The Fed's exit problem

The Fed's decision to continue with its $85 bn a month asset purchases program and thereby put to rest, at least for now, fears of a tapering of its third round of quantitative easing program, is surprising. Clearly, faced with the uncertainty surrounding the strength of US recovery and the effect of any unwinding on the global financial markets, the Fed has blinked. It has preferred to let the status quo continue. A few observations.

1. Given this line of thinking, it is now difficult to see how the Fed will ever, on its own, summon the courage to exit its extraordinary monetary accommodation. This is all the more so since any evidence of recovery is likely to be always mixed. And if there is any conclusive evidence of recovery, then it is most likely that the Fed is behind the curve in exiting. This represented a great opportunity, especially since the financial markets had recovered most of the lost ground.

2. The extended period of monetary accommodation is most certain to have solidified a very strong coalition of vested interests who have benefited from it. Needless to say, the financial industry has been the biggest beneficiaries. It is no surprise that Janet Yellen has got considerable support from the Wall Street despite the uncertainty surrounding her views on banking regulation.

3. The Fed may have become entrapped in a self-fulfilling dynamic. On the one hand the Fed believes that the market conditions demand continued monetary accommodation. However, on the other hand, the financial markets will always react adversely to any news of a tapering, irrespective of the underlying factors. Drug addicts are not likely to react with happiness when denied their dope!

4. The disproportionate focus on cheap credit to enable recovery from the Global Financial Crisis and the Great Recession betrays a cognitively biased view of managing an economic crisis, at least on two counts. One, as more fundamental policy responses are not forthcoming, a false belief develops surrounding the central bank's powers. It becomes very attractive to persist with monetary easing, especially when it is not leading to inflation or crowding-out. Two, the frame of reference for recovery gets anchored to the pre-crisis indicators - financial market and macroeconomic - irrespective of whether they are achievable or even desirable. Policies get therefore tailored with that objective in mind. It overlooks the possibility that fundamental structural conditions may have changed.       

A new economic conversation for India

My latest oped in Indian Express talks about a new economic conversation for India, one that squarely addresses fundamental issues about how growth can be inclusive. There is a small error, the number of people entering the workforce each year is estimated to be 12 million.

Zambia

This article makes very depressing reading. Colonialism may be dead, but colonial exploitation techniques are very much active...

Zambia’s GDP growth has been above six percent for over a decade, riding the wave, as always, of increasing copper prices. Copper is 40 percent of Zambia’s GDP and 95 percent of its exports, but little of that money makes it here... Many of the mining companies pay just 0.6 percent royalties to Zambia, far below the already-meager industry standard of three percent. One mine reportedly got the low rate by telling the government “this mine’s basically tapped out, we’ll just be here two years.” That was more than 13 years ago, and the royalty rate hasn’t gone up, even though the price of just about every mineral you can squeeze out of Zambia has.

There is even the colonial land grab...

First, a company comes in and gets the chief to allocate a big plot of land by promising to feed his tax base, build schools and roads, offer jobs to his friends and neighbors. Then the company pays off the surveyor to give the company more than the chief originally allocated, and to file a report saying the land is vacant, out of use, culturally insignificant.

As soon as the ink on the title is dry, the company starts negotiating with the national government to get a tax holiday so it can avoid paying the taxes that were the condition for the chief allotting the land. The chief complains—where are my schools, my hospitals, my jobs?—but by now the land isn’t under his authority anymore, it’s designated as “state land,” and he has as much a claim to it... The companies aren’t required to disclose the size of the land they purchase, the length of the lease, or the procedure they followed to get it. The people living on the land are in the dark until one day a company man knocks on their door with a deed to it and, if they’re lucky, a payout if they agree to leave.

If anything has to be done to improve the situation, the country needs a state that is capable of getting atleast somethings done. But on state capability, things look even bleaker ...

As of 2012, the Ministry of Labor only had 13 inspectors for the whole country. There are so few judges in the courts that people have reportedly waited in pre-trial detention for up to 10 years...Take lawyers. Zambia only has 1,000 of them, and they’re concentrated where the money is: Lusaka (government), Copper Belt (mining) and Livingstone (safari tourists). Some provinces don’t have any lawyers at all. The government operates a kind of legal bookmobile, a team of lawyers that travels around the country offering basic services, but it only comes to each province once every two months. If you miss it this time, you’re out of luck until it returns. Last year, only six lawyers were admitted to the bar out of 164 who took the exam. The year before that, it was 16 out of 145.

Even after stripping the anecdotal hyperbole associated with such accounts, this really is a very sad state of affairs.

Notwithstanding recent optimism, the state of affairs in many parts of Africa is very dismal. The commodities boom, recent oil discoveries especially in East Africa, and the encouraging performance of a few reformers like Rwanda and Botswana have concealed fundamental problems of development traps, state capability, institutional deficiencies, leadership failures, and so on. I am not convinced with the argument that over the past decade or so some of the aforementioned continental successes have changed the dynamics of Africa's development in a manner as to set the stage for these countries to progress on a sustainable growth path. 

Principles of a universal health insurance model

Health care reforms have been fiercely debated across the world for more than three decades. Unfortunately there has been limited consensus on even fundamental issues. I find this a bit surprising since there are certain basic and self-evident features of health care market, which have been widely researched, that distinguishes it from other markets. Here are atleast two very important features that distinguish health care from other services.

1. The provision of health care is different from any other service or good traded in the market. Even though a very rich body of established research has shown that health care market suffers acutely from problems of information asymmetry and inherent limits to competition (patients cannot shop either because of the urgency of their medical condition or because of limited choice in their geographical or insurance area). Health care is not broccoli.

2. An unregulated health insurance systems suffers from multiple sources of incentive distortions and resultant market failures. The disconnect between service delivery and price signal at all levels - doctors dispensing care, patients demanding care, providers selling diagnostic and procedures, employers paying premiums, or insurers paying providers - creates a web of incentives that works against keeping costs under control.

In light of this, a universal health insurance model would have to adhere to atleast the following five principles.

1. The widest possible risk pool is necessary to keep costs down. Healthy individuals would be averse to paying the high cost of insurance, though they would then impose negative externalities by seeking subsidized care (either as part of a public health care system or even in a private insurance scheme) when they get old. Mandatory enrollment is therefore critical to the success of any universal health insurance model.

2. The cost of insurance cannot be based on pre-existing conditions. If this were the case, insurers would cherry-pick and premiums would be highest for those most in need of health services, thereby negating the very objective of health insurance. Furthermore, it would force insurers into spending large amounts in screening and other administrative services, thereby reducing the efficiency of aggregate health care spending. Community rating - whereby insurers provide the same policy at same price to all people of an age group within an area irrespective of their pre-existing medical condition - has to be an essential requirement for any universal health insurance model.

3. Health care services have to be rationed. As people live longer and technology advances, the cost of health care will be raised by both supply and demand side factors. Given the fiscal constraints of governments, it may not be possible to deliver the best available care as part of a universal health insurance model. There would have to be rationing in atleast two dimensions. One, any universal health insurance model can be sustainable only if it restricts coverage to a basic set of services, with the boundaries of coverage being determined by the degree of fiscal space available for governments.

Two, as the choice of diagnostic and treatment options expand, accompanied with exponentially rising costs, we would also need to value human life and determine thresholds for certain critical and terminal care options. A robust system of determining cost-effectiveness of diagnostic and treatment options is essential to keep a lid on rising costs. The British NHS has the National Institute for Health and Care Excellence (NICE), which has the authority to adjudicate on the cost-effectiveness of new diagnostic and treatment options.

4. The pricing of health care services - diagnostic and treatment services - by care providers cannot be purely market determined. The most effective price discovery mechanism would be for suppliers, health providers, and consumers, insurers, to engage in negotiations at an appropriately large geographical level, and arrive at a clearly defined fee schedule for all services. In its absence, a government intermediated process of price fixing may have to do the role of price discovery.

5. Finally, a universal health insurance system, however well deigned, will not be affordable to the poorest without some degree of premium support. The extent of premium support would depend on the country's poverty levels.

Update 1 (9/23/2013)

Five percent of patients account for 50% of US health care spending, with the top 1% accounting for 20.2% of the spending. Most of this is concentrated in terminal care and mental health type conditions.



Update 2 (10/6/2014)
Excellent primer on health care spending in the US from Vox.

Technology and health care costs

I have blogged recently about how the recent wave of consolidation among health care providers in the has contributed to escalation of health care costs. The mis-aligned incentives among stakeholders - patients and doctors who do not see the prices, hospitals who charge as they like, insurers who pass on the cost to employers, and employers who pass on to employees by restraining pay rises - feeds the upward spiral. Health care costs have been rising in the US faster than elsewhere.


Another contributor to the high costs is technology. The US has been at the cutting edge of advances in health care technology, many of whose benefits are minimal and are not supported by much evidence. In a recent article, MIT Professor Jonathan Skinner wrote about such treatments,

These include expensive surgical treatments like spinal fusion for back pain, proton-beam accelerators to treat prostate cancer, or aggressive treatments for an 85-year-old patient with advanced heart failure. The prevailing evidence suggests no known medical value for any of these compared with cheaper alternatives. Yet if a hospital builds a $150 million proton accelerator, it will have every incentive to use it as frequently as possible, damn the evidence. And hospitals are loading up on such technology; the number of proton-beam accelerators in the United States is increasingly rapidly. 

High tech but limited value treatments may be playing a role in driving up health care costs. It will be interesting to investigate empirically and find out its contribution to the rise in aggregate health care costs.  

India's private sector debt induced banking crisis

India's version of crony capitalism ran something like this. Politically connected firms acquired public assets - land, mines, port and airport concessions etc - at extremely favorable terms. They developed these assets mainly through loans taken from the nationalized banks. Massive loans were most often extended without adequate due-diligence, at the behest of the Finance Ministry, which control these banks. Frequent recapitalization of these banks have kept them afloat. Rent-seeking has been pervasive, both at state and central levels.

After nearly a decade of this binge, the chickens have come home to roost. Public sector banks are saddled with large and unsustainably high non-performing assets, window dressed as restructured debt. Morgan Stanley estimates the share of non-performing and restructured loans at 9% in 2013 (up from 4% in 2009) and could reach 15.5%, or Rs 3.5 trillion, in the next two years. Most of the largest infrastructure firms are left with heavily debt-laden balance sheets whose adverse effects have been exacerbated by projects which have been inordinately delayed for various reasons and have undergone large cost over-runs. A recent report by Credit Suisse finds that the combined gross debt of the ten most indebted firms exceeded a staggering $100 bn last year.


The continuing economic weakness and plunging rupee is only worsening the situation. Indian firms hold nearly $225 bn of dollar denominated debt, half of which is estimated to be unhedged, leaving those firms badly vulnerable as rupee depreciates alarmingly.

There are no easy answers. As the new RBI governor announced, it is imperative that action be initiated to clear up the mess at the earliest. Whatever the form of debt restructuring, if we are not to unleash irreparable moral hazard, it is important that two things be borne in mind. One, private firms which borrowed and invested so recklessly should not be allowed to socialize their losses with favorable debt restructuring. India's version of "too big to fail" should be nipped in the bud. Second, this is a great opportunity to introduce greater professionalism into the management of India's public sector banks, especially the Finance Ministry's control over the bank boards. The debt restructuring should not be done by unconditional recapitalization of these banks.

Update 1 (14/10/2013)

From Livemint, about the concerns created by India's 10 most indebted corporate groups,

The combined gross debt of these 10 groups was Rs 63.10 trillion at the end of March. They also account for around 13% of the total loans in the books of Indian banks in fiscal 2012, a concentration risk that deserves regulatory attention. These large borrowers also have massive foreign borrowings, and anecdotal evidence suggests that much of it is unhedged. So the financial health of these 10 borrowers should concern not just their shareholders but also policymakers given the potential risks to financial stability.

The natural gas "subsidy" for US consumers

The biggest contribution to global energy subsidies come from the largest oil producers themselves, especially from the Middle East. However, countries like Saudi Arabia strongly contest this as an energy subsidy. They argue that they are selling at their cost of production, which is far less than the prevailing global oil price, and therefore incurring no loss or subsidy on the sales.

It is tempting to extend the logic to America's gas pricing. The global natural gas price, as reflected in the UK's NBP and Japan's JCC (admittedly for LNG), are far higher than the US's Henry Hub price. The recent spurt in US gas production from underneath shale formations has driven down prices in North America, whereas gas prices continue to remain indexed to oil prices in remaining parts of the world. This coupled with regulatory restrictions that deter the construction of LNG terminals off US coast for exports are the major contributor to this market fragmentation.

Imagine a Saudi Arabia which has banned oil exports and ring-fenced a domestic oil market where the price is $10 per barrel when the prevailing global market price is $80 per barrel. The fragmented natural gas market has some similarities to this hypothetical oil market. Instead of being priced at the marginal cost of the most expensive gas field, the North American natural gas consumers enjoy a price which is linked to the marginal cost of production from the least expensive source. Is the price differential a subsidy enjoyed by North American gas consumers? 

The Political Economy Risks to RBI's institutional credibility

My latest Governance Agenda column talks about the political economy risks to the institutional credibility of the Reserve Bank of India.