Contrasting tales of traffic management from both sides of the Atlantic

The prevailing traffic management paradigms on both sides of the Atlantic could not have been more contrasting. On the one side American cities are implementing policies that adapt cities to accommodate driving (by intelligent transport systems to improve traffic flow and apps to help drivers find parking spaces), while on the other hand European cities are creating environments that are hostile to cars (congestion pricing, outright car bans from green and pedestrian zones, closely spaced red lights, speed and parking restrictions, pedestrianization etc).

The strategies employed by European cities aims to make car use expensive and difficult and thereby force them into using other modes of transport. As a Times article writes, these policies complement inherent pedestrian friendly conditions,

"Built for the most part before the advent of cars, their narrow roads are poor at handling heavy traffic. Public transportation is generally better in Europe than in the United States, and gas often costs over $8 a gallon, contributing to driving costs that are two to three times greater per mile than in the United States... European Union countries probably cannot meet a commitment under the Kyoto Protocol to reduce their carbon dioxide emissions unless they curb driving. The United States never ratified that pact. "

Over the past two decades, there have been a marked shift towards policies that seek to make cities more inviting, with cleaner air and less traffic. In cities like Zurich, carless households have increased from 40 to 45 percent in the last decade, and car owners use their vehicles less. A stunning 91 percent of the delegates to the Swiss Parliament take the tram to work! Shopping malls and business districts have limited parking lots, thereby incentivizing people to get there on public transport.

Further, even as American cities try to synchronize green lights to expedite traffic flow, European cities have been shortening the green-light periods and lengthening the red light times so as to reduce waiting times for pedestrians. In stark contrast to countries like US and India which stipulate minimum parking space for apartment units and new buildings, building codes in Europe cap the number of parking spaces in new buildings to discourage car ownership. Store owners in Zurich who had worried that road closings and pedestrianization would reduce business have been pleasantly surprised to see 30-40% increase in pedestrian traffic.

Edward Glaeser opposes restrictions that bar drivers for the sake of barring driving (multiple red-lights etc) and favors policies that internalize the social costs (congestion fees, higher parking fees etc). Alex Marshall argues that "a city more oriented around walking, biking and transit is more desirable place to live and work".

Apart from an enabling policy framework, one of the most important but less discussed reasons for Europe's success with policies that restrict car usage is the very high marginal conformity to these restrictions among its citizens. In other words, once regulations are put in place, very few people jump red lights, stray into congestion and pedestrain zones, over-speed or not stop for pedestrians, or park their vehicles illegally.

In contrast, in countries like India, such violations are more common than observance of rules. As I have blogged earlier, the deterrent effect of enforcement acts mainly at the margins, on that minority who are most likely to violate, while it becomes ineffective when the majority are violators. Such violations persist because of their convenience - minimal or no costs, ease, socialization, inaccessibility to alternatives etc.

Having said that, it cannot be an excuse for lax enforcement. Some policies like high parking prices, pedestrianizing certain areas, restricting car usage into city centers at peak times etc, which are relatively less difficult to enforce should immediately form part of any meaningful attempt to reduce traffic congestion.

In any case, in the absence of good, world class, and affordable public transit systems, any set of policies aimed at restricting car use anywhere in the world, while laudable, are certain to fail. Whatever else central, state and local governments in India does to contain traffic congestion, massive investments in world class public transit is a sine-qua-non.

Automatic fiscal stabilizers and counter-cyclical fiscal policy

I have blogged extensively about the utility of fiscal policy in combating aggregate demand slumps, especially when the economy is facing the zero-bound in nominal interest rates.

However, unlike the more rules-based monetary policy, fiscal policy is subjective and deeply political. The classic fiscal policy alternatives like direct government spending on infrastructure face the problem of implementation lags. In contrast, automatic stabilizers kick-in immediately, being targeted on those most likely to spend any money provided to them. It no surprise that automatic stabilizers - unemployment insurance, food stamps etc - have among the highest fiscal multipliers.

The WSJ points to the apparent success of Sweden in managing its recovery from the Great Recession and attributes it to successful expansionary policies by both the government and the Riksbank. The Swedish economy grew 5.5% in 2010 and unemployment rate has fallen from its peak of 9% to 7%. Instead of high-profile direct spending and tax cuts, the Swedish government responded swiftly with automatic stabilizers to provide income, health care and other services to people who are unemployed. The Riksbank, initially lowered rates aggressively to zero, even taking it to minus 0.25% (savers had to pay 0.25% for the privilege of keeping deposits). Its quantitative easing program was more expansionary than even the Fed - the Riksbank's balance sheet was more than 25% of GDP in the summer of 2009, compared to 15% for the Fed.

Further, unlike many other developed economies, Sweden entered the recession in excellent fiscal health - its budget had a 3.6% of GDP surplus in 2007, to 3% deficit in the US. This gave the government enough cushion to indulge in extended fiscal expansion when recession struck. This was a result of a strong commitment, borne out of the bitter experience of its banking and economic crisis in early 1990s, to maintain a counter-cyclical fiscal policy.

Clice Crook points to the example of the US, where though the Obama administration came up with a large fiscal stimulus in 2009, mostly with tax cuts and direct spending, its impact was offset by the severe fiscal tightening by the local governments. He also writes about the relative lack of influence of fiscal stabilizers in the US,

"Two factors weaken automatic stabilizers in the US. First, the government is small, so economic fluctuations, other things being equal, move fiscal quantities less. Second, states are subject to balanced-budget rules. Much of the US government has to follow a pro-cyclical fiscal policy – cutting spending and raising taxes – during a recession."

The acrimonious debates surrounding fiscal expansion in the US underlines the need for a much greater role for automatic fiscal stabilizers. However, it is also important that these automatic stabilizers have automatic sunset clauses that ensure exit from fiscal expansion when the economy recovers. Mark Thoma makes an excellent case for greater use of automatic fiscal stabilizers during recessions.

In this context, Jeffrey Frankel, Carlos A. Vegh, and Guillermo Vuletin (pdf here) examined long-term fiscal policy in 94 countries (73 developing and 21 developed countries) over the 1960-2009 period and found that "the cyclicality of a country’s fiscal policy – a sign of its riskiness – is inversely correlated with the quality of the country’s institutions".

They examined the correlation between government spending and GDP for these countries over two periods, 1960-1999 and 1999-2009, and found a significant increase in countries with negative correlation (or counter-cyclical spending) over the two periods. In fact, among developing countries, those following counter-cyclical policies increased four-fold to 35% over the two periods. The graphic below indicates the correlation between spending and GDP for these countries in the 2000-09 period, with yellow and black bars representing developing and developed countries respectively.



The increase in counter-cyclicality in the conduct of fiscal policy by developing countries is evidence of greater maturity by policy makers and policy institutionalization in these countries. This maturity is corroborated by other indicators like reduced debt-to-GDP ratios in many developing countries. The authors "find that the cyclicality of a country’s fiscal policy is inversely correlated with the country’s institutional quality which includes measures of law and order, bureaucracy quality, corruption, and other risks to investment". They highlight the success of Chile with counter-cyclical fiscal policy and attributes it to institutional strengthening reforms since 1980s.

Learning outcomes assessment in primary schools

Learning outcome assessment has been the holy grail of primary school education. How do we assess, on an objective measure, the learning outcomes of each student? As a corollary, how do we assess the performance of teachers?

New York City has aggressively pioneered standardized testing to assess student learning outcomes for nearly a decade now. Such tests have been the centerpiece of Mayor Mike Bloomberg's school reform efforts. Now, in an attempt to directly assess teacher performance, it recently announced plans to develop up to 16 additional standardized tests to cover science, math, social studies and English for 3rd through 12th grades.

This is part of a new state law, wherein all school districts in New York State must evaluate teachers on a scale from "ineffective" to "highly effective", with potential firing for those rated ineffective for two years in a row. These tests would be in addition to the standardized state English, math and Regents tests students in the City's 1700 odd schools already take.

The new law, part of the nationwide "Race to the Top" initiative, mandates that 40% of a teacher's grade will be based on standardized tests or other rigorous, comparable measures of student performance. Half of that should be based on state tests, and half on measures selected by local districts (like that being proposed by New York City). The remaining 60% is to be based on more subjective measures, including principal observations.

However, as the Times report writes, "the prospect of more tests, particularly ones that will have a direct influence on teachers, is causing dismay among those who believe that students already spend too much time preparing for exams and not enough on the broader goals of education, like social and emotional development".

Nobody disputes the need for a system that assesses the outcomes of education, both at the student-level and cumulatively at school-level. However, any evaluation system has to be fair, rigorous, trustworthy, and reasonably reflective of the efforts put in by teachers and students to be acceptable to all stakeholders.

Excessively rules-based, formulaic, and centralized testing models are vulnerable to being gamed by stakeholders. Teachers, school administrators, students, and parents, all develop an incentive to subvert the evaluation mechanism. This trend gets amplified if the results are used for high-stakes personnel related decisions.

In countries like India, where there is no objective yardstick of comparing learning outcomes across different primary schools and where penalizing, leave alone firing, teachers is impossible, learning outcomes assessment may have three important uses.

1. It can be a very useful instrument to spot class-wise collective learning deficiencies among children and administer the required training for the teachers. It is commonplace to find that a major share of children in certain schools or classes have not understood certain concepts (say, the concept of carry forward addition) and it may be useful to spot such weaknesses and provide focused training on this concept to the particular teacher.

2. Class room instruction currently involves teachers teaching a defined syllabus on a single-track mode to all the students in a particular class. This approach fails to appreciate the widespread differences in the pre-existing learning levels among children. For example, since a vast majority of children in Class V do not have the learning competency of even Class III, teaching them Class V Math straight away without bringing them upto speed with Class IV learning levels is a recipe of widening the already existing learning gaps.

In the circumstances, it is critical that the children be divided into groups based on their learning levels, and classroom instruction structured to close the learning gap through some form of remedial education. Assessment scores can be a useful instrument in this.

3. Currently we have no system to track the learning trajectories of students across their schooling career. How much improvement has the student achieved in a year with respect to the benchmark for that particular class? What has been the improvement in learning levels in Math from Class III to Class V? What is the learning level of a particular student vis-a-vis his best friend?

This information is necessary to not only improve the quality of monitoring and tracking, but also to generate demand-side pressures among both parents and the child itself. If properly presented, such information can be used to generate intrinsic motivation among the child itself (subtle comparison of marks of all children in a friendship group) and among their parents. Currently, till the tenth class, parents have no reliable and objective mechanism to assess the learning levels of their child.

My argument is that, whatever its flaws, an objective and standardized mechanism to measure learning outcomes is a pre-requisite for making any meaningful improvements in our primary schooling system. Once in place, we can then worry about how to keep such testing mechanism dynamic enough to prevent it being gamed by stakeholders.

Update 1 (8/7/2011)

An investigation into Atlanta’s public school system has uncovered evidence that teachers and principals have been secretly erasing and correcting answers on students’ tests for as long as a decade. A state investigation found that 178 educators at 44 of the district’s 56 schools engaged in cheating. The report is a huge blow to an urban school district that for years was hailed as one of the country’s most successful due to increased student performance.

This is the second high profile teacher cheating example in US, following a USA Today investigation found evidence of teacher cheating among some of Washington DC's highest-performing public schools. See this Freakonomics post.

Returns to college education

In an interesting Times article, David Leonhardt (also here) points to several studies which appears to prove that in today's job market college education commands a significant premium, even in jobs where a degree is not critical. This importance of college degrees mirrors the pattern of early 20th century when blue- and white-collar workers alike benefited from having a high-school diploma. He writes,

"Construction workers, police officers, plumbers, retail salespeople and secretaries, among others, make significantly more with a degree than without one. Why? Education helps people do higher-skilled work, get jobs with better-paying companies or open their own businesses."

A recent study by Hamilton Project has found that college tuition in recent decades has delivered an inflation-adjusted annual return of more than 15%, much more than stocks, with a historical return of 7% and real estate with 1 %. Though, the value of the two-year associate’s degree stands out, it mostly reflects its much lower cost of acquiring it relative to a four-year degree, rather than a boost to long-run earnings.



Comparing the total dollar benefit (cumulative lifetime earnings) of various degrees reveals the superiority of a four year college degree. Over a lifetime, the average college graduate earns roughly $570,000 more than the average person with a high school diploma only — a tremendous return to the average upfront investment of $102,000 investment.



In fact, there is a large body of research which suggests that while different people are differentially enabled and their inherent abilities can impact earnings, it has been found that increased earning power of college graduates is determined mostly by their educational attainments.

Statistics on earnings by education levels is available here. See also this excellent study by Georgetown University researchers which analyzes 171 majors in 15 catgories and finds considerable variations in returns to acquiring them.

Higher education and health care

This post will point to a striking similarity between higher education and health care - the sky-rocketing prices for services in both markets.

I have already blogged extensively about the steep increase in the price of health care services, which has far outstripped the rate of inflation. The Economist points to an article by Malcom Harris which highlights the spectacular increase in the cost of college education,

"The Project On Student Debt estimates that the average college senior in 2009 graduated with $24,000 in outstanding loans. Last August, student loans surpassed credit cards as the nation’s single largest source of debt, edging ever closer to $1 trillion... Since 1978, the price of tuition at US colleges has increased over 900 percent, 650 points above inflation. To put that number in perspective, housing prices, the bubble that nearly burst the US economy, then the global one, increased only fifty points above the Consumer Price Index during those years."

What are the reasons for the steep increases in prices in both these markets? Apart from the standard reasons, here are some observations

1. The college education premium has increased considerably in recent years. The returns to higher education has grown exponentially, especially with the emergence of the knowledge-based sectors into prominence in the last two decades. It is therefore natural that students and parents volunteer to cough up whatever it takes to accquire higher education degrees.

This premium has also increased between colleges. A degree from an elite college commands a greater premium in the market than that from an ordinary college. It therefore becomes natural for colleges to increase their fees.

2. Technological innovations of the last decade have increased the quality of service delivery in both markets. Not only has the range of services offered expanded, but also their quality. This trend is more pronounced in health care, especially in critical care and interventions which either increase life spans or improve the quality of post-treatment life.

In such cases, the marginal benefit is clearly a longer lease of life. The enormity of the benefit naturally raises the premiums attached to it. The fact that an increasing number of people are willing to pay these huge premiums only amplifies the increase in premiums.

3. There is a behavioural dimension to the increases. In both markets, the recipients of the service does not directly pay for the service received. In health care, the insurance provider covers the cost of the treatment and the patients' exposure is limited to his periodic insurance premium payments. In other words, the cost of each treatment or service is not cognitively salient for its recipient.

Similarly, higher education is mostly financed with student loans. In most cases, the repayment of these loans are back-loaded and starts only after the student enters his high-paying job. This financing patterns ensures that the student is therefore not cognitively exposed to the full cost of his education.

In both cases, the absence of any direct connect of the patient and the student with the full cost of treatment and education respectively, mitigates the impact of increasing prices. The insurer and student loan agency act as cognitive smokescreens for the service recipients.

The supply-side problem in education

This blog has consistently held the view that merely addressing governance issues will not be enough to resolve India's numerous development problems. It requires addressing the fundamental requirements of massive capital investments and enhancement of the ability of citizens to purchase those services.

Conventional wisdom would have it that if certain conditions are fulfilled - local government administration is made more professional and accountable, effective enabling policy framework is established in infrastructure sectors, and there is more transparent regulation of standards in education or health care - then private investments would flow in.

A recent editorial in Mint pointed to the extraordinary 100% marks cut-off in a Delhi College for admission to undergraduate course and argued that it is a reflection of the lack of adequate number of quality colleges. Its prescription,

"What we need is more private and public investment, and the end of the licence raj."

In this context, an op-ed in the same newspaper on the same day highlights how hard it is to "run a high-quality, financially self-sustaining school". Regarding a school adhering to a basic set of standards - the number of teachers in school, their compensation, their professional development and that of other staff, improvements in curriculum, curriculum support material and infrastructure - he writes,

"The cost structure built up by the basics demands that he charges a price in the market (school fees), which is unavailable. The size of that segment of the market that can pay that fee is so small that the costs are unsustainable."

From the inputs side, a good school (one that fulfills all the aforementioned basic requirements) needs a market that can supply good quality teachers, effective school managers and principals, training facilities and resources, land and other infrastructure etc. And all this has to come at reasonable prices, so that demand is not choked off.

Unfortunately, the market for all these inputs is severely constrained in India. Good quality human resources, whether teachers or managers, are scarce and those available come with a rapidly increasing premium. Land and infrastructure in urban India is prohibitively expensive. The result is that schools are forced into compromising heavily on personnel and infrastructure standards.

Even assuming that an entrepreneur gets all this right, as the Mint op-ed suggests, he runs into the reality that only a small sliver of the population can afford the high fees that are essential to sustain such schools.

So we have the classic problem - it is costly to run a good quality school, therefore owners have to charge higher than desirable fees, which in imposes prohibitive entry barriers for most children, and in turn makes the school commercially unviable!

Where health care inefficiencies lie?

It is widely known that the market for health care services is rife with several market failures. See this seminal paper by Kenneth Arrow. It is also widely accepted that the United States, with its private health insurance market, is the best representation of these failures.

The Economist has a graphic that traces the major sources of wastage and inefficiencies and an estimate of the amounts. As the article points out, the pay-per-service model of insurance creates perverse incentives - "the more services a hospital provides, the more it is paid".



Ezra Klein makes the interesting point that even in comparison to single-payer systems like Canada (government is the only insurer) and UK (the government is not only the sole insurer of note but also employs most of the doctors and nurses and runs most of the hospitals), US, with its private insurance dominated health care market, has a much larger government health care system. It also has the highest private health care spending.



Health care, especially in light of the US experience, is also a classic example of "how it can be possible for unregulated free-market health-care systems to cost more and deliver inferior care than strongly regulated systems with heavy government involvement"!

See excellent graphics from Kaiser Foundation comparing health care costs across developed economies.

More notes on the Hellenic tragedy

Simon Johnson is spot on in his assessment of Greece's macroeconomic situation,

"The Greek government owes more than it can afford to pay, now or in the near future, at market interest rates. There are two options: reduce the payments through some form of restructuring, or move the debt into the hands of people who are willing to charge below market rates for the foreseeable future."

Alan Cibils has lessons for Greece from Argentina, which in the nineties pegged the peso to the US dollar on a 1 to 1 exchange rate and undertook agressive free-market reforms. It finally defaulted in 2001, devalued its currency in 2002, recovered its competitiveness and enjoyed nearly a decade of robust growth.

"Greece (and Ireland, Portugal and Spain) should learn lessons from Argentina's experience. First, the I.M.F. still promotes policies that inevitably make matters worse, demonstrating an inability to learn from past mistakes. Second, default can be a solution, since it can end an unsustainable situation, frees up fiscal resources for more productive use and eliminates the need for access to bond markets. And third, regaining control of the national currency and the ability to conduct independent monetary and fiscal policies are essential for economic recovery."

Dani Rodrik too advocates much the same, debt restructuring instead of the current policy of austerity and buying time,

"When Argentina defaulted on its debt a decade ago, the country became a pariah in the eyes of foreign bankers and bondholders and was shut off from international financial markets. Yet its economy recovered quickly and experienced rapid growth thanks to a large boost in external competitiveness provided by a vastly depreciated currency. The lesson is that default can be the better option when the alternative is years of continued austerity."

As this graphic highlights pointing to evidence of sovereign defaults since 1999, post-default five year average annual growth rates belies conventional wisdom that debt repudiations inflict long-term damage to those economies.

The Economist has this cartoon illustration of the Hellenic disaster.



Update 1 (24/6/2011)

NYT article has some interesting comparisons and contrasts with Argeentina. Highlighting the fact that sovereign defaults are not without costs, it writes that, a decade later, Argentina has still not been able to re-enter the global credit market.

At the time of its default, Argentina had a fiscal deficit of 3.2% of GDP to Greece's 10.5% of GDP in 2010. As a percentage of GDP, Greece's debt is at avery high 150% to Argentina's 54% at the time of its default. As Times writes,

"But perhaps the biggest bind for Greece is that it shares a common currency with the other European nations that use the euro. And so, unless it takes the imponderable and unprecedented step of breaking from the euro zone, Greece does not have access to one big tool — devaluing its sovereign currency — that has helped Argentina weather its economic storm... The big problem for Greece is that they have a strong currency, much stronger in relation to their productivity".

In 2001, Argentina defaulted and devalued its currency. However, the government waited until 2005, when its economy was already in recovery, to conduct the first of two debt restructurings. Non-government foreign investors — the biggest included pension funds from Italy, Japan and the United States — took haircuts costing them two-thirds of their investments.

The Indian growth story in a graph

This is a follow-up on yesterday's post. It is also a simplified theoretical representation and requires empirical validation (would be great if there was some serious empirical research along these lines!).

The graphic below represents a two factor economy, consisting of physical infrastructure and human resources. It traces the evolution of the two-factor production possibility frontier (PPF) and aggregate demand of the economy over the 1995-2010 period.



As can be imagined, from the discussion in the earlier post, the economy can be assumed to be operating well within the PPF in 1995 (point A) and moving closer to PPF by 2000 (point B). It has gone slightly beyond the PPF by 2005 (point C). However, by 2010, the aggregate demand (point D) has gone well past the PPF for the year. The economy is clearly over-heating. Note that the PPF has expanded by more or less the same pace. This trend is clearly unsustainable.

The Great Indian Inflation Challenge

The great Indian inflation debate shows no signs of abating and if the prevailing trends are any indication, it may continue well into the foreseeable future. The RBI recently enacted its 13th continuous repo rate increase in an attempt to bring inflationary pressures under control. But monetary policy may be on its last legs as the negative impact of high interest rates on economic growth already appears to have become predominant.

In the circumstances, it is not surprising that inflation has become a political football. Opposition parties, civil society organizations, and opinion makers in the media cry hoarse at the government's inability to bring down food prices. They blame everything from bad policies to corruption to inefficient bureaucracy to hoarding for the persistence of inflation. Why is the inflation monster becoming so intractable?

Econ 101 teaches us that economies are at their most efficient when they grow at their production possibility frontier, which is a function of the basic resources - manpower, capital, and infrastructure - available in the economy. Any economic growth is under-pinned by these available resources. As economies expand at their natural pace, it accumulates these resources, and a positive virtuous spiral of growth is generated - growth brings in tax revenues, which are funneled into capital investments, which in turn creates the platform for further growth.

However, when the economy experience a sudden growth spurt, wherein the trend rate of growth is suddenly lifted up, the available resources often get depleted quickly and its growth may fail to keep pace with the needs of economic expansion. In simple terms, the economy grows much faster than the supply of resources required to sustain the expansion. More factory capacity is built up than electricity supply can support; manufacturing production exceeds the ability of transportation facilities to move them by road, water and air; cities grow much faster than local governments can provide civic infrastructure facilities and so on. The economy is "over-heating".

Amplifying all this is the impact of growing incomes generated by the booming economy, which changes people's living habits and expenditure patterns. If coincidentally the government is indulging in some direct fiscal spending to boost incomes across the board, then the demand pressures burst open. In such circumstances, where aggregate demand is on the up and the supply infrastructure and other basic resources not keeping pace with the requirements, inflationary pressures are inevitable.

India is experiencing something similar to that described above. A decades long trend annual growth rate of around 5% suddenly gave way to near double-digit rates since the turn of the century. Once the initial slack and spurt of government investments had run its course, the supply constraints started showing up. The supply of capital resources stagnated and failed to keep pace with galloping demand.

Targets in critical infrastructure areas like provision of civic utilities, roads, power generation, port capacity addition, agriculture storage etc were repeatedly missed. A severe shortage of skilled factory and construction manpower and qualified engineering personnel has very badly affected businesses. The high interest rates are only exacerbating this trend by creating constraints on the supply of capital.

The well-intentioned NREGS has had the direct impact of giving thousands of crores of additional cash in the hands of rural poor, besides boosting labour wages across the board. The income effect created by all this has increased disposable incomes and boosted aggregate demand across the economy. The supply-side has badly lagged behind this huge spurt in demand. Inflation was almost inevitable and will persist till these conditions change.

It is clear that while the demand side is robust, the supply side appears constrained. The rise in inflation is therefore more due to cost push factors than demand pull ones. The primary objective in a cost push inflation scenario is to ease supply side bottlenecks. The major domestic supply side bottle necks that have been driving prices up include stagnating agricultural production and over-stretched infrastructure, especially power and transport logistics.

Assuming that the lions share of infrastructure investments should have come from governments, it would be reasonable to expect government investments to have increased atleast as spectacularly as the recent spike in GDP growth rates. However, even as gross fixed capital formation as a share of GDP has increased impressively since about 2003, government consumption as a share of GDP has remained stagnant. This is despite the considerable increases in government consumption by way of petroleum and other subsidies in recent years. It can be safely presumed that government capital investments, especially in infrastructure, lags badly and remains woefully inadequate.



On a historic perspective, India's economy has, atleast since about 2003, reached a new and higher growth phase. However, this (involving the near doubling of the average growth rates from about 5% annually to about 10%) has not been accompanied by any commensurate increase in government consumption (the spurt in 2008 can be attributed to the different kinds of stimulus spending).



The choices facing the Indian economy are stark. If it has to rein in inflation in the foreseeable future, capital investments in physical infrastructure and human resources will have to increase exponentially. Or else, faced with chronic supply constraints, inflation will persist, and ultimately growth itself will get compressed. Either are not easily resolved and will take considerable time.

The most plausible scenario appears to be a slip back into an intermediate trend growth trajectory, where moderation of growth stabilizes inflationary pressures. Hopefully, this time, the government gets its act together and channels massive investments into basic physical and human infrastructure, so as to set the stage for recovering back into the current high trend growth stage quickly.

PS: Once the over-heating economy line of reasoning is accepted, the central bank faces no trade-off between inflation targeting and economic growth. The objective then is to do monetary tightening so as to cool down economic growth to a level where the supply-side growth is in sync with the aggregate demand growth. The danger of course is that no-one knows how much tightening or cooling is optimal!

Update 1 (4/7/2011)

Evidence of overheating economy comes from this graphical survey by The Economist. Using inflation, current GDP and employment growth rates over the average of the past decade, credit growth rate, and current account deficits, it finds that India is among those handful of emerging economies which are clearly overheating.

The evolution of a financial asset bubble

(HT: Chris F Masse, Via MR)

Infrastructure facts - India Vs China

The 1318 km Beijing-Shanghai high-speed rail link, the longest in the world, and constructed within three years at a cost of $33 bn, is just one in the long list of mega infrastructure projects that China has been executing. To just put this in perspective, the total outlay for India's flagship urban development program, the Jawaharlal Nehru National Urban Renewal Mission, covering 64 largest cities in the country, including the metros, and spread over five years (2005-10) was slightly more than $20 bn.

The Bandra-Worli Sea Link (BWSL), built at a cost of Rs 1800 Cr (or ~$400 mn), several years behind schedule and with substantial cost over-runs, was greeted with much national rejoicing as further proof of our arrival as a big economic power. The Hangzhou Bay Bridge, the world's longest cross-sea bridge project, was built at a cost of $16 bn.

The comparison with China is truly humbling. However, this is neither an endorsement of the Chinese model of investment driven economic growth nor of mega-infrastructure projects in general. The contrast is drawn merely to put in perspective the infrastructure investment challenges facing emerging India.

Development priorities!

Sometime back I had blogged about the priorities of government at its cutting edge, as represented by the amount of time spent by District Collectors on various development sectors. I had argued that District Collectors, who head the implementation machinery, spend most of their time on poverty mitigation welfare programs at the cost of economic growth creating development.

Here is a Venn Diagram representation of the priorities of a District Collector in a typical Indian District.



The "everything else" includes electricity, roads, urban development, drinking water, other infrastructure, health, education, and so on. The skewedness in priorities, a reflection of the priorities of governments themselves, is stark.

Why incentives alone are not enough?

Econ 101 would have it that successful public policy is that which is designed with appropriately aligned incentives. However, the complexity of the real world means that when implemented, many of these incentives, doubtless laudable when seen in isolation, results in often undesirable outcomes. Here is one recent example.

Under the popular Arogyasri health insurance program run by the Government of Andhra Pradesh, government hospitals and its doctors are incentivized by way of cash payments for each patient treated. The presumption is that once the incentives are appropriately aligned, government hospitals would be able to attract patients under the scheme and use the incentive amounts to improve infrastructure and buy equipments.

However, it has been found that this incentive architecture has not been adequate to get government hospitals to attract patients under Arogyasri. Here are two possible reasons, which also informs us about the complexity involved in designing public policies.

1. It is an open secret that many government doctors, especially specialists, practice in private hospitals outside their regular working hours. There is evidence to suggest that these doctors are being offered much higher incentive payments by the private hospitals for every patient treated under Arogyasri. In fact, the government doctor even becomes a link to attract the patient to the private hospital. In other words, there is an unforeseen and even bigger incentive at work that nullifies the incentive structure built-into the scheme.

2. Most government hospitals do not have the required basic physical infrastructure and equipments to carry out many of the procedures. Further, even when they do have the equipments, the hospital environment is not conducive to attracting patients and for performing surgeries. Most often, the doctors in government hospitals face problems from lack of electricity or water, absent or recalcitrant nurses and attendants, equipments facing minor repairs or without consumables, and so on, all of which come in the way of their work. In contrast, in a private hospital, the doctor can merely walk into the operation theatre and carry out the surgery without any concern for managing the hoospital environment.

Therefore, despite the presence of the all facilities, patients prefer the private hospital and doctors exhibit an inertia to carry out operations. The last-mile cost imposed by the environmental challenges and the resultant behavioural inertia to do surgical procedures in the hospitals is often large enough to prevent the treatment getting carried out in the hospital despite the incentive to do so.

Both these reasons again highlight attention to the fact that while structuring incentives is necessary, it is far from adequate to ensure the achievement of public policy objectives. In this case, perversely enough, the program may have had the effect of widening the existing deep divide between government and private hospitals and creating a new divide between the good and poor government hospitals.

ECI nudges voter turnout in India?

The recent Assembly elections in five Indian states saw record voter turnouts. Political pundits promptly attributed it to anger among electorate against widespread corruption and misrule by the incumbent governments.



However, there is a strong likelihood that this increase was not merely because of discontent. After all, anti-incumbency factor is common in Indian democracy, and has rarely resulted in such uniform jumps in voter turnouts.

Incidentally, this was the first election where an electoral slip was delivered to all voters following a directive from the Election Commission of India (ECI). Accordingly, less than a week (most often 3-4 days) before the polling day, an electoral slip containing the date of polling, location of polling booth, serial number of the voter in the voters list, and his/her photo was delivered to all voters. Traditionally, voters slips were disbursed by political parties during the campaigning, especially to their potential voters, so as to encourage them to vote.

If the delivery of voters slips contributed to the inceases in voters turnout, then its transmission would have been through two routes.

1. The voters slips, delivered just before the polling day, may have served to remind voters about their voting obligation and generated a form of social pressure on the voter to turn up to vote. In other words, the slips may have primed the voters into voting.

2. The voters slips - especially the location of the polling station, date and time, and the reassurance about their names being on the voters list - may have served as "channel factors" that bridged the information asymmetry and nudged the voters into visiting the polling booth to cast their votes.

Either way, unwittingly, the ECI may have used a powerful insight from behavioural psychology to nudge citizens into voting. This may also be a powerful reminder to advocates of making voting mandatory that such subtle nudges are a more effective and sustainable approach to increase voter turnout.

PS: There is no confirmation that voters slips were responsible for the increase. The increases in turnout from 2006 to 2011, where voter slips were not used, does complicate drawing ready inferences. I am sure that in the coming days atleast some researchers would use constituency data to tease out effects, if any.

The Hellenic sovereign default draws closer

The inevitable sovereign default climax to the Hellenic tragedy appears to get closer with the downgrading of Greek debt by Standard & Poor to CCC. The three-notch downgrade makes Greece’s debt the lowest-rated in the world by S&P and Greece the lowest rated country in the world. This follows Moody’s Investors Service lowering Greece’s credit rating by three notches to Caa1.

Underlining this market belief about a sovereign debt default being only a matter of time, with 85% of respondents in a Global Investors Poll predicting a Greek default. Most investors also feel Ireland, with fiscal deficit at a staggering 32% of GDP in 2010, too will default and atleast one nation will leave the Euro by 2016.

Anticipating this, the Greek CDS spreads and 10 year bond yields have gone up. The CDS spread is close to 1600 points.



The benchmark 10 year government bond yield has touched 17%, shooting up from 13% at the begining of May. Two year bonds are at a staggering 26%.



On the macroeconomic front, Greece has an unemployment rate of 16.2% and fiscal deficit was 10.4% in 2010 and is set to rise. It has financing needs of close to 160 billion euros ($229 billion) through 2014. The government is struggling to get through the latest round of fiscal austerity measures.

It is amazing that Euro area policy makers have let things drift this far. For nearly a year now, even when the Greek bailout was engineered, it was amply clear that without significant restructuring, a sovereign default was only a matter of time. However, on ideological grounds and to avoid causing losses to its own banks (who have massive exposures in the peripheral economies), Germany and other major economies opposed all forms of debt restructuring. It was thought that austerity measures in these economies will bring back macroeconomic stability, increase revenues, and help them repay their debts. The bailouts, it was argued, will help reschedule the loans and insulate Greece from the credit markets for some time.

A year on, things have obviously got worse. The costs inflicted far outweigh the possible benefits of an early restructuring. The Greek economy has contracted far more and debt position worsened, not to speak of the damaging impact on Eurozone economies. A quick and decisive debt restructuring, while temporarily painful, would have avoided this prolonged hemorrhage.

Update 1 (17/6/2011)

Times writes about the steep increase in Greek CDS spreads, "An investor now has to pay about $2 million annually to insure $10 million of Greek debt over five years, compared with about $50,000 on the same amount of United States government debt".



Update 2 (6/7/2011)

Moody’s cut its rating on Portugal’s long-term government bonds to Ba2 from Baa1 or junk status and said the outlook was negative, hinting at more downgrades. Even though Portugal negotiated a $116 billion rescue package in May, the ratings agency cited the risk that the country would need a second bailout before it could raise funds in the bond markets again and that private sector lenders would have to share the pain. It expressed scepticism at the country's ability to meet the challenges it faces in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.

The downgrade came a month after a general election in Portugal in which voters unseated the Socialist government of José Sócrates. Since then, the new center-right coalition government, led by the Social Democrats and Prime Minister Pedro Passos Coelho, have pushed ahead with austerity measures and other reforms pledged by Portugal in return for its bailout.

Exploring India's "dynamism-dysfunction" paradox

The NYT has a thought-provoking article that uses the example of Gurgaon to highlight the increasingly obvious paradox with India - "dynamism wrestles with dysfunction"! Its conclusion - dynamism comes from private sector and the dysfunction can be traced to the government.

As the Times article writes with the example of Gurgaon, "economic growth is often the product of a private sector improvising to overcome the inadequacies of the government". In Gurgaon and elsewhere in India, the answer to the country's economic growth paradox that has gained currency is that "growth usually occurs despite the government rather than because of it". It is argued that if governments - central, state, and local - could get their act together, then everything could be so different. Is it as simple as that or does it merit a more nuanced perspective?

It is undoubtedly true that governance remains generally weak and ineffectual across the country. Bureaucracy is stifling, professionalism scarce, political populism rampant, and corruption all pervasive. It is also true that India's private sector, especially in the services, have been remarkable global success stories and have played a major role in placing the country into a robust growth path. Private entrepreneurship has blossomed spectacularly over the past decade despite numerous governance related obstacles.

Therefore, is the problem merely one of a dynamic private sector and a dysfunctional government? Will the problems and deficiencies in public infrastructure service delivery disappear and entrepreneurship bloom if governments become efficient? As always with public policy debates, there are several critical dimensions to the issue that have been brushed under the carpet in our eagerness to find answers and fix blame.

However, even if governments become more efficient and outcome focused, there are certain other critical pre-requisites for any government action to deliver results. Efficiency improvements and planning can only create the platform for effective public service delivery. It cannot be a substitute for the massive capital investments required to actually deliver public services. Further, a substantial share of such resources, for setting up the infrastructure and more importantly for its operation and maintenance, have to come from its users. Governments will have to bear the subsidy burden for the poor.

Let me illustrate both these issues with reference to the Times article.

1. Development requires massive financial investments. Development spending in India resembles a trickle-down drip, whereas the need of the hour is a large-sized pipe. The Times article writes about Gurgaon's deficiencies,

"Gurgaon... does not have: a functioning citywide sewer or drainage system; reliable electricity or water; and public sidewalks, adequate parking, decent roads or any citywide system of public transportation. Garbage is still regularly tossed in empty lots by the side of the road.

With its shiny buildings and galloping economy, Gurgaon is often portrayed as a symbol of a rising 'new' India, yet it also represents a riddle at the heart of India’s rapid growth: how can a new city become an international economic engine without basic public services? How can a huge country flirt with double-digit growth despite widespread corruption, inefficiency and governmental dysfunction?"

Addressing all these deficiencies require huge investments, running into thousands of crores. Each major city would require a few thousands of crores. After they are put in place, issues of governance assume importance. Governance improvements with deficient infrastructure is equivalent to running a complex software on a low-end and out-dated computer. However, unfortunately the trends in this direction have been far from encouraging.

In recent years, an impression has gained ground that government investments in infrastructure services could be substituted with private investments in the name of public private partnerships (PPP). All it requires is for governments to either contribute land as its equity or agree to pay an annuity to the developer to deliver the service, and private investors will que up. Governments at all levels across the country have been chasing PPP investors in the past few years to partner with governments in delivering civic and public infrastructure services. As can be seen, except in a few inherently private investment friendly sectors, the results have been dismal everywhere.

This outcome is to be expected. In its broad historical sweep, no major country in the world, including both developed and now emerging economies, have developed their public infrastructure except through massive direct public investments. Nowhere in the world have private investors replaced governments as the major or even a significant provider of services in sectors like urban civic infrastructure, mass transit, roads and bridges etc. These investments have been and continues to be the preserve of governments.

There is no secret for this. Investments in these sectors are capital intensive and require high user charges or tariffs to be sustainable (some like public transit run into problems even with high tariffs). The user charges and tariffs in India are too small that it is inconceivable that any government could permit raising them by the many times required to recover these user charges. The other alternative of governments subsidizing private service delivery would require massive annuity type payments, which are again beyond the resources of most local and state governments.

This gridlock is unfortunate because atleast some Indian cities have fairly robust and professional governance systems in place. There are a few cities which even have excellent City Development Plans, professionally prepared, which could not be operationalized for lack of resources. In fact, urban governance has improved considerably in many cities across the country in the past few years. But the hardware is missing.

2. Where do these massive investments have to come from? If these services are to be sustainable, there is no denying that users have to bear a considerable share of the cost, much more than what they are paying today, of accessing these services. Sample this from the Times,

"To compensate for electricity blackouts, Gurgaon’s companies and real estate developers operate massive diesel generators capable of powering small towns. No water? Drill private borewells. No public transportation? Companies employ hundreds of private buses and taxis. Worried about crime? Gurgaon has almost four times as many private security guards as police officers."

Herein lies another paradox - people are individually paying exorbitant rates to access services from private providers but collectively unwilling to agree to pay for the same from government agencies. The politics of taxes and tariffs is a major stumbling block to any increases in them. There is also the fact that only a small proportion of the population are actually paying for these high-priced private provision of civic services. (The anecdotal examples of poor people accessing drinking water from informal bore and tanker operators etc is a misleading generalization)

The misconception that privatization is the alternative for government service delivery and government service delivery is inherently inefficient has merely amplified this collective reluctance to pay for services. Why pay the government for a service, when its delivery is unreliable and quality questionable?

It is ingrained into the public discourse that government providers are inefficient and expensive, whereas private service providers can deliver the same service with much greater quality and cheaper. This misconception persists despite the fact that private service delivery costs much higher. Critics counter this argument by claiming the people are willing to pay higher user fees or prices if they are assured of reliability and quality. While theoretically unexceptionable, as I have argued here, this stumbles when faced with real world implementation.

The rich live in near complete isolation. They have their reliable and world-class utility services - water, sewerage, electricity, telephone etc - delivered by private service providers. They hire private security guards to maintain law and order in their gated communities. These self-contained communities have their own parks, gyms and other recreational facilities. They have all the exclusive global brand retail outlets and shopping malls to satisfy their desire for conspicuous consumption. Though they still have to endure the traffic congestions and bad roads, they can afford to do it from the luxury of their chauffeur driven limousines. (It is surprisingly less discussed in all debates about public transit systems about how the rich have no incentive in establishing it) And when they want to get away from even these, they have access to world-class airports and luxurious resorts.

In other words, the rich and upper middle-class are increasingly finding diminishing incentive in improving public infrastructure. And unfortunately, they are among the only category of users who can afford to pay the high prices required to establish and deliver world class civic services. If they abdicate, the ability of local governments to finance and sustain such services become even more tenuous.

None of this is to absolve governments and its machinery off blame for the dysfunctionality of our governance systems. It is just that the society and its government need to face up to the reality that world class public service delivery requires massive investments in infrastructure and a willingness by citizens (and wherever they cannot, by governments) to pay much higher than what they are paying now in the form of tariffs and taxes. Simplified explanations that attribute the dysfunction-dynamism paradox to the standard private-public sector stereotypes are merely brushing issues under the carpet.

Gurgaon's fundamental problem is that it requires massive investments in civic infrastructure. Possibly tens of billions of dollars. The city has grown far too fast for its cash-strapped local government (India is possibly the only major country where local governments do not get any share of the larger central and state taxes) to sustain any meaningful investments. It is of course important that the urban governance systems have to be competent and efficient enough to professionally plan and execute these investments and then effectively maintain them. But the finances for the hardware has to come first.

No major Indian city is presently capable of executing projects on a scale that cities like Gurgaon need nor have the financial resources to do so. I am also not sure whether the supply side has the expertise and capability to deliver on them even if the financial bottlenecks are overcome. After all, for all talk of government lethargy, the actual execution is done by private contractors.

Early warning indicators missed in Europe

Arguably the most important lesson from the sub-prime mortgage meltdown and the consequent Great Recession is that regulators and policy makers across the board either failed to spot or, if they did, ignored early warning signals of impending problems. Post-facto analysis has revealed ample and clear distress signals across many markets on which regulators and policy makers should have acted on.

As Floyd Norris writes by pointing to the examples of Spain and Ireland, more critical and objective analysis of national macroeconomic data could have given out clear indicators of the crisis ahead. Just five years back, both these countries were the star performers among all Euro zone economies with the highest GDP growth rates and lowest fiscal deficits and debt-to-GDP ratios.

However, as the graphic below shows, this rosy picture masked concerns about the unsustainable debts the private sector in these (and Greece and Portugal) were piling up. These borrowings were fueling rapid economic growth that, in turn, produced rising tax collections, allowing national governments to run budget surpluses. The big problem was that instead of going to productive capital investments, this money was finding its way into the property market, fuelling an unproductive property bubble across these countries.



When the crash came private excesses got nationalized and got converted to public sector debt. The massive bailouts of beleaguered financial institutions, fiscal stimulus spending to prop up the recessionary economy, and the slump in all tax revenues ended up devastating the government fiscal balances.

The financial market regulators clearly failed in their responsibility of broad management of the process of capital allocation. The end-use patterns of these external private capital inflows would have been very clear for anybody who cared to observe. But regulators turned the other way.

Bubbles make a mockery of the rational economic man hypothesis among all stakeholders, even regulators. Regulators living through a bubble have always given the impression of being carried away by its "irrational exuberance" and the feeling that the party will go on forever. Then there is the issue of nobody wanting to "take the punch bowl away when the party is on". How do we know that we are not nipping a new growth cycle in the bud?

But all these instincts flies in the face of all standard macroeconomic and financial market theories. There is ample historical evidence, supporting theories, to show how such distress signals could be forebodings of crisis ahead, if not appropriately addressed. It is a constant theme from history that if private sector deficits reached the levels of Spain, Protugal and Ireland, and they were going into fuelling a bubble, then a debt crisis is not far away. Why did regulators think that "this time is different"?

Does this mean that we need to have exclusive arms within the regulatory and policy making appratus whose main job is to exclusively look for the danger signs and act as devil's advocates? Risk managers in private financial institutions are mandated to do precisely this job for their firms, but failed spectacularly. Can we expect anything different from such managers within government regulatory and policy making machinery?

In any case, spotting early warning signals, dissseminating them widely in a cognitively salient manner, and triggering off actions to mitigate these indicators of distress are arguably the most important areas of work for academics, risk managers, regulators, and policy makers.

Efficiency Vs Cost trade-off in infrastructure

Conventional wisdom would have it that governments are not only very inefficient but also expensive in delivering public services. It is also widely believed that private sector is not only more efficient but can also deliver the same service more cheaply. In other words, in contrast with the private sector, government service delivery offers the worst of both worlds - inefficient and expensive. How does this conception square up with reality?

The cost-efficiency curves for a typical market for public service delivery in developing countries would look something like in the graph below.



Atleast for the short term (given the same investments), the cost of delivering a service at the same efficiency is much higher in the private sector than the public sector. See this, this and this (there are many more other reasons). This raises the issue of whether people are willing to pay the higher prices required to access these basic public services.

However, certain markets are more amenable for private contracting. The curves for such markets would look like this



In these markets, to achieve efficiency beyond certain point, Ee, the private sector is easily more cost-effective than the government. In such cases, beyond a basic minimum level of efficiency, Ee, the private sector can achieve the same efficiency as government, Eg, at far less cost than government (P1-P2).

In conclusion, public provision of services may be more cost-effective in most public infrastructure services. However, if the private sector is made to deliver the same services, at greater efficiency, that would have to come with a cost. In the absence of willingness of users to pay the higher price, governments may have to bear the higher cost of these services by subsidizing service delivery.

But in certain infrastructure services like airports, ports, power generation, and telecoms, which are single location services, involve considerable professional expertise in their management, and where cost recovery is possible (due to the economic profile of its users), it may be prudent to rely on private providers. They can deliver such services in a more cost-effective manner than government service providers.

PS: The graphs are intuitive representation and not based on any data.

Overcoming the moral hazard from contract renegotiations

I had blogged earlier about the increasing trend of contract renegotiations in infrastructure concessions and the moral hazard generated by it. Such re-negotiations generate inefficiencies in multiple dimensions.

Assured of the possibility of re-negotiations, bidders offer excessive bids to win the tender. This often screens out the best developers or operators who lose out to those with the political muscle to wring out favorable terms during re-negotiations. More importantly, it results in considerable cost escalation, as the re-negotiated terms are certain to be in favor of the bidder. In simple terms, re-negotiations fritter away the efficiency and cost-effectiveness gains that come from a competitive bidding process.

This assumes significance in view of the decision of National Highways Authority of India (NHAI) to focus more on BOT Toll contracts instead of annuity concessions. BOT Toll concessions carries the risk of over/under-estimation of traffic, which in turn often opens up contract re-negotiations. Experience from such re-negotiations show that they are neither transparent nor conclusive. The controversy surrounding the re-negotiations of the Delhi-Noida Toll Bridge is a case in point.

In this context, a recent report on infrastructure public private partnerships (PPP) in the US advocates the use of present value of revenues (PVR) contracts as a means to mitigate the risk of contract renegotiations. Such renegotiations are common in infrastructure contracts which are financed with service fees, like tolls and user charges. The demand (or traffic) risk associated with such contracts is generally borne by the bidders, who cite the shortfalls to re-negotiatee contracts.

It is in this context that flexible-term contracts like PVR contracts assume relevance. In a PVR contract, the regulator sets the discount rate and the user-fee schedule, and bidders bid the present value of the user fee revenue they desire. The firm that makes the lowest bid wins and the contract term lasts until the winning firm collects the user fee revenue it demanded in its bid.

If the demand is lower than expected, the concession period is longer, and vice-versa. The resultant elimination of demand-side risks reduces the risk-premiums demanded by the concessionaires and would attract investors at lower interest rates. The UK was the first to use such variable term contracts, for the Queen Elizabeth II Bridge over the Thames River and the Second Severn bridges on the Severn estuary. Both contracts will continue till the toll collections pay off the debt issued to finance the bridges and are predicted to do so several years before the maximum franchise period.

Chile used a PVR auction to contract out the improvement of the Santiago-Valparaíso-Viña del Mar highway in 1998. It has since adopted PVR auctions as the standard to auction highway PPPs.

The report points to two other important advantages with PVR. One, it provides for a natural fair compensation payable, if the government decides to terminate the contract early. It can buy out the franchise by paying the difference between the winning bid and the discounted value of collected toll revenue at the point of repurchase (minus a simple estimate of savings in maintenance and operations expenditures due to early termination).

Second, unlike fixed term contracts, variable term contracts are especially useful in urban highways, where ex-ante fixation of tolls carries considerable risks - either too high (which causes under-utilization and reduces revenues) or too low (which results in over-use and congestion, generates a windfall for the concessionaire, and distorts his incentive to make investments in improvements). In a PVR contract, the regulator could set the toll rate efficiently to alleviate congestion (by raising or lowering it), without causing any harm to the concessionaire.

Apart from highways, port infrastructure, water reservoirs, and airport landing fields are natural candidates for a PVR. However, the real world risk with PVR contracts is the possibility that regulators will be forced into keeping user fees or toll rates low for political considerations (to not alientate the voters). This would generate sub-optimal outcomes, with the concessionaire having a longer than optimal concession period.

Assessing Roger Federer's clay court legacy

Roger Federer's loss in the just concluded French Open finals will naturally ignite the ususal round of questions about his competence on clay. Critics will argue that this is further proof of the fact that he does not belong to the top rank of clay court players of all time.

Now let us examine this claim against the weight of facts. Since 2004, Federer has lost at Paris before the finals to just three players, all of whom were exceptional clay-court specialists. In 2004, he lost to three-time champion and arguably the best clay court player of his time, Gustavo Kuerten, in 2005 to the great Nadal, and in 2010 to two-time finalist (and at the time, red-hot on clay) Robin Soderling. Underlining his consistency on clay, in the past eight years Federer has entered the finals five times, won once, and lost four times (all to Nadal). His record, atleast in terms of finals and consistency on Parisian clay, is bested only by Borg and Nadal.

None of this would speak of a man whose competence on the red clay is questionable. In fact, his consistency alone should place him alongside all the great clay-courters of the open-era, like Guillermo Vilas, Borg, Wilander, Lendl, Courier, Kuerten, and Nadal. Further, his performance on his less favored surface should also be seen against the relatively poor performance of the other great non-clay champions like McEnroe, Becker, Edberg, and Samparas. So why the controversy?

It can be partially explained by a cognitive bias to which human beings are vulnerable - representativeness bias. It refers to the phenomenon where people evaluate a hypothesis (or its probability) by considering how much of it resembles readily available and salient data as opposed to using a Bayesian calculation.

People evaluate great champions by their wins, not their losses. In Federer's case, there are several factors that amplify the bias. Not only has he lost four finals, he lost all of them to his great opponent Nadal, who has won six. Nadal is the unquestioned clay court champion of his time, probably of all time. Federer falls terribly short in comparison to Nadal, atleast on clay. Further, people also compare his performance at French to the other Slams, where he has won 15 times. He has won on grass and hard-courts, despite Nadal. Though it only means that Federer is more comfortable and more competitive on these surfaces, people construe it as proof of his weakness on clay.

In conclusion, Federer may be a lesser player on clay, but less stronger and consistent than only two others!

Why health care cannot not be rationed?

One of the central themes of the debates about health insurance in the United States is the "rationing" of health care. Conservatives believe in the provision of unlimited access to all health care, irrespective of its costs and benefits, and oppose all attempts to ration health care on any cost-effectiveness criterion. On the contrary, liberals argue that the steep rise in health care costs leave governments with little choice but to restrict the types of care covered.

Governments across the world face a two-fold challenge with their health care budgets. On the one hand, a large number of public spending needs compete for scarce resources, while on the other hand aging populations and increasing cost of medical treatments put upward pressure on health care budgets. In this context, the rationing debate is all about whether governments should finance unlimited health care or should cap expenditures at some reasonable level. This essentially boils down to putting a value for human life. This value would vary, decreasing with age.

There are four fundamental challenges with health care that inevitably leads us down the path of rationing.

1. With terminal care patients, especially given the advances in medical technology, it may be possible to prolong lives, albeit at a massive treatment cost. In fact, end-of-life care is taking up an increasing share of health care budgets (approximately a quarter of the $450 billion that Medicare spent last year went to pay for care in patients’s last years of life). For example, many oncology treatments on patients with solid tumors are extremely expensive and prolong life by just a few weeks.

Should health insurance schemes cover these cases? More specifically, should government health insurance cover treatments that have no curative potential and are merely life-prolonging? Should governments refrain from aggressive therapies which have no chance for cure or recovering function? More generally, should governments cover all the possible treatment options?

The problem with rationing here is that distinguishing severely ill patients who are treatable from those who are terminal is not always simple. There is also the issue of treatments that while not curative, can improve the quality of post-treatment life.

2. The perennial problem for health insurance has been about managing the issue of over-treatment. Incentives of doctors, health service providers, and even patients are aligned to over-treat. Doctors and service providers get paid more if the patient undergoes more diagnostic tests and surgical interventions. Subjecting the patient to the full spectrum of diagnostic tests also protects doctors from expensive legal suits if something goes wrong with their treatment. And finally, patients too are comfortable and increasingly demand that all possibilities be ruled out during their treatment.

It therefore becomes critical for an insurance provider (and therefore governments which subsidizes the insurance scheme) to place restrictions that would contain over-treatment. This invariably results in some form of rationing.

3. Then there is the issue of over-diagnosis, especially for the elderly. For example, an "MRI will find nasty looking knee and spine abnormalities in many Medicare-aged patients who don’t (and won’t) suffer from serious knee or back pain. Most men over 80 have a few abnormal prostate cells that will never make them sick (and won’t be helped by treatment) but can be profitably labeled 'cancer'." Similarly, most old people will display evidence of heart disease if one looks hard enough.

Knowing when it is prudent or necessary to start treatment is also essentially a rationing decision. Insurers will have to take judgement decisions to either agree or disagree for certain treatments, though the patients may demand and doctors may want it.

4. Finally, there is the issue of ineffective treatments. The BMJ has classified more than 3000 treatments as either of unknown effectiveness (51 percent), beneficial (11 percent), likely to be beneficial (23 percent), trade-off between benefits and harms (7 percent), unlikely to be beneficial (5 percent) and likely to be ineffective or harmful (3 percent). In Britain, the National Institute for Health and Clinical Experience (NICE) is entrusted with the responsibility of studying treatments and declaring them ineffective or not and whether to be included in the NHS treatments.

Any attempt to restrict treatments whose effectiveness is largely questionable is another form of rationing. In the absence of such restrictions, pharma companies and health service providers have an incentive to push through treatments of doubtful value.

In any case, it is indeed surprising that conservatives in the US, who are all ardent free-market advocates, take umbrage at rationing of health care. After all, free-market itself is the ultimate rationing mechanism - one that rations scarce resources among competing interests in the most efficient manner. In other words, the debate should not be over whether health care should be rationed, but about how efficiently and fairly can this rationing be done.

Update 1 (22/8/2012)

Very good article on the need to ration healthcare by Eduardo Porter in the Times.