Outsourcing food production

Following in the footsteps of manufacturing in the 1980s and information technology in the 1990s, in the latest and most controversial examples of outsourcing, some of the major food importing nations are acquiring (buy or lease) vast tracts of poor countries' farmland in order to meet their foodgrain requirements. Supporters argue that such foreign investment are beneficial to the host countries, as they provide new seeds, techniques and money for agriculture, whereas opponents accuse it of neo-colonialism, wherein poor farmers will be pushed off land they have farmed for generations.



China, South Korea and the rich Middle Eastern countries are the largest investors in these farmlands, most of them in Africa. The International Food Policy Research Institute (IFPRI), estimates that between 15m and 20m hectares of farmland (fifth of all the farmland of the European Union) in poor countries, valued at between $20-30 bn, have been subject to transactions or talks involving foreigners since 2006. Unlike the colonial era farming ventures that sought to grow cash crops like coffee, tea, sugar or bananas, the current ones mostly focus on staples or biofuels — wheat, maize, rice, jatropha. Unlike the previous era when foreign farming investment was mostly private, the present transactions are between host governments and foreign regimes or companies closely tied to them, such as sovereign-wealth funds.

The sharp increase in food prices from 2007 and the middle of 2008 (The Economist index of food prices rose 78%) and the protectionist reaction among many major global grain producers, has given a fillip to this trend of procuring lands for growing foodgrains. The Arab countries, facing acute water shortage, see the African hinterlands, with their water resources, as ideal for meeting their food needs.

This wave of outsourcing is surely going to be one of the most controversial ones. Opponents point to the irony of Sudan, which is the recipient of the largest food-aid operation in the world, emerging as one of the largest hosts for such foreign investments in land and permitting the export of upto 70% of the crop. These deals have already aroused political opposition in countries like Madagascar, Zambia, and Cambodia. Such deals are accused of usurping the customary rights of local farmers over the government lands, strip hereders off the grazing pastures for their cattle, and deprive local population off water resources.

Update 1
Times has this nicely written article about the scramble for agricultural land in Africa, which atleast some people prefer to call agro-imperialism. Imagine famine ridden Ethiopia becoming the rice bowl of Saudi Arabia in a case of comparative advantage striking back!

Update 2
Ruchi Soya Industries, one of India's leading edible oil processors has signed a memorandum of understanding with the Ethiopian Government for cultivation of soyabean and setting up a processing unit on 61775 acres in Ganmbella and Benishangul Gumaz States on a lease basis for 25 years. It has an option to increase the area under cultivation to 123,550 acres.

Update 3 (22/12/2010)

NYT has this report on the great African land grab which is driving many Africans off their lands.

Update 4 (29/4/2012)

A compilation of all external land purchases in Africa reveals that 5% of all the continent's agricultural land have been purchased by outsiders. The report identifies 1008 deals since 2000 involving 76.33 m hectares of land – or roughly the size of Kenya. See the land compilation here.

Global nuclear power outlook

The historic Indo-US nuclear deal was hailed as a breakthrough in resolving India's chronic power deficits. However, as an NYT article points out, from the experience of Finland, the celeberations may be premature. A 1600 MW, 3 billion Euro modular design reactor, being built by Areva, which was supposed to be cheaper, faster to build, and safer, has now fallen short on all the three counts. It is found that of the 45 reactors being built around the world, 22 have encountered construction delays.



The OECD estimates that for nuclear power to have a high impact on reducing greenhouse gases, an average of 12 reactors would have to be built worldwide each year until 2030, whereas there are not even enough reactors under construction to replace those that are reaching the end of their lives.

Cap and trade in US

Early last week, the US Congress cleared the American Clean Energy and Security Act 2009, or the Waxman-Markey Bill, that seeks to establish a cap-and-trade system for curbing carbon-dioxide emissions. It calls for a 17% reduction in emissions of heat-trapping gases from 2005 levels by 2020 and 83% by 2050. Opponents have argued that the Bill would cause sharp increases in energy costs and the loss of millions of jobs.

However, to ease the passage of the Bill, its proponents agreed to give away 85% of carbon permits for nothing (free pollution permits, known as allowances), with only 15% being auctioned. Most of these allowances, which are set to expire only by 2030, are to electricity utilities and other energy intensive industries. Critics have therefore dencounced the Bill as massive corporate give-away.

Under the cap-and-trade system, industries that emit carbon dioxide would have to buy permits to do so, and a fixed number of permits would be auctioned each year. The permits would be tradable, so firms that found ways to emit less than they were entitled to could sell some of their permits to others. The system would motivate everyone to reduce emissions in the most cost-effective way. I have blogged earlier on the problems that bedevil the European Emission Trading Scheme (EU ETS) and how carbon tax is a better alternative to reducing carbon emissions.

Harvard Professor Robert Stavins though feels that "the allocation of allowances - whether the allowances are auctioned or given out freely, and how they are freely allocated - has no impact on the equilibrium distribution of allowances (after trading), and therefore no impact on the allocation of emissions (or emissions abatement), the total magnitude of emissions, or the aggregate social costs". He claims that firms face the same emissions cost regardless of the allocation method and the choice between auctioning and freely allocating allowances does not influence firms’ production and emission reduction decisions.

Update 1
William Buiter feels that the American Clean Energy and Security (ACES) Act of 2009 is worse than nothing: it is a con and a fraud.

Update 2
Greg Mankiw has this excellent column in the Times explaining the issues in cap-and-trade.

Falling business confidence

The Economist Intelligence Unit's (EIU) assessment of global business-environment (economic and political environment, finance, and infrastructure), captured in its Business Environment Rankings (BER) model, for the next five years for 82 countries points to a worsening of the outlook for more than half the countries surveyed. The model uses quantitative data, business surveys and expert assessments to measure the attractiveness of countries’ business environments. India improved its ranking from 62nd position to 59th, while China jumps 11 places from 56th to 45th for the 2004-08 and 2009-13 periods.



The report indicates that for the first time since the BER were introduced in 1996, the average business environment score for the 82 countries covered by the model is lower for the five-year forecast period (now 2009-13) than for the historical period (2004-08), thereby reversing the long-standing trend of continually improving global business environments as a result of robust growth, liberalisation and infrastructure improvements. The report says,

"The global business landscape will be characterised by greater caution, less liquidity, lower cross-border capital flows, tighter regulation and less risk-taking. Confidence in many countries has been battered, and may take a long time to recover... the deterioration in the global business environment reflects worsening market opportunities, increased macroeconomic and political risk, and problems in financial systems... Annual average global growth in 2009-13, measured at PPP exchange rates, is forecast to be only half the rate achieved in the previous five years at 2.3% compared with 4.6% respectively... The macroeconomic environment will be affected by increased budget deficits and public debt levels (the result of weak growth and fiscal stimulus measures), expected currency volatility and ongoing appreciable risks to asset prices. Poor ratings for the soundness of banking systems, financial sector distortions and impeded access to finance, in particular, will have a significant effect on the outlook for financial systems."

Mounting NPAs in US banks

Floyd Norris points to statistics released by the Federal Deposit Insurance Corporation (FDIC), which reveals that the overall loan quality at American banks is the worst in at least a quarter century, and it is deteriorating at the fastest pace ever. Of the entire book of loans and leases at all banks — totaling $7.7 trillion at the end of March — 7.75% were showing some sign of distress, up from 6.9% at end of 2008 and from 4.1% a year earlier. The report also highlights attention on the increasing troubles of smaller and mid-sized banks, weighed down by the souring commercial real estate loans and mounting losses, exacerbated by the difficulty in accessing credit.

Interpreting Keynes - restoring market confidence

The 'neo-classical synthesis' of Keynesianism and classical microeconomics holds that the economy is Keynesian in the short-run because wages and prices are "sticky" (as initially interepreted by John Hicks in England and Alvin Hansen in the US), while it is classical in the long-run when prices have found their right level. It implies that, to restore full employment, we simply need to realign nominal prices with nominal demand, either with monetary policy to stimulate private spending or with fiscal policy to replace private spending with public spending. Opponents of the Keynesian fiscal policy to stimulate aggregate demand, led by the likes of Robert Barro and Eugene Fama, invoke Ricardian equivalence to argue that government spending will crowd out private expenditure.

UCLA Professor Roger Farmer, in a series of recent working papers and articles, while conceding the usefulness of fiscal policy he argues that the fiscal stimulus induced government spending multiplier is smaller than claimed and presents an alternative approach to address such deep economic crisis. He argues that orthodox Keynesian interpretations of the General Theory misses the story and offers an alternative reconciliation of Keynes with microeconomics that does not rely on sticky prices.

About the problem with fiscal policy, he writes,

Keynes said three things in the General Theory. First: the labour market is not cleared by demand and supply and, as a consequence, very high unemployment can persist forever. Second: the beliefs of market participants independently influence the unemployment rate. Third: It is the responsibility of government to maintain full employment. He was right on all three counts. But he was wrong about something else.

Keynes thought that consumption depends on income... Consumption, and this is two thirds of the economy, depends not on income but on wealth... the theory of the (government spending) multiplier and the implication that fiscal policy can get us out of the current crisis rests on exactly this point... but if income depends on wealth then fiscal policy may be less effective than the Keynesians claim... fiscal policy cannot provide a permanent fix to the problem of high unemployment.

Prof Farmer raises doubts on the Ricardian equivalence claim since its logic "requires that rational forward looking households fully internalize the future tax burden of current fiscal profligacy", an unlikely fact since human "lives are short and not everyone cares for their descendents".

In the first paper, Prof Farmer claims that the equilibrium business cycle theory is flawed and presents an "alternative paradigm that retains the main message of Keynes’ General Theory and which reconciles that message with Walrasian economics". He argues that unemployment will remain trapped at a high level due to two labor market failures - arising from a lemons problem and an externality. The aforementioned two market failures makes it difficult and costly to match unemployed workers with vacant jobs, by not providing "the necessary price signals to ensure that a given number of jobs is filled in the right way". This results in economically and socially inefficient multiple "equilibria in which the unemployment rate is determined by the self-fulfilling beliefs of stock market participants". He writes,

"Firms decide how many workers to hire based on the demand for the goods that they produce. The demand for goods depends on wealth. Every different equilibrium unemployment rate is associated with a different set of prices for factories and machines and the value of these physical assets depends on what market participants think they will be worth in the future. The world economy is currently headed rapidly towards a high unemployment, low wealth equilibrium which was triggered by a loss of confidence in the value of assets, backed by mortgages in the US subprime mortgage market. The inability to value these assets has since led to an amplification of the crisis as panic hit the global financial markets. Even though the US stock market is appropriately valued based on historical price earnings ratios — investors are worried that the value of stocks could fall further... (any further) drop may prove to be self-fulfilling...".

In another working paper, he draws attention to a less costly and more effective alternative to fiscal policy. He feels that the "current financial crisis is an example of a shift to a high unemployment equilibrium, induced by the self-fulfilling beliefs of market participants about asset prices". His arguement is summed up as - "informational asymmetries cause missing markets, missing markets lead to the existence of multiple equilibria, and psychology, in the form of self-fulfilling prophecies, becomes an additional fundamental that selects an equilibrium".

Under such circumstances, a better "alternative might be for the Fed to intervene in the asset markets through purchases and sales of a broad index fund of stocks". He writes, "We need a new approach that directly attacks a lack of confidence in the asset markets by putting a floor and a ceiling on the value of the stock market through direct central bank intervention".

Incentive distortions in fuel economy regulations

Over the past week, both China and the US have adopted stronger automotive fuel economy standards in an effort to increase fuel economy and thereby reduce greenhouse gas pollution from burning gasoline. The Obama administration has announced more stringent Corporate Average Fuel Economy (CAFE) standard - a single standard nationwide, rather than two fuel efficiency standards, one for California and the 13 other states that chose to follow its more stringent Pavley standards, and another standard for the rest of the country under the existing CAFE program.

Harvard Professor Robert Stavins however feels that CAFE is a less effective instrument in addressing the global warming challenge than gasoline taxes or cap-and-trade approach. The former is an one-time levy on new vehicle purchases and thereby affects which cars are purchased, whereas the latter affects both vehicle purchases and the driving preferences. He also sees two other distortions in the CAFE standards approach

1. CAFE standards increase the price of new cars, and thereby have the "unintentional effect of keeping older — dirtier and less fuel-efficient — cars on the road longer". In other words, the CAFE standards increase becomes an example of vintage-differentiated-regulation.

2. CAFE standards decrease the cost per mile of driving and thus exhibits a "rebound effect". "People have an incentive to drive more, not less, thereby lessening the anticipated reduction in gasoline usage".

An interesting research paper by Lawrence Goulder, Mark Jacobsen, and Arthur van Benthem find similar incentive distortions arising from the dual fuel efficiency standards (California and 13 states and the rest) and other state specific initiatives.

1. The interaction between these state-level limits and the federal CAFE standard, gives automakers incentives to offset emissions reductions in the Pavley states with increased emissions in other states.

2. It induces substitutions of used cars for new cars and leads to reduced scrapping of used cars and thereby counteracts the initiative’s GHG emissions reduction goals.

James Kwak has this detailed post about the impact of CAFE standards on manufacturers, car buyers and the economy (jobs etc).

Global banking landscape 1999-2009

How much difference does a decade make? In 1999, the top 20 financial instiutitons by market capitalization was dominated by Wall Street, and few Japanese and Swiss banks.



By 2009, the Chinese had taken over, leaving Wall Street with just four representatives, seven less than in 1999. It looks a more globally representative landscape.



(HT: Steve Hsu)

More linkfest on the crisis

1. Excerpts from a symposium on the economic crisis presented by The New York Review of Books and PEN World Voices on April 30, 2009, which involved the former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, and Robin Wells. They debate what caused the crisis, how far are we along recovery road, end of leverage, Treasury View, global savings glut, structural changes in the economy.

2. Economists and scientists debate the shortcomings of neo-classical economics, how it led to the adoption of practices and recommendations that caused the crisis, and whether science and its tools can help save the world from such crisis. The scientists draw from compelxity science to focus on developing a scientific conceptualization of economic theory and modeling that is reliable enough to be called a science. Economists are not impressed.

3. Wired magazine explores the secrets of Googlenomics and its mentor, Hal Varian.

4. Lectures on econometrics.

5. Atul Gawande joins the debate on health care reforms (specifically, the choice between a single-payer system or a more competitive mixture of public and private insurance) and examines the cost of health care in a Texas town.

6. CEPR has this excellent list of economists who have described the second US stimulus as too small and have called for a third orund of fiscal stimulus in the US.

7. Larry Elliot compares the old and new economics and talks of a vacuum in modern day macroeconomics. Steve Levitt weighs in contending that macroeconomics is handicapped by the relative absence of data (in comparison with micro), which drives economists to mathematical models.

8. Critique of the efficient market hypothesis. But I liked this one from Burton Malkiel, "If you are leveraged 33-1, and you’re holding long-term securities and using short-term indebtedness, and then there’s a run on the bank — which is what happened to Bear Stearns — how can you blame that on efficient market theory?"

9. Reviewing Richard Posner's new book "A Failure of Capitalism", Brad De Long feels that it reflects the eclipse of the ideologies and techanigs espoused by the Chicago School. About the ongoing crisis, he writes, "we need to change the culture of Wall Street by changing how top-earning financial professionals are paid, changing the assets they trade to make the markets less opaque, and changing the risks they run by taking capital requirements very seriously once again. If we accomplish all three, there’s a chance that the next Minsky Moment that comes along will be a minor disturbance rather than a globe-shaking catastrophe for 100 million people. The key irrationality was a private-sector failure on the part of the shareholders and top managements of the banks to make sure that their traders had an appropriate stake in the long-run survival of the bank and not just in constructing a portfolio that would be marked-to-market at a high valuation on Dec. 31. And the government needs, for all our sakes, to compensate for this private-sector irrationality."

10. Fed Chairman Ben Bernanke's speech (full text here) to the Federal Reserve Bank of Kansas City’s Annual Economic Symposium in Jackson Hole, Wyomoing, which analyses the reasons for the crisis and claims that the economy is at the cusp of recovery.

11. Gary Gorton has this explanation of the financial crisis. He writes,

"All bond prices plummeted (spreads rose) during the financial crisis, not just the prices of subprime- related bonds. These price declines were due to a banking panic in which institutional investors and firms refused to renew sale and repurchase agreements (repo) – short-term, collateralized, agreements that the Fed rightly used to count as money. Collateral for repo was, to a large extent, securitized bonds. Firms were forced to sell assets as a result of the banking panic, reducing bond prices and creating losses. There is nothing mysterious or irrational about the panic. There were genuine fears about the locations of subprime risk concentrations among counterparties. This banking system (the "shadow" or "parallel" banking system) – repo based on securitization – is a genuine banking system, as large as the traditional, regulated and banking system. It is of critical importance to the economy because it is the funding basis for the traditional banking system. Without it, traditional banks will not lend and credit, which is essential for job creation, will not be created."

Public policy dilemmas - Town Planning

This post on town planning violations is drawn from personal experience and reflects the dilemmas associated with implementing "black and white" rules in the the "grey" real world. These comments are not intended as judgements or criticisms of rules, but only meant to spotlight attention to the difficulty of administering conventional rules and regulations in a complex society like ours.

The commonest complaint against urban planners is their failure to regulate building violations - set backs, cantilever projections and elevations, parking areas, additional floors/pent houses etc. Under the existing rules, building plans are approved by the Town Planning Department after collecting a security deposit along with the regular building permission fees. This deposit is forfeited if any plan violations are detected. Since violations have become the norm (I can confidently say that 100% of our buildings violate plans!) and security deposit invariably gets forfeited, builders have internalized the security deposit as a form of building fee. They have come to see the security deposit not as a deterrent against violations, but a component of the building fee which accounts for the cost of violations!

Apart from vaastu considerations (the resulting deviations are generally small facade or orientation related modifications), builders deviate from approved plans because it effectively increases the built-up area of their properties or enhances its market valuation. With property and rental values ruling at spectacular levels in cities, any incremental built up area is worth its weight in gold.

With monetary penalties not an adequate enough deterrent, in the last two years Town Planners in a few states have sought to penalize violators by appropriating a share of the built-up area. The builders were mandated to mortgage a small share (say 10%) of their constructed area before the plan is approved, which would revert to the Urban Local Body (ULB) in the event of violations.

However, despite this "draconian" provision, initial impression is that builders continue to violate. Fundamentally, violations occur because either the cost of losing the mortgaged area is not prohibitive (which is less likely) or the belief persists that Government will not enforce the mortgage rule (more likely). Now here comes the dilemma facing policy makers.

The simplest solution would be to immediately get the mortgaged space transferred to the ULB, which could then use it for some public purpose, say a local sanitary or engineering office or a quarter for employees or a community reading room. To drive home the deterrent effect, it can use the space to store sanitation materials, with all the attendant negative externalities on its surroundings! Such a stance would be a clear signal of the Government's resolve to uphold the rule of law.

However, enforcing this will not be easy as it will invariably spawn court litigation besides the usual political and other pressures. Given the fact that the violations will be larger in the bigger apartment and commercial complexes, appropriation of space is likely to adversely impact their valuations. In other words, there is an economic inefficiency dimension to appropriating the mortgaged area. Further, with time and increasing number of plan approvals, administering these spread out properties will become a challenge.

Another solution would be to lease back the space to the builder at market rents, prohibitively high enough in most urban centers. This will be easier to administer (can be collected along with property tax), besides earning substantial revenues to the ULB. But this course of action will effectively monetize the penalty, thereby carrying the moral hazard of condoning the violation of rules. Under this dispensation, the builders will continue to deviate, so long as the economic benefits from the violation exceeds the expenditure on the rent.

Under the circumstances, what should the government do? Both the possible choices, and their variants, have ramifications that go beyond the immediate stage one. In many ways, this dilemma is typical of the many that face policy makers on a regular basis. Most often the choices are a reflection of the inevitabilities and complexities of social and political realities in India.

Flexible labor markets and the co-relation of economic growth

The steeply rising US unemployment rates in comparison to the relative calmness and stability in labor markets across Europe, despite the much bigger adverse shock on the real economy in the latter, raises questions about the superiority of the much trumpeted flexible labor markets in the US. In fact, unemployment in the US appears set to go past that in the EU 15, with the March rate for the United States (8.5%) being higher than the rates of 11 of the 15.



In an excellent post, John Quiggin questions the efficiency of the America's labor markets with the flexibility it affords to hire and fire workers, on the grounds that the variance of unemployment rates is minimal. Quiggin writes, "Generally speaking, employment protection laws lower the variance of employment and unemployment but have no clear effect on the average levels." In other words, the EU unemployment rates while being higher in expansions, will be lower in contractions. He also feels that, when comparing US and the EU, "there is a sharper class divide, and less social mobility in the US than in the EU".

As Floyd Norris writes, the resilience of uenmployment rates in EU can atleast partially be attributed to the social "safety nets in many Western European economies (which) made it easier for people to keep their jobs as the economy declined".

As the ongoing crisis unfolds, as many hallowed principles of economic theory bites the dust and as conventional wisdom takes bruising knocks, it is becoming increasingly clear that the rising tide of global economic growth over the past two decades concealed the worm of disaster. Co-relations were mis-interpreted for being causations and economic theories were constructed on very brittle edifices. The more definitive test of a theory is when subjected to adversity and how it responds during an economic crisis.

Update 1
Lane Kenworthy comes to much the same conclusion by comparing the employment rates for the two most recent business-cycle peak years - 2000 and 2007 - during which the US was one of just a few nations where employment rates declined.

Update 2
Even as Euro area unemployment rate rose to 9.2% in April 2009, here is a NYT op-ed on how labor market de-regulation may be coming to an end in Europe and workers protections and greater unemployment insurance is going strong.

Changing face of Central Banking

I had blogged earlier about how Central bankers across the world had come to believe that they had to merely to calibrate their interest-rate tools (the short term, overnight, money market rate, whose changes in turn got transmitted across the interest rate chain) to keep a lid on inflation, thereby ensure financial stability and full employment, and smooth over the business cycle. However, as the sub-prime mortgage crisis showed, this "inflation targetting" approach failed to prevent the build-up of imbalances that presaged the crisis and was insufficient in dealing with failing banks and financial-market stress as the crisis developed.

The Economist points out has a nice summary of the changing role of Central Banks. A few od the observations here

1. Central Banks, led by the Federal Reserve, have turned from being lenders of last resort to "become lenders of first resort when banks stopped trusting each other. They are, increasingly, arbiters of which types of borrowers get credit. With the reputation of market discipline in tatters, central bankers will get vast new supervisory powers. All this is dragging central banks back towards political turf from which they had been distancing themselves for years."

2. Now, with recession deepening, interest rates touching the zero-bound, credit markets frozen up, and deflation taking hold, Central Banks have run out of conventional monetary policy options. Deflation and not inflation is the main enemy. The global savings glut and credit squeeze broke the link between short and long-term interest rates. The Central Banks have resorted to a number of unconventional responses, "expanding their lending operations through a mixture of more types of credit and collateral, longer terms and more counterparties", as outlined below.





3. Central Bankers embrace of macro-prudential regulation to prevent the build-up of endogenous systemic risks is a reversal of their hitherto held position "to shed supervisory duties and concentrate on monetary policy". Supervision was seens as a "distraction from the pursuit of price stability and created potential conflicts - a central bank might run an inflationary policy to cushion a failing banking system, or prop up an insolvent bank to cushion the economy".

Finance and its negative externalities...

... deserves to be taxed! So writes Martin Wolf (via David Leonhardt),

The UK has a strategic nightmare: it has a strong comparative advantage in the world’s most irresponsible industry. So now, in the wake of the biggest financial crisis since the 1930s, the UK must ask itself a painful question: how should the country manage the cuckoo sitting in its nest?...

... The fiscal costs of this crisis will be comparable to those of a big war... Loss of jobs and incomes will also scar the lives of hundreds of millions of people around the world. All this occurred, in part, because institutions replete with highly qualified and highly rewarded people were unable or unwilling to manage risk responsibly.

[W]hat framework is needed to ensure that the operation of the financial sector is compatible with the long-run health of the UK and world economies? Quite simply, the sector imposes massive negative externalities (or costs) on bystanders... So how should one manage a sector that produces such 'bads'? The answer is: in the same way as any polluting activity. One taxes it.

And about the way ahead for Britain (and this applies for other economies), he has five recommendations - global regulation to prevent regulatory arbitrage; ensure that owners and managers of financial institutions internalise most of the costs of their actions; reject egregious special pleading (on the pretext of maximizing innovation) from the industry; diversify the economy away from finance; and ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state.

Green shoot of an L-shaped recovery?

The latest report on economic prospects from the San Francisco Federal Reserve indicates that, unlike the V-shaped rebounds of previous recessions, this time around the recovery will be a slow and painful process. More graphs on the US economy are available here.



(HT: Economix)

Updates 1
Boston Fed too sees slow recovery. And Cleveland Fed examines the movements of yield curves and feels much the same.

Management of Chinese reserves and the US-China "co-dependence"

One of the most fascinating sub-plots in the global economic drama over the next few months would be over how the Chinese government manages its foreign exchange reserves, especially its investments in dollar denominated assets and US Treasuries. Over the past few months the Chinese accumulation of forex reserves has slowed, thanks to the decline in global trade, but its purchases of US Treasuries (though not of agency debt like the fixed income securities issued by US government backed entities) have continued to grow, though at a much slower rate than the ballooning borrowing needs of the US Treasury. It has been estimated that 82% of China's foreign reserves are in dollar denominated assets.





The global de-leveraging has resulted in a massive flight of capital, from both American and from other country financial institutions, to dollar denominated assets and the US Treasuries. At a time when the global markets have been paralyzed by deep uncertainties about counter-party risks, the US Treasuries have offered the attraction of safety and liquidity, despite their low yields.

But there have been interesting shifts in recent months. First, the Chinese have been selling the debt of US government-sponsored enterprises like Fannie Mae and Freddie Mac and substituting the same with US Treasuries. This has created the impression that the Chinese are continuing to finance the major share of US borrowings, despite the fact that it has effectively stopped putting fresh money into dollar assets. Second, as concerns mount about the soaring US deficits, the Chinese government has also been swapping its investments in long term Treasury Bonds for short-term T-Bills. As NYT writes, "This gives China the option of cashing out its positions in a hurry, by not rolling over its investments into new Treasury bills as they come due should inflation in the United States start rising and make Treasury securities less attractive."

There are two contrasting opinions on the impact of possible movements of Chinese reserves. The view that burgeoning US deficits could unleash inflationary pressures and frighten Chinese investors away from US Treasuries and into other currency bonds and thereby force up US interest rates is nicely articulated by David Leonhardt. All this would in turn prolong the recession.

Paul Krugman takes issue with this and argues that when faced with a liquidity trap, which means "an incipient excess supply of savings even at a zero interest rate" or "too large a supply of desired savings". Further, the declining trade and current account deficits and upward shift in domestic household savings will keep this supply of savings coming for some time to come. He argues that if China draws down these surplus reserves (or its accumulation of reserves slows down) to spend more, it will only boost the global aggregate demand and increase trade and thereby help the US economy. If it only shifts these reserves to other currencies, it will only weaken the dollar and boost US exports. Either way, it will not be doomsday scenario as predicted by many. And in any case, if the Chinese do start pulling out of US Treasuries, it will only drive down the Treasuries, thereby forcing them to take big hits on their investments, which presently earn nearly $50 bn in income every year.

In the final analysis, global macroeconomic imbalances triggered off by the global "savings glut" can be eliminated only if the US moves from being a consumption nation to saving more, and the emerging economies, especially China, saving less and consuming more. As David Leonhardt writes, "Americans became hooked on cheap goods and cheap money, and China came to depend on the income from selling those goods." Now to remedy the imbalance, China must become hedonistic and Americans thrifty! However, the trends are not encouraging with the Chinese consumer spending declining to 35% in 2009, down from 40% in 2004 and almost 50% in the early 1990s. By comparison, the share is 54% in India, 57% in Europe and 70% in the United States.

Analyzing school achievement gap in the US

Two reports - by the McKinsey and the annual survey of Programme for International Student Assessment (PISA) of the OECD countries - highlight the poor quality of schools and student achievement in the US and its impact on economic outcomes. It also finds that achievement gaps get bigger the longer children have been in school; socio-economic standing is a strong predictor of educational attainment, much more than in many other countries; and it aggravates economic inequality. The McKinsey report also finds that this education achievement gap imposed a cost amounting to 9-16% of GDP in the 1983-98 period, equivalent to a permanent depression in the US.

There are many reasons for failing schools. As Clive Crook writes, "Local financing of schools means that students in rich areas are lavished with resources, whereas schools in poor areas are often starved... Teachers’ unions have a death grip on the system and are having none of it. In many parts of the country, sacking a teacher, however incompetent, is next to impossible." He feels that the way forward is to bring in accountability and competition by offering alternatives to failing schools through the likes of self-governing charter schools and school vouchers.

On a different note, Lane Kenworthy feels that "schools don’t increase inequality; they just don’t do enough to overcome the inequality produced throughout childhood by differences in families, neighborhoods, peers, and other influences" (genetics and environmental differences). He draws attention to the studies by cognitive psychologist Richard Nisbett who writes that "much, if not most, of the gap in academic achievement between lower- and higher-SES children, in fact, is due to the greater summer slump for lower-SES children". In other words, the cognitive skills of children in lower socioeconomic status (SES) households tend to stall or actually regress, whereas those of children from high-SES households, who are more likely to engage in stimulating activities, fare much better during the summer.

In any case, the importance of schools and its quality is clearly established as the vital determinant in determining school achievement and economic outcomes.

Treasury View is back and why it is wrong

The long discredited Treasury View of government spending that claims that stimulus plans do not add to current resources in use but just move resources from one use (private spending) to another (government spending), is again being heard. I have blogged on it earlier here.

Niall Ferguson and Kevin Phillips are the latest to join the fiscal expansion is contractionary bandwagon. While they argue in favor of massive liquidity injections (as advocated by Milton Friedman) to avert a banking crisis, they reject Keynesian stimulus spending by running up massive fiscal deficits. They claim that the stimulus spending will increase the public debts and fiscal deficits and thereby trigger off inflationary pressures and force up interest rates. The fiscal expansion then ends up being a contraction.

Both Paul Krugman (and here) and Brad DeLong have argued that when the economy is facing a liquidity trap this view is incorrect and both Monetarist liquidity injections and Keynesian fiscal stimulus are necessary. They claim that when the interest rate is near zero monetary expansion and deficit spending do not offset but reinforce each other.

Their arguement is based on the reality that the banking system has stopped performing its natural role of buying bonds from corporations, which in turn uses the proceeds to invest in their plant and equipment. In the circumstances, the only alternative is for Government to step in. As Krugman writes,

"By buying a lot of private securities, the Federal Reserve is... playing the role the private banking system is no longer playing properly... debt-financed spending on infrastructure by the Obama administraition is filling the hole left by the collapse in business investment... It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending... until the excess supply of savings has been sopped up... [and the interest rate consistent with full employment rises above zero]".

In other words, there is no excess demand for savings to drive up interest rates. Scott Sumner weighs in here. Excerpts from the recent PEN World Voices debate on how to deal with the crisis is available here.

Google's home electricity usage software

Google is partnering with eight electricity distribution utilities across the world (including Reliance Energy in India) to use its PowerMeter software that will intearact with the "smart meters" (or automatic meter reading instrument) to provide (in their computer screens) real time information on electricity usage information for consumers. They in turn can optimize and minimize the use of their devices, according to the grid availability and the Time of Day (ToD) tariff rate for that period. PowerMeter, which is presently undergoing beta testing, has a graphix-rich, web-enabled interface for consumers to view their energy use profile.

More banking regulation proposals

William Poole has this market based, cycle-proof banking regulation proposal,

"As a condition of enjoying the benefits of a bank charter, every bank must issue 10-year subordinated notes equal to 10 per cent of its total liabilities. The specification can be adjusted, but this one serves to illustrate the proposal. The subordinated debt would be unsecured; holders would stand last in line among all creditors in the event that a bank had to be shut down. The sub debt requirement would be in addition to existing requirements for equity capital.

Genuine reform requires that four minimal requirements be met, and the sub debt proposal qualifies. First, banks need more capital to protect the federal deposit insurance fund. Second, there must be more market discipline: each bank would be forced to roll over maturing sub debt equal to 1 per cent of its liabilities each year. Third, financial stability requires that a bank not be subject to runs. Sub debt cannot run, because of the 10-year maturity.

Fourth, and critically important, some creditors and not just equity owners must be at risk, which is clearly the case with sub debt. Sub debt provides much more market discipline than equity, because a bank in trouble with a weak share price is not forced to do anything. Maturing sub debt, however, does discipline the bank and if the bank cannot roll over the debt, it must shrink by 10 per cent to live within its remaining outstanding sub debt. This system is stable because any bank can contract by 10 per cent within a year by letting loans run off and/or by selling other assets. It is highly desirable that contraction be managed by the bank itself and not by regulators."

Do gymnasiums lower crime?

I had blogged earlier about the findings of a study that the "proliferation of violent films (in the US) have contributed towards making the streets safer by keeping violence prone individuals inside film theatres". It was found that these films and crime serials in television, aired during times when crime vunerability potential are the highest, keeps potential criminals entertained indoors and keeps them out from indulging in crime. In other words, such violent crime movies and television soaps, "crowds out" crime.

Taking cue from this behavioral insight, I have a feeling that well equipped community gymnasiums can help deter crime in cities. It is typical of our cities, especially the poorer neighbourhoods and slums, for the unemployed youth of the locality to hang around in groups. In the absence of any anchor activity and location for hanging out, such groups get pushed into the crime infested under-belly locations of the slums where they socialize swiftly into becoming criminals.

It is in this context that gyms can offer both the location and activity to nudge such vulnerable youth away from crimes. Such gyms would provide a socially accepted and legal outlet for letting out the pent-up energies of crime-prone individuals. Municipal and police authorities in Indian cities should therefore be looking at encouraging the construction of gyms, especially in crime prone localities, as part of their crime prevention strategies.

Why card-based utility payments have not taken off in India?

It is unfortunate that internet based payments, despite its relative convenience when compared to physical across the counter payments, for utility services like property tax, water and sewerage tax, electricity and telephone bills have not taken off in India as expected. Across the country, online payments, through credit or debit cards, have been a small fraction of the total collections, even in urban centers and in well run public utilities.

For the past six months, we have been trying to introduce mobile based utility payments in our distribution utility (APEPDCL). Numerous meetings have been held with all the major payment service gateway providers and major public and private sector banks and numerous proposals have been initiated, though nothing has taken off.

Lack of adequate awareness and apprehensions about the security of such transactions, coupled with the difficulty of accessing the service, are partially responsible for the poor customer response. However, the major deterrent to more widespread use is the transaction value indexed user fee (as opposed to a flat rate) imposed on such transactions. In many ways, this user fee model is an excellent example of monopoly power and inefficient incidence of taxation.

A consumer wants to make his electricity bill payment online through his credit card. The credit card company (Visa and Master Card are the two major retail electronic payment network operators in developing economies like India) charges him a fee of 1.75% (or in the range) of the transaction value plus the service tax (12.36%) on the said fees. This means that consumer A, with a Rs 100 electricity bill has to pay a fee of Rs 1.75 to the card company, and consumer B, with a Rs 10000 bill has to pay Rs 175. In other words, the absolute value of the transaction fee increases with the value of the utility or service bills. This leads to incentive distortions and causes all round inefficiency for a variety of reasons, a couple of which are outlined below.

1. The transaction fee as a percentage of the bill amount dis-incentivizes the larger bills, while incentivizing smaller ones. This is likely to result in a large number of transactions of small amounts and a limited number of larger value transactions. However, since smaller bill value consumers like A are less likely to use credit card and internet to make their payments, than consumers like B, even the small value transactions do not materialize. Further, the higher bill consumers are more likely to use the services of people who can run the errand of physically remitting their bills at the collection counters.

Since these transactions are processed on-line, from the respective customer accounts, the actual transactions costs are the same (one would presume that the costs associated with such transactions are the same) for every transaction, irrespective of the amounts involved. It therefore stands to reason that the transaction fee should also be the same, or atleast have an upper limit. It is clearly evident that the high transaction fees are distorting the incentives and keeping away customers.

2. The consumers with the larger payouts make payments through their bank accounts or mainly through cash payments at the electricity utility's collection centers. Both have transaction costs, for both the consumer and the bank, and the latter is an extremely inefficient option. In case of cash payments, the consumer has to physically withdraw the cash, thereby imposing costs on both himself and the bank, and then make payments at the counters, which involves significant transaction and opportunity costs for both the consumer and the utility.

Changing the revenue model for credit/debit card payments for public utilities from a percentage based to a flat rate based system will be a Pareto improvement. The number of customers using the facility will multiply, the credit card service provider and banks will make more money, the collection efficiency of the public utilities will improve, the considerable transaction costs involved in across-the-counter payments will be minimized, and consumer satisfaction will invariably increase.

Utilities are also restrained by regulatory restrictions in either passing on the cost of the card transaction or bearing it itself. Private businesses selling goods and services on-line do not pass on the cost to the consumers and bear the transaction fee themselves or have some (of which I am not aware) arrangement with the network operators.

Portugal succeeds with decriminalizing drugs

Freakonomics draws attention to a study of the Portuguese decision in 2001 to decriminalize drugs (full paper here), which finds that it has reduced drug use, HIV infection rate from addicts sharing dirty needles, increased the number of people seeking drug treatment, and helped re-assimilate problem drug users into society.

Under this legal dispensation, drug possession for personal use and drug usage itself are still legally prohibited, but violations of those prohibitions are deemed to be exclusively administrative violations and are removed completely from the criminal realm. People caught with small quantities of drugs were no longer sent to prison, but were sent to rehab centers.

Update 1
Freakonomics debates decriminalization of marijuana here.

Cost of obesity and a Pigouvian tax on obesity

David Leonhardt has a nice post in Economix, which points out that in the US, the prices of many unhealthy foods like soda, butter and beer have declined in real terms over the past three decades, whereas that of healthier vegetables and fruits have risen substantially.



The Rand Corporation, using their Future Elderly Model, has estimated that obesity costs the US federal government $40 bn every year.

As the obesity challenge becomes ever more serious, the calls for Pigouvian obesity taxes - sugar-sweetened beverage excise tax, soda tax etc - have mounted. Kelly Bronwell and Thomas Frieden have studied the harmful effects of consumption of sugared beverages and the price sensitive nature of soda consumers, and have proposed a soda tax.

Proponents of such taxes argue that it will both disincentivize activities and products causing obesity and generate revenues to cover costs incurred by the government due to obesity.

On a contrarian note, I had posted earlier about how exorbitantly higher taxes, esecially on alcohol and tobacco, ends up increasing crime rates.

Update 1 (28/9/2010)

Study finds obesity is contagious.

Update 2 (7/10/2011)

Freakonomics reports that Denmark became the first country to impose a nationwide fat tax. From now on, foods in Denmark with saturated fat content above 2.3% will be taxed 16 Danish kroner ($2.87) per kilogram of saturated fat; which works out to a tax of about $1.28 per pound of saturated fat.

Halliburton then, BlackRock now?

Every crisis has a silver-lining for a "select" few. Halliburton profitted from the invasion of Iraq. Now a little know money manager BlackRock, has emerged as a "suspiciously ubiquitous" advisor, contractor and fund manager for the massive US banking bailout plans.



It now manages $1.3 trillion in assets for big private clients, including hedge funds and foreign governments. It has won contracts to manage the rescues of Bear Stearns, Citigroup, and AIG, besides a contract to help Fannie Mae and Freddie Mac. The all-pervasive role of BlackRock in bailouts has raised questions about whether "its roles as government adviser, giant federal contractor and private money manager will inevitably collide".

As NYT asks, "Can a company that is being paid to price and sell troubled assets for the government buy the same kinds of assets for private clients without showing preference? And should the government seek counsel from a company whose clients stand to make or lose billions if those policies are enacted?"

BlackRock is expected to be one of the primary private beneficiaries in the Public Private Investment Program (PPIP), the $1 trillion federally subsidized plan to purchase troubled assets from banks in parnership with private investors. In any case, if even recent history is any indicator, there may be many skeletons waiting to tumble down from the BlackRock cupboard!

Assessing judicial interventions in public service delivery

One of the strongest justifications for having an active and impartial judiciary in a developing country is the need to protect the poor and under-privileged from the excesses of executive action at all levels. Is the objective being served? Are our courts successful in protecting these categories of citizenry from being harassed by executive fiats and the capriciousness of officials and politicians? Or have the courts, like the other esteemable organs of our Government, lost their way in this quest? In other words, have courts too fallen prey to the same vested interests whose sway over the other organs of governance have strengthened?

Judicial oversight is expected to restrain executive lapses that transgress the legal and natural rights of citizens, and ensure that natural justice is delivered. The presence of judicial check reassures the citizens against exploitation and harassment by the various organs of government with which they have regular interface - town planning, property registration, taxation, electricity, local body certifications, revenue (District Collector), and the police.

Anybody who has worked in local bodies or public utilities or taxation or registration or land administration (revenue) departments, would acknowledge the frustration that comes from administering the large numbers of cases where massive amounts (or lands and buildings) get locked up in court litigation for procedural lapses (by government department, often willful, so as to help the evaders) where the substance of violation is clearly established. Thus buildings without plans continue to exist, wholesalers and businesses evade commercial and income taxes, established government lands remain in private possession, public utilities are restrained from disconnecting the services of defaulting users, and so on.

But such judicial powers are a double edged sword, in so far as the possibility of its misuse is considerable, especially with the existing socio-political and socio-economic power structures. Armed with intelligent and well-connected lawyers (who are naturally more likely to be incentivized by money than any altruism), it becomes possible for those who can afford the price, to help the courts interpret law in their favour, often at the cost of public good.

It is natural to expect them and those with malafide intentions to use every means available to legalize the status quo. It is in the interest of a land grabber or tax evader or violator of building rules to freeze, temporarily atleast, his illegal gratification in the form of say, an interim court direction. The absence of effective sun-set provisions to such directions, and the near impossibility of getting such them vacated, means that these interim directions are more than temporary. And as the famous aphorism goes, "justice delayed is justice denied".

The inherent nature of interpreting principle of natural justice and the negative legacy of government service delivery means that the benefit of doubt gets invariably given to the petitioners. While this is evidently just in the case of those citizens whose rights are transgressed by the executive, it comes as a smokescreen for violators and evaders to push through (or get pushed through) their claims. This also provides a convenient alibi for decision makers to protect the status quo and assist vested interests.

It may be worth the exercise if someone could collect data on government-citizen cases in the High Courts, Supreme Court, and lower courts over the past decade, and analyze it to identify trends and patterns in court decisions. The analysis could look at how and in whose favour these cases are disposed off, comparing the durations of trial in cases where the citizens and government are plaintiffs, the durations of the interim stays given on these cases, comparing the final and the interim orders, the socio-economic profiles of the parties and the nature of decisions in each case etc.

It will also be interesting to have studies which analyze the transaction costs - time, money, difficulty of access etc - faced by litigants in approaching the higher judiciary. One could also analyze the details of cases, in say land title claims by private individuals or tax/property evasion or building violations, where government is the appellant/petitioner and see how many cases have been won by the Government.

At the risk of making a judgment, I am inclined to believe that government agencies contest lower court decisions only if there are substantial grounds supporting their claim. The benefit of doubt is generally given the petitioner and the case closed wherever the lower courts rule in favor of the petitioner. This would only logically increase the probability that the final verdict in such appeals should be in favour of the government. However, an analysis of the final orders in such cases indicates that government generally ends up losing the vast majority of even such cases for a variety of reasons, most often unrelated to the substance of the case (and related to the procedural lapses committed by the government agency).

One suggestion that could go a long way in improving the performance of Indian courts would be the introduction of a sunset clause for all interim directions of the courts.

Big Government and development

William Easterly writes that "Development doesn't require big government", and he is as wrong as his ideological opposites who claim the supremacy of the "big government". The likes of Prof Easterly emphasise the importance of the market over Government in pulling nations out of poverty. They argue that development can be achieved by promoting entrepreneurs and freeing the space for innovators, and unleashing the enormous creative potential of poor people.

It is plain misleading to attribute the "homegrown success in Botswana, the East Asian tigers, India, Chile, Turkey and China" as victory of the market-led development strategy. Far from it, the respective governments played aggressively interventionist roles in both proactively allocating resources ("picking winners", to use the much abused phrase), across sectors and classes of peoples, and creating the opportunities that enabled the market mechanism to succeed. Development comes neither from exclusively following either state-planned investment nor from government vacating space for the market forces to play itself out.

For a start, let us take Prof Easterly's example of entrepreneurs. Entrepreneurs require access to capital, technology and skills, both for himself and his labour, apart from an enabling legal framework that can help enforce contractual obligations in his commercial transactions. All these are absent or at best have marginal presence in many of the least developed nations.

It is now universally accepted that governments should provide rule of law. Over and above that, examples from across history - the US, Europe and more recently Japan and Asia-Pacific - show the critical role played by governments in directing capital, catalysing or developing and sharing technology, and supplying skilled labour and professionals. In fact, there are no known examples where the market has played the dominant role in the provision of all these ingredients during the inital stages of development.

From the supply side, where are the market and its participants in these least developed economies? In all these economies, the market is in its incipient stage, limited in its depth and breadth. In fact, it is inconceivable that the private sector can provide these linkages in any of these developing nations, for any time in the near future.

In this context, it is also important to subject to closer scrutiny the romanticised notions of the poor and ordinary people and their "peculiar aptitudes for solving the problems of their own time and place". Yes, everyone has entrepreneurial drive and it is important that we have in place policies that promote them. But mere promotion, without having in place the other ingredients, will, at best open up and diversify the opportunities for survival, as the example of Self Help Groups (SHGs) in India have shown. The same example also gives ample evidence of the limitations of such strategies, as discussed here and here.

World disaster map

If a newly released UN study that compares different types of natural disasters against population and economic trends is any indicator, India is the global epicenter of risk of death from such disasters. And within the country too, its Himalayan frontiers look especially vulnerable.



The report also finds that a prime factor contributing to increased vulnerability is urbanization, with about one billion people already crammed into what are euphemistically called "informal" settlements in and around cities, better known as slums, and 25 million more moving in each year. These communities are usually built on steep slopes, floodplains or other vulnerable spots.

Industrial policy and emerging economy growth

The ongoing global economic crisis has focussed attention on the role of global macroeconomic imbalances, manifested in the massive savings and trade surpluses run up by the developing countries which finances the voracious consumption appetite of developed world consumers. It has therefore raised doubts about the sustainability of the export-led, reserves-amassing East Asian growth model.

The success of these developing economies have come from diversification into manufactured and other modern industrial goods, following what Dani Rodrik calls "productivist" policies - undervalued currencies, industrial policies, and financial controls. The events of the recent months have exposed the limitations of this growth model, especially for the medium and large-sized developing economies. An undervalued currency, while subsidizing the production of manufactured goods (by making exports competitive), also taxes domestic consumption (by keeping imports costly).

Prof Rodrik feels that the twin objectives of global macroeconomic stability and economic growth in developing countries can be simultaneously achieved if the domestic demand in these economies expands along with economic output. The developing countries can then allow their currencies to find its real market value and still maintain their competitiveness through targetted investments in infrastructure and explicit industrial policies.

Thus developing countries can "grow rapidly even if world trade slows and there is reduced appetite for capital flows and trade imbalances" through a two-track policy of stoking domestic demand and targetted industrial policy. As Prof Rodrik says, "developing countries will have to substitute real industrial policies for those that operate through the exchange rate... Greater use of industrial policies is the price to be paid for a reduction of macroeconomic imbalances." He also exhorts organizations like the WTO to be more tolerant of such industrial policies.

Instead of indulging in semantic jugglery about conditional probabilities, as William Easterly does with his examples of Latin America and Africa, it may be more sensible to take cue from Dani and study the conditions under which such industrial policies are likely to be successful. And, while pursuing such policies, it is of critical importance to keep in mind the dangers of creeping protectionism, in the guise of "industrial policy".

Update 1
Robert Reich joins the debate on industrial policy asking whether, "Could chunks of the old auto industry be adapted to producing high-speed rail or, more generally, highly-efficient people-moving systems of the future or, even more generally, green technologies that support such systems?" He talks of the "need for a broader and more imaginative approach to industrial policy - one that integrates all the different ways government influences industry, and achieves overarching public goals".

Mark Thoma feels that such direct intervention policies could end up creating distortions and prefers governments to put in place incentives that drives businesses to the desired outcomes. He also feels that given the high unemployment rates, the government could do more than it has done in the past to insulate workers from the effects of structural change and to speed the transition.

Infrastructure delays and second-best solutions

The Businessline argues that the UPA government achieved less than 40% of the target in roads, ports and power sectors due in large part to the bureaucratic restrictions imposed by the Planning Commission, especially in the bidding process. This blog could not agree more and has posted extensively on the same here, here, here, here, here, and here.

First, it took a long time to formulate the model concession agreements or contract principles. Then the stiff technical qualification norms outlined in the RFQs imposed high entry barriers that both minimized competition and opened up litigation from those excluded. The result was re-tenders and delays.

Now, theoretically and going by the principles of the World Bank and other agencies, the Planning Commission cannot be faulted for adopting the best practice of globally accepted tendering standards. But in the real world of developing economies with their numerous supply side constraints, such best-practice models end up being "the enemy of the good"! In the circumstances, second-best models offer more effective alternatives.

However, unfortunately there are no specific set of second-best alternatives that can be used across the board for resolving these problems. Less bureaucracy will surely help reduce delays and expedite bidding out projects. But any such dilution will have to be balanced with stringent mechanisms to ensure that the outcomes are not compromised or distorted, as the Hyderabad example demonstrated.

Economic Gangsters

I have been reading Ted Miguel and Ray Fisman's interesting account of corruption in economies - Economic Gangsters. They have tried to capture the different ways in which economic gangsters try to game the market to their benefit, and how such corrupt practices can be detected and reported. A couple of examples of the methods that can be used to measure corrupt practices include

1. Tracking the variations in share prices of companies whose fortunes are allegedly closely tied with that of the ruling clique. The difference between the variations of the market and that of the specific share, in other words the beta, is an indicator of the extent of nepotism and corruption involved. As the hold on power of the ruling establishment weakens or when the ruler suffers from ill-health, the fortunes of those dependent dips and this is often reflected in the decline in share prices of those companies.

2. Difference between the records of the volume and amount of materials exported from a country to that received by the importing country gives an idea about the extent of smuggling. This difference is accounted for by either under-reporting the quantity and/or price at the importing port, or by reporting a substitute good with lower import tariffs.

Both these parameters can be useful for policy makers in identifying and then taking necessary action to contain the activities of economic gangsters. I have already posted about their (and others) arguement about how adverse commodity price movements or weather shocks increases the probability of civil wars by as much as a third.

I can easily think of another indicator that can similarly both measure and locate "black money" within Indian economy - real estate transactions. The records of land transaction values from the Registration department can be compared with the available information about the prevailing market values, to identify both the location and the extent of money that has found its way from and into the parallel economy.

Congestion pricing in airports

Freakonomics draws attention to the decision by the Transportation Department of New York to cancel its plans for auctioning off slots at the three city airports, so as to reduce congestion and attendant delays. Strong backlash from airlines and industry groups, coupled with lawsuits and a court-ordered stay, are being held responsible for the decision.

However, I feel that this postponement is only temporary, especially since it appears that further investments in modernization can achieve very limited capacity addition to handle more flights. Under such circumstances, as Econ 101 teaches us, price rationing is the only way to allocate scarce resources. Congestion pricing is already successful in road use in cities like London, and would (as in the case of New York's three airports) efficiently allocate airline usage both across multiple airports and different times of the day.

The net economic benefits (for passengers, airlines, and the environment) associated with reduction in delays for arrivals and departures, shorter aircraft taxiing times for both take-off and landing, and ease of getting to the airport, would more than off-set the costs imposed by an appropriately tailored congestion pricing scheme.

Social sector spending and inequality

Economix (via the OECD - Society at a Glance 2009 survey) has a nice graphic which captures the relationship between social sector spending as a proportion of Net National Income (NNI) and the Gini coefficient among all OECD nations.



The graphic appears to show an inverse relationship between inequality and social sector spending. For the 30 OECD members, public social spending accounts for an average of 24.4% of net national income, and the average Gini coefficient is .311, whereas the same for the United States are 18.1% and .391 respectively. Predictably, the Scandinavians are at the other end of the spectrum.

Monetary policy transmission challenge

The Fed may have lowered the federal funds rate to virtually zero, but the real rates faced by various private decision makers - credit cards, car and other personal loans, mortgages, municipal bonds, corporate bonds etc - remains high, more so since inflation has also fallen. The monetary policy may have been notionally expansionary, but has in real terms been anything but.





This is similar to the challenge facing the monetary authorities in India, though the underlying reasons vary. Though the Reserve Bank of India (RBI) has cut the short-term repo rates by 425 basis points since mid-September and the reverse repo rate by 275 basis points, it has hardly offered any relief to borrowers. As is clear from the figure below, the benchmark prime lending rates (BPLR), a reference rate for bulk of loans, banks haven’t reduced their lending rates even by half as much as the reduction in policy rates, with private and foreign banks being far slower in cutting their benchmark rates.





The credit squeeze has also led to other structural distortions in the credit pricing mechanisms. Though the BPLR is a floor rate, charged to borrowers with highest credit ratings or prime customers, banks have been charging top-notch corporate steep discounts below BPLR and retail borrowers or SMEs well above the benchmark. With the bulk of loans being advanced below BPLR, the BPLR has become a "non-transparent tool of credit pricing" and impedes the smooth transmission of monetary policy signals. The band within which the lending rates vary, for different categories of customers with similar credit profile, is too large to be reflective of a sound credit pricing market.

Update 1
All banks will have to adopt the 'Base Rate' system in place of the current Benchmark Prime Lending Rate (BPLR) system from April 1, 2010. The Base Rate, applicable for all new loans and for those old loans that come up for renewal, will be the minimum rate for all commercial loans and banks will not be permitted to resort to any lending below this rate.

Base rate will comprise cost of deposits, adjustment for the negative carry in respect of CRR and SLR, un-allocable overhead cost for banks and profit margin, among others. The RBI has said that the actual lending rates charged to borrowers would be the Base Rate plus borrower-specific charges, which will include product-specific operating costs, credit risk premium and tenor premium.