India FDI fact of the day

Painting the India growth story with a single stroke of the brush is not advisable. As the FT writes, the picture that emerges from the foreign direct investment (FDI) trends is no different,

More than 3 in every 4 dollars of equity FDI allocated to Indian regions in the last 12 years went to the state of Maharashtra and its capital Mumbai, Delhi and Bangalore (in the state of Karnataka) – territories that account for a mere 18 per cent of the population... The western region received over $100bn of FDI equity inflow in the last twelve years out of the $130bn altogether. The figure contrast with a mere $320m of equity FDI that reached the eastern states of Orissa, Jharkhand and Bihar over the same period. With 15 per cent of the Indian population, they secured just 0.2 per cent of all FDI.

The patent madness is private gain at the cost of consumer welfare

A nine member jury in San Jose, California has found Samsung guilty of infringing the design and user-interface patents of Apple and has awarded $1 bn in damages. Apple's claim was that Samsung had copied its touchscreen features such as “tap to focus in on a column of text, pinch to zoom into a picture of webpage”, “bounce back” scrolling, edge-to-edge sleek glass front, rounded corners, and the grid of colorful, round-cornered app icons.

Samsung has said that the patent ruling gives "one company a monopoly over rectangles with rounded corners" and described it as "a loss for the American consumer that will lead to fewer choices, less innovation, and potentially higher prices”. I am inclined to agree with Samsung on this.

As the stakes in the smartphone market has gotten bigger, Apple has been committed to make life difficult, if possible eliminate, Google's Android operating system. In fact, it has already sought to block the sale of several Samsung devices in the US. This latest victory over Samsung has to be seen in this backdrop and it is certain to put device makers pursuing Android-based software wary of attracting litigation.

This issue spotlights attention on the debate about the utility of patents, especially of certain features and of long duration, in many sectors. Sebastian Mallaby points to a recent study by Michele Boldrin and David Levine who question the utility of patenting electronic technologies and argue that the best policy may be to not grant any patent at all. They contend that unlike pharmaceuticals, which require long-drawn and expensive clinical trials, technology innovators, especially those at the design end, incur far less expenses. Further, given the network effects associated with these technologies, they are amply rewarded by the first-mover advantage which confers considerable commercial opportunities. Apple's remarkable success with short-cycled product innovation, enough to make handsome profits, is proof enough for this.

As Mallaby writes, securing patents have become an end in itself,

By one count, in 2005, 41 companies claimed 8,000 patents associated with 3G communications technology. Other standards, such as MP3 music, are similarly surrounded by thickets of competing claims. Even a manufacturer that does its best to license the patents it uses may be accused of infringement... Some patents are kept deliberately low-profile in hopes that deep-pocketed companies will violate them unknowingly, at which point patent holders pounce. Last year US companies spent about $29bn fending off raids from “non-practising entities”, also known as patent trolls, litigators who own bundles of patents with no intention of using them to build products.

Further, far from dealing with technical issues of the technology standards of a phone, this patent ruling is confined to the so-called "touchy-feely" parts of the phone. As an FT article wrote,

It seems a strange state of affairs when the company that holds patents for transmitting a signal to a 3G mobile phone can be trumped by the company that has designed how a photo bounces around on that mobile phone’s screen.

In other words, Apple's patents are for being the first to adapt symbols from our universal language. Imagine what would have happened if patents were granted to the design of a square shaped box lap-top or to the generic design of a browser window or a clamshell mobile phone. Or if a patent is granted when someone comes up with a round-shaped laptop or mobile phone. At best, such patents only stunt the development of the sector. At worst, when seen in their total historical perspective, they appear farcical.    

School choice debate resurfaces

The school vouchers movement gets a boost from this study (pdf here) of the privately funded New York School Choice Scholarship Program. The Foundation offered scholarship, worth $1400 per year (1998 dollars), to approximately 1000 low income families with children of elementary school age for a period of three years to attend private, religious, or secular schools of their choice in New York.

The study tracked the different outcomes, including college going behavior, of 2666 students over more than a decade. Though it saw no significant effects on college enrollment, it found that using a voucher to attend private school increased the overall college enrollment rate among African Americans by 24 percent. They write,

We find evidence of large, significant impacts on African Americans, and fairly small but statistically insignificant impacts on Hispanic students. A voucher offer is shown to have increased the overall (part-time and full-time) enrollment rate of African Americans by 7.1 percentage points, an increase of 20 percent. If the offered scholarship was actually used to attend private school, the impact on African American college enrollment is estimated to be 8.7 percentage points, a 24 percent increase. The positive impact of a voucher offer on Hispanic students is a statistically insignificant impact of 1.7 percentage points... The impact of an offer of a voucher was to increase full-time college enrollment rate by 6.4 percentage points, a 25 percent increment... If the scholarship was used to attend a private school, the impact was about 8 percentage points, an increment of about 31 percent. No statistically significant impacts were observed for Hispanic students.

Now I have blogged here and here in some detail about the challenges associated with school vouchers. Contrary to its logical (and economic) simplicity and attractiveness, there is limited empirical evidence on the efficacy of vouchers in improving educational outcomes (read learning levels). The results from the pioneer in school vouchers, Chile, has been disappointing. In the US too, the gains have been limited, mostly confined to small gains with African Americans (something affirmed by the present study). These gains could be easily attributed to the widely acknowledged greater discipline and teacher-student interaction in the median private school over the median public school.

I presume that the obvious objectives of school choice would be to improve non-learning related outcomes (increase enrollment and retention rates), improve student learning levels, and also make the public school systems more competitive. Consider the first objective. In fact, the more worse the public school system, the higher would be the gains in all the non-learning outcomes. The New York study does not dwell much on the learning level improvements and prefers to confine itself to improvements in non-learning outcomes like enrollment and college attendance. On learning levels itself, there is very limited evidence that school choice is effective. On the effects of competition, while I am not aware of any empirical studies, I have blogged about the possible forces that would be generated from a school voucher program, which is most likely to climax in further enfeeblement of public school systems.

In any case, it may be inaccurate to evaluate the impact of school vouchers in isolation from the relative differences between private and public schools. In developing countries, most students given a choice are likely to choose private schools. Assuming the average private school in most developing countries to be superior to the public school, atleast in discipline and teacher interaction, certain outcomes are inevitable - attendance and therefore some marginal improvements in learning levels, higher retention and college enrollment. Do we attribute this to school choice or the mere fact that the private school is superior?

However, if the choice is between competing private schools, there may be some merit in a school voucher program, especially in cities. But here too geographical and other considerations may often end up preventing parents from exercising the desired choice, even more so among children from underprivileged backgrounds. Then the issue becomes one of the parent being fortunate enough to have a good private school in the neighborhood and therefore being able to send his/her child to that school.

In other words, the randomized trial to evaluate school vouchers is effectively one that evaluates the relative effectiveness of private and public schools. This is a larger and entirely different issue. And herein lies the heart of the matter. How do we improve public school systems? In particular, are there positive externalities from the presence of private schools, both natural and policy driven, that can be leveraged to improve public schools?

The best that can be said about school voucher program is that when run concurrently with efforts to improve public schools systems, it can have all round beneficial effects. It can become one more instrument to improve the competitiveness of public schools. In its absence though, it will merely promote the agenda of backdoor privatization of school education.

On "Why Nations Fail"

So Jeff Sachs, via MR, argues that geography is as much a factor in development as political institutions,

In places where production is expensive because of an inhospitable climate, unfavorable topography, low population densities, or a lack of proximity to global markets, many technologies from abroad will not arrive quickly through foreign investments or outsourcing. Compare Bolivia and Vietnam in the 1990s, both places I experienced firsthand as an economic adviser. Bolivians enjoyed greater political and civil rights than the Vietnamese did, as measured by Freedom House, yet Bolivia’s economy grew slowly whereas Vietnam’s attracted foreign investment like a magnet. It is easy to see why: Bolivia is a landlocked mountainous country with much of its territory lying higher than 10,000 feet above sea level, whereas Vietnam has a vast coastline with deep-water ports conveniently located near Asia’s booming industrial economies. Vietnam, not Bolivia, was the desirable place to assemble television sets and consumer appliances for Japanese and South Korean companies.

I agree. Furthermore, I strongly believe that "inclusive" political institutions - which protect individual rights, secure property rights, foster entrepreneurship and thereby promote inclusive economic institutions - do not guarantee higher incomes and improved human welfare forever. The increasingly unsustainable trend of widening inequality, decreased income mobility, and concentration of wealth and political power in the US - an exemplar of inclusive political institutions - would appear to weaken their hypothesis.

This is no Marxian argument. As I have blogged here, here and here, there is an inexorable dynamic to modern capitalism (as is practiced and promoted world-wide), even with all its inclusive political institutions, that makes elite capture of the economic and political institutions inevitable. Even when those at the lower part of the wealth ladder experience income growth (and this is itself debatable), the disproportionately higher rate of income growth at the top of the ladder makes concentration of wealth and political power a near certainty.

At the other extreme, in India, again despite relatively robust and inclusive political institutions, poverty and underdevelopment has remained persistently high for more than half a century. Inclusive institutions which protect individual and property rights have not translated to the expected economic growth. Clearly, there is something more to the story of "making development happen" or "sustaining growth" that goes beyond "inclusive" political institutions.

In both cases, other ingredients or conditions, which are essential to the effective functioning of these inclusive institutions have declined (as with the US) or not taken strong enough roots (in case of India). In other words, "inclusive" institutions cannot sustain by themselves nor are they adequate to generate high growth rates. Alternatively (and may be simultaneously), Governments have not been able to effectively mitigate market failures. 

However, I am inclined to largely agree with their converse argument that "extractive" political institutions - which place power in the hands of a few and beget extractive economic institutions, which feature unfair regulations and high barriers to entry into markets - inhibit sustainable economic progress.

In any case, there is something amiss about the disproportionate focus on "inclusive institutions", to the near exclusion of all else, in "Why Nations Fail". The search for that magic pill which can explain economic development and national economic growth has a long history of failures. Despite their hugely impressive scholarship, Acemoglu and Robinson are only the latest set of explorers in this quest.

The financial sector distortions in three graphics

In the aftermath of the sub-prime mortgage meltdown, there has been a fierce debate on the spectacular growth of the financial sector in recent decades and its attendant resource mis-allocation problems. Here are three excellent graphics that captures the essence of what has gone wrong.

Buoyed by a wave of financial market deregulation policies, the sector's share of the GDP of western economies have exploded since the mid-nineties.

This excessive returns are reflected in the steep increase in financial sector compensation since then. In particular, the ratio of executives compensation to the average worker's salary has rocketed.


















Financial sector wages have grown exponentially. As compensation returns rose, risk appetites too ballooned, thereby leaving a trail of incentive distortions everywhere.

The long post-war era of the Great Moderation suddenly gave way to the Great Excess!

Populist assault on incentives

I have an op-ed in Mint today which talks about how populist policies are distorting incentives.

Three graphics on the school education crisis in the US

In the context of the raging debate about poor quality of learning outcomes in the US, here are three revealing graphics from a presentation given by Jon Moynihan at the LSE (via Derek Thompson). The first highlights the high functional illiteracy level among school leaving students.

The second graphic highlights how teaching has slipped down the career preference ladder for new job market entrants.

The third shows that in terms of salaries, American teachers are the lowest paid among all major developed economies.

Dutch Vs American income distribution

Dani Rodrik has a post that compares the income distribution in US and Netherlands and asks whose citizens are better of. He writes,

The bottom 40% or so of the population is better off in the Netherlands, especially as we go lower in the distribution of income.  The bottom 5% have nearly double the income in the Netherlands.  The top 50%, by contrast, are significantly better off in the US. So are the Americans better off than the Dutch? I cannot tell you. But I can say that per-capita GDP or aggregate productivity numbers cannot answer the question.

I am not sure I agree with Dani's ambiguity on this. Consider the theoretical case. The question is to compare the relative "utility" or "happiness" levels of "America" and "Netherlands" in the aggregate. It is known that the marginal utility or happiness from every additional unit of income decreases with increasing income. Therefore, those in the lower half of the income ladder experience a much higher marginal utility from their additional incomes than those in the upper half. This means that the Dutch, with higher incomes for their bottom half, will have greater cumulative marginal utility than Americans, who have higher incomes for their upper half. In other words, controlling for the difference in per-capita incomes, in the aggregate, the Dutch are better off than the Americans.

Now let me illustrate the philosophical case from a Rawlsian perspective. Assuming you take birth in this world from a veil of ignorance, which distribution of income would you prefer? Since we would want to hedge for the worst case scenario, the Rawlsian answer would be the Dutch income distribution.

Therefore on both theoretical and philosophical grounds, the Dutch income distribution would appear to be superior or the Dutch better off than the Americans. 

World's biggest corporate arbitrage opportunity...

... is for corporates in developed countries to relocate or focus attention on emerging economy markets, says this McKinsey report.

The stimulus debate is getting really painful

Just when it appeared that the sheer weight of evidence indicating that the ARRA stimulus spending measures worked in promoting economic growth and reducing unemployment was enough to settle the debate, a group of distinguished economists have once again reminded us that we may be living in the dark age of macroeconomics.

The whole debate is now becoming ever more painful and a real torture. Clearly, ideological predilections have taken over the instincts and reasoning powers of even the most distinguished of economics professors. Even when faced with overwhelming evidence, they dig in and refuse to acknowledge the facts. Their theories become articles of faith.

Consider this. The economy is facing a liquidity trap, with interest rates locked in at near zero and expected to remain so for an extended time. Inflation remains very low and expectations too appear firmly anchored. Household balance sheets are some way off from regaining normalcy and therefore consumption is muted. This in turn keeps private investments away. In any case, banks, hobbled with several problems, still remain wary of normal lending, especially to the second-tier of corporates and small and medium enterprises. Fears of government borrowing "crowding-out" private investments is therefore largely illusionary. The disasters in Europe and weakening economic environment in many emerging economies, including China, makes the prospect of export-led growth remote. Hobbled with falling revenues, state and local governments continue to lay off workers and cut down on their ongoing programs.

In the circumstances, federal government is the only agent with the ability to power the economic growth engine. In other words, fiscal and monetary policy should take over. But monetary policy, even with quantitative easing and other accommodatory policies, has limited traction. However, the ultra-low interest rates makes borrowing cheap and fiscal policy potentially useful. And the poor state of America's infrastructure provides ample opportunities, indeed necessities, for public spending.

This logical case for another round of stimulus is supported by standard macroeconomic theory. The IS-LM model, which demonstrates the interaction between the goods and services and the money markets, leaves us with no doubts about the way forward. At close to the zero-bound, since cash and bonds become interchangeable, at the margins, money is just being held as a store of value, and changes in the money supply (say, by way of increased government borrowings) have no effect. Government spending results in economic expansion.




















In the absence of fiscal policy action, the economy risks being trapped in a deflationary, low growth, high unemployment equilibrium for an extended period. If there is any doubt, one only need to look at post-nineties Japan.  

Reducing healthcare costs

It is widely known that health care costs for the same treatment or procedure or test can vary by multiples across the United States. Atul Gawande's latest essay looks at ways to bend the health care cost curve by getting hospital chains to emulate commoditized fast food chains in managing consistency in cost and quality over a wide range of services when provided at locations spread out across the country.

He points to the success of Cheesecake Factory in providing over 300 dinner items with similar, standardized quality to 80 million customers each year at the same cost (for each item) across all its 160 odd American restaurants. He contrasts their success - in providing food with great variety and quality at affordable cost - with America's health care services market,

Our costs are soaring, the service is typically mediocre, and the quality is unreliable. Every clinician has his or her own way of doing things, and the rates of failure and complication (not to mention the costs) for a given service routinely vary by a factor of two or three, even within the same hospital.

In simple terms, Gawande's question is that if restaurant chefs can be trained to deliver standardized food quality across the country, then what is it that prevents doctors (in different hospitals) from delivering standardized care with consistency in quality and cost. He tells the story of Cheesecake Factory, 

If a restaurant were to stock too much, it could end up throwing away hundreds of thousands of dollars’ worth of food. If a restaurant stocks too little, it will have to tell customers that their favorite dish is not available, and they may never come back... The company’s target last year was at least 97.5-per-cent efficiency: the managers aimed at throwing away no more than 2.5 per cent of the groceries they bought, without running out. This seemed to me an absurd target. Achieving it would require knowing in advance almost exactly how many customers would be coming in and what they were going to want, then insuring that the cooks didn’t spill or toss or waste anything. Yet this is precisely what the organization has learned to do.

The chain-restaurant industry has produced a field of computer analytics known as "guest forecasting"... They have forecasting models based on historical data—the trend of the past six weeks and also the trend of the previous year. The predictability of the business has become astounding. The company has even learned how to make adjustments for the weather or for scheduled events like playoff games that keep people at home... Every six months, the Cheesecake Factory puts out a new menu. This means that everyone who works in its restaurants expects to learn something new twice a year. The March, 2012, Cheesecake Factory menu included thirteen new items. The teaching process is now finely honed: from start to finish, rollout takes just seven weeks.

The difficulty with creating Cheesecake Factories among hospital chains is with standardizing treatment regimes and universalizing best practices in diagnosis. Doctors and patients, atleast some of them, are certain to resist micro-managed commoditized treatment protocols. Gawande writes about the vast diversity in joint-replacement surgeries - different makes of artificial joints, different kinds of anesthesia, different regimens for post-surgical pain control and physical therapy - and about the efforts of Dr John Wright at Boston's Brigham and Women's Hospital in standardizing knee replacement surgery protocols.

Dr Wright gathered a group of people from every specialty involved—surgery, anesthesia, nursing, physical therapy—to formulate a single default way of doing knee replacements... they studied what the best people were doing, figured out how to standardize it, and then tried to get everyone to follow suit. They came up with a plan for anesthesia based on research studies—including giving certain pain medications before the patient entered the operating room and using spinal anesthesia plus an injection of local anesthetic to block the main nerve to the knee. They settled on a postoperative regimen, too... 

Wright had persuaded the surgeons to accept changes in the operation itself; there was now, for instance, a limit as to which prostheses they could use. Each of our nine knee-replacement surgeons had his preferred type and brand. Knee surgeons are as particular about their implants as professional tennis players are about their racquets. But the hardware is easily the biggest cost of the operation—the average retail price is around eight thousand dollars, and some cost twice that, with no solid evidence of real differences in results...

The surgeons now use a single manufacturer for seventy-five per cent of their implants, giving the hospital bargaining power that has helped slash its knee-implant costs by half. And the start-to-finish standardization has led to vastly better outcomes. The distance patients can walk two days after surgery has increased from fifty-three to eighty-five feet. Nine out of ten could stand, walk, and climb at least a few stairs independently by the time of discharge. The amount of narcotic pain medications they required fell by a third. They could also leave the hospital nearly a full day earlier on average (which saved some two thousand dollars per patient).

Gawande also draws attention to how the University of Michigan Health System standardized blood transfusions to patients, reducing the need for transfusions by thirty-one per cent and expenses by two hundred thousand dollars a month. However, their implementation on scale, country-wide and across specialties, is a massive challenge. Even where standards and treatment protocols were standardized, it has been difficult to get doctors to adhere to them.

Given the low-hanging fruits, it is appropriate that, despite all the attendant challenges and systemic resistance, some basic level of protocols based standardization should be made mandatory. Only some cutting edge discretion should be given to the individual doctors. However, such standardization and analytics is possible only if data collection is made a central focus in all health care activities. In medical care, this means electronic patient and hospital record management.

How do soda taxes reduce consumption?

The WSJ writes about the controversy surrounding the proposed new soda tax under consideration in Richmond City, northeast of San Francisco.

In May, Richmond's City Council agreed to put a measure on the November ballot to charge businesses a penny for every ounce of those beverages they sell in the city. If it passes, it would be the first city tax of its kind in the nation and the first to be approved by voters.

Now, I see two possible effects of a soda tax packaged this way, both of which will work towards reducing consumption of soft drinks. One, the standard "price effect" arising from the higher prices payable by the consumer due to incidence of taxation. Second, the more subtle "signaling effect" due to the negative imagery on soft drinks consumption conveyed by the reason underlying the decision to impose a tax. This signaling may be more effective if the tax is described as a "sin" tax, in so far as it would signal to the religious and moral sentiments of its consumers.

Which is of these two effects is more powerful in reducing consumption? What are their respective contributions? This has important implications for public policy. If the signaling effect is reasonably powerful, then it opens up possibilities for limiting certain negative externalities. More specifically, it would mean that even a small tax (and therefore more politically acceptable) can be effective in mitigating a negative externality if packaged appropriately. 

It would be great to explore this through a randomized control trial experiment (RCT), preferably at Richmond itself, to segregate the relative consumption reductions achieved by the two effects. 

Why India's power sector is a mess in a graph

The graphic below provides the best evidence that India's power sector is a national disgrace.

The most shameful thing is that despite two high profile national programs (the APDRP and R-APDRP), the aggregate technical and commercial (AT&C) loss percentage today is higher than at the beginning of the nineties. As I have blogged here, this has little to do with inadequate investments in infrastructure and other technical issues.

Transmission and distribution losses are a combination of technical losses and commercial losses. The former, consisting of line and transformer losses, is rarely more than 6-8%. It therefore means that the major contributor to AT&C loss is commercial in nature - theft and other unaccounted for supply like agriculture. Addressing this problem is simply a governance challenge. Unfortunately, Indian state does a very bad job of addressing them.

Interestingly, it is not just the government owned utilities, but the private utilities too suffer from the same governance problems. This is reflected in their respective AT&C losses - 19.89% for BSES Yamuna, 16.85% for BSES Rajadhani, and 12.39% for NDPL - for 2010-11. And all these figures are in the National Capital Territory area, with predominant non-agriculture services, after a decade of privatization. Further, it is all the more surprising since these utilities have spent massive amounts on technical loss reduction measures. These figures are comparable or even higher than that of the much larger distribution utilities in states like Andhra Pradesh and Karnataka.

As the disaggregated (division-wise) figures of BSES Yamuna shows, there are a number of persistent high loss divisions, most of them clearly being due to failure to control theft and other commercial losses. Clearly, apart from the formidable challenge of agriculture, controlling pilferage by way of outright theft, tampering of meters, and so on are not easily addressed.

Such micro-governance challenges can be tackled only through rigorous and intense, always politically difficult, local policing and enforcement, mostly beyond the powers of mere utilities, leave alone private ones. Technology and privatization will not deliver on these. More on this in later posts.

Unintended consequences of carbon credit trades

Consider the parable of a child who is prone to occasional misbehavior. To encourage him to change this bad habit, every time he misbehaves the parents offer a small cash reward if the child behaves well for a week afterwards. The child soon realizes the benefit from misbehaving as frequently as possible so as to maximize his reward payouts. The net result is that, far from reducing bad behavior, the cash reward actually ends up worsening the child's behavior.

In a similar context, Times has an interesting story that highlights how carbon trading to mitigate ozone-depleting greenhouse gas emissions (used in refrigeration and air conditioning) has had the unintended effect of actually increasing emissions. It shows how this has distorted the incentives of manufacturers of such gases

The more dangerous the gas, the more that manufacturers in developing nations would be compensated as they reduced their emissions... they could earn one carbon credit by eliminating one ton of carbon dioxide, but could earn more than 11,000 credits by simply destroying a ton of an obscure waste gas normally released in the manufacturing of a widely used coolant gas...That incentive has driven plants in the developing world not only to increase production of the coolant gas but also to keep it high...

Since 2005 the 19 plants receiving the waste gas payments have profited handsomely from an unlikely business: churning out more harmful coolant gas so they can be paid to destroy its waste byproduct. The high output keeps the prices of the coolant gas irresistibly low, discouraging air-conditioning companies from switching to less-damaging alternative gases. That means, critics say, that United Nations subsidies intended to improve the environment are instead creating their own damage...

The production of coolants was so driven by the lure of carbon credits for waste gas that in the first few years more than half of the plants operated only until they had produced the maximum amount of gas eligible for the carbon credit subsidy, then shut down until the next year... The manufacturers have grown accustomed to an income stream that in some years accounted for half their profits... Some Chinese producers have said that if the payments were to end, they would vent gas skyward.

In fact, these 19 plants producing HFC-23 have taken 46% of all carbon credits issued by the United Nations Environment Program.

This is yet another example of the challenge associated with effective enforcement of any emissions trading scheme. I have blogged earlier here, here, and here, about how carbon tax, being very simple, is a more realistic and therefore implementable strategy to reduce carbon emissions.

More market failures in Munis

America's $2.7 trillion municipal bond market is infamously opaque and has witnessed several failures and defaults. But even by its standards, as Gillian Tett writes, the case of Poway Unified, one San Diego educational district, in issuing so called "capital appreciation" bonds, is scandalous,

Last year, it issued some $105m worth of "capital appreciation" bonds to finance previously planned investment projects. These are similar to zero-coupon bonds, meaning the district does not need to start repaying interest or capital until 2033.As a result, Poway’s local authority has been able to promise to keep local taxes unchanged while completing previously promised investments (building projects, computers and so on). But, there is a big catch: to compensate for this payment deferral, these bonds are paying double-digit interest rates and cannot be redeemed early. When the bond is repaid in 2051, the total bill will be more than 10 times the initial loan.

This is no exception among California's school districts. Other San Diego school authorities have indulged themselves similarly - Oceanside Unified (borrowed $30m but will need to repay $280m), Escondido Union (borrowed $27m, faces $247m repayments) and San Diego Unified (borrowed $164m, will repay $1.2bn). In fact, while California may be an extreme case, the situation is not thought to be much better elsewhere.

These are classic regulatory failures. None of these bonds are backed by any credible repayment revenue streams. The issuers gambled on capital appreciation to finance repayments. The credit rating agencies who rated these bonds failed to signal the glaring deficiencies in the bonds issue. Regulatory gatekeepers who were supposed to ensure that issuers adhere to certain basic principles of prudent financial management looked the other way.

It is yet another reminder to those who claim that financial markets regulate themselves that financial markets cannot function effectively without strong regulation.

India Labour Fact of the Day

At the Maruti factory, even staff workers earn less than $2 an hour; their counterparts in Japan take home nearly $40 an hour for the same work.

(HT: Latitude NYT)

The HLEG report examined

Livemint reports that the Planning Commission, drawing on the recommendations of the Prime Minister's High Level Experts Group (HLEG), is contemplating a radical overhaul of India health care system in its Twelfth Plan (2012-17). The Commission divides health interventions into two categories - public health issues such as immunizations, births and HIV testing to be financed and delivered by the government, and the delivery of clinical services through the managed network system of public and private providers. It quotes the Chairman of the Commission, Mr Montek Ahluwalia,

Universal healthcare is perhaps best delivered if we move away from the present system, in which public healthcare providers are funded by the budget, to operating a network of primary, secondary and tertiary providers, where the network is paid on a per-capita basis depending on the number of people registered with it. The network could consist of pure public sector providers, or it could include some private providers on suitable terms. This certainly incentivizes the network to minimize costs and to emphasize preventive care since the total payment is fixed... Whoever manages the network will have to divide the total receipts between levels. Remuneration to doctors may have to be linked to patients actually seen. People will not be able to go straight to higher levels of the network, but will have to go through on a referral basis.  

The report also quotes the HLEG chairman, Dr Srinath Reddy's summary of its recommendations,

The HLEG had suggested a package of essential health services, which includes preventive, promotive, curative and rehabilitative services. The provision of these services has to be free of cost, and public sector facilities should be the main provider... Where necessary, private providers may be contracted-in on clearly defined terms. This should be done directly by the public sector without recourse to an insurance intermediary. For universal healthcare to succeed, with respect to public health and clinical services, it is essential that the public healthcare delivery system is strengthened all the way from the sub-centre to the district hospital.

Taken together, these statements do not bode well for health care reforms. Interestingly, both stand at the two extremes of how health care should be delivered. Both have all the hallmarks of classically misguided policy suggestions masquerading as informed prescriptions.

1. I am not aware of the HLEG's mandate, but its two prescriptions - what constitutes universal health care and the details of its standards, and how it should be delivered - are two entirely different issues, requiring very different competencies. While the HLEG's constitution does make it eminently well placed to address the first issue, I am not sure about its competency to address the second.

2. The HLEG's elimination of the use of an insurance intermediary, even to deliver tertiary care services, is surprising. The report too does not contain any valid justification for such a sweeping advocacy, especially when insurers are an important actor in any universal health care system where the presence of private operators is significant.

3. Managing the proposed public-private healthcare providers network in a country like India, where private providers increasingly dominate the market in secondary and tertiary care, even in rural areas, is no mean task. In fact, very large and experienced insurers, even in developed markets, have not been able to successfully manage the incentive distortions that are inevitable in health care markets. All the talk of contracting private providers on "suitable terms" or "clearly defined terms" betrays an understanding of the complexity of managing such contracts.

For example, the just released Annual Health Survey reports of grossly excessive C-section deliveries in private hospitals. Compounding problems is the near complete absence of health care service delivery standards for private sector. In view of all this, to imagine that the government will be able to effectively manage the regulation of contracted service delivery in a vast and diverse country like India, even if segmented regionally, appears to be a stretch. In fact, it is an invitation to crony capitalism in health care.

In simple terms, Mr Ahluwalia equates health care delivery to any other market where services can be bought and sold efficiently if incentives are aligned. Dr Reddy effectively advocates throwing more money on public institutions in the hope that more beds, specialists, and equipments will deliver universal healthcare. Both misdiagnose the issue and their prescriptions are bound to fail. As I blogged earlier, the immediate need is to have somebody in India's health care policy making establishment to "kill off bad ideas".

Income mobility for its own sake is good?

Tyler Cowen's defence of the case against income mobility has some very interesting arguments. He writes,

For a given level of income, if some are moving up others are moving down. Do you take theories of wage rigidity seriously? If so, you might favor less relative mobility, other things remaining equal. More upward — and thus downward — relative mobility probably means less aggregate happiness, due to habit formation and frame of reference effects.

Paul Krugman takes umbrage at this and accuses Tyler of promoting a form of class society. However, from behavioural economics point og view, Tyler is right. Researchers have shown that people generally suffer from loss-aversion bias - they are more motivated by avoiding a loss than acquiring a similarly sized gain.

Analyzing income mobility from this framework, it therefore follows that there is a net decrease in happiness with any changes in income levels. Those losing their income status suffer from a much greater loss than those benefiting from similar gains in income status. The economist would therefore argue that any income distribution is a Pareto optimum and any change in this would involve lowering aggregate happiness.

Tyler's central point is that at any particular income level, "there was no gain per se from having a higher rate of mobility churn, if not accompanied by higher standards of living". He also argues that the best way to ensure upward mobility is "to have a high rate of economic growth and spread across many income classes". In fact, he writes that if the general standard of living is rising, mobility takes care of itself over time. I have two issues here

1. Given the prevailing extremes in income distribution, even assuming stagnant incomes, there is a compelling in favor of higher mobility churn by itself. In the circumstances, a decrease in incomes at the top of the ladder (due to say, increase in taxation) generates limited marginal discontent. The magnitude of the loss aversion bias at the highest income levels is small, whereas the happiness from similarly sized gains at the bottom of the ladder are much higher.

2. Recent trends are ample proof of the fact that if the general standard of living rises, income mobility does not automatically take care of itself. Over the past quarter century, though standard of living has improved dramatically, income increases have been captured by those at the top of the income ladder.

Alex Tabbarok's defense of Tyler is not convincing. He picks up an simplified illustration which takes away from the complexity of income mobility in modern societies.

To repeat, given the high level of concentration of wealth at the top of the income ladder, any income mobility by way of shifts in the distribution of income, even at the same standard of living, generates beneficial effects.

Private participation in municipal water sector

Marginal Revolution has an interesting post in response to this article which discusses the effectiveness of municipal water privatization in the US. The article writes,

Across the nation cash-strapped municipalities are considering the sale of their public-utility systems. These moves are intended to raise cash and rid the municipalities of expensive liabilities such as debt service and pension obligations. But officials considering this approach might do well to look to France and other nations that are rapidly moving in the opposite direction with a “remunicipalization” of their utility systems. In 2010, Paris, in the best known case of remunicipalization, ended contracts with the world’s two biggest water service companies, Suez and Veolia, bringing an end to their 100-year private duopoly. The reversal of a century-old practice in Paris was an acceleration of an international movement away from private control.

Tyler Cowen argues that water privatization may fail in well developed markets as the private contractors acquire skills to manipulate the political and regulatory process. Similarly, the absence of adequate purchasing power and the difficulty in collecting bills, makes privatization difficult to implement in very poor countries. However, he claims significant cost and quality benefits from water privatization in middle income countries, in terms of ease of mobilization of capital, expansion of water coverage, increase in quality of supply, and reduction in unaccounted for water.

I will disagree with Tyler on this. My argument is that instead of wholesale, end-to-end privatization, a more nuanced approach of privatizing specific services in the sector, depending on the specific local conditions, may be a more effective approach to encouraging private participation in the sector. Political considerations arising from the need to maintain distributional fairness in pricing and allocation is a major imepdiment to any privatization efforts. Further, the inherent difficulty of establishing baseline standards and monitoring quality of outcomes defined in a contract too makes private contracting difficult to manage successfully.

Services like billing, database management, and contracting employees are the simplest to outsource. Likewise, maintenance of upstream assets like treatment facilities too are amenable to private participation. Efficiency improvement services like supervisory control and data acquisition (SCADA) can be both installed and maintained by private agencies. However, maintenance of distribution network is difficult to regulate and monitor. At best, the maintenance of 24 hours supply distribution networks in certain distinct metering areas, where distributional concerns are not an issue, can be outsourced.

For more on these, see this, this, this, and this.

India's electricity mess

The massive power blackout in 20 states of North, East, and the Northeast of India, for several hours, affecting 670 million people should serve as a rude wake up call on arguably India's biggest infrastructure bottleneck - electricity generation and transmission.

Amidst all the search for explanations, it cannot be denied that the the immediate cause for the blackout is a simple and shocking grid management failure at multiple levels. The load management centers at the utility, state, and regional levels are supposed to monitor the grid drawls and the frequency of transmission. If the drawl exceeds the utility/state's allocation or if the transmission frequency falls below 49.5 Hz, the load managers at each level are supposed to activate circuit breakers and cut off certain outgoing feeders that provide load relief.

There is a system of cascading accountability. If the utility continues to overdraw, the state level managers are supposed to disconnect supply to certain incoming 132 KV feeders to the utility, thereby forcing load reliefs. Similarly, for the state as a whole, if its load managers fail to respond with required load reliefs, the load managers of the Power Grid Corporation of India are supposed to cut off the state's incoming 220KV or 400 KV feeders so as to offset the excess drawl. Instructions to provide load relief gets transmitted down to the utility and state, and if this fails to elicit the desired response, the feeders are forcibly tripped off.  

In simple terms, Blackout Tuesday was triggered off by simultaneous failures in monitoring at three levels. Given the commonplace nature of this monitoring and the widespread instances of forced load reliefs, it strains credulity that it was a case of simple monitoring failure. The NYT quoted a  previous regulator who captured this failure appropriately,

He attributed this week’s problems to the bureaucrats who control the system, saying that civil servants are beholden to elected state leaders who demand that more power be diverted to their regions — even if doing so threatens the stability of the national grid.

This failure should not be glossed over. The simple management failure should not be confused with the larger policy failings. Without getting into the reasons for overdrawls nor that for inadequate generation, those responsible for this failure should be held accountable in the interest of ensuring future grid discipline. The over-drawing states of UP, Rajasthan, Haryana, and Punjab should be suitably penalized so as to deter others from persistent overdrawls. India's wildly overstretched electricity sector - hobbled with problems in generation, transmission, and distribution - will collapse if basic grid discipline breaks down.

All talk about the need to have excess capacity of stand-by peaking power plants to meet such contingencies of excess drawls is largely superfluous. Leave alone adequate level of generation and transmission redundancies, we are some way off from even having adequate off-peak time capacity. In the circumstances, the least that can be done to prevent things worsening further is to do everything possible to maintain grid discipline.

More on the psychology of poverty

One of the most enduring and deeply controversial debates on poverty is about what causes poverty. Conservatives lay the blame for poverty on the poor themselves, specifically their apparent laziness. They point to the stereotyped image of poor people idling away, shirking work and indulging in self-destructive behaviour to validate their claim. However, this argument fails to resolve the causation-correlation problem - whether they are the cause or symptoms of poverty?

Bryan Kaplan writes,

If people are poor because they're behaving irresponsibly, they should be far down our queue of people to help - if they belong on the queue at all... I also happen to think that reducing the generosity of the welfare state and making assistance conditional on good behavior will (eventually) reduce bad behavior... the fact that poor people are often the authors of their own destitution is morally significant and sadly neglected.

I am not very convinced with this reasoning. In fact, I am inclined to agree with recent findings from behavioural sciences research that point to causal links running from poverty to bad behaviours. In particular, they highlight the self-control and commitment challenges imposed on people who are constantly exposed to an environment of scarcity in time and money. In fact, the "bone-headedly simple", "very very bad" choice trade-offs on "drinking" or "smoking" or "single-motherhood", are not as simple as it appears. Consider this parable that may resonate with many of us.

Mr Meritocrat is deeply satisfied man, completely at peace with himself, his world, and his work. He gets up in the morning, attends to his natural calls, drinks the hot coffee served by his servant, reads newspaper and browses the internet from the comfort of his air-conditioned room, switches on the morning television to do yoga, takes bath, has his breakfast, gets driven to office, and has his personal assistant arrange the daily schedule. He then dives deep into his hugely rewarding and enriching work, for which he pockets a fortune each month. And I could go on.
Now consider this counterfactual. He wakes up to find that there is no water in the toilet, no servant to boil tea, and no electricity to read newspaper or browse the internet or do yoga. Worse still, his cook has taken leave, forcing him to prepare his breakfast. After he gets ready, he finds that his vehicle has broken down and he needs to wait till a taxi is hired. Thanks to the delays, he arrives late for the morning meeting. There he finds that a critical functionary has taken leave for the day, rendering the meeting largely superfluous. The cascade of events leds to a build up stress that takes it toll on Mr Meritocrat, whose productivity declines precipitously for the day. The downsward spiral will take many forms and could go a long distance down.
Mr Meritocrats' travails, amplified many times over and in a qualitatively more depressing form, echoes with the plight of a poor slum resident of any Indian city. He wakes up every morning to a day of struggles. A daily routine characterized by a seemingly endless succession of such struggles, drains him/her emotionally and congnitively, and manifests in less than desirable behaviours.

This reasoning considerably complicates the search for explanations for poverty. In any country, even in tightly controlled command economies or despotic autocracies, merit and effort does get rewarded, though the extent varies. However, to draw the simplified linear inference that, therefore, all those not successful do not have the requisite merits is simply misleading. Those apparently "irrepsonsible lifestyles" on "bone-headedly simple" issues are therefore not necessarily a matter of choice.

A more nuanced search for explanations, one that accounts for the serious incentive and behavioural distortions caused by poverty itself, necessary for us to make any meaningful and sustainable dent in addressing the scourge of poverty.