years, wage revision was never a major demand. The workers share of the rents had more than made up for their lower wages. But this wage revision demand now was understandable given the fall in rents.
Second, the VMC have long been using hired water tankers for supplying water and tippers/tractors for transporting garbage. Such contracting is ususally done based on annual open tenders. But surprisingly enough, the old tenders were being extended since 2002 despite the Standard Schedule of Rates (SSR) tender rates and the diesel prices having gone up substantially. Since there were a number of allegations going around that these vehicles were not doing the full requirement of trips but were claiming the trip charges, it was decided to introduce GPS based monitoring technology.
Though the contractors and their drivers initially responded by deliberately tampering the installed GPS devices, it was soon controlled and the GPS monitoring system got standardized. Complaints fell and garbage lifting improved. Then the demands for recalling tenders based on the new rates started growing, and finally climaxed in fresh tenders being called and contracting done at the latest SSR rates. Hitherto, the trips evaded had more than made up for the loss suffered by way of lower trip charges. But now the GPS had reduced the trip evasion possibilities, thereby making the old rates unsustainable.
Third, the VMC executes engineering works worth about Rs 40 Cr every year through contractors under the supervision of the Engineering officials. There is a wonderfully balanced equilibrium in this long standing arrangement, which is widely acknowledged as being rampantly corrupt. The contractors boost their margins by diluting the quality of the works and shares it with the supervising engineers who are therefore incentivized to look the other direction on quality. The corporators and political representatives are also co-opted into this arrangement, and do not complain about the quality of works. Despite occasionally highlighting the lapses in quality, the media too generally prefer to turn a blind eye and take a share in the spoils. In order to improve quality and control this rent seeking, it was decided to introduce a system of Third Party Quality Control checks on all works, and computerize the entire work flow of recording, check measurements, bills preparation, bills sanction and payment.
Once the initial resistance, which involved all efforts to sabotage the new measures, had died down and the stakeholders had become reconciled to the changes, the underlying problems began to surface. The TPQC enhanced the quality and the work flow automation reduced rent seeking opportunities. The actual costs began to rise for the contractors, and the other stakeholders started facing declining rents. Works which were hitherto being tendered out at a discount to the estimated contract values, despite the rising construction costs, were now being finalized at the maximum permissible tender premium. The pool of contractors bidding for works shrunk, as those unqualified and fly-by-night contractors felt the quality side pressures and dropped out. Contractors associations started highlighting their genuine problems arising from fluctuating market rates for construction materials and the inadequate SSR. In fact, a crisis loomed with the contractors staying away from participating in engineering works and many bigger works could not be entrusted because of failure to attract bidders despite repeated tenders.
In all cases, the IRIS, GPS, TPQC and the work flow automation were exogeous interventions that disrupted the inefficient, but mutually beneficial equilibrium. The equilibrium was sustained by the strength of the coalition between the various stakeholders that thrived on the rent sharing. Interestingly in all the cases, the rent seeking was controlled in the process of improving quality of services and products delivered. But in the process, the expenditures increased as the agents started facing the real costs of the services. All this in trun sets in motion a spiral of efficiency and performance improvements.
These interventions were done more as a quality enhancement drive, than as a specific anti-corruption drive, thereby putting the rent coalition on the backfoot. Improving quality is widely acknowledged as a desirable, and steps taken to improve it does not face open opposition. In contrast, specific anti-corruption drives is more likely to face open opposition on many specious grounds.
But this success of IRIS or TPQC or GPS is not the final word. The rent seeking coalition will continuously explore the possibility of forming new alignments, that can overcome the obstacles posed by the external interventions. A new equilibrium develops and rent seeking continues, till another exogenous intervention comes. A robust civil society through say, a Residents Welfare Association, can play a critical role in quality oversight and check corruption. Ultimately this demand-driven, social audit is the only sustainable, long-term and most effective weapon against corruption.
After sub-prime mortagages, here comes Credit Default Swaps
Gretchen Morgenson claims that Credit Default Swaps (CDS), instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts, are set to follow sub-prime mortgages and collateralised debt obligations into the people's imagination (or nightmares!).
Credit default swaps were invented by major banks in the mid-1990s as a way to offset risk in their lending or bond portfolios. In a credit default swap, two parties enter a private contract in which the buyer of protection agrees to pay the seller premiums over a set period of time; the seller pays only if a particular credit crisis occurs, like a default. These instruments can be sold, on either end of the contract, by the insurer or the insured. This is captured in the flow chart below.
From a mere $900 billion in 2000, it has ballooned to more than $45.5 trillion in 2007 — roughly twice the size of the entire United States stock market, and dwarfing the US Treasury securities outstanding. And like sub-prime mortgages and CDOs, this market is also unregulated, and populated by hedge funds, private equity firms, and other financial wizards. Commercial banks are among the biggest participants — at the end of the third quarter of 2007, the top 25 banks held credit default swaps, both as insurers and insured, worth $14 trillion, up $2 trillion from the previous quarter. CDS have been iussued on specific corporate debt, indexes representing a basket of debt, on CDOs, and other asset backed securities.
Like with all other instruments the risks remain the same - counter party identification and pricing/valuation. Placing accurate values on these contracts is just one of the uncertainties facing the big banks, insurance companies and hedge funds that create and trade these instruments. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold. As investors who have purchased such swaps try to cash them in, they may have trouble tracking down who is supposed to pay their claims. Further, because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim.
During the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In fact, there is no exchange where these insurance contracts trade, and their prices are not reported to the public. Because of this, institutions typically value them based on computer models rather than prices set by the market.
Years of a healthy economy and few corporate defaults led many banks to write more credit insurance, finding it a low-risk way to earn income because failures were few. Speculators have also flooded into the credit insurance market recently because these securities make it easier to bet on the health of a company than using corporate bonds. Both factors have resulted in a market of credit swaps that now far exceeds the face value of corporate bonds underlying it.
But many speculators, particularly hedge funds, have flocked to these instruments to bet on a company failure easily. Before the insurance was developed, such a bet would require selling short a corporation’s bond and going into the market to borrow it to supply to the buyer.
Morgenson sums up the uncertainty thus, "It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim."
Update 1
More on the $30 trillion market CDS and regulating it by Gretchen Morgenson here. During the bubble, far too much of this insurance was written at way too cheap a cost, leaving the market insolvent now.
Update 2 (22/5/2010)
Floyd Norris examines the debate surrounding why CDS is no different from any insurance. Plain and simple, CDS are insurance - the buyer of the insurance gets paid if the subject of the swap cannot meet its obligations and the seller of the swap gets a continuing payment (like premiums) from the buyer until the insurance expires.
Where CDS differs from conventional insurance is that it does not have an "insurable interest" (which says that you cannot buy insurance on my life, or on my house, unless you have an insurable interest). Many who despise credit-default swaps argue that they can be used to force companies to fail. The swap market is thin, and even a relatively small purchase can drive up prices. That very movement may make lenders nervous, cause liquidity to dry up and bring on unnecessary bankruptcies.
He writes about another possible impact of credit-default swaps, their ability to undermine bankruptcy laws,
Credit default swaps were invented by major banks in the mid-1990s as a way to offset risk in their lending or bond portfolios. In a credit default swap, two parties enter a private contract in which the buyer of protection agrees to pay the seller premiums over a set period of time; the seller pays only if a particular credit crisis occurs, like a default. These instruments can be sold, on either end of the contract, by the insurer or the insured. This is captured in the flow chart below.
From a mere $900 billion in 2000, it has ballooned to more than $45.5 trillion in 2007 — roughly twice the size of the entire United States stock market, and dwarfing the US Treasury securities outstanding. And like sub-prime mortgages and CDOs, this market is also unregulated, and populated by hedge funds, private equity firms, and other financial wizards. Commercial banks are among the biggest participants — at the end of the third quarter of 2007, the top 25 banks held credit default swaps, both as insurers and insured, worth $14 trillion, up $2 trillion from the previous quarter. CDS have been iussued on specific corporate debt, indexes representing a basket of debt, on CDOs, and other asset backed securities.
Like with all other instruments the risks remain the same - counter party identification and pricing/valuation. Placing accurate values on these contracts is just one of the uncertainties facing the big banks, insurance companies and hedge funds that create and trade these instruments. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold. As investors who have purchased such swaps try to cash them in, they may have trouble tracking down who is supposed to pay their claims. Further, because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim.
During the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In fact, there is no exchange where these insurance contracts trade, and their prices are not reported to the public. Because of this, institutions typically value them based on computer models rather than prices set by the market.
Years of a healthy economy and few corporate defaults led many banks to write more credit insurance, finding it a low-risk way to earn income because failures were few. Speculators have also flooded into the credit insurance market recently because these securities make it easier to bet on the health of a company than using corporate bonds. Both factors have resulted in a market of credit swaps that now far exceeds the face value of corporate bonds underlying it.
But many speculators, particularly hedge funds, have flocked to these instruments to bet on a company failure easily. Before the insurance was developed, such a bet would require selling short a corporation’s bond and going into the market to borrow it to supply to the buyer.
Morgenson sums up the uncertainty thus, "It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim."
Update 1
More on the $30 trillion market CDS and regulating it by Gretchen Morgenson here. During the bubble, far too much of this insurance was written at way too cheap a cost, leaving the market insolvent now.
Update 2 (22/5/2010)
Floyd Norris examines the debate surrounding why CDS is no different from any insurance. Plain and simple, CDS are insurance - the buyer of the insurance gets paid if the subject of the swap cannot meet its obligations and the seller of the swap gets a continuing payment (like premiums) from the buyer until the insurance expires.
Where CDS differs from conventional insurance is that it does not have an "insurable interest" (which says that you cannot buy insurance on my life, or on my house, unless you have an insurable interest). Many who despise credit-default swaps argue that they can be used to force companies to fail. The swap market is thin, and even a relatively small purchase can drive up prices. That very movement may make lenders nervous, cause liquidity to dry up and bring on unnecessary bankruptcies.
He writes about another possible impact of credit-default swaps, their ability to undermine bankruptcy laws,
"Normally, a creditor wants to keep a company out of bankruptcy if there is a decent chance it can survive. If it does go broke, the creditor wants to maximize the value of the company anyway, so that more will be available to pay creditors. But what happens if a major creditor, who might even control one class of bonds, has a much larger position in credit-default swaps?
Will he not have interests directly at odds with those of other creditors, since he will do better if the company ends up with less to pay its creditors? Might that creditor seek to, and perhaps be able to, sabotage the company’s best hopes for revival?"
Thursday, February 21, 2008
Decoupling-recoupling debate
Will the rest of the world stay coupled to or decouple from the US economy? This is the crux of an interesting debate going on about the likely impact of a US recession on the global economy.
If the actions of the Central Banks in the past few weeks are anything to go by, the world economy appears to have de-coupled from the US, atleast for the present. This decoupling was highlighted by the fact that interestingly, except for the Canadian Central Bank, no other major Bank cut rates in response to the two recent, unprecedented 125 basis points cuts by the Federal Reserve. While recession fighting is the pre-dominant concern for the US Fed, inflation remains the major worry for most other Central Banks.
For many years now, the US consumers and the financial innovations of Wall Street firms have been the engines of global economic growth. The historic low interest rates first fuelled a stock market and then a real estate boom, which in turn generated a "wealth effect” that saw "irrationally exuberant" consumers spend like there was no tomorrow. The trade deficit touched $827 bn in 2006-07, as the Asia-Pacific economies competed with each other in exporting to the US. This deficit was in turn financed by their huge foreign exchange surpluses, through what Kenneth Rogoff described as “the biggest foreign aid programme in world history”.
The impact of a US downturn will be most immediately and strongly felt in the closely integrated $170 trillion global financial markets. The recent boom in the emerging equity markets have been driven in large measure by huge Foreign Portfolio Investments from US and Europe. The massive sub-prime mortgage related losses suffered by the Wall Street banks and the solvency problems facing them will now constrain the credit available for new investments. There is also a strong possibility of capital flight from investments in emerging economies, so as to cover the losses in their home markets.
Conversely, the weak dollar and falling interest rates, coupled with inflationary expectations and recessionary fears, makes the US equity and bond markets unattractive, thereby presenting the emerging economies as excellent alternatives. This will also provide an opportunity for their equity and debt markets to develop the requisite depth and breadth, besides strengthening of the regulatory framework.
The closely integrated financial markets on both sides of the Atlantic, and fall in demand for US imports, will render Europe especially vulnerable in the event of a recessionary hard landing. Similar housing bubbles and sub-prime mortgage problems in many European countries, coupled with a strong Euro and high oil and commodity prices, will keep Europe coupled. Any credit crunch will adversely affect the bank lending dependent European corporate sector’s ability to produce, hire and invest. The ailing, export-driven Japanese economy is also more vulnerable to a US recession and supply shocks. A slowing economy, as in Europe, and weak domestic demand means that there are limited internal sources of economic growth.
It is a little different with the emerging economies. A US recession will immediately hurt imports and thereby directly affect jobs and economic growth in the trade dependent Asia-Pacific. Exports form 40% of GDP for China and S Korea, and 50-75% for the rest of East Asia, and the US accounts for a 20-30% share. Also, the rise of China has radically changed the Asian global production and supply chain, making everyone more dependent on the US. Increasingly, East Asian countries export inputs and intermediate goods to China, which in turn leverages its low labor costs to process and assemble these inputs into finished products that are then exported to the US. Further, with over $2 trillion invested in US T Bonds, a US recession and weak dollar will lower returns.
However, the impact of a US recession can be considerably mitigated if these economies manage to generate adequate domestic consumption. In 2007, despite the slowdown in exports, all the emerging Asian economies grew faster as domestic demand more than made up for the fall in exports. The corporate sector in most of Asia is healthy, with high capacity utilization, strong balance sheets and robust profits. Unlike previous US downturns, the macroeconomic fundamentals are stronger now - balanced budgets, growing forex surpluses, lower inflation - giving them enough room to maneuver even with a hard landing in the US.
The danger for the rest from a US recession is indirect. A slowdown in China will reduce the demand for raw materials and commodities from Asia, Latin America and Africa. This will exert a strong downward influence on commodity prices, thereby hurting all commodity exporters, who had been hitherto piggy riding on the gluttonous Chinese appetite. However, this will benefit the commodity consumers among the emerging economies, as the cheaper imports will make their import-intensive exports more competitive, besides encouraging domestic demand and restraining inflationary pressures.
Among the emerging economies, India seems best placed to tide over a US recession. Its exports form just 23.5% of GDP, and the share of exports to US is only 2% of GDP, compared to 8% for China and over 20% for ASEAN. Unlike East Asian economies whose major exports to the US are manufactured goods, employing large number of people, the major exports from India are software services, whose direct influence on jobs and the larger economy, is much less.
To conclude, while the global financial markets are likely to remain closely coupled to Wall Street, the real economies elsewhere, without being fully coupled or decoupled, may still emerge unscathed from the Main Street recession. The emerging economies are unlikely to catch a serious cold as the US economy sneezes into a recession, but they will surely feel the chill!
If the actions of the Central Banks in the past few weeks are anything to go by, the world economy appears to have de-coupled from the US, atleast for the present. This decoupling was highlighted by the fact that interestingly, except for the Canadian Central Bank, no other major Bank cut rates in response to the two recent, unprecedented 125 basis points cuts by the Federal Reserve. While recession fighting is the pre-dominant concern for the US Fed, inflation remains the major worry for most other Central Banks.
For many years now, the US consumers and the financial innovations of Wall Street firms have been the engines of global economic growth. The historic low interest rates first fuelled a stock market and then a real estate boom, which in turn generated a "wealth effect” that saw "irrationally exuberant" consumers spend like there was no tomorrow. The trade deficit touched $827 bn in 2006-07, as the Asia-Pacific economies competed with each other in exporting to the US. This deficit was in turn financed by their huge foreign exchange surpluses, through what Kenneth Rogoff described as “the biggest foreign aid programme in world history”.
The impact of a US downturn will be most immediately and strongly felt in the closely integrated $170 trillion global financial markets. The recent boom in the emerging equity markets have been driven in large measure by huge Foreign Portfolio Investments from US and Europe. The massive sub-prime mortgage related losses suffered by the Wall Street banks and the solvency problems facing them will now constrain the credit available for new investments. There is also a strong possibility of capital flight from investments in emerging economies, so as to cover the losses in their home markets.
Conversely, the weak dollar and falling interest rates, coupled with inflationary expectations and recessionary fears, makes the US equity and bond markets unattractive, thereby presenting the emerging economies as excellent alternatives. This will also provide an opportunity for their equity and debt markets to develop the requisite depth and breadth, besides strengthening of the regulatory framework.
The closely integrated financial markets on both sides of the Atlantic, and fall in demand for US imports, will render Europe especially vulnerable in the event of a recessionary hard landing. Similar housing bubbles and sub-prime mortgage problems in many European countries, coupled with a strong Euro and high oil and commodity prices, will keep Europe coupled. Any credit crunch will adversely affect the bank lending dependent European corporate sector’s ability to produce, hire and invest. The ailing, export-driven Japanese economy is also more vulnerable to a US recession and supply shocks. A slowing economy, as in Europe, and weak domestic demand means that there are limited internal sources of economic growth.
It is a little different with the emerging economies. A US recession will immediately hurt imports and thereby directly affect jobs and economic growth in the trade dependent Asia-Pacific. Exports form 40% of GDP for China and S Korea, and 50-75% for the rest of East Asia, and the US accounts for a 20-30% share. Also, the rise of China has radically changed the Asian global production and supply chain, making everyone more dependent on the US. Increasingly, East Asian countries export inputs and intermediate goods to China, which in turn leverages its low labor costs to process and assemble these inputs into finished products that are then exported to the US. Further, with over $2 trillion invested in US T Bonds, a US recession and weak dollar will lower returns.
However, the impact of a US recession can be considerably mitigated if these economies manage to generate adequate domestic consumption. In 2007, despite the slowdown in exports, all the emerging Asian economies grew faster as domestic demand more than made up for the fall in exports. The corporate sector in most of Asia is healthy, with high capacity utilization, strong balance sheets and robust profits. Unlike previous US downturns, the macroeconomic fundamentals are stronger now - balanced budgets, growing forex surpluses, lower inflation - giving them enough room to maneuver even with a hard landing in the US.
The danger for the rest from a US recession is indirect. A slowdown in China will reduce the demand for raw materials and commodities from Asia, Latin America and Africa. This will exert a strong downward influence on commodity prices, thereby hurting all commodity exporters, who had been hitherto piggy riding on the gluttonous Chinese appetite. However, this will benefit the commodity consumers among the emerging economies, as the cheaper imports will make their import-intensive exports more competitive, besides encouraging domestic demand and restraining inflationary pressures.
Among the emerging economies, India seems best placed to tide over a US recession. Its exports form just 23.5% of GDP, and the share of exports to US is only 2% of GDP, compared to 8% for China and over 20% for ASEAN. Unlike East Asian economies whose major exports to the US are manufactured goods, employing large number of people, the major exports from India are software services, whose direct influence on jobs and the larger economy, is much less.
To conclude, while the global financial markets are likely to remain closely coupled to Wall Street, the real economies elsewhere, without being fully coupled or decoupled, may still emerge unscathed from the Main Street recession. The emerging economies are unlikely to catch a serious cold as the US economy sneezes into a recession, but they will surely feel the chill!
Wednesday, February 20, 2008
Randomized trials in development economics
David Leonhardt has this column in the Times, where he describes the work of the Abdul Latif Jameel Poverty Action Lab at MIT as the most influential work going around on the critical questions facing modern society. Using the methodology of randomized trials, Estehr Duflo, Abhijit Banerjee and Co seeks answers to why so many people in the world are so crushingly poor and what can be done to combat this poverty.
In the randomized trial methodology, a particular anti-poverty strategy would be tested for its efficacy in much the same way as in medical research, by studying its influence on a community (or group) where the particular strategy has been implemented and on another where it has not been. Randomized trials can be very useful in shaping policy by understanding what causes the problems we are trying to cure and which cures work. The results can be analysed to draw meaningful conclusions about the effectiveness or otherwise of the particular policy choice. This in turn can be the basis for advising developing country governments on anti-poverty programs and also in making the most optimal use of aid money.
But as Dani Rodrik points out, there are dangers associated with the generalization possibilities implicit in randomized trials. This arises because there is nothing standard (or uniform) about the settings or context under which the specific society or economy exposed to the trials responds to the anti-poverty particular strategy. The contexts exhibit a mind-numbing diversity between and within developing societies, and their possible responses to the specific strategy or approach could (and will) itself exhibit similar diversity.
In the randomized trial methodology, a particular anti-poverty strategy would be tested for its efficacy in much the same way as in medical research, by studying its influence on a community (or group) where the particular strategy has been implemented and on another where it has not been. Randomized trials can be very useful in shaping policy by understanding what causes the problems we are trying to cure and which cures work. The results can be analysed to draw meaningful conclusions about the effectiveness or otherwise of the particular policy choice. This in turn can be the basis for advising developing country governments on anti-poverty programs and also in making the most optimal use of aid money.
But as Dani Rodrik points out, there are dangers associated with the generalization possibilities implicit in randomized trials. This arises because there is nothing standard (or uniform) about the settings or context under which the specific society or economy exposed to the trials responds to the anti-poverty particular strategy. The contexts exhibit a mind-numbing diversity between and within developing societies, and their possible responses to the specific strategy or approach could (and will) itself exhibit similar diversity.
Why retail margins are low?
The consumer is the king, atleast in terms of pricing. He is demanding better quality products with more features and customized to his requirements, and all that at the same or even lower price!
Two articles - one by James Surowiecki in the New Yorker, Greenback Blues, and the other by Rama Bijapurkar in the Economic Times, Testing times for consumer goods - describe the competitive pressures facing retailing in US and India.
Both claim that while retailing topline has been growing, the bottomline is being squeezed due to a variety of factors. The fast changing consumer habits and preferences, multiple segmenting of the market, and need for flexibility in the supply chain management, have all contributed to making retailing one of the most rapidly evolving business sectors in the country. Faced with intense competition, retailers are not in a position to pass on the increased costs to the consumer despite rising input costs. The low inflation and the cuts in excise duties have also contributed to keeping prices from rising and even falling.
An increasing share of the products sold by large retailers and big malls are that category of consumer durables which exhibit relatively high price elasticity of demand. The demand for these goods, which have subsitutes and whose purchase can be easily postponed, falls as the prices rise and rises as the prices fall. With the margins being very small for the regular consumption goods, retailers rely on the other products to boost their toplines. But the stiff competition reduces their ability to maintain high margins for even these category of products.
The presence of the informal retailers are a strong deterrent on the big brand retailers increasing prices. As the success of Wal-Mart confirms, the overwhelming share of consumers even in a mature market and rich economy like the US remain extremely price sensitive. Further, entry barriers have become high, thereby forcing existing retailers to adopt all possible means to stay on as long as possible in the hope of cashing in on any future windfall.
The low interest rates and the consequent availability of easy finance has brought a larger number of consumers into the market. The relative stability of the financing market and the resulting fierce competition among these companies has also played its part in keeping prices low.
Retailing is one of the sectors profoundly influenced by the forces of globalization. Globalization has created a massive global retail supply chain, which integrates raw material producers, intermediate goods manufacturers, wholesalers and retailers. It has brought out the benefits of comparative advantage among producers and manufacturers, and lowered costs across the entire supply chain. This has kept prices down and maintained a tight lid on global inflation. In fact, there is a strong merit in the claim that the most important Chinese export has been low inflation.
It is also arguable that the richer nations (and the consumers there) have benefited disproportionately from the lower prices and the consumption boom that emerged from it. It not off the mark to claim that the Chinese and other Asian tax payers and workers have been subsidising US consumers by keeping domestic currencies weak (in relation to the dollar), fiscal and other incentives for exporters and low wages.
Two articles - one by James Surowiecki in the New Yorker, Greenback Blues, and the other by Rama Bijapurkar in the Economic Times, Testing times for consumer goods - describe the competitive pressures facing retailing in US and India.
Both claim that while retailing topline has been growing, the bottomline is being squeezed due to a variety of factors. The fast changing consumer habits and preferences, multiple segmenting of the market, and need for flexibility in the supply chain management, have all contributed to making retailing one of the most rapidly evolving business sectors in the country. Faced with intense competition, retailers are not in a position to pass on the increased costs to the consumer despite rising input costs. The low inflation and the cuts in excise duties have also contributed to keeping prices from rising and even falling.
An increasing share of the products sold by large retailers and big malls are that category of consumer durables which exhibit relatively high price elasticity of demand. The demand for these goods, which have subsitutes and whose purchase can be easily postponed, falls as the prices rise and rises as the prices fall. With the margins being very small for the regular consumption goods, retailers rely on the other products to boost their toplines. But the stiff competition reduces their ability to maintain high margins for even these category of products.
The presence of the informal retailers are a strong deterrent on the big brand retailers increasing prices. As the success of Wal-Mart confirms, the overwhelming share of consumers even in a mature market and rich economy like the US remain extremely price sensitive. Further, entry barriers have become high, thereby forcing existing retailers to adopt all possible means to stay on as long as possible in the hope of cashing in on any future windfall.
The low interest rates and the consequent availability of easy finance has brought a larger number of consumers into the market. The relative stability of the financing market and the resulting fierce competition among these companies has also played its part in keeping prices low.
Retailing is one of the sectors profoundly influenced by the forces of globalization. Globalization has created a massive global retail supply chain, which integrates raw material producers, intermediate goods manufacturers, wholesalers and retailers. It has brought out the benefits of comparative advantage among producers and manufacturers, and lowered costs across the entire supply chain. This has kept prices down and maintained a tight lid on global inflation. In fact, there is a strong merit in the claim that the most important Chinese export has been low inflation.
It is also arguable that the richer nations (and the consumers there) have benefited disproportionately from the lower prices and the consumption boom that emerged from it. It not off the mark to claim that the Chinese and other Asian tax payers and workers have been subsidising US consumers by keeping domestic currencies weak (in relation to the dollar), fiscal and other incentives for exporters and low wages.
Tuesday, February 19, 2008
Corruption in development programs
The former Indian Prime Minister, late Rajiv Gandhi had famously acknowledged that only 15 paise of every rupee spent on development reaches the target beneficiaries. The rest gets dissipated in the bureaucratic maze in which the program is couched, as transaction costs and rents. The Comptroller and Auditor General's (CAG) recent six-month audit report of the government's flagship National Rural Employment Guarantee (NREG) scheme from 513 gram panchayats in 68 districts across 26 states revealed that only 3.2% of the registered households benefited by securing 100 days of employment a year between February 2006 and March 2007. Siphoning off funds through fraudulent cards was the commonest form of corruption.
All this raises important questions. What should be the role of the bureaucracy in administering a development scheme? Is bureaucracy an inevitable accompaniment to development schemes? Is there a trade-off between procedural rigour and achieving specific development outcomes? Is it possible to reduce the bureaucratic red tape and still deliver the welfare and development programs without lowering their effectiveness?
One of the commonest complaints against government welfare programs is about the amount of bureaucracy involved in administering them. It is observed that the larger the program, the more bureaucratic the delivery channels become. There are essentially two main reasons why development and welfare programs get mired in red tape and bureaucracy
1. The target beneficiaries - individuals, groups and areas - are amazingly heterogenous, especially in a complex and diverse society like India. Typical Central and State government development schemes are designed top-down, and attempts to factor in all the possible requirements and contingencies - all categories of beneficiaries, and all regions and areas - and thereby standardize the scheme for the entire country. The resultant labyrinth of procedures and guidelines tend to make the programs complicated and opaque.
2. The need to put in place adequate checks and balances to prevent the scheme being subverted or exploited by vested interests. A multi-layered regulatory architecture develops, that seeks to minimize official discretion and thereby eliminate all opportunities for corrupt practices. We therefore have elaborate tendering processes and procedures, multiple filters for identifying beneficiaries etc. This requirement often becomes an alibi for bringing in multiple layers of bureaucracy, which often end up losing sight of the very objectives of the scheme.
In the effort to include all the requisite needs and demands, while at the same time plugging all avenues of rent seeking, the scheme gets entangled in a complex maze of rules and regulations, procedures and guidelines. The marginal benefit associated with every additional layer of bureaucracy is overwhelmed by the marginal cost incurred by way of transaction rents and delays. All this introduces three major sources of corruption in any Government welfare program.
1. The rent component of the transaction costs associated with administering the program. This involves the rents in moving files, expediting or influencing process level macro-decisions etc.
2. The sanctions or critical decision making in the program. Quite often this involves decisions like selecting beneficiaries, identifying works, finalizing villages or habitations, and the process of allotting work (tenders, nominations etc).
3. Release of money and its distribution/disbursal. In this case, rent seeking occurs mainly in the form of pilferage and siphoning off the final benefits.
There are no simple solutions to addressing these problems. Any effort should focus on containing the amount of corruption, but should not get bogged down in a futile effort to eliminate corruption. Analysis of the aforementioned sources indicates a few prescriptions
1. All the sanctions and critical decision making should be decentralized and done as close to the cutting edge as possible. This in turn should not be an excuse for blind decentralization, that often leaves fledgling institutions, without the requisite expertise and capacity, to administer activities that are much beyond their competence and ability. The remedy then becomes more harmful than the problem itself. The levels of decentralization will vary across states and should be left to the discretion of individual states.
2. Only the objectives and broad contours of the program should be shaped at the level of the Central or State Governments. The details of the processes and the guidelines should preferably be left to the discretion of the competent authorities at the district or even lower level.
3. The entire work flow of a scheme, from conception to delivery, should be made transparent. Computerization can help.
4. Minimize the number of transactions in the work flow and also the number of interfaces for the public with the Government agency. To the extent that any transaction or interface presents opportunities for rent seeking, this will naturally reduce corruption. Single window clearances, use of technology like cell phone, SMS etc can help.
5. Money should be released directly to the competent lowest level agency that is actually administering the activity. This can be facilitated by computerization of internal processes and using the recent advances in banking processes. Preferably, welfare handouts should be directly released to the bank accounts of the beneficiaries.
All this will not eliminate corrpution. It will at best control and contain it significantly and reduce public harassment. Once these prescriptions - transparency, decentralization, simplification - are addressed in a basic form, we should leave it to the system to take care of rent-seeking. These prescriptions will help align the incentives of the administering officials with the desired scheme outcomes. Any effort to consciously address corruption or reduce official discretion, by building in additional checks and balances will only be counter-productive. By introducing multiple filters to screen the selection process and procedural complexity in tendering process, we are only providing enough grist to the rent seekers to feast on. We can do better by acknowledging that it is not possible to completely eliminate rent seeking, and some extent of rent seeking is inevitable and may even be desirable (more on this in a later post).
After a certain basic level of standardization, an inverse relationship kicks in between procedural rigour and bureaucratic overisght on one hand and efficiency and effectiveness on the other. This is especially true of massive Government programs in a diverse context like in India. Some amount of official discretion, with the attendent risk of rent seeking, is inevitable if we are to achieve our desired outcomes. It is better to have a development scheme that achieves at least a portion of its desired objectives while enriching a few, than have a scheme that only enriches the many without achieving any of the objectives. At the risk of sounding cliched, it is better to be not penny-wise and pound-foolish!
All this raises important questions. What should be the role of the bureaucracy in administering a development scheme? Is bureaucracy an inevitable accompaniment to development schemes? Is there a trade-off between procedural rigour and achieving specific development outcomes? Is it possible to reduce the bureaucratic red tape and still deliver the welfare and development programs without lowering their effectiveness?
One of the commonest complaints against government welfare programs is about the amount of bureaucracy involved in administering them. It is observed that the larger the program, the more bureaucratic the delivery channels become. There are essentially two main reasons why development and welfare programs get mired in red tape and bureaucracy
1. The target beneficiaries - individuals, groups and areas - are amazingly heterogenous, especially in a complex and diverse society like India. Typical Central and State government development schemes are designed top-down, and attempts to factor in all the possible requirements and contingencies - all categories of beneficiaries, and all regions and areas - and thereby standardize the scheme for the entire country. The resultant labyrinth of procedures and guidelines tend to make the programs complicated and opaque.
2. The need to put in place adequate checks and balances to prevent the scheme being subverted or exploited by vested interests. A multi-layered regulatory architecture develops, that seeks to minimize official discretion and thereby eliminate all opportunities for corrupt practices. We therefore have elaborate tendering processes and procedures, multiple filters for identifying beneficiaries etc. This requirement often becomes an alibi for bringing in multiple layers of bureaucracy, which often end up losing sight of the very objectives of the scheme.
In the effort to include all the requisite needs and demands, while at the same time plugging all avenues of rent seeking, the scheme gets entangled in a complex maze of rules and regulations, procedures and guidelines. The marginal benefit associated with every additional layer of bureaucracy is overwhelmed by the marginal cost incurred by way of transaction rents and delays. All this introduces three major sources of corruption in any Government welfare program.
1. The rent component of the transaction costs associated with administering the program. This involves the rents in moving files, expediting or influencing process level macro-decisions etc.
2. The sanctions or critical decision making in the program. Quite often this involves decisions like selecting beneficiaries, identifying works, finalizing villages or habitations, and the process of allotting work (tenders, nominations etc).
3. Release of money and its distribution/disbursal. In this case, rent seeking occurs mainly in the form of pilferage and siphoning off the final benefits.
There are no simple solutions to addressing these problems. Any effort should focus on containing the amount of corruption, but should not get bogged down in a futile effort to eliminate corruption. Analysis of the aforementioned sources indicates a few prescriptions
1. All the sanctions and critical decision making should be decentralized and done as close to the cutting edge as possible. This in turn should not be an excuse for blind decentralization, that often leaves fledgling institutions, without the requisite expertise and capacity, to administer activities that are much beyond their competence and ability. The remedy then becomes more harmful than the problem itself. The levels of decentralization will vary across states and should be left to the discretion of individual states.
2. Only the objectives and broad contours of the program should be shaped at the level of the Central or State Governments. The details of the processes and the guidelines should preferably be left to the discretion of the competent authorities at the district or even lower level.
3. The entire work flow of a scheme, from conception to delivery, should be made transparent. Computerization can help.
4. Minimize the number of transactions in the work flow and also the number of interfaces for the public with the Government agency. To the extent that any transaction or interface presents opportunities for rent seeking, this will naturally reduce corruption. Single window clearances, use of technology like cell phone, SMS etc can help.
5. Money should be released directly to the competent lowest level agency that is actually administering the activity. This can be facilitated by computerization of internal processes and using the recent advances in banking processes. Preferably, welfare handouts should be directly released to the bank accounts of the beneficiaries.
All this will not eliminate corrpution. It will at best control and contain it significantly and reduce public harassment. Once these prescriptions - transparency, decentralization, simplification - are addressed in a basic form, we should leave it to the system to take care of rent-seeking. These prescriptions will help align the incentives of the administering officials with the desired scheme outcomes. Any effort to consciously address corruption or reduce official discretion, by building in additional checks and balances will only be counter-productive. By introducing multiple filters to screen the selection process and procedural complexity in tendering process, we are only providing enough grist to the rent seekers to feast on. We can do better by acknowledging that it is not possible to completely eliminate rent seeking, and some extent of rent seeking is inevitable and may even be desirable (more on this in a later post).
After a certain basic level of standardization, an inverse relationship kicks in between procedural rigour and bureaucratic overisght on one hand and efficiency and effectiveness on the other. This is especially true of massive Government programs in a diverse context like in India. Some amount of official discretion, with the attendent risk of rent seeking, is inevitable if we are to achieve our desired outcomes. It is better to have a development scheme that achieves at least a portion of its desired objectives while enriching a few, than have a scheme that only enriches the many without achieving any of the objectives. At the risk of sounding cliched, it is better to be not penny-wise and pound-foolish!
Monday, February 18, 2008
Bernstein on Music and Beethoven
I came across two You Tube clips. I didn't know that the great Leonard Bernstein was as brilliant a communicator as he was a conductor.
The first is an absolutely fabulous description (overture!) of Beethoven's music and in particular, his Ninth Symphony. Bernstein describes Beethoven's music "accessible without being ordinary". Bernstein goes on to describe the Final movement of Ninth Symphony, where Beethoven sets to music Freidrich Schiller's poem 'Ode to Joy', as a "celeberation of the birthday of music itself"!
The second is a brief, but brilliant exposition of what music expresses and how it does so. He claims that music is a metaphorical language that explores our psychic landscapes and is capable of "naming the un-namable and communicating the unknowable".
The first is an absolutely fabulous description (overture!) of Beethoven's music and in particular, his Ninth Symphony. Bernstein describes Beethoven's music "accessible without being ordinary". Bernstein goes on to describe the Final movement of Ninth Symphony, where Beethoven sets to music Freidrich Schiller's poem 'Ode to Joy', as a "celeberation of the birthday of music itself"!
The second is a brief, but brilliant exposition of what music expresses and how it does so. He claims that music is a metaphorical language that explores our psychic landscapes and is capable of "naming the un-namable and communicating the unknowable".
Sunday, February 17, 2008
Declining dollar story
Two recent events have made headlines and highlight the serious struggles the greenback is facing. First, Bloomberg news recently reported that Brazilian supermodel Giselle Bundchen, the world's highest paid fashion model, specifically demanded that her fees for promoting P&G's Pantene products be paid in euros and not dollars.
Second, Bill Gross, the CIO of Pacific Investments and Management Company (PIMCO), and manager of the world's largest bond fund, advised his clients, "We've told all of our clients that if you only had one idea, one investment, it would be to buy an investment in a non- dollar currency".
Another manifestation of the struggle facing the dollar is the weekend rush at the US-Canada border, with Canadians flooding into the US for their shopping. With the US dollar having fallen 67% against the Canadian dollar over the last five years, Canadians now find it cheaper to make even their regular purchases across the border. This trend is catching on among the wealthier Europeans too, who are crossing the Atlantic in ever larger numbers for their shopping excursions. The dollar has depreceiated by over 35% against the Euro since 2001.
Consider the forces at work that have driven down the dollar to historic lows. A stock market and then real estate bubble triggered a "wealth and income effect" that in turn inflated a consumption boom, which drove down household savings into negative territory over the span of less than a decade. This period coincided with the Chinese export-led growth boom, which deluged the US market with cheap imports and further indulged the US consumers. This fortunate coincidence of factors, coupled with robust economic growth kept both inflation and unemployment low. In the aftermath of the tech stocks bubble and the 2001 recession, interest rates were pared down to historic lows, as Alan Greenspan sought to reassure the financial markets.
The abundance of easy money also triggered off a massive financial boom. Banks gave a go by to old fashioned standards of credit-worthiness and started lending "teaser loans" and using off-balance sheet entities to finance highly risky ventures. A revolution in financial innovation and re-engineering got unveiled, bypassing the regulators. A whole series of exotic financial instruments with an alphabet soup of names, administered by smart mathematics and finance whizkids, using complex computer models, flooded the market. Investors, small and big, were swept away by the "irrational exuberance" and deluded into believing that "risk" was a thing of the past and an "age of the perpetual bull" was on us!
Then bad news came from the trading desks at Bear Stearns and Northern Rock, the bubble started signs of deflating. Then came more bad news of defaults and home repossessions and loan foreclosures, and then more and more...! As Ken Rogoff says, "surging capital flows into the US artificially held down interest rates and inflated asset prices, leading to laxity in banking and regulatory standards and, ultimately, to a meltdown."
In the meantime, the consumption boom and resultant surge in imports, meant that the US current account went spectacularly into the red, and burgeoned to 6.1% of GDP or $857 bn for 2006-07. Fortunately the Asian Central Banks, faced with appreciating currencies and the need to maintain their export edge, started intervening in the foreign exchange markets and amassed billions of dollars in reserves. In the absence of adequate depth and breadth in their local financial markets and chastened by the experience of the 1997 currency crisis, these Central Banks saw the US dollar and T Bonds a safe investment. Since they saw safety and liquidity as the predominant concern, they were willing to overlook the small returns these instruments were offering.
With the party now turning sour, what are its consequences on the US dollar? What has changed to make the dollar unattractive? For a start, the US deficit has become clearly unsustainable, with borrowings touching almost $2 billion a day! The sub-prime mortgage crisis provided another trigger. The wealth effect is disappearing or has already disappeared! Consumption and investment is falling, and unemployment is rising. The devil of inflation is threatening to rear its head, and a recession is looming or has already arrived. The generous Asians, faced with inflationary pressures in their own economies, and fearful of putting all their forex reserve eggs in the dollar basket, are no longer showing the same interest in gobbling up the US T Bonds. The foreign investors too have become wary of any more investments in both the US equity markets and the businesses. And now comes the final nail in the dollar's coffin from private investors like Giselle Bundchen! The conditions for a downward pressure on the dollar is unmistakable.
Low interest rates makes US debt instruments less attractive. US T Bonds are now one of the lowest yielding among the developed economies. A declining dollar makes this handicap even more obvious. It also discourages foreign investors. On the positive side, the cheap dollar has been undoubted filip to US exports, and has started making a dent on the trade deficit. But at what cost? Eco 101 teaches us that a decline like what the dollar has been experiencing should be the harbinger for run-away inflation and ultimately rising interest rates.
But as Larence Summers recently pointed out, the falling dollar should not have come as a surprise. He writes, "History suggests that periods when a country’s economy turns down, short-term interest rates are declining and financial strains are increasing are likely to be periods when a nation’s currency depreciates. Moreover the US current account has for years now been financing consumption rather than investment, with the financing coming increasingly from debt rather than equity and shorter rather than longer-term debt. There is nothing very new about a decline in currency of a country running a large current account deficit and whose economy is softening."
Martin Feldstein is among those who feel that a falling dollar is good news. He feels that a cheaper dollar and the resultant increase in US export competitiveness, will be critical in narrowing the US current account deficit and rectifying the external account imbalances. He writes, "A more competitive dollar will raise net exports, reducing the probability that the current weakness will turn into an outright recession. Looking further ahead, as the US household saving rate rises from its current low of nearly zero to a more normal level, consumer spending will slow, driving down aggregate demand. A declining dollar will then help to maintain growth and employment by raising exports and causing American consumers to shift their spending from imports to domestically produced goods and services."
In any case, it is not going to be long before the non-modelling world too decides to say - pay up in Euros, no dollars please.
Second, Bill Gross, the CIO of Pacific Investments and Management Company (PIMCO), and manager of the world's largest bond fund, advised his clients, "We've told all of our clients that if you only had one idea, one investment, it would be to buy an investment in a non- dollar currency".
Another manifestation of the struggle facing the dollar is the weekend rush at the US-Canada border, with Canadians flooding into the US for their shopping. With the US dollar having fallen 67% against the Canadian dollar over the last five years, Canadians now find it cheaper to make even their regular purchases across the border. This trend is catching on among the wealthier Europeans too, who are crossing the Atlantic in ever larger numbers for their shopping excursions. The dollar has depreceiated by over 35% against the Euro since 2001.
Consider the forces at work that have driven down the dollar to historic lows. A stock market and then real estate bubble triggered a "wealth and income effect" that in turn inflated a consumption boom, which drove down household savings into negative territory over the span of less than a decade. This period coincided with the Chinese export-led growth boom, which deluged the US market with cheap imports and further indulged the US consumers. This fortunate coincidence of factors, coupled with robust economic growth kept both inflation and unemployment low. In the aftermath of the tech stocks bubble and the 2001 recession, interest rates were pared down to historic lows, as Alan Greenspan sought to reassure the financial markets.
The abundance of easy money also triggered off a massive financial boom. Banks gave a go by to old fashioned standards of credit-worthiness and started lending "teaser loans" and using off-balance sheet entities to finance highly risky ventures. A revolution in financial innovation and re-engineering got unveiled, bypassing the regulators. A whole series of exotic financial instruments with an alphabet soup of names, administered by smart mathematics and finance whizkids, using complex computer models, flooded the market. Investors, small and big, were swept away by the "irrational exuberance" and deluded into believing that "risk" was a thing of the past and an "age of the perpetual bull" was on us!
Then bad news came from the trading desks at Bear Stearns and Northern Rock, the bubble started signs of deflating. Then came more bad news of defaults and home repossessions and loan foreclosures, and then more and more...! As Ken Rogoff says, "surging capital flows into the US artificially held down interest rates and inflated asset prices, leading to laxity in banking and regulatory standards and, ultimately, to a meltdown."
In the meantime, the consumption boom and resultant surge in imports, meant that the US current account went spectacularly into the red, and burgeoned to 6.1% of GDP or $857 bn for 2006-07. Fortunately the Asian Central Banks, faced with appreciating currencies and the need to maintain their export edge, started intervening in the foreign exchange markets and amassed billions of dollars in reserves. In the absence of adequate depth and breadth in their local financial markets and chastened by the experience of the 1997 currency crisis, these Central Banks saw the US dollar and T Bonds a safe investment. Since they saw safety and liquidity as the predominant concern, they were willing to overlook the small returns these instruments were offering.
With the party now turning sour, what are its consequences on the US dollar? What has changed to make the dollar unattractive? For a start, the US deficit has become clearly unsustainable, with borrowings touching almost $2 billion a day! The sub-prime mortgage crisis provided another trigger. The wealth effect is disappearing or has already disappeared! Consumption and investment is falling, and unemployment is rising. The devil of inflation is threatening to rear its head, and a recession is looming or has already arrived. The generous Asians, faced with inflationary pressures in their own economies, and fearful of putting all their forex reserve eggs in the dollar basket, are no longer showing the same interest in gobbling up the US T Bonds. The foreign investors too have become wary of any more investments in both the US equity markets and the businesses. And now comes the final nail in the dollar's coffin from private investors like Giselle Bundchen! The conditions for a downward pressure on the dollar is unmistakable.
Low interest rates makes US debt instruments less attractive. US T Bonds are now one of the lowest yielding among the developed economies. A declining dollar makes this handicap even more obvious. It also discourages foreign investors. On the positive side, the cheap dollar has been undoubted filip to US exports, and has started making a dent on the trade deficit. But at what cost? Eco 101 teaches us that a decline like what the dollar has been experiencing should be the harbinger for run-away inflation and ultimately rising interest rates.
But as Larence Summers recently pointed out, the falling dollar should not have come as a surprise. He writes, "History suggests that periods when a country’s economy turns down, short-term interest rates are declining and financial strains are increasing are likely to be periods when a nation’s currency depreciates. Moreover the US current account has for years now been financing consumption rather than investment, with the financing coming increasingly from debt rather than equity and shorter rather than longer-term debt. There is nothing very new about a decline in currency of a country running a large current account deficit and whose economy is softening."
Martin Feldstein is among those who feel that a falling dollar is good news. He feels that a cheaper dollar and the resultant increase in US export competitiveness, will be critical in narrowing the US current account deficit and rectifying the external account imbalances. He writes, "A more competitive dollar will raise net exports, reducing the probability that the current weakness will turn into an outright recession. Looking further ahead, as the US household saving rate rises from its current low of nearly zero to a more normal level, consumer spending will slow, driving down aggregate demand. A declining dollar will then help to maintain growth and employment by raising exports and causing American consumers to shift their spending from imports to domestically produced goods and services."
In any case, it is not going to be long before the non-modelling world too decides to say - pay up in Euros, no dollars please.
Friday, February 15, 2008
Why our flagship programs fail to meet their targets?
Every year the budget reels out depressing statistics of our abysmal failure in utilizing plan funds earmarked for the various government programs. The Union Finance Minister Mr P Chidambaram, recently claimed that as many as 301 projects, costing Rs 20 crore and above each, were delayed between one and 96 months, and the cumulative cost overrun was Rs 48,961 crore.
The Economic Times reports that, "The National Highways Authority of India (NHAI) completed only 32% of its target during 2007-08, or upgrading and strengthening just 917 km of highways in the nine months ending December 2007, as against the target of 2,885 km. It spent Rs 10,500 crore during this period, out of a total budget of Rs 17,615 crore for the fiscal. The government offered contracts for only 278 km of highways up to October 2007 against the target of awarding 3,278 km under NHDP-III in 2007-08. Even for NHDP-II projects, consultants could not be appointed. According to a report submitted by NHAI to the road transport department, 54 contracts covering 544 km were delayed as on December 31, 2007. Under NHDP-IV, the government has so far awarded only 1,048 km as against a target of 2,995 km during the current financial year."
The story of failure to meet the targets is captured in the two graphics shown below
A first glance of the list of the schemes gives some inference about the reasons for the huge performance shortfall. All of them (except National Highways) are implemented through the regular Government agencies and their executing or engineering wings. There is a serious limitation with implementing such major programs and schemes which have earmarked budgets and fixed time-lines, through the regular engineering departments. These projects demand professional expertise, experience, intense monitoring and supervision, and requires considerable flexibility in execution, all of which are difficult to infuse into Government systems. Apart from it being a great challenge to introduce project management practices into Government administrative systems, private Project Management agencies also find it difficult to work within the scope of Government bureaucracies.
It is no wonder then that the one successful example of project implementation in India in the past decade has been the Golden Quadrilateral Project, implemented as it is through an autonomous and professionally staffed agency like the National Highways Authority of India (NHAI). By successfully insulating the Project from political and other external influences and from bureaucratic red tape, the NHAI has implemented many works well in advance of schedule. It has successfully embraced land acquisition methods acceptable to land losers, new construction technologies, latest contracting procedures, innovative business models, private sector participation, and independent project monitoring and evaluation systems.
By exploring and actively encouraging various Public Private Partnership (PPP) and fully private models, the NHAI has been instrumental in bringing in modern technologies and developing a very vibrant market of private construction companies. It has shown the way for similar professionally executed PPP transport projects like the Delhi Metro, airports in Hderabad and Bangalore, and a few ports.
But unfortunately, the success in the highway roads and transport sector has been more an exception to the norm. The cupboard of professionally executed and managed PPP projects remains bare for the other sectors, especially in rural and urban infrastructure.
Here is a laundry list of a few government and market side problems associated with utilizing plan funds, especially in construction-based sectors. Government side deficiencies first.
1. Many layers of bureaucracy and multiple filters is responsible for exasperating delays and provides ample opportunities for rent seekers. Even small clarifications while executing projects tend to require clearances from the top, thereby often leaving the projects stranded mid-way directionless.
2. Most of our big projects are not conceived and executed in any integrated manner, after finalizing all backward and forward linkages. It is common place for big projects to be initiated without a proper Detailed Project Report (DPR) or financial closure.
3. Inappropriate and outdated tendering and work contracting procedures. A legacy of a bygone era of closed and over-regulated market, these rules and regulations stand out as clear anachronism in the modern age where the private sector and the market is a critical influence and integral partner in the process of development. Restrictive tender eligibility conditions often shuts out many interested and qualified contractors.
4. Inadequate monitoring and implementation mechanism. Independent Project Monitoring and Implementation Units, Third Party Quality Control (TPQC), Accrual-based double entry Accounting Systems etc have made little headway into Government bureaucracies.
5. Low penetration of sophisticated process automation technologies like Supervisory Control and Data Acquisition (SCADA), intelligent transport systems (ITS), Global Positioning System (GPS) based networks, energy savings devices etc in public service utilities and government works.
6. Failure to quickly and adequately embrace concepts like PPP and Management Contracts.
7. Failure to adopt professional project management approach in project execution.
I have dwelt on the supply side issues affecting this in a previous post. But let me reiterate them with a few more specific additions.
1. Limited number of eligible works contractors in all sectors except roads. Most often there are only three or four qualified and eligible contractors for the big projects.
2. High entry barriers to the contracting market arising from rigid and unreasonable pre-qualification and eligibility norms. This ensures that the market is trapped in a limited circle of participants.
3. Limited number of suppliers and manufacturers. For example, there is only one manufacturer in the entire country of large ductile Iron pipes used in water supply, sewerage and irrigation.
4. Extremely under-developed market for services like outsourcing and Operation & Maintenance of public service utilities,
5. Lack of process modernization, manifested by the very low penetration of Ready Mix Concrete (RMC), non-invasive road cutting technologies like lateral drilling, pre-cast materials etc
6. Limited or even no large vendors of sophisticated technologies like ITS, SACADA, GPS based networks, GIS systems.
7. Poorly developed backward or downward linkages - limited number of qualified consultants for preparing Master Plans and DPRs, undeveloped market in debt financing etc.
8. Acute scarcity of skilled personnel like structural and environmental engineers, process control analysts, designers, surveyors, architects, accountants etc
9. Nascent market in monitoring systems for Government works and activities - Project Monitoring Softwares, TPQC etc.
10. High perceived risk associated with infrastructure projects and in financing them. (except roads)
11. All the big contractors are based in the metros and the big cities, and have limited presence in even the Tier II cities. They do not even have their branches in many of the smaller cities. Given the large overhead costs and the expenditure in mobilizing personnel and other logistics, it therefore becomes less profitable for them to bid for even larger works in these cities. And whenever they do bid for these works in the larger cities, they invariably sub-contract it to the smaller contractors. But unfortunately many of the smaller cities do not even have the sub-contractors with the minimum required experience.
China scores over India in executing large projects without time and cost over-runs, thanks mainly to the infusion of professionalism in project conception, design, tendering, execution and monitoring. But execution through a separate project management unit may not be easy, given the geographically spread out and piecemeal nature of works like rural water supply, housing, civic infrastructure, medical and health care etc. However, all the other components of project conception and design, tendering and monitoring can surely be done in a more professional manner. More about this in a later post. Unless we get these things right, we will continue to have the same story and graphics to tell next year too!
The Economic Times reports that, "The National Highways Authority of India (NHAI) completed only 32% of its target during 2007-08, or upgrading and strengthening just 917 km of highways in the nine months ending December 2007, as against the target of 2,885 km. It spent Rs 10,500 crore during this period, out of a total budget of Rs 17,615 crore for the fiscal. The government offered contracts for only 278 km of highways up to October 2007 against the target of awarding 3,278 km under NHDP-III in 2007-08. Even for NHDP-II projects, consultants could not be appointed. According to a report submitted by NHAI to the road transport department, 54 contracts covering 544 km were delayed as on December 31, 2007. Under NHDP-IV, the government has so far awarded only 1,048 km as against a target of 2,995 km during the current financial year."
The story of failure to meet the targets is captured in the two graphics shown below
A first glance of the list of the schemes gives some inference about the reasons for the huge performance shortfall. All of them (except National Highways) are implemented through the regular Government agencies and their executing or engineering wings. There is a serious limitation with implementing such major programs and schemes which have earmarked budgets and fixed time-lines, through the regular engineering departments. These projects demand professional expertise, experience, intense monitoring and supervision, and requires considerable flexibility in execution, all of which are difficult to infuse into Government systems. Apart from it being a great challenge to introduce project management practices into Government administrative systems, private Project Management agencies also find it difficult to work within the scope of Government bureaucracies.
It is no wonder then that the one successful example of project implementation in India in the past decade has been the Golden Quadrilateral Project, implemented as it is through an autonomous and professionally staffed agency like the National Highways Authority of India (NHAI). By successfully insulating the Project from political and other external influences and from bureaucratic red tape, the NHAI has implemented many works well in advance of schedule. It has successfully embraced land acquisition methods acceptable to land losers, new construction technologies, latest contracting procedures, innovative business models, private sector participation, and independent project monitoring and evaluation systems.
By exploring and actively encouraging various Public Private Partnership (PPP) and fully private models, the NHAI has been instrumental in bringing in modern technologies and developing a very vibrant market of private construction companies. It has shown the way for similar professionally executed PPP transport projects like the Delhi Metro, airports in Hderabad and Bangalore, and a few ports.
But unfortunately, the success in the highway roads and transport sector has been more an exception to the norm. The cupboard of professionally executed and managed PPP projects remains bare for the other sectors, especially in rural and urban infrastructure.
Here is a laundry list of a few government and market side problems associated with utilizing plan funds, especially in construction-based sectors. Government side deficiencies first.
1. Many layers of bureaucracy and multiple filters is responsible for exasperating delays and provides ample opportunities for rent seekers. Even small clarifications while executing projects tend to require clearances from the top, thereby often leaving the projects stranded mid-way directionless.
2. Most of our big projects are not conceived and executed in any integrated manner, after finalizing all backward and forward linkages. It is common place for big projects to be initiated without a proper Detailed Project Report (DPR) or financial closure.
3. Inappropriate and outdated tendering and work contracting procedures. A legacy of a bygone era of closed and over-regulated market, these rules and regulations stand out as clear anachronism in the modern age where the private sector and the market is a critical influence and integral partner in the process of development. Restrictive tender eligibility conditions often shuts out many interested and qualified contractors.
4. Inadequate monitoring and implementation mechanism. Independent Project Monitoring and Implementation Units, Third Party Quality Control (TPQC), Accrual-based double entry Accounting Systems etc have made little headway into Government bureaucracies.
5. Low penetration of sophisticated process automation technologies like Supervisory Control and Data Acquisition (SCADA), intelligent transport systems (ITS), Global Positioning System (GPS) based networks, energy savings devices etc in public service utilities and government works.
6. Failure to quickly and adequately embrace concepts like PPP and Management Contracts.
7. Failure to adopt professional project management approach in project execution.
I have dwelt on the supply side issues affecting this in a previous post. But let me reiterate them with a few more specific additions.
1. Limited number of eligible works contractors in all sectors except roads. Most often there are only three or four qualified and eligible contractors for the big projects.
2. High entry barriers to the contracting market arising from rigid and unreasonable pre-qualification and eligibility norms. This ensures that the market is trapped in a limited circle of participants.
3. Limited number of suppliers and manufacturers. For example, there is only one manufacturer in the entire country of large ductile Iron pipes used in water supply, sewerage and irrigation.
4. Extremely under-developed market for services like outsourcing and Operation & Maintenance of public service utilities,
5. Lack of process modernization, manifested by the very low penetration of Ready Mix Concrete (RMC), non-invasive road cutting technologies like lateral drilling, pre-cast materials etc
6. Limited or even no large vendors of sophisticated technologies like ITS, SACADA, GPS based networks, GIS systems.
7. Poorly developed backward or downward linkages - limited number of qualified consultants for preparing Master Plans and DPRs, undeveloped market in debt financing etc.
8. Acute scarcity of skilled personnel like structural and environmental engineers, process control analysts, designers, surveyors, architects, accountants etc
9. Nascent market in monitoring systems for Government works and activities - Project Monitoring Softwares, TPQC etc.
10. High perceived risk associated with infrastructure projects and in financing them. (except roads)
11. All the big contractors are based in the metros and the big cities, and have limited presence in even the Tier II cities. They do not even have their branches in many of the smaller cities. Given the large overhead costs and the expenditure in mobilizing personnel and other logistics, it therefore becomes less profitable for them to bid for even larger works in these cities. And whenever they do bid for these works in the larger cities, they invariably sub-contract it to the smaller contractors. But unfortunately many of the smaller cities do not even have the sub-contractors with the minimum required experience.
China scores over India in executing large projects without time and cost over-runs, thanks mainly to the infusion of professionalism in project conception, design, tendering, execution and monitoring. But execution through a separate project management unit may not be easy, given the geographically spread out and piecemeal nature of works like rural water supply, housing, civic infrastructure, medical and health care etc. However, all the other components of project conception and design, tendering and monitoring can surely be done in a more professional manner. More about this in a later post. Unless we get these things right, we will continue to have the same story and graphics to tell next year too!
Tuesday, February 12, 2008
Why high taxes on alcohol and tobacco are counterproductive?
The one constant in every Indian budget have been the fiscal proposals on ever higher taxes on tobacco and alcohol products. The taxes on these products are today many times more than the actual price of the product. Have you ever wondered who among the customer and the tobacco company pays what share of the tax? Before we go on, let us examine the markets for tobacco and alcohol products.
Tobacco and alcohol generally have a captive or "addicted" group of consumers. Though there are also those occassional users, they are a small minority and are not the focus of our attention. The major category consists of the former, whose demand for these products is relatively invariant with respect to changes in price, or thier price elasticity of demand is very low. In other words, the demand for these products among this former category, is inelastic. Eco 101 (or a simple graphical illustration would show) says that for products with inelastic demand, the incidence of taxation is much higher on the consumers than on the sellers.
Further, a large share of those chronically addicted are likely to be those with difficult social and even crime backgrounds. They are also more likely to be the economically weaker sections. As we have seen, under the circumstances, there is a very strong chance that the higher prices forces these socially challenged addicts to become more desperate and resort to more crime and other anti-social activities to finance their purchases. This is surely going to impact crime rates.
There is another interesting dimension to raising prices on cigarettes, brought out in an NBER article Do Higher Cigarette Prices Encourage Youth to Use Marijuana? by Frank J Chaloupka et al. It is conventionally thought that higher cigarette prices results in marijuana substitution. The article argues that marijuana and cigarettes are not substitutes, and also claims that any reduction in cigarette smoking (due to higher prices) also results in a fall in the use of similar substance abuse like drinking, marijuana and other illicit drug use.
Interestingly, in the US, adjusted for inflation, taxes on alcoholic drinks have been falling, because taxes on them have hardly budged since early 1990s. Arguing in favor of higher taxes on products like tobacco and alcohol, David Leonhardt has highlighted this.
Update 1 (13/3/2010)
Deliana Kostova, Hana Ross, Evan Blecher, and Sara Markowitz used individual-level data from 20 developing countries, and estimated that the price elasticity of cigarette demand among youth is -1.83. They tehrefore argue that policymakers in developing countries could reduce cigarette consumption by youths by raising taxes. A 10% increase in the price will reduce youth cigarette demand by 18.3%.
Tobacco and alcohol generally have a captive or "addicted" group of consumers. Though there are also those occassional users, they are a small minority and are not the focus of our attention. The major category consists of the former, whose demand for these products is relatively invariant with respect to changes in price, or thier price elasticity of demand is very low. In other words, the demand for these products among this former category, is inelastic. Eco 101 (or a simple graphical illustration would show) says that for products with inelastic demand, the incidence of taxation is much higher on the consumers than on the sellers.
Further, a large share of those chronically addicted are likely to be those with difficult social and even crime backgrounds. They are also more likely to be the economically weaker sections. As we have seen, under the circumstances, there is a very strong chance that the higher prices forces these socially challenged addicts to become more desperate and resort to more crime and other anti-social activities to finance their purchases. This is surely going to impact crime rates.
There is another interesting dimension to raising prices on cigarettes, brought out in an NBER article Do Higher Cigarette Prices Encourage Youth to Use Marijuana? by Frank J Chaloupka et al. It is conventionally thought that higher cigarette prices results in marijuana substitution. The article argues that marijuana and cigarettes are not substitutes, and also claims that any reduction in cigarette smoking (due to higher prices) also results in a fall in the use of similar substance abuse like drinking, marijuana and other illicit drug use.
Interestingly, in the US, adjusted for inflation, taxes on alcoholic drinks have been falling, because taxes on them have hardly budged since early 1990s. Arguing in favor of higher taxes on products like tobacco and alcohol, David Leonhardt has highlighted this.
Update 1 (13/3/2010)
Deliana Kostova, Hana Ross, Evan Blecher, and Sara Markowitz used individual-level data from 20 developing countries, and estimated that the price elasticity of cigarette demand among youth is -1.83. They tehrefore argue that policymakers in developing countries could reduce cigarette consumption by youths by raising taxes. A 10% increase in the price will reduce youth cigarette demand by 18.3%.
Sunday, February 10, 2008
Health Care economics
Health care services market is different from the market for any other service in many respects. It suffers from a number of incentive distortion problems and market failures, which causes classical free markets to fail. It has been observed across the world that as real income rises, people expect more medical care. This demand is accelerated by the rapidly aging populations and the expanding list of lifestyle diseases and problems. This increasing demand, coupled with the proliferation of sophisticated technologies and advances in diagnostic tests and surgical procedures, all of which are invariably expensive, have meant that health care costs have been soaring.
For the last 30 years, health-care costs have been rising 6 percent to 8 percent a year in the US - more than double the inflation rate in the rest of the economy - because demand keeps outstripping supply. To give one example, in 2001, with prices across the US economy up less than 2 percent, hospital costs rose 8 percent, drug costs increased 16 percent, physician costs jumped 9 percent, and insurance premiums increased 10 percent.
Why health care costs are so prone to inflation? What are these incentive distortions and market failures that bedevil the health care services market? What is the influence of medical insurance on the development of the health care services market?
I have tried to list out some of the major incentive distortions and market failures that distinguish the health care market from other services.
1. Market suffers from inherent monopoly characateristics. Surgical procedures or drugs are most often unique, thereby relying on one or a few suppliers/producers. Further, the availability of specialists is also limited, thereby giving them considerable bargaining power. There are no cheaper alternatives to fall back on, if prices rise.
2. Health care services cannot be substituted. Unlike other services, health care cannot be substituted and the costs associated with not accessing it are often unacceptably high and even fatal.
3. Health care services market, especially for the emergency, life saving treatments is inelastic. In fact, in many ways, primary health care services atleast, exhibit Giffen characteristics of demand rising even as the prices rise.
4. Given the specific, skilled and doctor-centric nature of health care services, it will always experience supply side contraints. Supply side limitations by way of the numbers of doctors and specialists, and the small numbers of skilled specialists cannot be easily overcome. These constraints will get exacerbated as more an more people get covered by better medical facilities, both through rising incomes and better medical insurance cover.
5. The market suffers from an information assymetry problem. The inherently technical nature of tests and procedures, ensures that there is a heavily skewed information assymetry between the doctors and the patients. Most patients are in no position to make a choice between treatment options, and have to place their full trust on the judgement of the doctors. As we have seen, this often gets betrayed. There is a genuine difficulty in converging the faith in doctor's judgement and the patient's apprehensions in an objective, quantifiable manner.
6. Inherent difficulty in achieving convergence between the financial incentives of the sellers (doctors) and the buyers (patients). The patients want to receive health care at the lowest cost, but do not possess the technical expertise to be aware of what they need. The doctors, who know what the patient needs, is often incentivized by pharmaceutical companies and medical equipment and service providers to over treat the patient.
7. Trade off between the diagnostic optimum and doctor's experience, distorted by the potential costs of legal claims. Doctors make their diagnosis of the patients condition based on both their professional experience of similar symptoms and situations, and the results of the diagnostic tests conducted. But in view of the ever present danger of legal damages in the case of wrong or mis-diagnosis, doctors tend to become over cautious in making their diagnosis. Even for the simplest ailments, doctors insist on conducting the full protocol of medical tests before making their diagnosis and prescription. Apart from contributing to delays in delivering treatments with its attendant consequences, this also increases health care costs for little marginal benefit. An experienced doctor should be able to easily, with more or less assured certainty, make accurate diagnosis of simpler ailments and medical problems. Medical insurance only accentuates this problem, as insurance companies hedge themselves against any possible legal claims.
8. The intermediation role of diagnosis in confirming treatment options increases the costs substantially. In many ways, diagnosis form the critical determinant in deciding the treatment option, and is increasingly forming a major share of the full treatment. The scope of diagnosis has expanded over the years to include tests that not only confirm the presence of certain ailments, but also preclude the possibilty of others not always related or relevant to the ailment under treatment. This also leads to over use of medical tests and thereby increases demand.
9. Medical Insurance suffers from the moral hazard problem. With their premiums having been paid, the patients have an incentive to approach the doctor and carry out the full spectrum of medical tests and undergo all necessary and unnecessary surgical procedures, so as to reassure themselevs that they have availed off all the possible diagnostic and treatment options. The easy availability of information in media like the internet makes patients demand the maximum possible standards in their treatment. In other words, since it does not cost them any more, insured patients tend to over-use medical care even for minor complaints. It has been found that even teh use of deductibles for each treatment visit, does little to deter frivolous visits. This artificially generated demand, in turn contributes towards cost inflation, besides causing supply compression and other market distortions.
10. Unlike other services, medical insurance sellers stand to gain by selling their policies to those who need it the least and denying the service to those need it the most. This means that they go great lengths to screen the applicants, in the process sharply increasing the transaction costs. It is estimated that 19 cents in every dollar spent in medical health care in the US is taken away by transaction costs.
11. Health Insurance generates certain cognitive biases. Since people do not pay directly the premium costs, being shared with the employer and deducted from the salary, they tend to be not directly aware of the costs incurred. This is exacerbated by the tax concessions given to both employers and employees for their respective contributions.
12. Unlike other services, comparing drugs, devices and procedures are difficult. Comparative effectivenesss studies for them are very rare. Past comparative effectiveness trials have shown that older and cheaper anti-psychotic drugs are often just as good as expensive new ones. Similar comparison of two rival treatments of patients with stable coronary artery disease - a traditional combination of angioplasty and drugs versus drugs alone - measured by heart attacks and survival rates, found no difference. This difficulty to compare prevents the patients from doing any cost-benefit analysis of treatment options.
There is an excellent article in the Slate by Robert Shapiro, which brings out some of these problems.
For the last 30 years, health-care costs have been rising 6 percent to 8 percent a year in the US - more than double the inflation rate in the rest of the economy - because demand keeps outstripping supply. To give one example, in 2001, with prices across the US economy up less than 2 percent, hospital costs rose 8 percent, drug costs increased 16 percent, physician costs jumped 9 percent, and insurance premiums increased 10 percent.
Why health care costs are so prone to inflation? What are these incentive distortions and market failures that bedevil the health care services market? What is the influence of medical insurance on the development of the health care services market?
I have tried to list out some of the major incentive distortions and market failures that distinguish the health care market from other services.
1. Market suffers from inherent monopoly characateristics. Surgical procedures or drugs are most often unique, thereby relying on one or a few suppliers/producers. Further, the availability of specialists is also limited, thereby giving them considerable bargaining power. There are no cheaper alternatives to fall back on, if prices rise.
2. Health care services cannot be substituted. Unlike other services, health care cannot be substituted and the costs associated with not accessing it are often unacceptably high and even fatal.
3. Health care services market, especially for the emergency, life saving treatments is inelastic. In fact, in many ways, primary health care services atleast, exhibit Giffen characteristics of demand rising even as the prices rise.
4. Given the specific, skilled and doctor-centric nature of health care services, it will always experience supply side contraints. Supply side limitations by way of the numbers of doctors and specialists, and the small numbers of skilled specialists cannot be easily overcome. These constraints will get exacerbated as more an more people get covered by better medical facilities, both through rising incomes and better medical insurance cover.
5. The market suffers from an information assymetry problem. The inherently technical nature of tests and procedures, ensures that there is a heavily skewed information assymetry between the doctors and the patients. Most patients are in no position to make a choice between treatment options, and have to place their full trust on the judgement of the doctors. As we have seen, this often gets betrayed. There is a genuine difficulty in converging the faith in doctor's judgement and the patient's apprehensions in an objective, quantifiable manner.
6. Inherent difficulty in achieving convergence between the financial incentives of the sellers (doctors) and the buyers (patients). The patients want to receive health care at the lowest cost, but do not possess the technical expertise to be aware of what they need. The doctors, who know what the patient needs, is often incentivized by pharmaceutical companies and medical equipment and service providers to over treat the patient.
7. Trade off between the diagnostic optimum and doctor's experience, distorted by the potential costs of legal claims. Doctors make their diagnosis of the patients condition based on both their professional experience of similar symptoms and situations, and the results of the diagnostic tests conducted. But in view of the ever present danger of legal damages in the case of wrong or mis-diagnosis, doctors tend to become over cautious in making their diagnosis. Even for the simplest ailments, doctors insist on conducting the full protocol of medical tests before making their diagnosis and prescription. Apart from contributing to delays in delivering treatments with its attendant consequences, this also increases health care costs for little marginal benefit. An experienced doctor should be able to easily, with more or less assured certainty, make accurate diagnosis of simpler ailments and medical problems. Medical insurance only accentuates this problem, as insurance companies hedge themselves against any possible legal claims.
8. The intermediation role of diagnosis in confirming treatment options increases the costs substantially. In many ways, diagnosis form the critical determinant in deciding the treatment option, and is increasingly forming a major share of the full treatment. The scope of diagnosis has expanded over the years to include tests that not only confirm the presence of certain ailments, but also preclude the possibilty of others not always related or relevant to the ailment under treatment. This also leads to over use of medical tests and thereby increases demand.
9. Medical Insurance suffers from the moral hazard problem. With their premiums having been paid, the patients have an incentive to approach the doctor and carry out the full spectrum of medical tests and undergo all necessary and unnecessary surgical procedures, so as to reassure themselevs that they have availed off all the possible diagnostic and treatment options. The easy availability of information in media like the internet makes patients demand the maximum possible standards in their treatment. In other words, since it does not cost them any more, insured patients tend to over-use medical care even for minor complaints. It has been found that even teh use of deductibles for each treatment visit, does little to deter frivolous visits. This artificially generated demand, in turn contributes towards cost inflation, besides causing supply compression and other market distortions.
10. Unlike other services, medical insurance sellers stand to gain by selling their policies to those who need it the least and denying the service to those need it the most. This means that they go great lengths to screen the applicants, in the process sharply increasing the transaction costs. It is estimated that 19 cents in every dollar spent in medical health care in the US is taken away by transaction costs.
11. Health Insurance generates certain cognitive biases. Since people do not pay directly the premium costs, being shared with the employer and deducted from the salary, they tend to be not directly aware of the costs incurred. This is exacerbated by the tax concessions given to both employers and employees for their respective contributions.
12. Unlike other services, comparing drugs, devices and procedures are difficult. Comparative effectivenesss studies for them are very rare. Past comparative effectiveness trials have shown that older and cheaper anti-psychotic drugs are often just as good as expensive new ones. Similar comparison of two rival treatments of patients with stable coronary artery disease - a traditional combination of angioplasty and drugs versus drugs alone - measured by heart attacks and survival rates, found no difference. This difficulty to compare prevents the patients from doing any cost-benefit analysis of treatment options.
There is an excellent article in the Slate by Robert Shapiro, which brings out some of these problems.
Saturday, February 9, 2008
Who is an Insurgent?
It is widely acknowledged that terrorism and terrorists draw their sustenance from economic deprivation and exploitation, coupled with lack of proper education. This analysis has been applied to both sub-national insurgencies and international terrorism. In India, the naxalite movement has been traced back to relative deprivation and regional disparities. But increasing evidence points to the explanation not being as simple as thought.
A cursory analysis of all the leadership of the insurgent Naxalite movement in India reveals that its leaders mostly come from financially well-off and educated backgrounds. Though the foot soldiers are recruited from the deprived and aggrieved communities, the leadership is dominated by outsiders, most often from outside the community itself. Thus we have upper caste leadership for the predominantly tribal and lower caste naxalite movement. Apart from the intelligentsia, even the more important positions of such groups, like the explosives expert, major suicide bombers, mainly come from outside the aggreived community or from the more well off and educated from the community. More broadly, it has been found that the leadership and the guiding force in shaping such movements come from well educated and financially sound individuals, who are attracted to the cause of the aggrieved.
Alan Krueger, a Princeton professor, has done pathbreaking research on why so many terrorists come from middle-class backgrounds, by drawing in on data from thousands of Middle Eastern and German terrorists. In "What Makes a Terrorist," he presents his argument in full. The Christian Science Monitor called the book a "a concise, accessible argument against the notion that we can defeat terrorism through aid and education." Prof Kruger argues that from both the supply side (with educated recruits better able to understand and appreciate socio-economic and political causes for the grievance) and demand side (terrorist organizations want success in their missions and educated recruits are more likely to succeed), better off and educated individuals are more probable and desirable recruits.
But Gary Becker argues that a few high profile examples like the 9/11 bombing are a red herring and do not convey an accurate picture about the educational and economic backgrounds of terrorists. Positing the counter example of the backgrounds of the suicide bombers in the first Intifada against Israel, who were young (mean age of 20), unmarried, and without college education, he claims that better economic opportunities reduce the attraction of terrorist martyrdom. The educated terrorists with good economic opportunities, who carried out the high profile 9/11 attack, get attracted only by vital leadership roles in an exceptional mission.
He says, "Just as economic progress greatly affects family structure and the amount of freedom available, it also sharply reduces the willingness of people to hide or otherwise protect terrorists because they have more to lose if they are caught. Although leaders of terrorist organizations usually come from more educated classes, these organizations rely on numerous foot soldiers to do a lot of the dirty work. They are generally recruited from younger and less educated groups. It becomes much harder to recruit many of these soldiers when good jobs are available, especially if these recruits are asked to commit suicide."
Gerald Posner takes a different position and argues that given the limited supply and the increasing need for specialised skills and technical sophistication, coupled with courage and training, means that terrorists have to be educated and hence more likely to be from middle class backgrounds. He does an economic analysis of the demand and supply for terrorists, and traces the origins to the presence of a widely-felt public grievance - economic or most often political.
He says, "If demand for terrorism is grievance-driven, then one can expect the supply of terrorists to come mainly from the intelligentsia, for the members of the intelligentsia are more likely than ordinary people to be moved by ideas, resentments, and political ambitions rather than by material concerns. They have the leisure and the education to think big thoughts, like overthrowing a government, which rarely brings material improvements."
While the long term solution may be to eliminate the grievance itself, there are some initiatives that can be taken in the short and medium run. These aforementioned analyses of terrorists and their motivations, seems to indicate that supply side internventions to choke out recruits for terrorist organizations may not be very effective. I am more inclined towards Alan Kruger's demand side interventions like efforts to degrade the terrorist organizations financial and technical capabilities, and vigorous protection and promotion of peaceful means of protest, thereby reducing the demand for pursuing grievances through violent means. Providing many windows for ventilating grievances can be a more effective weapon against terrorism than efforts to choke off recruitment.
A cursory analysis of all the leadership of the insurgent Naxalite movement in India reveals that its leaders mostly come from financially well-off and educated backgrounds. Though the foot soldiers are recruited from the deprived and aggrieved communities, the leadership is dominated by outsiders, most often from outside the community itself. Thus we have upper caste leadership for the predominantly tribal and lower caste naxalite movement. Apart from the intelligentsia, even the more important positions of such groups, like the explosives expert, major suicide bombers, mainly come from outside the aggreived community or from the more well off and educated from the community. More broadly, it has been found that the leadership and the guiding force in shaping such movements come from well educated and financially sound individuals, who are attracted to the cause of the aggrieved.
Alan Krueger, a Princeton professor, has done pathbreaking research on why so many terrorists come from middle-class backgrounds, by drawing in on data from thousands of Middle Eastern and German terrorists. In "What Makes a Terrorist," he presents his argument in full. The Christian Science Monitor called the book a "a concise, accessible argument against the notion that we can defeat terrorism through aid and education." Prof Kruger argues that from both the supply side (with educated recruits better able to understand and appreciate socio-economic and political causes for the grievance) and demand side (terrorist organizations want success in their missions and educated recruits are more likely to succeed), better off and educated individuals are more probable and desirable recruits.
But Gary Becker argues that a few high profile examples like the 9/11 bombing are a red herring and do not convey an accurate picture about the educational and economic backgrounds of terrorists. Positing the counter example of the backgrounds of the suicide bombers in the first Intifada against Israel, who were young (mean age of 20), unmarried, and without college education, he claims that better economic opportunities reduce the attraction of terrorist martyrdom. The educated terrorists with good economic opportunities, who carried out the high profile 9/11 attack, get attracted only by vital leadership roles in an exceptional mission.
He says, "Just as economic progress greatly affects family structure and the amount of freedom available, it also sharply reduces the willingness of people to hide or otherwise protect terrorists because they have more to lose if they are caught. Although leaders of terrorist organizations usually come from more educated classes, these organizations rely on numerous foot soldiers to do a lot of the dirty work. They are generally recruited from younger and less educated groups. It becomes much harder to recruit many of these soldiers when good jobs are available, especially if these recruits are asked to commit suicide."
Gerald Posner takes a different position and argues that given the limited supply and the increasing need for specialised skills and technical sophistication, coupled with courage and training, means that terrorists have to be educated and hence more likely to be from middle class backgrounds. He does an economic analysis of the demand and supply for terrorists, and traces the origins to the presence of a widely-felt public grievance - economic or most often political.
He says, "If demand for terrorism is grievance-driven, then one can expect the supply of terrorists to come mainly from the intelligentsia, for the members of the intelligentsia are more likely than ordinary people to be moved by ideas, resentments, and political ambitions rather than by material concerns. They have the leisure and the education to think big thoughts, like overthrowing a government, which rarely brings material improvements."
While the long term solution may be to eliminate the grievance itself, there are some initiatives that can be taken in the short and medium run. These aforementioned analyses of terrorists and their motivations, seems to indicate that supply side internventions to choke out recruits for terrorist organizations may not be very effective. I am more inclined towards Alan Kruger's demand side interventions like efforts to degrade the terrorist organizations financial and technical capabilities, and vigorous protection and promotion of peaceful means of protest, thereby reducing the demand for pursuing grievances through violent means. Providing many windows for ventilating grievances can be a more effective weapon against terrorism than efforts to choke off recruitment.
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