Monday, August 30, 2010

Analyzing the impact of UDRS

Umpire Decision Review System (UDRS), the arrangement under which decisions of on-field cricket umpires can be referred to the off-field umpire for review by either team, has generated an intense debate. A behavioural analysis of the system reveals two interesting possibilities.

1. Aware of the possibility of reviewing a bad decision, there is the likelihood of the on-field umpire relaxing slightly. He may be more hesitant, and even err on the side of caution and rule not-out, on knife-edge decisions. Will the quality of umpiring therefore suffer?

2. Bowling teams are certain to target their limited allocation of reviews on the best (or the in-form) batsmen from the opposing team. This means that batsmen like Sachin Tendulkar can expect to have a review on most appeals turned down by the umpire. This effectively deprives them of the beneficial side (from the batsman's point) of the law of averages, and leaves them always on the negative side (though the batsman could himself subject atleast some of the negative decisions to review). The batsman is more likely to miss some negative decisions than the bowling side is likely to miss an escape!

Hitherto they benefited both from a reputational intimidation generated reluctance (when compared to other batsmen), however small, of umpires to rule them out without being doubly sure, and from enjoying the beneficial side of law of averages (like everybody else). UDRS and the near-certainty of review virtually eliminates these benefits.

However, there is also the possibility that the availability of UDRS (and the near-certainty of its use in case of an appeal being turned down) will increase the likelihood that umpires to play-safe with decisions involving superstar batsmen. Which of these two trends will prevail? Since superstar batsmen and form players will always be the target of UDRS, does this mean batting averages will fall?

More on the supply constrained Indian economy

Following on about the debate on supply constraints and an over-heating Indian economy, the graphic below shows that the growth rates in cement, steel, and electricity generation (the three critical inputs in capital investments) all remained well below the nominal GDP growth rates for most of the last decade.

Saturday, August 28, 2010

Chinese aid policy in perspective

Ironically enough, the sub-prime crisis and the Great Recession may have raised questions about the need for self-professed flag bearers of capitalism to take lessons from China about many of the features of capitalism itself. In any case, there is one area where they should surely learn from China - pursuit of mutually beneficial, self-interest driven foreign aid policy.

With a mix of quasi-barter and long-term capital investment projects, China has been negotiating complex overseas aid cum investment programs, which while providing invaluable good quality infrastructure for impoverished African countries also benefits the Chinese economy.

China has successfully managed to leverage its comparative advantage in construction and engineering (achieved by undertaking massive similar infrastructure projects at home) - roads, ports, railways, power plants, and buildings of all kinds - to secure access to mineral inputs and agricultural products, with generous use of the massive domestic savings (touching 50% of GDP) and trade surpluses, channeled through its Export-Import Bank.

The story goes something like this. Identify a remote mining or farming area in interior Africa. Propose to construct and maintain rail and/or road infrastructure, even sell rail rolling stock and trucks, all with mostly its own firms and labor, in return for a share of the produce from the mined or the farms for an extended period of time.

The direct benefits would be good quality infrastructure (with its maintenance) without any upfront capital investments for the locals and commodity resources for the gluttonous Chinese economy. The indirect benefits for China are even more substantial - excellent long-term investment opportunity for its savings, remunerative and relatively safe platform to deploy the large foreign exchange surpluses, enormous goodwill generated in the host country with its attendant geo-political benefits, and a firm foothold into one of the last remaining untapped markets. The maintenance contracts also enables China to exercise some informal political control over the mining areas.

Currently, China finances large-scale infrastructure projects, focused mainly on railways and power projects, in atleast 35 African countries, the biggest recipients being Nigeria, Angola, Ethiopia, and Sudan, through marginally concessional loans channeled through China Export-Import Bank. Though a large part of China’s development assistance is in non-concessional loans and export credits, which does not officially count as "aid", the manner in which it is structured (their upfront nature, salience, presence of large Chinese workforce, continuing involvement through maintenance etc), contrasted with the utter incompetence and lack of commitment of the host governments, creates the impression, atleast in the local popular perception, of these investments being an example of some Chinese beneficence.

In many respects, as Ronald McKinnon writes, China's aid policy bears striking resemblances with the British and American colonial and post-colonial interventions in many developing countries. Britain's comparative advantage with engineering skills and need for minerals led it to making investments in railways sytems in India and Argentina in the 19th century, while US made similar investments, through its large private corporations, in large dams and power plants in many countries of Asia, Africa and Latin America.

Update 1 (8/4/2012)

Times has a nice article on China's aggressive aid-driven strategic diplomacy in the Caribbean.
China announced late last year that it would lend $6.3 billion to Caribbean governments, adding considerably to the hundreds of millions of dollars in loans, grants and other forms of economic assistance it has already channeled there in the past decade.

It has provided a flurry of loans from state banks, investments by companies and outright gifts from the government in the form of new stadiums, roads, official buildings, ports and resorts in a region where the United States has long been a prime benefactor. Chinese construction companies and workers have been working hard to quickly establish these promised assets. In some places, Chinese contractors or workers have stayed on, beginning to build communities and businesses.

While some of these gifts have been to buyover these countries from recognizing Taiwan, the greater long-term intent is to surely to gain a foothold in America's "near abroad".

Friday, August 27, 2010

Performance-based pay for teachers

Econ 101 teaches that "incentives matter", and there are numerous real-world examples of its application, none more so than with structured cash-incentives. So why not introduce performance-based pay for teachers?

A recent study of country-level performance-pay measures from the PISA-2003 (does not include India) international achievement micro data by Ludger Woessmann of the University of Munich estimated student-level international education production functions. After controlling for various cross- and within-country biases and other salary adjustments, he finds that math, science, and reading achievement scores in countries with performance-related pay are about one quarter standard deviations higher. He writes,

"The results of cross-country education production functions that extensively control for student, school, and country background factors suggest that students in countries that make use of teacher performance pay perform significantly better in math, science, and reading than students in countries that do not use teacher performance pay. The size of the association between use of performance-related pay and student achievement is about one quarter of a standard deviation on the math and reading tests and about 15 percent of a standard deviation on the science test.

Given the well-established nature of teacher bonuses in many countries, these associations are likely to capture general-equilibrium effects of performance-related pay which are likely to combine long-term incentive effects of motivating current teachers with sorting effects of changing the pool of applicants for the teaching profession."

I had blogged earlier about a study by Prof Karthik Muralidharan about evaluation of incentives-based teacher performance in 500 government primary schools in Andhra Pradesh which found that "there could be significant gains from moving to a system of hiring teachers on fixed-term contracts and then using performance measures to pay bonuses on an ongoing basis and to inform the tenure decision after a longer period of performance measurement".

I am inclined to believe that any teacher performance-based pay system, while unobjectionable at a theoretical level, may be very difficult to implement, both for political and administrative reasons, in the prevailing environment in countries like India. While it may succeed in a limited area and time, it may not yield the desired results with a more ambitious scope and pan-Indian area of implementation.

Thursday, August 26, 2010

Analyzing the bond market surge

One of the defining characteristics of the bond markets in the last few months has been the steady and continuous decline in yields. Therefore, bond market yields have assumed center-stage in an intense debate about the impact of rising sovereign debts across developed economies.

Bond yields have been falling in the major economies of US...

... United Kingdom ...

... Japan...

... and Germany

However, even as these bond yields have been falling, those of the weaker peripheral PIIGS economies have been rising, as reflected in the widening spreads with the benchmark 10-year German Bunds.

Bond vigilantes argue that the burgeoning deficits mean that it is only a matter of time before inflation returns and interest rates rise, thereby driving up bond yields. However, there are others who argue that the high unemployment rates, dismal short and medium-term economic prospects, and reluctance of governments to undertake further fiscal expansion, means that deflation (and not inflation) is the greater danger. In the circumstances, they argue that declining bond yields are a natural market reaction.

A third point of view that is getting louder is the claim that a bond market bubble may be inflating. They argue that faced with uncertain economic prospects, deflationary expectations, and possible sovereign-debt crises, investors are abandoning equities and postponing investments, and fleeing to the relative safety and liquidity of bond markets.

As Paul Krugman has written, the bond bubble hypothesis looks suspect in an environment where everyone expects unemployment rates to remain high and inflation to remain low (or even negative) for a long time. This effectively means that short-term federal funds rates are most certain to remain at its zero-bound level for "and extended period of time", in turn ensuring much the same with longer-term rates. Further, all the common interest rate forecasting models point to rates remaining at the zero-bound for a very long time. Also, as Krugman argues, currently none of the major market players are gorging on leverage to inflate a bubble.

The rising sovereign debt-burdens too have been generating uncertainties in the financial markets about the dangers of sovereign debt-defaults. This too has generated a increased demand for safe and liquid assets among investors. As Ricardo Caballero has written, the sub-prime crisis has seriously disrupted the private supply of safe assets and the recent European crisis destroyed part of the public supply of safe assets, thereby leaving investors with few options but to invest in the few remaining perceived (atleast till now) safer assets. He writes, "Moreover, each of these crashes raised perceived uncertainty and hence the demand for safety, thus the quantity gap keeps growing, and the yield of the few remaining "safe" assets has to implode in order to restore equilibrium."

The rising bond prices now, especially when supply of government bonds has increased dramatically following the spurt in government borrowings to finance stimulus programs, only means that the demand for government bonds has been increasing much faster than the rapidly growing supply. Since the regular purchasers like China have been net sellers on the US government debt markets in recent weeks, most of the buyers of government bonds have been cash-rich domestic banks which have been using the huge amounts of money released by the monetary accommodation into purchasing government bonds. In other words, the money printed and released by the central banks is getting locked up within the financial markets itself without flowing into the real economy, thereby perpetuating a liquidity trap.

Finally, for the bond vigilantes, there is the remarkable decade-long experience of Japan with ultra-low interest rates and bond yields, despite the country's rising sea of debt, which has been hovering at nearly 200% of GDP for many years now. Japanese 10-year bond yields are ruling below 1% and has been on a continuously falling trend, and the 5-year CDS spreads are comparable to those of Germany.

But the sceptics may have grounds for concern since, irrespective of whether we call it a bubble or irrational exuberance, the fact remains that bond yields have deviated considerably from other benchmarks. Equity risk-premiums, the expected excess return of shares over government bonds, are at record highs in America, Germany, Japan and Britain.

The critical issue will be how the exit proceeds. How will the markets react at the first signs of deflationary expectations bottoming out and central banks look towards raising rates? How will the markets react to any central bank efforts to contain and emergent inflationary pressures by selling huge quantities of bonds to drain out the massive quantities of liquidity injected?

Given the fact that markets over-react in both directions, it is very much possible that the larger the decline in bond yields, greater and more violent could be the upward correction. Further, since it may be a few years before the first signs of recovery (in unemployment and inflation) appears, the bond market fundamentals may deviate even further before the return journey begins (though long-term bond yields cannot fall below 0%!).

If an indiscriminate and excessive market reaction then takes place, everyone would start blaming the current policies for having inflated the bond prices (Note that this illustrates how bubbles are often a post-event market reaction). The Economist points to the surge in ten-year government-bond yields from 0.5% to 1.5% in just three months in Japan in 2003 following expectations that deflation was fading off and fueled by casual remarks by the Bank of Japan.

In conclusion, all macroeconomic and market indicators appear to amply justify the declining trend in bond market yields, though the extent of declines may be somewhat debatable (ultimately, post-facto, if there is a bubble and it bursts with a violent surge in yields, then the extent of deviation will be held up as having signaled the bubble). However, the big challenge will be to manage (or more realistically, hope for) a smooth market turn-around once the deflation fears ease off and unemployment rate starts to fall. On the brighter side, given the prevailing economic environment it is hard to expect any recovery before 2012-13, thereby giving the bond markets more time to assess the fundamentals and return to normalcy. In other words, though the current market reaction is justifiable, it is to be hoped that the bond yields return to normal with a soft landing.

See an excellent Economist debate on the issue here - I am inclined towards Paul Seabright and Tyler Cowen's caution, purely due to the uncertainties associated with any exit.

Update 1 (30/8/2010)
Nick Rowe makes the interesting point that since bonds and money (the medium of exchange) are close substitutes (and more so now, at ultra-low rates), a bond bubble becomes a problem once it spills over into a bubble in money. He writes, "An excess demand for the medium of exchange is what causes, and is the only thing that can cause, a general glut of all goods. And that causes employment and output to fall, and both consumption and investment to fall."

From a general equilibrium perspective, he writes, "if we define the "fundamental" value of an asset as the price that asset would have if all markets, not just the market for that asset, were in long-run equilibrium (and with inflation at target), then bond prices are above their fundamental values."

Wednesday, August 25, 2010

A "big push" in roads?

I don't believe in the magic-pill route to development or eliminating poverty. However, if asked to name the one area where investments could potentially have far-reaching impact, I will stick out my neck and choose transportation infrastructure.

This would include state highways, rural connecting and other internal roads that links the basic habitation unit to atleast the nearest state highway. A network of roads - atleast two-lane, preferably four-lane - connecting villages to the national or state highways would have a dramatic long-term impact on the economic prospects of those areas. In fact, it may not be a hyperbole to claim that such roads can single-handedly (since other accompaniments invariably follow) turn around the fortunes of large parts of interior rural India.

The closest parallel is with the development of the Interstate Highway road network in the US. It is now widely accepted that this Interstate Highway System has been one of the most important foundations for America’s phenomenal post-War growth. It dramatically increased the country's economic competitiveness and promoted the rapid spread of economic activity across the country.

In a country without a decent network of national highways, the Government of India's decision at the turn of the last decade to invest heavily in the Golden Quadrilateral and other NHAI projects was understandable. This initiative has spurred large investment inflows into the sector, including a surprisingly high share of private sector investments. But the remarkable development of national highways over the last decade has only served to increase the stark contrast with the abysmal condition of state highways.

In fact, the full potential of the NH system itself can be realized only by extending the network downstream to the rural and urban population centers. A "big push" investment drive in sub-NH road network, in turn integrated with the national highways, has the potential to be a game-changer by creating the required conditions for sustainable economic growth.

The mere presence of a good connecting road would itself dramatically transform the economic prospects of even the remotest of village and enable it to compete at a more or less even footing in the market for economic opportunities.

Here is a list of immediate and first-level of productivity/efficiency improvements and economic activity simulations that can be the result of a massive expansion of sub-NH road network.

1. Primarily, it immediately increases the accessibility of remote locations to urban and nearby industrial/commercial centers. Businesses benefit by way of the dramatic reductions in the cost of transportation of inputs and finished products.

2. It dramatically improves mobility and lowers all barriers imposed by distances. Workers find it easier to commute longer distances for their jobs, students can attend schools and colleges in the nearby town, patients can seek better care and lives can be saved by taking the services of the hitherto distant tertiary care centers, and so on.

3. It increases labor market efficiency by removing distance related frictions. Good transport facilities have the effect of forging closer integration of labor markets across distances and occupations. It arbitrages away labor market inefficiencies and facilitates more effective matching of supply and demand.

4. It promotes better price integration across the country by easing out transport-dependent arbitrage opportunities. The significant transportation costs often translates into substantial price differentials on many items between urban and interior India.

5. It lowers the cost of providing various government services. Lower transportation costs exerts a downward pressure on construction and maintenance expenditures on infrastructure assets, welfare goods (like PDS, by reducing the cost of moving and storing stocks) and services (by increasing the number of villages an extension officer, or ANM, can cover).

6. It enhances the quality of services delivered by the government. A good transport infrastructure will enable teachers, nurses, doctors, agriculture officers, and other officials to reach their workplaces quicker and spend more time there. Its productivity improvement effect on field functionaries can be considerable.

7. It is a force multiplier for the government's supervisory apparatus. Monitoring officials find it easier to visit schools, clinics, and farms in the remotest areas. Conversely, the easier accessibility (and the attendant higher probability of a surprise inspection) of such areas could exercise a considerable deterrent on now commonplace practices like absenteeism and shirking. Increased mobility effectively expands the span of control of monitoring officials.

8. Finally, apart from increasing the mobility of labor and capital, improvements in roads and related transportation facilities also facilitates faster and closer social and cultural integration of the remotest parts with the remaining areas and of villages with cities. Improved transport infrastructure immediately and most saliently exposes Bharat (interior parts) to the opportunities of emerging India.

9. The immediate trigger for the development of the Interstate Highway System in the US was to expedite the massive war time mobilization. A good network of roads can be an invaluable contributor towards enhancing national security, both from external enemies and against natural disasters. Connectivity enables swifter manpower and resource deployment, from and into the nations interiors, in case of national emergencies.

10. A comprehensive investment plan in sub-highway roads would by itself drive massive capacity expansion on the supply-side. It would require huge mobilization of material inputs and skilled and unskilled manpower. Downstream investments in petrochemicals, cement, steel, heavy equipment, engineering colleges and polytechnics are natural accompaniments.

How do we finance these massive investments? Unlike the National Highways, these roads are not going to generate much private sector interest for any toll-based investment model. And as experience from across the world, even from the homelands of free-market, would indicate, finances for such roadways will have to come from governments.

The fuel cess, which was recently enhanced to Rs 2 per liter of diesel and petrol sold, is an important source of investments for the national highways. A share of such cess, coupled with a specific road tax on new vehicles, can generate some share of the resources. In this context, a carbon tax on petrol and diesel, can be used to both mobilize resources and also address the climate change problem.

Another source of financing would be for state and local governments (or their Special Purpose Vehicles) to float 15-20 year "Build India Bonds" (both taxable and tax-free) to mobilize resources from the growing debt market. This would enable project entities raise the huge upfront resources required without putting large one-time strains on government budgets.

The annuity payments can be financed from budgetary support and from revenue streams that emerge consequent to the development of the area. Such revenue streams include road impact fees levied on commercial (and residential) developments in the aftermath, share of the property and other taxes that follow the road, etc. Finally, at some point in time, in cases where the areas development exceeds the critical mass, it may become possible to even introduce tolls to cover the remaining debts.

And this "big push" into the debt markets, would, in one stroke, contribute more towards increasing the depth and breadth of the India's debt markets and improving the overall balance and stability of its financial markets than any other financial market reform.

Update 1 (13/12/2010)

An estimated 40% of the road traffic in the country plies on the National Highways, though the NHs form less than 5% of the national road network (only 70,000 km out of total road network of 3.3 m km). About 30% of NH netowrk is single lane, 53% double lane, and only 17% four-lane and above. Of the 70,000km of NH, only 15000 km are being developed and maintained by NHAI, while the rest are built and maintanined by the road transport ministry through the state public works departments. It is estimated that the country's roads will require $75-90 bn investments in the next five years.

Update 2 (29/1/2011)

A World Bank working paper evaluated the aggregate and spatial economic impacts of China's newly constructed National Expressway Network, focussing, in particular, on its short-run impacts, and found that "aggregate Chinese real income was approximately 6 percent higher than it would have been in 2007 had the expressway network not been built".

Another working paper by Gael Raballand, Rebecca Thornton,Dean Yang et al finds that good roads alone may not be enough to generate traffic in rural areas. It writes from a randomized experiment in Malawi that subsidized a minibus service over a six-month period over a distance of 20 kilometers to serve five villages,

"Using randomly allocated prices for use of the bus, this experiment demonstrates that at very low prices, bus usage is high. Bus usage decreases rapidly with increased prices. However, based on the results on take-up and minibus provider surveys, the experiment demonstrates that at any price, low (with usage) or high (with low usage), a bus service provider never breaks even on this road... this experiment explains that motorized services need to be subsidized; otherwise a road in good condition will most probably not lead to provision of service at an affordable price for the local population."

Update 3 (19/5/2011)

The World Bank reports of a bridge built across Loange River on National Highway No. 1 between the cities of Kikwit in Bandundu province and Tshikapa in Kasaï-Occidental has had a dramatic impact on lowering food prices and generating economic growth. The Loange Bridge provides a continuous road link across six provinces in DR Congo and it also enables a connection between Central Africa and countries in East and Southern Africa. It was built over a period of 18 months at a cost of US$36 million.

Monday, August 23, 2010

A supply-constrained Indian economy?

I had blogged earlier about the possibility that the supply-side of the Indian economy is unable to meet the galloping demand that is driving the high rates of GDP growth, and its role in stoking inflation.

Cement, steel, and electricity are arguably the three most critical inputs in most capital investment projects, and effective proxies for aggregate growth itself. It may therefore be instructive to examine the relative rates of growth in these sectors to see whether the supply is growing fast enough to keep pace with GDP growth.

First, here is a comparison of the relative rates of growth of the three sectors in China and India over the last two decades. China is adding cement capacity at the rate equivalent to India's total production. See also this excellent bubble graphic of the two countries cement production.

Chinese steel production has taken off vertically since the turn of the millennium, whereas India's has plateaued.

The same is the story with electricity sector too, with the Chinese take-off coinciding with around the turn of the century.

More worrying is what emerges from the comparison of India's GDP growth rates over the past decade-and-half with the respective growth rates in steel, cement, and electricity generation.

The growth rates in electricity has been consistently below even the real GDP growth rate, while that of the other two sectors have hovered around the real GDP growth rates. In contrast, sectoral growth rates in China has been well above its GDP growth rate. Typically, growth rates in these critical sectors should be atleast higher than the nominal GDP growth rates. The picture in steel, cement and electricity sectors are broadly representative of other input sectors.

The aforementioned graphics highlight the critical supply-side challenges faced by the Indian economy. In the absence of dramatic increases in production of critical inputs, much like what China has seen over the last decade, India's ability to sustain high rates of economic growth will be doubtful. In the circumstances, fighting inflation with monetary and other conventional demand-management policies will be akin to tilting at the windmills.

Statistics from here, here, here, and here.

Sunday, August 22, 2010

Choosing among public policy alternatives

In a recent op-ed in the New York Times, George Loewenstein, one of the founding fathers of behavioral economics, struck a note of caution on the euphoria surrounding the use of nudge-based solutions to addressing major public policy problems.

"Behavioral economics should complement, not substitute for, more substantive economic interventions. If traditional economics suggests that we should have a larger price difference between sugar-free and sugared drinks, behavioral economics could suggest whether consumers would respond better to a subsidy on unsweetened drinks or a tax on sugary drinks. But that’s the most it can do. For all of its insights, behavioral economics alone is not a viable alternative to the kinds of far-reaching policies we need to tackle our nation’s challenges."

Felix Salmon adds this interesting dimension of analysis in the context of the Ubel-Loewenstein argument,

"Consider an issue with two possible lines of attack: a cheap behavioral-economics solution, B, and a more expensive and politically-fraught substantive solution, S. Does implementing B make implementing S less likely? If B didn’t exist, would S be more likely to come about? Surely there are cases where the answer to both questions is yes — and where therefore behavioral economics is a bad thing, not a good thing. The ability to cover up issues with a behavioral band-aid is often just a way of doing as little as possible while appearing to tackle the issue at hand.

That said, in a lot of cases S would never happen anyway, and in those cases B is better than nothing. And in other cases S will happen either way, and again adding B to the mix is going to be a good thing. So the only cases we’re worried about are the ones where the existence of B significantly changes the likelihood of implementing S."

Now, a whole host of public policy challenges and their possible solutions can be subjected to the "Salmon Test". It can be an excellent touchstone to choose from among competing policy alternatives.

Let me illustrate this dilemma with the problem of improving learning outcomes in schools. School performance is intimately related to teacher and student attendance, which determines the quality of teaching-learning. The existing school regulatory architecture contains adequate provisions for monitoring attendance, though not the final learning outcomes.

In view of the aforementioned, the government has a choice of either strengthening its supervisory mechanism (S) or designing an IT-based performance evaluation system that can accurately reflect teaching-learning outcomes and use that to nudge teachers, students and parents (B). The longitudinal data (tracking child learning outcomes over entire primary schooling and teacher value-addition) generated from the latter can then be deployed in the form of appropriate nudges to first get teachers and students to attend, then push them into improving their performances, and finally informing and getting parents more closely interested in their child's progress.

The former (S) while being difficult to implement, is evidently more sustainable and certain of its effect. In contrast, the later (B) presents a less difficult (more technology-centric) and attractive populist behavioral solution, though it is vulnerable to generating some unanticipated incentive distortions (eg. gaming the tests to inflate results). In the circumstances, as Felix Salmon wrote, there is the distinct possibility that governments would prefer the later and ignore the former.

It is also natural (given the limited supervisory bandwidth and other resources) that the implementation of Plan B would significantly reduce the likelihood of implementation of Plan S. However, the choice becomes clearer once we analyze the possibility of pushing through Plan S. Given the formidable administrative and political challenges (unions etc) to be overcome in establishing a strong and consequently effective supervisory mechanism, the possibility of Plan S getting implemented is remote. In the circumstances, Plan B naturally emerges as the only available alternative.

In other words, Plan B passes the "Salmon Test" as the preferred policy direction for improving learning outcomes in primary schools.

The economic challenge facing politicians and how we see it

This quote from Paul Seabright's book (via Greg Mankiw) is an appropriate representation of the challenge faced by politicians (and the despair of citizens at politicians' inability to make much headway) fighting arguably two of the most formidable macroeconomic challenges of present times - unemployment in the US (and elsewhere) and inflation in India.

"Politicians are in charge of the modern economy in much the same way as a sailor is in charge of a small boat in a storm. The consequences of their losing control completely may be catastrophic (as civil war and hyperinflation in parts of the former Soviet empire have recently reminded us), but even while they keep afloat, their influence over the course of events is tiny in comparison with that of the storm around them. We who are their passengers may focus our hopes and fears upon them, and express profound gratitude toward them if we reach harbor safely, but that is chiefly because it seems pointless to thank the storm."

But just as a sailor intent on wrecking the storm-battered boat, if the politician is intent on extinguishing (by fiscal and monetary contraction, as in the US, and populist short-termism, as in India) the only realistic chance of reaching the shores safely, then the despair of the citizenry is well-founded!

Friday, August 20, 2010

Industrial Policy in green technology vehicles

In the latest example of classic industrial policy, the Chinese government has decided to invest billions of dollars over the next few years to develop electric and hybrid vehicles in a grand plan to become a world leader in green technology. This latest announcement, which follows massive investments and considerable success with conventional and renewable power generation equipments, telecommunication equipments, urban metro-rail systems, and light-rails, is only the latest example of benign government guided-industrial development, an approach which is making a comeback with some vengeance, thanks singularly to the mandarins in Beijing.

In an effort to become a world leader in new energy vehicles, the state-owned Assets Supervision and Administration Commission (SASAC) - which operates under China’s cabinet and oversees about 125 of China’s biggest state-owned companies - has formed an alliance of sixteen the largest state-owned companies in the related sectors. They include the country's top three oil majors, top two power grid operators, several military and aviation companies, and two major automakers - China FAW Group Corp and Dongfeng Auto Corp.

The stated objective is to accelerate research and development of electric vehicles, fuel cells, and charging systems in China, create required industry inter-operability standards for vehicles in the sector, and build internationally competitive Chinese electric car brands. The government proposes to invest 100 billion yuan ($14.7 billion) on electric vehicles by 2012, making it one of the world’s most ambitious attempts (including in any private company) to develop more energy-efficient vehicles.

Though details of the plan were not released (and will probably never be), it is proposed to get atleast 500,000 energy-efficient electric and hybrid vehicles into the market over the next three years, and such vehicles are expected to account for 5% of passenger car sales in the the world’s biggest and fastest growing auto market.

The Times correctly describes this as another example of how China seeks to marshal massive amounts of resources and tackle new industries and create markets within a highly ambitious time-frame.

This follows a national campaign launched by the central government in early 2008 aimed at getting 1,000 electric vehicles on the roads in at least 10 cities each year to encourage people to buy electric cars. Underlying its commitment to combating pollution and reducing carbon emissions, China has already pledged to reduce its carbon intensity by 40-45% in 2020 from the 2005 level, and also set a target of raising the use of non-fossil energy to 15% of total energy consumption.

While India too has many similar policies to promote non-conventional energy, the difference is that China does it, certainly on a commercially meaningful scale and possibly without the overbearing bureaucracy that crowds out serious interested parties (and crowds-in those seeking to merely skim-off the subsidies). In fact, like the latest example of green technology vehicles, such policies are aimed explicitly at full-fledged market creation instead of being mere pilots for learning. Needless to say, the allocations for such industrial policy interventions in China are massive compared to the minuscule cosmetic allocations in India. Notice also the ambitious time-lines, just two years for the latest one, to incubate and commercially develop technologies.

It is inevitable with such policies that a not insignificant share of investments will get wasted, inefficiently mis-allocated, and/or even pilfered. By selecting a few big makers over the others, the government is clearly playing favorites among its own corporations, leave alone discriminating against private manufacturers (with all the attendant inefficiencies and incentive distortions). Further, contracts will get awarded to cronies and favorites.

But the global market ambitions, arising out of the desire (and explicit objective) to compete and capture global markets (like the earlier cases with power and telecom equipments, rail rolling stock etc), ensures that there is a considerable premium placed on the quality of these products. The scale at which such policy interventions are made effectively ensures that the producers have the economies of scale to both adapt and develop technologies, gain adequate market experience, and develop the expertise required to compete in the global markets.

Thursday, August 19, 2010

So, a "good teacher" it is!

One of the most frustrating deficiencies in the education sector, at the pre-matriculation and more so at primary school level, is the virtual absence of reliable measures of learning outcomes. In many respects, education stands alone as the only sector without any objective yardstick whatsoever for evaluating the value-addition from the massive resources poured in.

Alone among all professionals, teachers are not subjected to any objective and reliable, direct or indirect, measure of performance evaluation. In every other sector, there are atleast some standard measures of evaluation, though it is a different matter that they are rarely used in any meaningful manner.

Surely, any system where people wake up to suddenly discover that a significant number of people who have been exposed to it for nine years are unable to pass the most basic of examinations and are, to be charitable, semi-literate, or a major share of its products are downright unemployable, deserves to be completely revamped.

In this context, Freakonomics points attention to an analysis of seven years of Los Angeles state standardized test-score data in Math and English from 6,000 state teachers by the L.A. Times and the Rand Corp., which finds that teacher effectiveness is three times more influential than school attendance on student performance.

The study using longitudinal student-level achievement data found that greater variations existed in the quality of teachers within each school than between schools in affluent and poorer neighborhoods. It found that highly effective teachers, the ones who consistently and dramatically raise their students' scores, are fairly evenly distributed among schools and across different levels of experience and education. Strikingly, it found that after a single year with teachers who ranked in the top 10% in effectiveness, students scored an average of 17 percentile points higher in English and 25 points higher in math than students whose teachers ranked in the bottom 10%.

Put differently, though parents obsess with picking the right school for their child, it matters far more which teacher the child gets. Yet parents have no access to objective information about individual instructors, and they often have little say in which teacher their child gets. Further, contrary to widespread belief, many of the commonly assumed factors responsible for improving teachers' effectiveness - experience, education and training - had little bearing on improving students' performance. Most interestingly, the students' race, wealth, English proficiency or previous achievement level played little role in whether their teacher was effective.

In fact, they also find that the commonest distinguishing characteristics of effective teachers were a tendency to be strict, maintainance of high standards, encouragement of critical thinking, and the engagement of his or her students. See an FAQ on the methodology adopted here.

The graphic compares the contrasting performances (in terms of raising the percentile of students able to do specified level of Math and reading) of two teachers teaching the same lessons at two different fifth grade classes at the same school

Another graphic demonstrates how the difference between the student's expected growth (each student's past test performance is used to project his performance in the future) and actual performance is the value a teacher adds or subtracts during the period. The projection based on past performance means that no teacher is hampered by the presence of low-performing students. The value-added compares students to themselves in previous years, rather than to other students with different backgrounds. For all the aforementioned reasons, this methodology can therefore be used for longitudinal tracking of students and teacher value-addition.

The study finds that many important teacher qualifications have little effect on student outcomes and "more experienced or better educated teachers are no more effective in the classroom than inexperienced teachers with only undergraduate diplomas".

It draws attention on the need to "focus on measuring teacher skills and preparation that predict subsequent teacher performance in the classroom". They write,

"Districts could consider developing policies that place importance on output measures of teacher performance. Current policies emphasize teacher qualifications that are inputs to student learning. These inputs are costly to produce and sustain in terms of hiring and salary costs, but they have little consequence on student achievement outcomes. A better approach would be to incorporate value-added measures of teacher effectiveness into teacher assessments. Teachers and administrators should have access to value-added measures of teaching effectiveness.

These measures would provide useful feedback for teachers on their performance and for administrators in comparing teacher effectiveness. Merit pay systems would realign teaching incentives by directly linking teacher pay with classroom performance. Merit pay is 'results oriented' in the sense that compensation focuses on the production of specific student outcomes. The challenge for designing a merit pay system for teachers is in defining an appropriate composite of student learning (output) and in measuring teacher performance in producing learning...

We find that teachers with better nominal teaching tools (e.g., experience, education, licensure scores) perform no better than teachers with weaker qualifications, but the current system provides little reward for better classroom performance. Perhaps teachers with extra teachings skills have too little incentive to fully utilize those skills in a compensation system that rewards their measured inputs and ignores their outputs. By realigning the incentive system and rewarding student achievement gains, we might find a different ordering of teacher effectiveness and improved overall levels of student learning."

Here are a few observations

1. The critical challenge will be in the administration of the standardized tests. How do we manage the logistics of standardized examinations, given the wide geographical spread and massive numbers of students being tested? How do we ensure the purity of both the examination invigilation and paper valuation? In other words, how do we ensure the administration of the massive exercise of standardized tests without compromising on the purity of its results?

One way would be to outsource the process itself. However, its cost and more importantly, the perception and resultant salience of an externally outsourced assessment process will amplify opposition from the unions. Administering it through internal arrangements, for example by shuffling teachers across schools, too will raise formidable administrative and supervisory challenges. However, in the initial stages, this appears to stand the best chance of success.

2. A perception that such value-addition analysis would be used to assess teachers will naturally raise political opposition from the unions. It may therefore be necessary to completely de-link its use from high stakes decisions like punishing teachers.

In fact, mere disclosure of teacher-wise value-addition for each student and the entire class, will go a long way in contributing towards increasing performance outcomes. Appropriately designed student report-cards aimed at parents, teacher-report cards aimed at administrators, and school-report cards intended for community at large, can play an important role in getting all stakeholders to respond in a manner that will nudge teachers to improving their performance.

3. In order to buy acceptance among teachers, such value-addition analysis should be spun-off as say, "teacher enhancement feedback programs". Analysis of classroom data and student learning outcomes can be used to deduce specific skill-deficiencies of teachers. This can in turn be used to objectively design training programs and impart focused trainings to teachers based on their respective deficiencies.

4. The biggest source of last-mile challenge will be in ensuring that the data collected, analyzed and presented is acted upon. It is commonplace in government to have massive data being collected and not being utilized in any meaningful manner. And the sheer volume of longitudinal data collected only increases the probability of policy-making getting buried in the small detail of numbers.

As aforementioned, this last-mile problem can be overcome with effectively designed and institutionalized policies that uses the data to simultaneously inform parents about their students' performance, administrators about the respective value-addition (and value-subtraction) of teachers and performance of schools, and teachers about where they and their students are lagging behind.

This information disseminated in the most cognitively effective manner (well designed report cards), through platforms like school management committees, and utilized to design training programs for teachers and remedial classes for students, can go a long way towards improving the quality of our education system.

Update 1 (7/9/2010)

See this collection of LA Times stories on the teacher value-addition study. And this, this, and this from NY Times.

See this website of SAS EVAAS, the most comprehensive reporting package of value-added metrics available in the educational market, which provides valuable diagnostic information about past practices and reports on students’ predicted success probabilities at numerous academic milestones.

Update 2 (23/10/2011)

A study of New York City schools by Jonah E. Rockoff and Cecilia Speroni explored the power of objective (student achievement data) and subjective (evaluations from both applicant interviews for a certification program and mentors who worked with teachers their first year) measures of teacher evaluations finds considerable merit in the later. They write,

"We find evidence that teachers who receive better subjective evaluations of teaching ability prior to hire or in their first year of teaching also produce greater gains in achievement, on average, with their future students. Consistent with prior research, our results support the idea that teachers who produce greater achievement gains in the first year of their careers also produce greater gains, on average, in future years with different students. More importantly, subjective evaluations present significant and meaningful information about a teacher’s future success in raising student achievement even conditional on objective data on first year performance. This is an especially noteworthy finding, considering that variation in subjective evaluations likely also captures facets of teaching skill that may affect outcomes not captured by standardized tests."

As Freakonomics writes, "Among the many knocks on the new push for objective evaluation measures is that they fail to capture the nuances of teaching, which the authors believe traditional subjective methods do much better."

Wednesday, August 18, 2010

Future of public transport?

In an audacious proposal to address the problem of urban public transport and transport related air pollution, and emblematic of everything that China has been doing over the last two decades, a Shenzen-based company, Shenzhen Huashi Future Parking Equipment Co Ltd, has developed a "straddling bus" that appears to jump right out of science fiction.

As the Times reports, this "odd-looking, extra-wide (6 m) and extra-tall (4-4.5 m) vehicle that can carry up to 1,200 passengers... requires neither elevated tracks nor extensive tunneling" and can "be powered by a combination of municipal electricity and solar power derived from panels mounted on the roofs of the vehicles and at bus stops". Its passenger compartment spans the width of two traffic lanes and sits high above the road surface, thanks to a pair of fence-like stilts that leave the road clear for ordinary cars to pass underneath. It runs along a fixed route, on fixed rails along the road margins (they could serve as access control), and has an average speed of 40 kilometers per hour.

The developers claim that the "straddling bus" could reduce traffic jams by 25-30% on main routes by ferrying as many passengers as 40 conventional buses, besides potentially saving the 860 tons of fuel that 40 buses would consume annually, and preventing 2,640 tons of carbon emissions. They also claim that its building cost is only 10% of what it would cost to build an equivalent subway. A 186-km long pilot for the project being planned in Beijing’s Mentougou District, to begin construction by the end of the year.

The demonstration video below makes for fascinating viewing.

Evolution of world GDP distribution

The Economist draws on Angus Maddison's historical data tables to highlight the evolution in the respective shares of GDPs of the major economies (in PPP terms) from 1 AD.

The graphic shows that China and India were the biggest economies in the world for almost all of the past 2000 years. While they will surely not attain the same respective shares ever, it is inevitable that over the coming half century, they could become the two largest economies. China just passed Japan to become the second largest economy in the world. Interestingly, India was the largest economy for three-fourths of the period.

Update 1 (1/7/2012)

Excellent graphic of the changing face of global GDP distribution since 1 AD. Note how India and China dominated the world economy for much of the period and it is only since 1800s that the western economies have been dominant. 

Derek Thompson makes the good point that "everything to the left of 1800 is an approximation of population distribution around the world and everything to the right of 1800 is a demonstration of productivity divergences around the world".

Tuesday, August 17, 2010

Observations from communal marriages

For the past five years, the Tirumala Tirupati Devasthanam (TTD) has been organizing mass marriage programs, "kalyanmastu", across the state, with the objective of helping poor people to get married without running up debts, promote Hindu culture and counter missionary propaganda.

TTD gifts each couple (from the below poverty line families) with a gold mangalasutram, silver toe rings, and a set of wedding clothes to the couple, and to an attendant. It also hosts feast for sixty people from each couple's side, and provides free darshan for six members belonging to the bride and bridegroom family at the Venkateswara temple at Tirumala.

So far, more than 35000 such weddings have been conducted as part of the Kalyanamastu. It is estimated that TTD spends about Rs 10000 for each couple. Here are a few observations from the latest round at Hyderabad.

1. It is undeniable that poor people incur considerable expenditure in organizing marriages and large debts are an inevitable legacy of a marriage. Apart from lowering marriage ceremony expenditures, such unions are less likely to involve dowries.

Since everyone gets married, incur considerable expenditure on their marriage ceremony, and the resultant debts impact a larger number of people (families of both, especially the bride), mass marriages offer a considerable welfare dividend. In many respects, it is equivalent to a large one-time cash transfer.

2. Like all government interventions involving dispensing some benefits, such mass marriages are also vulnerable to leakages. There is the strong possibility that atleast some of the couples already had their wedding recently and have been tempted by the incentives (especially the free darshan). What increases its likelihood is the fact that government officials are given targets to mobilize couples for such weddings.

3. Private marriages are deeply personal events. At a cultural level, arranged weddings are most often sustained, atleast in the initial stages, by the powerful influence of traditions and conventions. The strong memories of the marriage ceremony itself, in the exclusive presence of friends and relatives, will serve as a powerful binding force.

Does the impersonal nature of mass-marriages mean that its psychological impact on the couples are not deep enough? Put differently, it may be fair to say, the contribution of the memory of the marriage ceremony itself towards sustaining the marriage (atleast for the first few years) will be smaller for such mass-marriages.

4. Do such weddings encourage love-marriages, where couples elope to get married? Since the couples incur no expenditure and since they are impersonal occasions (given the large numbers of marriages taking place), they provide an excellent platform for couples fleeing to marry in relative anonymity.

5. What has been the longevity of such marriages? For all the aforementioned reasons, there is atleast a reasonable theoretical case that such marriages may not be as adhesive as the regular private marriages. But then, the fact that these weddings are taking -place before Lord Balaji could offset some of the perverse incentives.

In any case, communal marriages throw up numerous opportunities for immediate individual-level incentive changes and longer-term sociological changes.

Monday, August 16, 2010

Lessons from the German recovery (till date)

Even as the economies across Europe and the US appear to show no signs of any sustainable economic recovery from the Great Recession, there is growing evidence that Germany may be slowly breaking away.

The Germany economy is estimated to have grown at an astonishing quarter-on-quarter economic growth rate of 2.2%, the best performance since reunification 20 years ago and equivalent to a nearly 9% annual rate if growth were that robust all year. The country’s unemployment rate in July 2010 was 7.6%, almost at the pre-crisis level, down from 9.1% in January, and far cry from the over 13% rate five years back when the country was a symbol of labor-market inflexibility.

This performance is bound to lend credence to the German government's argument in favor of fiscal prudence and making short-term sacrifices (like informal wage freezes/restraints) necessary for long-term success.

It cannot be denied that the German economic rebound is a testimony to the role of targeted fiscal spending programs, mainly in the form of automatic fiscal stabilizers as against the conventional approaches of large-scale infrastructure government spending programs or tax cuts, during economic downturns. Its unique short work scheme, "Kurzarbeit", which allows companies to cut workers’ hours and the government would make up some of the lost wages, has been attributed to have played a significant role in preventing mass lay-offs.

In fact, during the first quarter of 2010, 22% of all firms and 39% of manufacturers were estimated to have used Kurzarbeit, whose financing comes from a fund filled in good times through payroll deductions and company contributions. At its peak in May 2009, roughly 1.5 million workers were enrolled in the program, and the OECD has estimated that by the third quarter of 2009, more than 200,000 jobs may have been saved due to it.

The main driver behind the German recovery has been exports, which rose in June by 28.5% compared with the year before, the highest level since the financial crisis began to pinch in October 2008. The weakening Euro has helped improve the competitiveness of German exports and the robust growth in China-led emerging economies have provided the demand for those exports. The decreasing yields on benchmark German bonds and widening spreads between German and other fellow Euro zone member benchmark bonds has meant lower cost of capital for German businesses.

In contrast to German fortunes, the French economy grew at just 0.6% in the second quarter, Italy and Spain by an anemic 0.4% and 0.2% respectively, while Greece’s shrank 1.5%. The German recovery will contribute growth in rest of Europe only if its economic growth rate translates into higher consumer spending and greater imports, especially from other Euro members.

There is the danger that the first signs of recovery would get the federal government to cut spending further in an effort to reduce the fiscal deficit and debt burden. This could, like the famous examples from history, nip out the nascent buds of growth and pull the economy back into slow growth phase. Another major concern is the possibility of slowdown in China, dragging down German exports and with slowing down growth.

Even the claim that Germany exercised fiscal austerity during the crisis and its recovery may be incorrect. In fact, Berlin actually spent more of its gross domestic product on fiscal stimulus than any other continental European state during the financial crisis. In fact, the IMF has estimated that apart from the US, Germany had the largest crisis-related discretionary fiscal stimulus among all the major economies in both 2009 and 2010. As already indicated, its fiscal spending was more targeted, especially at cushioning the labor market and those aimed at specific sectors like the successful cash for clunkers.

Further, there are important differences between the states of US and German economies (before and over the last three years) that makes the simple austerity-caused-recovery hypothesis look doubtful. Property markets in Germany did not experience the same degree of irrational exuberance as the US and the German banks and financial institutions did not indulge in the same level of recklessness. The macroeconomic account was more balanced in Germany.

Unlike the US, the social democratic polities of continental Europe have a much more effective social safety net that can mitigate the adverse effects of a recession. Traditionally, exports have been the locomotive of the German economy, whereas consumer spending has being the engine of growth in the US. However, while consumer spending declined significantly in the US, German exports held steady after a short blip in 2008.

Finally, the series of labor market reforms in Germany since 2005 have considerably enhanced labor market flexibility. As part of these reforms, retirement age was raised to 67 from 65, welfare payments were lowered and hiring and firing regulations were eased. These and other reforms may have contributed to increasing the resilience of the German economy and helping it recover faster than its neighbors.

Update 1
See this Krugman post which compares the real GDP and unemployment changes in the US and Germany over the past three years and finds how Germany managed to weather the worst of the job market, thanks to its automatic fiscal stabilizers and schemes like short-work.

Sunday, August 15, 2010

The case against austerity gets stronger

The events of the last three years have repeatedly exposed the limitations of prevailing macroeconomic theories and models in both reliably predicting events and finding solutions to problems. The latest issue that has polarized economists and policymakers relates to timing the exit from the Great Recession induced expansionary policies of the past two years.

On the one hand, most developed economies (Germany looks an exception) are facing burgeoning debts, unsustainable deficits, and rapid expansion in the monetary base, all stoking fears of unleashing inflation and a long and tortuous recovery path. Contractionary policies appear to be the need of the hour. However, on the other hand, the unemployment rates are at record levels, consumer demand and investment climate are weak, battered business and household balance sheets, and credit markets are yet to recover. These macroeconomic conditions demand fiscal and monetary expansion to utilize idle resources and stimulate economic growth.

The theoretical argument of the austerians is the old Treasury View - the deficits will unleash inflation, crowd-out private borrowing, and choke medium and longer-term growth prospects. The stimulus supporters point to the large unemployment rates and monetary policy losing traction when faced with the zero-interest rate bound, and argue that a liquidity-trap induced deflation is a bigger threat.

In this context, the signs are far from encouraging. Across both the US and Europe, the fiscal stimulus and its contribution to growth is tapering off, without any signs of a sustained economic recovery on the landscape. In fact, there is a real danger of the Great Recession morphing into the Great Stall.

In the US, many economists are forecasting a slowdown in economic growth for the second half of the year, perhaps to an annual rate as low as 1.5%, on the back of weak consumer spending which accounts for 70% of economic activity. This also means that the unemployment rate is not only not likely to improve, but could worsen (the US economy needs to grow at 2.5% just to keep the unemployment rate where it is). Escaping a double-dip now looks difficult. More dangerously, a Japan-style deflation-induced depression looks a distinct possibility.

Globally too, as a recent ILO report claims, youth unemployment rate increased to 13% in 2009 from 11.9% in the last assessment in 2007. Of the 620 million young people (ages 15 to 24 in the work force), about 81 million were unemployed at the end of 2009 — the highest level in two decades of record-keeping by the organization.

Nouriel Roubini
feels that "the global economy, artificially boosted since the recession of 2008-2009 by massive monetary and fiscal stimulus and financial bailouts, is headed towards a sharp slowdown this year as the effect of these measures wanes". In fact, he points to the strong possibility of a double-dip recession. What makes the situation even more dangerous is the fact that "the fundamental excesses that fueled the crisis – too much debt and leverage in the private sector (households, banks and other financial institutions, and even much of the corporate sector) – have not been addressed", and private sector de-lveraging (which just began) is now being followed by public sector de-leveraging.

The biggest immediate challenge facing the developed economies today is that of unemployment. The extent of damage inflicted to corporate and household balance sheet by the sub-prime crisis and the recession that followed means that private investment and consumption, the traditional locomotives of growth, are still some way away from getting back to business as usual. Public spending remains the only anchor to keep aggregate demand from falling further.

Most importantly, in a highly inter-twined world economy, national economic prospects are strongly dependent on the policies in other countries and fiscal contraction in a major economy has strong spill-over effects outside. David Leonhardt has an excellent graphic in the Times that shows the co-ordinated nature of the global stimulus exit,

The graphic and the IMF figures show that the contractionary impact of the withdrawal will be substantial - 4.6% of GDP for the US and 2.5% of GDP for the UK, and a little more than 2% worldwide from 2009 to 2011.

Further, unlike the thirties, when the war kept up the European stimulus spending and helped the world economy even when others exited the stimulus, this time all the major economies are lock-step coupled in their exit. If everybody is exiting, where will the aggregate demand gap get filled remains the million dollar question, especially when there are serious doubts about the ability of the private sector to step in.

In this context, the austerians are obviously hoping that China (and even India) will be an anchor for the world economy, in providing the demand for both raw materials and manufacturing exports from elsewhere. However, with its economy overheating and labor unrest forcing changes in the labor markets, China's ability to act as the global engine of growth is debatable.

Amidst the controversy surrounding the issue, the US Federal Reserve's FOMC early this week, while acknowledging that the recovery had slowed, said that interest rates will stay "exceptionally low" for an "extended period" (a language the Fed has been using since March 2009). More interestingly, it voted against shrinking the Fed’s unusually expansive balance sheet ($2.054 trillion on 4/8/2010) by "reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities". The Fed hopes that this action may put downward pressure on long-term interest rates and stimulate borrowing by keeping rates low for the foreseeable future.

From January 2009 to March 2010, the Fed bought $1.25 trillion in mortgage-backed securities and about $175 billion in debt owed by government agencies, primarily the housing finance entities Fannie Mae and Freddie Mac. The Fed had planned to allow the size of that portfolio to shrink gradually as the securities matured or the debts were prepaid. In March, the Federal Reserve Bank of New York estimated that at least $200 billion of the mortgage-related securities and debt would mature or be prepaid by the end of 2011. Another option available to the Fed is to lower the interest rate (now 0.25 percent) it pays on the roughly $1 trillion in reserves that banks hold at the Fed.

This decision on continuing with monetary accommodation follows recent decisions to extend unemployment benefits over and above the 26 weeks to upto 99 weeks and aid to school districts and states to prevent large-scale layoffs of teachers and public employees. The first would cost about $18 bn, while the second will cost $26 bn. The long-term fiscal impact of these two decisions are marginal, whereas they would have considerable immediate impact, especially in cushioning the jobless and protecting jobs. Taken together, these are tentative baby steps towards continuing some level of fiscal and monetary accommodation in the light of the bleak economic prospects.

Faced with such difficult circumstances, economic policy-making has to choose the lesser evil. Given the sharp decline in the labor market and extent of damage caused to business and household balance sheets, contractionary policies are only likely to push the economy further down the abyss into a possible depression. Fiscal and monetary expansion is therefore the only choice. Even with expansion, it has to be hoped that recovery will be fast and sustained enough to provide adequate stimulus to drive the economy back up the recovery slope.

Update 1 (27/8/2010)
Arjun Jayadev and Mike Konczal examined 26 instances of deficit reductions during among OECD countries between 1970-2007, and found that countries historically do not cut their deficits in a slump, instead addressing these problems during a non-recessionary time; when countries cut in a slump, it often results in lower growth and/or higher debt-to-GDP ratios; there is no episode in which a country facing the same circumstances as the United States (recent recession, low interest rates, high
unemployment) has cut its deficit and succeeded in reducing its debt through growth; there is little evidence that cutting the federal deficit in the short-term, under the conditions the United States currently faces, would improve the country’s prospects.

Update 2 (3/9/2010)

Ireland has for sometime been the poster child for Washington Consensus policies. It had one of the bigest real estate bubbles and resultant banking crisis - Ireland’s three main banks built up loans and investments by 2008 that were three times the size of the national economy. When the crisis hit, it followed the same policies that US Treasury adopted - guaranteed all the liabilities of banks, injected government funds to keep these financial institutions afloat; and bought the most worthless assets from banks, paying them government bonds in return. On the fiscal side, it cut public wages, cut public expenditures, reduced the budget deficit to restore confidence in the markets.

Despite all this, Ireland is now being seen as the next Greece, and its CDS spreads have been rising.

Demand-response parking meters

Via Economix, comes news that San Francisco proposes to introduce nearly 5000 smart parking meters that charge based on demand-supply conditions.

"Those will not only let you pay with a credit or debit card (and soon a special SFMTA card), but automatically adjust parking rates based on supply and demand, which means you could pay anywhere from $0.25 to $6.00 an hour depending on how many free spaces there are. Those rates are determined with the aid of some sensors that keep a constant watch on parking spaces, which also means you'll be able to check for free spaces in an area on your phone or your computer before you even leave the house."

See the parking meter website here.

Update 1 (22/8/2010)

Donald Shoup writes in favor of higher curb parking prices, which will deter crusining in search of parking space, which not only wastes resources and time, but also inconveniences other drivers and adds to the parking problems. See this, this and this.

Update 2 (3/6/2011)

The San Francisco Municipal Transportation Agency seeks to address the problem of traffic congestions with a twofold approach - to change the price of a parking space according to demand and thereby keep spaces open on every block, and to lead drivers to open spaces using an array of sensors, eliminating congestion caused by circling drivers.

The prices at 7,000 meters and 20 city-owned parking garages are adjusted with the aim of keeping two spaces available on every block. Drivers could pay from 25 cents to $6 an hour depending on demand. Currently, rates run from $2 to $3.50 an hour.

Friday, August 13, 2010

Resolving the "last-mile" challenges

Here is my Mint op-ed on resolving the naggingly difficult last-mile challenge in development policy making using insights from behavioural economics. Many modern-day public policy problems involving last-mile challenges may be more effectively tackled with a careful mixture of incentive structuring and facilitative nudges.

Nudging to solve the "last-mile" problems

In a provocative recent op-ed in the New York Times, George Loewenstein, one of the founding fathers of behavioural economics, struck a note of caution on the euphoria surrounding the use of nudge-based solutions to addressing major public policy problems.

"Behavioral economics should complement, not substitute for, more substantive economic interventions. If traditional economics suggests that we should have a larger price difference between sugar-free and sugared drinks, behavioral economics could suggest whether consumers would respond better to a subsidy on unsweetened drinks or a tax on sugary drinks. But that’s the most it can do. For all of its insights, behavioral economics alone is not a viable alternative to the kinds of far-reaching policies we need to tackle our nation’s challenges."

There is no denying the fact that the recent interest in behavioral economics is increasingly showing signs of "irrational exuberance", with a claim for explanation and solution for every problem. But without being a magic-pill for those problems, as I shall attempt to show, behavioral economics has a specific and critical last-mile role in achieving the desired objectives.

The great development challenges of the past half-century have involved putting in place the infrastructure - physical and manpower - to deliver the basic welfare functions of the government. Accordingly, the big challenge was to construct schools and hospitals and recruit adequate numbers of teachers, doctors and nurses. In agriculture, it was to make massive investments in irrigation, encourage use of fertilizers, and enable access to credit and extension services. Similarly, provision of civic services involved massive investments in water, sewerage, electricity, and garbage collection and disposal services.

Government programs were designed with the specific objective of ensuring adequate availability of these basic requirements, and it was presumed that once put in place, the objectives would be automatically achieved. The qualitative side of the problem, the one that focuses on the outcomes, was never the object of much attention.

This approach was understandable since it was time when the basic ingredients were themselves deficient. How do we talk about learning outcomes when there were no adequate teachers and schools; control child mortality and maternal deaths without adequate hospitals and doctors to provide even primary health care; or talk about sanitation and personal hygiene when the majority of households do not have water, sewerage and toilets?

Today, though considerable amount of work still needs to be done, there have been significant advances to meet these infrastructure deficiencies. There is now ample evidence to prove that while all these inputs are necessary, they are not sufficient to achieving the objectives in education, health care, nutritional support, agriculture, and so on.

A different set of challenges have emerged in the achievement of these desired objectives. These include as diverse challenges as getting people to avoid open-defecation and use toilets, parents to send children to school and then college, patients to adhere to a medication schedule, poor people to save more, citizens to keep surroundings clean, and so on.

Harvard economist, Sendhil Mullainathan classifies these as daunting "last-mile" problems. He advocates marrying scientific method with art, psychology, and marketing to address the "frustrating" last mile problem in obtaining successful outcomes using various technological and other innovations.

It is therefore time to reach beyond the inputs-driven paradigm and explore what it takes to get a teacher to teach, a doctor to treat, people to exhibit civic responsibility, and farmers to improve productivity. In view of the complex nature of human interactions, micro-founded public policy approaches that take into account the behavioral biases of individuals may be more effective at addressing these issues.

The regulatory approach to addressing such last-mile problems have failed to yield the desired results, leaving us with only incentives and nudges. While incentives can help to design the most effective decision-making environment, carefully structured nudges can enable actors overcome cognitive biases and take appropriate decisions.

As recent research in behavioral economics has shown, even when incentives are put in place, people often tend to take the sub-optimal decisions. This arises either due to various cognitive biases like decision making inertia (paradox of choice or decision paralysis), complexity with the decision making environment, short term biases etc.

Let us take the example of nurses involved in ante-natal and immunization activities. She would need to record and maintain reports of the various indicators relating to the mother and child over nearly two years, and then take specific time-bound or remedial actions based on those. Even with the best of regulatory architecture and incentive structures, it is well nigh impossible to ensure effective implementation. However, a technology-based solution that uses mobile phones to both collect information and then remind the nurses about their specific actions at the appropriate times, can be an effective nudge in overcoming the last mile-challenge.

Similarly, many other critical modern-day public policy problems involving the last-mile challenges like water and energy conservation, littering and segregation of garbage at homes, promotion of safe-sex, controlling crime and obesity and so on may be more effectively tackled with a careful mixture of incentive structuring and facilitative nudges.

None of this is to ignore the importance interventionist, hard-choices like taxes and mandatory choice requirements. It is surely facile to assume that such complex issues can be resolved with simple regulatory and/or technological fixes.