Health care graphics

I am copying these excellent graphics from Derek Thompson on the challenges facing health care sector in the US. They are representative of the problems faced by health care sector across many countries.

Health care is most cost-effective in Western Europe and East Asia. The contrast with the hugely expensive and relatively ineffective American health care system is stark.



America's health care inflation over the past 30 years trumps that in all other major economies.



Contrary to conventional wisdom, health care costs are not dominated by insurer profits and transaction costs, but by hospital and physician costs and pharmaceuticals.



Slowing the growth of health care spending would require squeezing many of these slices of the pie at the same time by, for example, increasing the payoff of investments, making hospitals more efficient, reducing doctor pay, and making prescription drugs less expensive.


The top 5% of spenders account for almost half of all health care spending.



The top 1% spends $90,000 per person on health care, 381 times more than the bottom 50%. This also means that certain categories of consumers soak up a major share of the health care spending. This also means that the focus of cost-cutting should be focussed on them.



The 1% of health care spenders are much, much sicker than the rest of the country. But almost half of them are in good, very good, or excellent health. Is there a window for cost cutting there?



But of the top 1% of health care spenders who make up 20% of all health care spending, 2/3rds are older than 55.



America's long-term budget crisis is nearly entirely a crisis of government health care spending, which is overwhelmingly in Medicare and Medicaid.



Thanks to incredible advances in heart surgery and medicine, the cardiovascular related deaths per capita have declined by 80 percent since 1950.

Hysteresis effects of recessions

What are the long-term consequences of prolonged periods of high unemployment and slower economic growth? As economic growth returns back to normal levels, does the labour market recover to its pre-crisis normal? Does capital investment by businesses and investments in research and development regain its pre-crisis trends? In simple terms, how much time does it take for the actual output to close the gap with the potential output? Or is there a danger that a permanent output gap will get crystallized?

In a recent paper, Brad DeLong and Lawrence Summers highlighted the important role of hysteresis effects. They claim that a long enough recession can erode the capability of both human and physical capital, and recovery cannot be taken for granted. There is enough evidence that long-term unemployment has scarring effects on those affected. I have blogged earlier about the harmful effects of long-term unemployment.

Greg Ip has written in Free Exchange about the possibility that America's potential output itself may have come down during the Great Recession. He points to the reduction in labour force participation rate, which appears to have stabilized at a lower level, and the lower (than trend rate) productivity rate in recent years. He argues that the actual output has been depressed for so long that hysteresis has set in and dragged the potential output down with it.

Mark Thoma has a striking illustration of the long-term consequences of deep recessions by pointing to the example of East Asian economies after their recessions following the 1997 currency devaluation crisis. All the major East Asian economies - South Korea, Malaysia, Indonesia, Hong Kong and Thailand - continue to remain considerably behind their long-term trend growth rates, even a decade after that crisis.











Much the same fate has befallen Japan since its early nineties asset prices crash. The economy fell-off the trend line for a prolonged period. Though there were signs of a recovery in the second half of last decade, the sub-prime crisis appears to have snuffed that out.


If hysteresis does indeed drag and keep down growth, then that alone would be a strong enough reason for governments to indulge in aggressive monetary and fiscal accommodation to boost aggregate demand and ensure that all idling resources are optimally employed.

Industrial Policy in oil and gas exploration in US

The Bush administration in the US led an aggressive push to both deregulate oil and gas exploration drilling activities and unlock newer reserves in an effort to limit America's energy dependence on external sources. A task force, led by Vice President Richard Cheney and comprising of top oil executives was established to push policies that promoted the aforementioned objective.

The NYT has an excellent story that illustrates how proactive policies, some of them controversial for various reasons, including allegations of cronyism, played a critical role in ushering in a boom in oil and gas exploration in the US. 

The task force’s work helped produce the Energy Policy Act of 2005, which set rules that contributed to the current surge. It prohibited the Environmental Protection Agency from regulating fracking under the Safe Drinking Water Act, eliminating a potential impediment to wide use of the technique. The legislation also offered the industry billions of dollars in new tax breaks to help independent producers recoup some drilling costs even when a well came up dry.

Separately, the Interior Department was granted the power to issue drilling permits on millions of acres of federal lands without extensive environmental impact studies for individual projects, addressing industry complaints about the glacial pace of approvals. That new power has been used at least 8,400 times, mostly in Wyoming, Utah and New Mexico, representing a quarter of all permits issued on federal land in the last six federal fiscal years.

The Bush administration also opened large swaths of the Gulf of Mexico and the waters off Alaska to exploration, granting lease deals that required companies to pay only a tiny share of their profits to the government.

All these measures encouraged oil companies to start investing in new exploration technologies to access the more difficult oil and gas sources, especially deep drilling for oil through high-pressure hydraulic fracking and horizontal drilling to unlock gas reserves beneath shale rock formations. Once the oil prices started rising in 2005 and 2006, these newer technologies suddenly became attractive and a boom ensued in deep drilling and unlocking shale gas reserves. Deep drilling and fracking opened up large new oil fields, including off-shore fields. Similarly, horizontal drilling and high-pressure fracking opened up massive reserves of gas underneath layers of shale rocks.

There is another distinguishing feature of this aggressive industrial policy push which is of great relevance for countries like India. Deep drilling in West Texas desert and off-shore locations in the Gulf of Mexico and Alaska coast, raised considerable opposition on environmental grounds. There have been valid concerns about the adverse impact of hydraulic fracking on gound water sources and surface run-off pollution of nearby water bodies. However, the federal government has not strayed away from its policy focus,

How the country made this turnabout is a story of industry-friendly policies started by President Bush and largely continued by President Obama — many over the objections of environmental advocates — as well as technological advances that have allowed the extraction of oil and gas once considered too difficult and too expensive to reach... Some areas of intense drilling activity, including northeastern Utah and central Wyoming, have experienced air quality problems. The drilling technique called hydraulic fracturing, or fracking, which uses highly pressurized water, sand and chemical lubricants that help force more oil and gas from rock formations, has also been blamed for wastewater problems. Wildlife experts also warn that expanded drilling is threatening habitats of rare or endangered species.

 In the US, the consequences of this aggressive industrial policy push has been  hugely beneficial,

Not only has the United States reduced oil imports from members of the Organization of the Petroleum Exporting Countries by more than 20 percent in the last three years, it has become a net exporter of refined petroleum products like gasoline for the first time since the Truman presidency. The natural gas industry, which less than a decade ago feared running out of domestic gas, is suddenly dealing with a glut so vast that import facilities are applying for licenses to export gas to Europe and Asia. 

National oil production, which declined steadily to 4.95 million barrels a day in 2008 from 9.6 million in 1970, has risen over the last four years to nearly 5.7 million barrels a day. The Energy Department projects that daily output could reach nearly seven million barrels by 2020. Some experts think it could eventually hit 10 million barrels — which would put the United States in the same league as Saudi Arabia.

In fact, this boom in oil and gas exploration is providing a much needed boost to the national economy itself.

The newfound wealth is spreading beyond the fields. In nearby towns, petroleum companies are buying so many pickup trucks that dealers are leasing parking lots the size of city blocks to stock their inventory. Housing is in such short supply that drillers are importing contractors from Houston and hotels are leased out before they are even built. 

The contrast with the flip-flops and prevarication that characterises the central government policy on mining and environmental concerns in India could not have been more stark. The source of one of the biggest infrastructure bottlenecks, the relatively slow electricity generation capacity addition, can be traced to the failure to open up new coal mines in the face of environmental opposition. The consequent impact on the national economy has been devastating.

Oil prices and incentives

SUV’s accounted for 18 percent of new-car sales in 2002, but only 7 percent in 2010.

Incentives matter. Americans have responded to the sharp increase in oil prices since the middle of the last decade by cutting down on their oil consumption.  

The Mexico City BRT model

The Streetsblog has an interesting account of the history of public transport facilities in Mexico City. In the past quarter century, the City has seen its public transit system move from a predominantly publicly-run metro and high-capacity bus based system to one which came to be dominated by private micro-buses. Since 2006, a Bus Rapid Transit (BRT) system, the Metrobus, was started.

The Metro-buses have played an important role in transforming the Mexico City into a more lievable, sustainable, and healthy city. It has been spearheaded by Mayor Marcelo Ebrard whose six year term, about to end this year, has coincided with the start of the Metro-bus project. 



Historically, Mexico City has had a large high-capacity bus based public transport system. However, a wave of privatization policies in the eighties and nineties saw these buses give way to private micro-buses. In fact, whereas in 1986, 42% of trips in Mexico City took place on a high-capacity bus, it plummeted to just 10% by 1994.



The experience with private micro-bus was not satisfactory. The largely unregulated fleet of micro-buses reduced average traffic speeds, lowered road safety (buses competed to get customers and reach their destinations fastest), and increased pollution levels (due to old buses being used and lower average speeds). It also spawned a web of corruption, as these buses were run by political leaders and local syndicates. But things have been looking up since the introduction of the metro-buses through a public private partnership (PPP). Travel times have fallen considerably in the BRT routes and average traffic speeds have risen.



The implementation of Mexico City's BRT system has certain unique features which makes it an interesting case study. The BRT system replaced 1077 micro-buses, which were essentially family-run operations, in certain routes with about 300 metro-buses. The low-floor Metro-buses have their own dedicated lanes, and people pay fares on platforms while waiting so that the buses can move very rapidly. The city government oversees the Metro-bus program and financed the road and station infrastructure.

The government organized the micro-bus drivers, about 800 of them, into collectives and arranged loans for them to purchase these metro-buses. They operate the buses, use the revenues to maintain operations, and make decent profits. This Metro-bús business model of displacing existing micro-bus drivers and then hiring them as BRT rolling stock operating companies, with the government providing the fixed infrastructure, is an excellent example of PPP.

As part of its BRT project under the JNNURM, the Government of India had made it mandatory for cities to form Special Purpose Vehicles (SPVs), preferably involving private operators, to run the BRT fleet. However, the challenge with this arrangement is that most of these cities had state-run Road Transport Corporations (RTCs) operating highly profitable services on the proposed BRTS routes. Naturally, the RTCs were reluctant to cede rights over these routes. State governments saw a way out of the impasse by co-opting RTC as a partner, often the majority partner, in the SPV. This left the door open for RTC to exercise backdoor control of the new BRT system, thereby considerably diluting the rigour and effectiveness of its implementation.

It is no surprise that the biggest success with BRTS has come from those cities where RTC services were either absent or where public transport services were with the urban local body. In these places, the local body has been able to bring in external professional expertise and structure Special Purpose Vehicles (SPVs) that can effectively manage the BRT services.

The private Vs public sector debate in perspective

A dominant recurring theme in debates about development in India is about how the private sector can complement the government. In fact, there are a large number of influential voices who today feel that the private sector, if they are unshackled off their regulatory chains, can assume the dominant role in the development process.

In other words, they advocate that the government should put in place "the enabling framework" (translation - limited regulation and lower taxation) and should cede the space for the "markets to work its magic". At best, the government can continue to play a marginal role as service provider, if only to keep the markets competitive and honest.

Accordingly, it is suggested that governments should promulgate public policy that enables a dominant role for private sector in secondary and tertiary health care and education, urban infrastructure like water and sewerage, roads, electricity distribution and so on. In all these sectors, they argue, governments should step aside and free the private sector from regulatory restraints. They see government as having failed (and nonbody can dispute that) and therefore, as a corollary, the private sector should take over. So what gives?

There is no denying that over the past decade-and-half, the private sector in India has shown adequate capability to assume a greater role in this journey. However, this evidence cannot be stretched to conclude that the private sector is now capable of delivering the major share of the burden in delivering on these objectives. It is imperative that we place the role of private sector and governments in their proper perspective.

Let me illustrate this with the example of the provision of affordable urban housing. The mainstream debate on the issue is today focussed on putting in place an enabling framework that will help private developers bring more housing stock into the market, on unlocking the large chunks of government lands with various government agencies through public private partnerships (PPPs), and facilitating access to credit to home buyers. Supporters argue that these policies will help the private sector seize the initiative and meet the massive housing requirement for the economically weaker section (EWS).

This argument reveals a shocking level of disconnect with reality. The overwhelmingly major share of demand for affordable housing in cities comes from the EWS. Therefore, it is only appropriate that the priority for any policy that seeks to increase the supply of affordable housing should be on housing for EWS. This naturally means that LIG, MIG, and other categories of housing, while important, will be secondary priorities for public policy.

However, the aforementioned mainstream agenda is heavily skewed in the opposite direction. Private sector has an important, even dominant, role to play in the provision of housing for LIG, MIG, and other categories. But on purely commercial considerations, the burden of provision of EWS housing will have to vest with government.

Consider the commercials. The conservative cost of any decent 300 sqft multi-storied EWS house will be around Rs 2-2.5 lakhs. This is excluding the considerable cost of land and infrastructure. Assuming a tenor of 15 years and interest rate of 10%, a Rs 1 lakh loan will require an equated monthly instalment (EMI) of Rs 1100. This is about the maximum that an EWS household can pay. In fact, an EMI of Rs 800, which means a loan of Rs 75000 at the same terms, is a more realistic estimate. At the first estimate, assuming an upfront beneficiary payment of about Rs 20000, the subsidy will have to be Rs 0.8-1.3 lakh. Add in the land and infrastructure cost, the subsidy burden per unit will multiply a few times. Who is going to finance this construction subsidy? How many EWS beneficiaries can access banks for loan tie-up, especially given the massive NPAs banks have piled up in this category? Would it not be required for governments to use most of the available scarce pool of public lands for EWS housing?

Given this, governments will have to heavily subsidize any EWS housing schemes. Private participation will have to be confined to construction (on tenders), professional project management, and possibly outsourcing of rent collection and maintenance services. No PPP, innovative structuring of projects, or establishment of enabling policy framework can gloss over this reality.

In the circumstances, efforts to leverage private participation with allotment of government lands at concessional rates (or even free of cost) or provide generous fiscal concessions to developers, will merely constrain scarce public resources and detract from the more important and several times bigger challenge of building an adequate stock of EWS housing. In other words, by following the mainstream agenda, we will end up, at best, meeting the objectives with respect to a small part of the market, while overlooking the major portion of the market. None of this is to downplay the importance of LIG, MIG, and other parts of the market, but only to argue that its promotion should not come at the cost of the much larger market and public policy priority regarding EWS housing.

The choices that face public policy makers are stark. Should we allot scarce public lands to private developers or take up development on PPP so as to promote LIG/MIG housing or should we use them to develop stock of public EWS housing? Similarly, who should take precedence in the use of government's limited fiscal resources in the housing sector?

Similar analysis can be done for many other sectors to expose the ignorance that masquerades as informed opinion and knowledge in advocating a dominant role for private sector and a marginal role for government in the development process in those sectors. I believe that if governments have been found to fall short in delivering its objectives, the solution is not to simply abdicate the responsibility and cede ground to private sector. This would be unwise, especially in areas where the inherent nature of the problem makes the private sector unsuitable and government participation imperative.

In the circumstances, while encouraging private participation, the main focus of the debates should be on policies that strengthen the government's ability to manage such initiatives and increase their likelihood of success. The scarce financial and administrative resources of public agencies should be channeled towards ensuring bang for the buck with its full range of objectives. Simplifying the problem by taking the easy way out will only exacerbate the problem. Further, public policy should not be captured to fuel the interests of certain categories of consumers and participants within each sector.

Fiscal Policy in Depressions

Lawrence Summers and Brad DeLong have this paper which argues that in severely depressed economies, which are also constrained by the zero-interest rate bound, discretionary fiscal policy can be a powerful instrument to revive growth. They write,

In normal times central banks offset the effects of fiscal policy. This keeps the policy-relevant multiplier near zero. It leaves no space for expansionary fiscal policy as a stabilization policy tool. But when interest rates are constrained by the zero nominal lower bound, discretionary fiscal policy can be highly efficacious as a stabilization policy tool. Indeed, under what we defend as plausible assumptions of temporary expansionary fiscal policies may well reduce long-run debt-financing burdens. These conclusions derive from even modest assumptions about impact multiplier, hysteresis effects, the negative impact of expansionary fiscal policy on real interest rates, and from recognition of the impact of interest rates below growth rates on the evolution of debt-GDP ratios. While our analysis underscores the importance of governments pursuing sustainable long run fiscal policies, it suggests the need for considerable caution re-garding the pace of fiscal consolidation in depressed economies where interest rates are constrained by a zero lower bound.

Following the apparent triumph of monetarism in the seventies, Keynesianism had been upstaged as the dominant macroeconomic stabilization ideology for nearly three decades till the Great Recession took hold. It was believed that front-loaded fiscal consolidation for deficit-reduction coupled with accommodatory monetary policy would help achieve price stability, positively shape expectations and restore market confidence, encourage investment and consumption, and thereby boost aggregate demand. It would help successfully combat short-term business cycle problems and address medium-term growth dimensions.

It was also believed that the multiplier of discretionary fiscal policy was small. When the economy is close to its productive level, fiscal policy induced rise in demand will run up against supply constraints, thereby fuelling inflation, and rise in interest rates. This tightening of monetary policy, at a time when the economy needs accommodatory monetary policy, will end up crowding out private investments and off-setting the aggregate demand gains due to higher government spending. In contrast, monetary policy packs a much greater punch as an economic stabilization policy instrument. However, when there is a deep economic downturn coupled with interest rates touching the zero-bound, fiscal policy assumes a different character.

As Summers and DeLong write, there are atleast three distinguishing features of the current economic situation in many developed countries that leaves monetary policy without much traction and makes discretionary fiscal policy critical.

1. The absence of supply constraints and interest behavior associated with an economy constrained by the zero-bound means that the multiplier associated with fiscal expansion is likely to be substantially greater and longer lasting. The expectations of growth returning and raising inflation, and thereby lowering real interest rates, magnifies the multiplier.

2. Even very modest hysteresis effects through which output shortfalls affect the economy's future potential have a substantial effect on estimates of the impact of expansionary fiscal policies on future debt burdens. They find evidence that mitigating protracted output losses like those suffered by the United States in recent years raises potential future output. In other words, downturns have the potential to permanently lower the potential output and the trend rate of growth - "Large recessions may create labor-market as well as capital-stock hysteresis".

For example, the longer the economy stays depressed, the more likely that workers will quit the labour force altogether. Therefore, by putting these people back to work today, stimulus generates higher taxes not just this year but for years to come, lowering the long-term debt burden.

3. Extraordinarily low levels of real interest rates raise questions about the efficacy of monetary policy as a source of stimulus, and reduce the cost of fiscal stimulus.

In this context, Paul Krugman has this nice scatterplot of the changes in GDP growth rates against the change in government consumption among Eurozone economies. The correlation is unmistakably salient.

Education and healthcare as sources of middle class deprivation?

I have written about the coming middle class deprivation due to the rising cost of healthcare, education, housing, and energy prices.

In this context, Stephen Rose has two excellent graphics in The Atlantic. The first shows the relative changes in prices of household consumption basket in the US over 60 years. Health care and education stand out as items which have experienced the biggest increases in prices.



The second shows the relative changes in the shares of items in that basket over the past 40 years. Here too health care stands out. Its share of the household consumption basket has risen from 8.1% in 1967 to 18% in 2007.



Necessities like food and clothing, which gobbled up 42% of our spending in 1947, have dwindled to just 16% of spending by 2007.

The larger point, of relevance to countries like India, is that poverty and middle-class deprivation in the coming years will be driven by the increasing cost of health care and higher education.

Is the global "safe assets" bubble bursting?

The 10-year German bund and US T-Bond are ruling at historic low yields. As the graphics below indicates, the yield on German bund is slightly below 2% while that on US Treasuries is slightly above 2%.




Obviously, especially with the US, fundamentals cannot explain the historic lows. The US economy is just emerging out of a deep recession and there are serious question marks about the sustainability of this recovery. The German economy, while strong in comparison to its crisis-ridden Eurozone partners, faces serious external threats.

The widely accepted explanation for this historic-low sovereign bond yields is their role as perceived "safe-havens". Since the sub-prime mortgage bubble burst, the US Treasuries have emerged as the preferred safe and liquid asset for investors world-wide. America's burgeoning public debt and anemic economy has not prevented capital flight from emerging economies and elsewhere into US Treasuries, driving down their yields. Similarly, across Europe, once the real depth of problems faced by the peripheral economies became apparent in early 2011, the German bunds have emerged as the preferred safe haven.

In the US, apart from this, the Fed, through its quantitative easing and "Operation Twist" programs, played an active role in driving down longer-term sovereign debt yields in order to stimulate the economy.

Consequently, both assets have been driven to ultra-low rates. While this has helped both countries, especially the US, access foreign capital at cheap rates, and thereby reduce the impact of their real debt burden, it has had all the effects of an asset bubble in both countries.

Banks in US and Europe have stacked up massive quantities of German bund and US T-Bond. In fact, at these ultra-low rates, banks were effectively paying money to both central banks in return for the safety and liquidity these assets provided. Investors and hedge funds spent huge funds to buy into both securities to take advantage of its rising values. It appeared to offer them both risk assurance and handsome returns. An asset bubble in both these securities has been the inevitable result.

This trend has mirrored a similar rise in yields across their partners, especially among the Eurozone economies. The spreads with German bund of the peripheral Eurozone economies have risen sharply. Bond yields have risen in many emerging economies too as the global economic uncertainty increased.

That this is a full-blown bubble is borne out by the fact that sovereign bond yields on both securities are at their lowest for more than 40 years and nearly 25 years for US T-Bond and German bund respectively. Therefore, it is inevitable that these yields have to rise considerably before global bond markets regain their balance. The recent fall in the prices of both bonds, while very small, may be the trigger for the bursting of the US-German sovereign bond bubble.

With the world economy on the recovery path and Eurozone troubles appearing to have crossed its worst, the global bond markets are looking up. This would reduce the premiums associated with safe-havens and thereby set the stage for returning the German and US sovereign bond yields to their normal valuations. Though this will create its own set of problems, especially for banks which have stocked up with these safe assets, it bodes well for the long-term global macroeconomic balance.

The distortions caused by "preventive care"

Is over-diagnosis and over-treatment the logical corollary to preventive care? It increasingly appears so, atleast if America is any yardstick for such assessment.

Over the past couple of decades, as health care budgets started ballooning, successive American governments have started focusing attention on preventive care so as to do early diagnosis and limit health care expenditures. Simultaneously, as health care costs started rising, private insurers too faced the same incentives.

An excellent article in the Times points attention to the increasing trend of conducting recurrent diagnostic screening on healthy individuals for various medical conditions. In the United States, healthy men are regularly screened for prostate cancer and healthy women for breast and cervical cancer.

In the past, doctors made diagnoses and initiated therapy only in patients who were experiencing problems... But increasingly we also operate under the early diagnosis precept: seeking diagnosis and initiating therapy in people who are not experiencing problems. That’s a huge change in approach, from one that focused on the sick to one that focuses on the well... in the past, you went to the doctor because you had a problem and you wanted to learn what to do about it. Now you go to the doctor because you want to stay well and you learn instead that you have a problem.

The article highlights the negative effects of such screenings and claims that it results in needless appointments, needless tests, needless drugs and needless operations,

This process doesn’t promote health; it promotes disease. People suffer from more anxiety about their health, from drug side effects, from complications of surgery. A few die. And remember: these people felt fine when they entered the health care system.

In the past, doctors used their clinical skills extensively to make diagnosis. However, for a variety of reasons, doctors today prefer to exercise their clinical skills only after examining the results of an array of diagnostic tests. This elevation of evidence from diagnostic tests to clinical acumen has, apart from dramatically increasing medical care costs, generated several incentive distortions in a market already riddled with information asymmetry and moral hazard.

I am inclined to believe that there are broadly three factors which have contributed towards this trend towards over-treatment and over-diagnosis. One, diagnostic and treatment technologies have improved dramatically over the past two decades thereby enhancing the possibility of successful detection and cure. Second, faced with the increasing prospect of malpractice litigation and patient demand to undergo all diagnostic tests, doctors prefer the easier way out and prescribe the full range of diagnostic screening before their diagnosis. Finally, as I have blogged earlier, the nature of medical insurance has eliminated any incentive among both doctors and patients to optimize diagnostic testing.

Hawthorne Effect in RCTs

Angus points to this study by a group of researchers that appears to point to significant "pseudo-placebo effects" in RCTs. It can also be viewed as an example of the significant role of expectations in shaping the responses to various interventions.

In two separate RCT experiments in rural Tanzania, farmers were supplied better varieties of cowpea seeds. In the first traditional RCT, the control group were informed and supplied traditional seeds while the treatment group were similarly supplied modern seeds. In the second double-blind RCT, both groups (and experimenters) were unaware as to what type of seed they received, though they were aware of the experiment.

The traditional RCT showed a significant, over 20% increase in yields from the modern seed, whereas, the productivity increase due to seed effect in the double-blind RCT was virtually zero. Most interestingly, a comparison of the two control groups revelead that the production increased in the double-blind control group by as much as the two treatment groups. This is a measure of the pseudo-placebo effect - it captures the crop and harvest differential due to beliefs and associated behavioral responses, not to modern seed.

The researchers found that farmers responded to being supplied with modern seeds by planting in their most productive lands, increasing their plantation areas, and also by maintaining optimal spacing. Each of these, especially the last, contributed towards improving yields.

In other words, "the expectation of receiving the treatment can cause people to modify their behaviors in a way that produces a significant "average treatment effect" even if the actual intervention in not particularly effective". The double blind RCT showed that virtually all of that improvement comes from changed behavior, not from any improved effectiveness due to the use of the modern seed. They write,

The double-blind analysis learns us that the increment in output is not due to the quality of the seeds at all, but instead to a behavioral response of the farmer (who plants the – suspected – modern seeds further apart). Positive treatment effects evaporate when controlling for this. The main conclusion is not to shun RCTs — far from it. However, we should interpret the outcomes of RCTs with proper caution, especially when jumping from output to outcomes and impact. The magnitude of the pseudo-placebo effect depends on the participants’ subjective expectations with respect to the degree of complementarity of the intervention and privately supplied inputs.

They caution against drawing inferences from preliminary findings and advocate repeating the experiments to analyze the changes in responses as expectations evolve,

Biased assessments also occur when participants have the wrong set of expectations about complementarities. To attenuate this source of bias it would be advisable to repeat experiments over various production cycles, allowing participants to learn about the nature of the innovation offered to them. As knowledge accumulates, their response becomes better tailored to the innovation, enabling the analyst to obtain an estimate of the total impact of interventions that captures both the innovation effect as well as the optimized behavioral response.

Aside from the learnings about the interpretation of RCT results, this study is an excellent example of the power of shaping behavioural expectations and responses. It raises the possibility of shaping expectations of a target group - farmers, women, teachers, students, patients, poor etc - by nudging them through creative marketing and awareness creation initiatives. Atleast in certain areas, this has the potential to be cheaper and more sustainable than the convetional hard interventions.

Global poverty rates are down

Tim Taylor points to a briefing note by Shaohua Chen and Martin Ravallion which indicates progress in global poverty reduction. The graphic captures the decline in poverty levels during the 1981-2008 period.

Looking back to the early 1980s, East Asia was the region with the highest incidence of poverty in the world, with 77% living below $1.25 a day in 1981. By 2008 this had fallen to 14%. In China alone, 662 million fewer people living in poverty by the $1.25 standard... In 2008, 13% (173 million people) of China’s population still lived below $1.25 a day. In the developing world outside China, the $1.25 poverty rate has fallen from 41% to 25% over 1981-2008, though not enough to bring down the total number of poor, which was around 1.1 billion in both 1981 and 2008... The $1.25 a day poverty rate has fallen in South Asia from 61% to 36% between 1981 and 2008. The proportion of poor is lower now in South Asia than any time since 1981.

But on the $2 a day basis, 70.9% of South Asia's population were living below the poverty line, down only marginallty from the 87.2% in 1981. On both poverty counts, a much greater proportion of Chinese were living below the poverty line in 1981. However, as the graphics below indicate, on both poverty standards, by the beginning of 1990s, China had overtaken India.




India's poverty rate reduction has been far slower than China's, reflective of the trickle-down, redistribution-driven economic growth strategy pursued by it.

Trust and capitalism

"Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence."

- Kenneth Arrow

The parking problem in malls

How fair is it to charge shoppers a fee to merely enter the shop? If there is a premium experience attached to shopping there and a demand for that experience, it is appropriate to impose an entry fee. In its absence, it may not be economically viable for the shop to charge an entry fee as a commercial revenue stream. So how is it that large shopping malls in many Indian cities collect parking charges from their customers vehicles?

I can think of two possible reasons.

1. From the demand-side, the consumers/shoppers may value the mere experience of shopping in these malls and therefore may be willing to put up with having to pay the parking charge as an entry fee. The mall operators ride on this demand and capture it in the form of parking charges.

2. From the supply-side, the parking charges, which are often exorbitantantly high in cities like Hyderabad, have become a significant revenue stream for the Mall operators. In fact, the returns (by way of sales and profits thereon) from the premium outlets may be comparable to the parking charges collected from the visitors to the same outlets.

Does this "free-market determined pricing model" lead to economic efficiency all round? As could have been expected, the free-market price determination process inevitable results in the fragmentation of the different activities into separate revenue streams with their respective distortionary effects.

1. The shop-owners/franchises get away by socializing a major negative externality. They do not pay the price for the negative externality created by their customer's vehicle parking. Since this is not internalized into their costs, the shop-owner pays a smaller rent than would have been the case if all externalities were internalized. It distorts their incentives. They offer numerous promotional and other offers to attract more customers without having to bother about its social costs.

In fact, the shops make free money here. Since all these mall shops are outlets peddling branded products, their sale prices are fixed, irrespective of whether the parking charges are internalized or not. In the circumstances, by having palmed off the responsibility of arranging parking facility to the mall operator, the franchisee would see a mall space as being more profitable that having his own exclusive separate shop, where he would have to himself arrange for separate parking.

2. Instead of viewing parking as an accompaniment service to be bundled with shops, the mall operator sees the parking charges as another full-fledged commercial service from which they seek to make more money. Given the large volume of shoppers, they view it as a revenue stream with considerable commercial potential. In fact, many mall operators outsource this to another service vendor, with a contract aimed at maximizing their returns. This parking operator would naturally be left with no option but to increase the parking fees and maximize his revenues.

3. As both the aforementioned points convey, in the absence of its internalization, the price of the negative externality is now completely borne by the customer. Admittedly, the shopper has to pay the cost of the convenience of using a car for his shopping. But it is only fair that he shares it with the shop from where he makes the purchases.

This again raises the issue of whether free-markets always lead to the most efficient outcomes. A more efficient system would be one where it is regulated that parking in all malls should be free and the mall operator should collect the cost of maintaining the parking facility from the individual shops. There are several ways to apportion the parking costs on the shops. Even if some reasonable charge is collected, it could be reimbursed to the customer on production of the shopping bill. Interestingly, some shops do this, but not others. This will also help the operator gather data on which shop is the largest source of parking externality.

For sure, such regulations may create their own distortions. But I am inclined to believe that its distortions are likely to be far less inefficient than that created by the current free-market price determination model.

Migration of health personnel and market failure

The international market for highly skilled workers is a Chicago economist's dream. On the one hand, between the developed economies and the least developed economies, there exist vast differentials in pay and opportunities for skill development for professionals. On the other hand, immigration rules in developed countries, many of whom face a shortage of such professionals, are very liberal and welcome, even incentivize, such migration.

It is therefore no surprise that large numbers of professionals - doctors, engineers, scientists, mathematicians etc - migrate from the least developed countries to the most developed ones. Free-market advocates would rationalize this trend as efficient - professional workers improve their skills, are better remunerated, and are happier. If questioned about its adverse impact on the parent country (due to say, doctor migration), they would point to the long-term trickle down beneficial impact - flow of remittances, skilled doctors returning back and setting up specialty hospitals and transferring expertise to local doctors, and so on.

However, in the real world, such long-term trends take time and its costs are catastrophic. There is a clear market failure. Nowhere is this impact most debilitating on the parent country than in case of medical professionals, especially from the least developed countries. An excellent report in the Times examines the impact of migration of doctors from Africa to the United States. It writes,

About 530 Ghanaian doctors practiced in the United States in 2006, which amounted to about 20 percent of the doctors left in Ghana, according to an article in The New England Journal of Medicine. Zambia... had no surgeons performing this (laparoscopic surgeon) less-invasive surgery, though the Netherlands had recently donated a laparoscope... the median salary of a surgeon in New Jersey is $216,000. In the main hospital in Lusaka... a surgeon makes about $24,000 a year.

In this context, the Times report points to a study published in The Lancet in early 2008, which reveals the shocking impact of migration of medical professionals - doctors, nurses, and pharmacists - on the parent countries of sub-saharan Africa. The authors, a group of doctors, argue that active recruitment of health workers from African countries is a systematic and widespread problem throughout Africa and should be viewed as an international crime. They write,

Overall, there is one physician for every 8000 people in the region. In the worst affected countries,such as Malawi, the physician-to-population ratio is just 0·02 for every 1000 (one per 50000)... the UK, for example, has over 100 times more physicians per population than Malawi. Furthermore, almost one in ten doctors working in the UK are from Africa... An estimated 13272 physicians trained in sub-Saharan Africa are practising in Australia, Canada, the UK, and the USA. Around a third of medical graduates from Nigerian state medical schools migrate within 10 years of graduation to Canada, the UK, and the USA...

In Malawi, for example, there has been a 12% reduction in available nurses due to migration. In 2000, roughly 500 nurses left Ghana, double the total number of nursing graduates for that same year... Liberia has a pharmacist-to population ratio of only one to 85 000, 77 times lower than that in the USA. In 2001, more pharmacists emigrated from South Africa (600) and Zimbabwe (60) than graduated (500 and 40).Many pharmacy outlets have closed because of a scarcity of trained pharmacists and pharmacy technicians.

Assuming the trend rate of physician attrition rate due to migration and incidence of HIV in sub-Saharan Africa, the paper projected the impact on HIV treatment. In the 2006-12 period, it estimated an almost three-fold increase in the number of patients per physician (from about 9000 to 26000) and an overall decrease in the number of physicians treating patients with HIV from 21000 to about 10000.



In this context, an Econ 101 analysis of this trend in the field of health care teaches us that such migration is efficient if the total gains from it offset the losses suffered. In other words, the financial rewards and professional skill addition gains to the individual health worker and the benefits accruing to the host country should exceed the obvious losses suffered by the parent country. However, as the Lancet report and the shocking state of health care indicators in sub-Saharan Africa shows, the losses suffered by these countries are of a much higher magnitude.

China - Irrepsonsible Superpower?

Export restrictions that have pushed prices for the 17 rare earths in markets outside China up to several times the level of prices inside China, giving companies an incentive to move factories to China. These rare earth export restrictions are... about favoring Chinese industry over global industry...

Rare earths are vital to various sophisticated technologies, including smartphones, smart bombs, large wind turbines and electric cars. Tungsten and molybdenum are used to strengthen steel and other industrial materials. China is the world’s dominant producer of rare earths, tungsten and molybdenum, and it has imposed increasingly stringent export taxes and quotas on them for the past two years despite having promised the WTO when it joined in 2001 that it would remove export taxes and quotas on all goods except for a handful of other products.

Such policies are also another reason why China cannot be considered a responsible power. The sanctity of a contract with China is dependent on the whims and fancies of those who rule Beijing. For example, China halted shipments of rare earths to Japan for two months in the fall of 2010 during a dispute over contested islands in the East China Sea. This propensity to employ its trade policy blatantly to arm-twist its trade partners as part of strategic diplomacy is a sign of an insecure superpower.

Such flippant actions are all the more likely with autocratic regimes like China, where domestic pressure is unlikely to play a countervailing role against such whimsical policies. Contrast this with India's U-turn on cotton exports ban due to domestic political opposition.

For a more detailed discussion on China's rare earth's policy, see this.

What is the maximum marginal tax rate?

Large sovereign debts and fiscal deficits are the biggest problems facing many developed world economies, including the United States. In this context, the need to raise government revenues has naturally led to a debate about raising taxes and, in particular, the impact of raising the marginal income tax rates on the incentive to work.

Christina and David Romer have a new working paper which examined the impact of the frequent, drastic, and heteregenous policy-induced changes in marginal tax rates on the incentive to work of those at the top 0.05% of the income distribution during the inter-war years. They write about four findings,

First, consistent with what one would expect given the tremendous identifying variation, they are very precise. Second, they show that taxes are indeed distortionary: the null hypothesis of no effect is overwhelmingly rejected. Third, they indicate that the distortions are small. Our baseline estimate of the elasticity of taxable income with respect to the after-tax share (that is, one minus the marginal tax rate) is approximately 0.2. This is considerably smaller than the findings of postwar studies (though generally within their confidence intervals). Finally, the estimates are extremely robust.

James Kwak interprets the Romer's finding that the elasticity of taxable income for these 0.05% (the super-rich) with respect to changes in the after-tax income share is 0.19.

"An elasticity of 0.19 implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates."

He argues that instead of being dis-incentivized from working, these super-rich respond by trying to game the tax system,

Recent US history shows that when you raise taxes on the rich, they don’t stop trying to make money: they just pay their lawyers and accountants more to avoid paying taxes. The solution to that is a simpler tax code with fewer exclusions and deductions.

The interpretation of James Kwak is close to that estimated by a study on optimal taxes by Peter Diamond and Emmanuel Saez. Using parameters based on the literature, they suggest that the optimal tax rate on the highest earners is in the vicinity of 70%. See Paul Krugman's discussion here.

In this context Karl Smith points to the interaction between income and work to add another explanation for why the impact of higher marginal tax rates on the super-rich is likely to be minimal. As people grow rich, they slowly substitute their domestic and other non-core (other than their income earning activity) work and time/effort expenditures by hiring others to do that work (like household chores) or private charters (using their private jets instead of waiting at the airports) so that they can spend more time on their core-activity. This in turn increases incomes further. However, as they become super-rich, they would have more or less exhausted such substitution alternatives. They become indifferent to any marginal income changes.

Free market and meritocracy

Conservatives have for long opposed government regulation as stifling individual initiative and enterprise, and thereby causing inefficiencies, rent-seeking, and economic stagnation. Accordingly, as exemplified in the free-market focussed neo-liberal consensus and the recent Tea Party activism in the US, they advocate a very limited role for the government.

I will not go into a discussion on this. Suffice to say, the conservative argument is only part of the story. There is another dimension to the debate that is nowadays much less discussed and which poses a greater threat to economic growth than government per se. In fact, a more nuanced appreciation will lead us to the conclusion that government excesses may only be a symptom of the malaise, but not its underlying cause.

I am inclined to believe that the biggest danger facing societies and economies is the gradual sub-ordination of the institutional framework - social, economic, and political - that governs economic and political activities to the vested interests of those holding the reins of economic power. The power exterted by those at the top of the economic ladder inevitably permeates the institutional framework which determines the allocation of resources. Marx, after all, had a point.

This has several manifestations. A recent book by Charles Murray has sparked off an intense debate in the US about the divergence between the professional and working classes in white America over the last half century. In particular, it highlights how the various institutional elements in the society and economy favor the children of more well-off parents "to move seamlessly from their privileged upbringings to privileged careers" without a struggle. This stands in sharp contrast to the stiff entry-barriers and massive struggles that others face in even acessing their opportunities.

The biggest danger with such trends is the strong potential for elite capture of this institutional framework. As historians have documented, this would also involve using the government to protect and further their interests. An excellent recent illustration of this struggle is the attempt by the Koch Brothers to gain greater control in the activities of the libertarian Cato Institute in the face of strong opposition from the Cato Board.

The irony in this cannot be missed. At the back of Cato publications is written, "In order to maintain its independence, the Cato Institute accepts no government funding." However, now, reflective of the dangers posed by the power-elite, the biggest danger facing Cato is not government, but its own private benefactors. The Koch Brothers, who are major share holders in Cato Institute, want to increase their financial stake and thereby exert greater control in its activities. It is obvious that they want Cato to become unabashed promoters of their personal ideological prejudices, even at the cost of the institution's professional integrity.

In this context, Rajeev points to a brilliant old op-ed by Michael Young, who succinctly puts the issue in perspective,

It is good sense to appoint individual people to jobs on their merit. It is the opposite when those who are judged to have merit of a particular kind harden into a new social class without room in it for others. Ability of a conventional kind, which used to be distributed between the classes more or less at random, has become much more highly concentrated by the engine of education. The new class has the means at hand, and largely under its control, by which it reproduces itself...

So assured have the elite become that there is almost no block on the rewards they arrogate to themselves. The old restraints of the business world have been lifted and... all manner of new ways for people to feather their own nests have been invented and exploited.

Government and state machinery cuts both ways. They can be instruments to promote economic growth, enable access to opportunities, and reduce poverty. But they can also become the hand maiden of vested interests. Unfortunately, the dynamics of forces that drive the modern economy and governments are increasingly gravitating towards the latter. Most worryingly, the institutional checks and balances that existed to pre-empt such trends are being slowly chipped away.

I haven't yet read the recently released book, Why Nations Fail. But one of the central insights of Daron Acemoglu and James Robinson is that nations succeed, among other things, when their institutions of power are inclusive. In other words, they should not become "extractive institutions", where they become instruments to serve the interests of the elite. If this is happening in societies across the world, and there are compelling evidence, then aforementioned trends do not bode well.

Update 1 (22/3/2012)

Daron Acemoglu and James Robinson argue that the biggest concern with economic ienquality is that it brings along with it a reduction in equality of opportunity and generates political inequality,

Economic inequality will lead to greater political inequality, and those who are further empowered politically will use this to gain a greater economic advantage by stacking the cards in their favor and increasing economic inequality yet further -- a quintessential vicious circle... The wealthy have greater access to politicians and to media, and can communicate their point of view and interests - often masquerading as "national interest" - much more effectively than the rest of us. How else can we explain that what is on the political agenda for the last several decades has been cutting taxes on the wealthy while almost no attention is paid to problems afflicting the poor, such as our dysfunctional penal system condemning a huge number of Americans to languish in prisons for minor crimes?

Globalization and the dairy farmer

Adam Davidson has a really nice account of the impact of globalization and financial market engineering on the humble dairy farmer. He writes about how milk production went from being a local to an international market by chronicling the travails of one small New Jersey milk farmer Robert Fulper,

For most of the 20th century, dairy farming was a pretty stable business. Cows provide milk throughout the year, so farmers didn’t worry too much about big seasonal swings. Also, at base, dairy-farming economics are simple: when the cost of corn and soybeans (which feed the cows) are low and milk prices are high, dairy farmers can make a comfortable living. And for decades, the U.S. government enforced stable prices for feed and for milk, which meant steady, predictable income, shaken only by disease or bad weather...

But by the early aughts, to accommodate global trade rules and diminishing political support for agricultural subsidies, the government allowed milk prices to follow market demand. People in other parts of the world — notably China and India — also became richer and began demanding more meat and dairy products. Animal feed, especially corn and soybeans, became globally traded commodities with all the impossible-to-predict price swings of oil or copper. Today Robert can predict his profit or loss next month with all the certainty that you or I can predict the stock market or gas prices. During my visit, Robert said that his success this year will be determined by, among other things, China’s unpredictable economic growth, the price of gas (influenced, of course, by events in Iran and Syria) and the weather in New Zealand (a major milk exporter), where a drought can send prices skyrocketing.

Faced with such uncertainty and globalization, financial market innovation could not have been far away,

In the last decade, dairy products and cow feed became globally traded commodities. Consequently, modern farmers have effectively been forced to become fast-paced financial derivatives traders... There are ways to manage, and even profit from, these new risks. The markets offer a stunning range of complex agricultural financial products. Dairy farmers (or, for that matter, anybody) can buy and sell milk and animal-feed futures, which allow them to lock in favorable prices, hedge against bad news in the future and so forth. There’s also a new product that combines feed and milk futures into one financial package, allowing farmers to guarantee a minimum margin no matter what happens to commodity markets down the road.

However, the impact of these innovations, ostensibly aimed at hedging dairy farmers against the risks arising out of globalization, have not been on expected lines,

The Fulpers, like most people, are too busy with their day jobs to truly monitor the markets. But dairy farming has its own 1 percent: that tiny sliver of massive farms, with thousands of cows, that make the biggest profits and are better equipped to pay agriculture-futures experts to help them manage risk. They continue to invest and grow. Unable to keep up with the changes, many smaller farms have gone out of business in the past decade.

This story has parallels across sectors and countries. As countries open up their borders and globalize, occupations and livelihoods become exposed to greater risks. Inflation (for consumers), price volatility (for producers), and job losses (for employees) are some of the commonplace sources of the resultant uncertainty that adversely affect all three categories of people. In order to mitigate them, financial instruments get concocted and peddled. However, irrespective of their real utility, these products, by their inherent nature, are out of bounds for the vast majority of people who are worst affected by the vagaries of globalization.

So, in its balance sheet, globalization has the potential to leave vast numbers at the bottom of the income ladder deeply vulnerable. It therefore becomes important to carefully calibrate the pace and sequence of opening up individual sectors within national economies so that its negative externalities can be minimized. One of the most powerful policy levers to promote such calibrated globalization is to establish a universal social safety net.

In the final analysis, a cushion against the external shocks inflicted by globalization for those affected - both by way of a universal social safety net and some livelihoods training support - is the best insurance policy for globalization itself.

India's fiscal crisis in graphics

It is clear that whatever the RBI does with monetary accommodation, the path towards creating conditions for sustainable economic growth lies in reining in the growing fiscal deficit.



A recent report by the Goldman Sachs estimated the combined fiscal deficit of states and center for 2011-12 to touch 9% of the GDP, easily the highest among all the major emerging economies. It attributes this high deficit to the twin problem of falling tax base and ballooning subsidy burden. The Rs 40000 Cr gap in the ambitious disinvestment target is another major contributor.



The biggest long-term concern is the low tax-to-GDP ratio. India's tax-to-GDP ratio is again among the lowest among the major emerging economies.



Worse still, after steadily rising since beginning of the last decade, it has been falling since the recession struck. And it shows no signs of having bottomed out and is expected to fall further this year.



Subsidies are the elephant in the room. The food, fertilizer and fuel subsidy bills have been rising alarmingly in recent years. Unfortunately, with the 2014 elections looming large, the prospects of structural reforms to roll-back subsidies appears bleak.

Democracy!

(HT: Aguanomics)

China fact of the day

China today creates the equivalent of another Greek economy every eleven and a half weeks, and one-tenth of another eurozone economy every year.

HT: Jim O'Neill

The transformation of NREGS

My article in Pragati which examines the transformation of the NREGS from a demand-driven unemployment insurance program to a supply-driven employment creation programme is available here.

India and South Asian Region

Mostly Economics points to an IMF working paper that examines the trends in inter-regional trade within South Asia and the impact of India's economic growth on her neighbours.

Government transfers from India, both grants and loans, especially to the smaller countries like Bhutan, Nepal, and Maldives are significant. However, the level of private sector integration - apart from remittance flows of migrant workers in India, especially of workers from Bangladesh, Maldives, and Nepal - has remained small. A major source of spill-over from India is in human capital formation arising from students studying in India, administrative capacity building, and Indian support for health and education sectors in these countries.

The estimation suggests that an increase in growth in India by 1 percentage point is correlated with a rise in growth in South Asian Countries (SAC) economies by 0.37 percentage points... (other studies) show that a 1 percentage point increase in GDP per capita growth in South Africa is correlated with a 0.5–0.7 percentage point rise in growth in the rest of Africa for the period 1980–99. They also find a 1 percentage point increase in China’s growth is correlated with an average of 0.5 percentage point increase in the growth of the rest of the world for the last two decades, with potentially larger effects for Asian countries.

India's trade, both as a share of global trade and in absolute volumes, has multiplied in the last decade and half. However, even as its trade with all emerging economies and regions have grown dramatically, its trade with its neighbours has remained stagnant.



The Southern African Customs Union (SACU) has aided the closer integration of the five regional economies and helped the smaller countries benefit from South Africa's economic vibrancy. In fact, since trade is tariff-free within the region, South Africa accounts for more than 80 percent of the imports of the smaller members of the South Africa Region (SAR). But they have been also able to build solid export markets outside South Africa. In contrast, the share of trade of India's SAARC neighbours has been very small. While the trade shares of Afghanistan and Pakistan are understandable, the relatively small share of trade that Sri Lanka and Bangladesh have with India is surprising.



Infrastructure, especially energy, railways, and telecommunications, offers exciting opportunities for co-operation between these economies. The smaller economies could benefit immensely from leveraging India's expertise in these sectors. While the Indian government will have to facilitate the strengthening of this mutually beneficial partnership with long-term loans and other forms of aid, India's private sector may have to seize the opportunities that are slowly emerging in these countries. Some form of strategic diplomacy to deepen such links is the need of the hour

Closer economic relationship will not only add another, probably critical, growth dimension to these economies, but also help alleviate the mistrust that characterize political relationships among countries in the region. For India, it will lay the foundation for smoother relationships in its "near abroad" so that its more ambitious global ambitions can be pursued.