China graphs of the day

From among an excellent collection of graphs about China's extraordinary quarter century of growth available here, a few stood out.

For some time now it has been well known that China was the engine of global economic growth. Whole countries have been transformed by its insatiable appetite for commodities. This has become more pronounced since the Great Recession.

What makes the Chinese economic growth truly amazing is its contribution to the spectacular decline in poverty. The contrast with South Asia is stunning.

The scorching pace of growth though has had its negatives, with a steep increase in carbon-di-oxide emissions. 

Stockholm's music cluster

MR points to this fascinating article highlighting Sweden's remarkable success in the field of pop music. Since the seventies, starting with ABBA, Swedes have dominated pop music scene with music bands, singers, song-writers, and producers. Song writers and producers from Stockholm have been behind the success of a long line of singers that include Katy Perry, Lady Gaga, Madonna, Usher, Avril Lavigne, Britney Spears, The Backstreet Boys, Pitbull, Taylor Swift, One Direction, Maroon 5, Kelly Clarkson, and many others. It writes,

Sweden, and in particular Stockholm, is home to what business scholars and economic geographers call an “industry cluster”—an agglomeration of talent, business infrastructure, and competing firms all swirling around one industry, in one place. What Hollywood is to movies, what Nashville is to country music, and what Silicon Valley is to computing, Stockholm is to the production of pop. In fact, Sweden is the largest exporter of pop music, per capita, in the world, and the third largest exporter of pop overall. And in recent years, the country has seized not just the message, but the medium as well: As the industry moves toward a distribution model that relies on streaming music services, the Stockholm-born Spotify is a dominant player, with 24 million users per month.

The article highlights that this success was the unintended result of a concerted arts-education campaign by Swedish authorities, supported by Church and Conservatives, initiated in 1940s to stamp out the growing influence of degenerate music from America and encourage more uplifting classical music. It writes,

Municipal schools of music spread across the country... Many of the schools, which were often free to attend, allowed students to borrow instruments, as if from a public library, for a nominal fee... municipal music schools increased the odds that Swedes would discover their talents, while also giving the country an unusually music-literate domestic audience. Other knock-on effects were less obvious. The municipal schools provided an indirect subsidy to the music industry itself, for instance, by offering a steady supply of flexible teaching jobs to musicians... Outside the classroom, the government also encouraged young musicians with subsidies for practice space and even practice itself... 

And perhaps most importantly, Sweden’s municipal schools gave rise to social networks of musically inclined youth—networks that ultimately formed the basis for the Swedish capital’s music industry cluster. So much information is transferred in bars, informal institutional settings, in social networks, and in the movement of people between firms... Sweden’s capital city was especially conducive to this kind of transfer. The size of Stockholm is probably perfect... Everyone knows everyone. If you go into a music store to buy strings, you know the clerk because you played with him when you were little. If you go to a record label, you know the people there.

This is yet another addition to the literature on the emergence of talent cluster and regional comparative advantage. The larger message I carry from this are two-fold.

1. Such outcomes are largely serendipitous. Post-facto one can point to the series of government interventions as elements of a consciously designed plan. However, as is evident from this story (and from all others), the emergent dynamics of such processes are unpredictable. Even when they produce the intended result, its takes a long period of incubation, with several ebbs and flows.

2. Agglomeration advantages are as important to knowledge-based industries as to traditional brick and mortar ones. The bits and bytes of pop music industry reside in the brains of human beings and is therefore, theoretically atleast, amenable to diffused and dis-aggregated growth. But, as the example of Stockholm highlights, direct human interaction plays a central role in the process of creation and transfer of ideas that drive even this industry. 

Questions about China's "incremental" reform process

Amidst the spectacular economic success of China, we often forget the apparently far-sighted nature of its political leadership. In particular, the ability of Chinese authorities to manage the time, pace, and sequence of reforms in several areas has been an equally impressive achievement. Two recent events are illustrative.

First, in recent weeks, reversing its position, the People's Bank of China (PBoC) has allowed the renminbi to depreciate, albeit slightly, against the dollar. In fact, it has doubled the band in which the currency can move to 2% around a rate fixed by the PBoC each trading day morning. The yuan had been among the only major currency which has not declined against the dollar in recent months, and its persistent stability against the dollar had given the impression that investments in the renminbi assets can only appreciate.

As Prof Barry Eichengreen has written, by allowing the currency to depreciate, the Chinese government may be signalling that holding renminbi is not an one-way bet (with attendant consequences of massive carry trade drive capital inflows and imported inflation). It would re-shape the expectations of investors and set the stage for the government to not only pursue a more flexible exchange rate policy but also pursue financial market liberalization without distorted incentives in place.

Second, most recently, in the first case of domestic bond default, the government allowed Shanghai Chaori Solar Energy Science and Technology Company to default on an interest payment. Aimed at alleviating the entrenched belief that the government will always bailout struggling companies, it comes at a time when warning signals about corporate debt have become flashing red. There have been numerous reports of corporate, especially public sector entities, having accumulated massive debts on the back of permissive lending standards.

Analysts claim that this is the beginning of a policy to allow "incremental but controlled" defaults among corporates in certain sectors, so as to mitigate the moral hazard as well as to churn out the worst run and inefficient firms. About 80% of the China's 60.3 trillion renminbi corporate debt comes from bank loans, leaving public sector banks heavily exposed to any crisis.

I am not sure whether the Chinese government can keep orchestrating carefully calibrated moves on such complex issues repeatedly. Their success till date ought to be attributed more to the favorable headwinds from long-period of economic boom, which provided the cushion to initiate reforms, as well as plain good luck. Now that growth is slowing, and in any case the spectacular rates are no longer sustainable, the government's ability to pull off such deft maneuvers may have narrowed considerably. 

Getting legislators to legislate

An oft-repeated complaint among bureaucrats is that legislators interfere too much in operational issues like transfers of field functionaries and procurement of goods and services. It is common knowledge that the MP or MLA have strong vested interest in the postings of officials deputed to work in their constituency and the contractors awarded local works or supply orders. Legislators put pressure on officials to violate rules to accommodate these vested interests. It forms a major source of patronage and a channel to keep their loyal followers satisfied. But this interference in routine administrative activities contributes to the politicization of grass-roots administration as well as the erosion of state capability.

 

Why do law-makers end up becoming rule-breakers? The simple answer is that of patronage, corruption, and self-aggrandizement. A more sophisticated answer is that it is a reflection of responsibilities and incentives within the system.

The unfortunate reality is that legislators, or law-makers, spend very little time on their primary responsibility of making laws. Though Parliament and Assemblies discuss and legislate laws, much of that work is notional. The major part of the work of preparing legislations is done by the concerned Ministry, at the instance of the ruling coalition. The individual legislators have a very limited role in this process. Apart from their occasional intervention, if any, in the discussions that take place in the legislature when the bill is tabled, the legislator could be nominated to a Parliamentary or Assembly Standing Committee that are sometimes constituted to scrutinize the Bill. Their other statutory responsibility is participation in the activities of the regular legislative committees. A legislator is typically a member of one such committee and his time commitment for this is minimal.

Here, the nature of India’s parliamentary democracy differs from that in countries like the US. In the US, legislations are brought forth as private member bills, where a handful of legislators, often cutting across party lines, come together and formulate bills which are then brought before the legislature. While the provision of private members bills exists in India too, it is rarely used as parties front legislations. 

Accordingly, legislators in US have large office establishment to facilitate the process of preparing legislations. A typical Congressman has an official establishment with 40-60 staff members, the MP in India has to rely on just 1-2 official assistants. The situation is even more perilous with MLAs. In the absence of any support staff, it is extremely difficult for even well-meaning and committed legislators to contribute meaningfully to making laws or even plan for the long-term development of their constituencies.

Deprived off any substantial role in their primary role of law making, legislators expend their energies on activities within their constituency. This generates two negative externalities. One is the proclivity to interfere in administrative matters at the district and constituency levels. The other involves competition and conflict with their counterparts in the district, block, and village panchayats. The latter becomes especially pronounced in cases where they belong to different political parties. The turf battles in turn ends up exacerbating the politicization of administration and weakening of public systems.

So how do we get Indian legislators to become meaningful participants in the process of development?   

Managing complicated public projects

Nothing unfamiliar, but the way Clay Shirky describes it is excellent. In the context of the problems faced during the launch of the HealthCare.gov insurance portal in the US, he describes the challenges faced by technology projects,

On a major new tech project, you can’t really understand the challenges involved until you start trying to build it. Rigid adherence to detailed advance planning amounts to a commitment by everyone involved not to learn anything useful or surprising while doing the actual work. Worse, the illusion that an advance plan can proceed according to schedule can make it harder to catch and fixed errors as early as possible, so as to limit the damage they cause. The need to prevent errors from compounding before they are fixed puts a premium on breaking a project down into small, testable chunks, with progress and plans continuously reviewed and updated. Such a working method, often described as “agile development,” is now standard in large swaths of the commercial tech industry.

The larger a tech project is and the more users it will have, the likelier it is that unexpected bugs will surface. And the longer term a technological prediction is, the likelier that it is wrong. A technology plan that tells you what will be happening next week is plausible. One that tells you what will happen next year is far less so. One that tells you what will happen in five years is largely fiction. So thinking of a tech project as something that can be implemented according to a single, fixed plan, with a product that can be delivered in a package at some fixed date long down the road, can be a recipe for disaster.

Each step of a tech project’s implementation thus serves three functions. The obvious function is bringing the project further toward completion. But two other functions are also essential: any step in the implementation tests the assumptions that went into the design, and it produces new information that can and should be used to inform planning for the rest of the project. The people who want to be able to procure technology the way they would procure pencils often ignore both of those informative functions... One might think that detailed advance planning would be extremely helpful in this regard, but in fact, what overly meticulous planning actually does is trade away flexibility long before it is necessary, making it harder, rather than easier, to handle unforeseen problems as they inevitably arise...

Each step of a tech project’s implementation thus serves three functions. The obvious function is bringing the project further toward completion. But two other functions are also essential: any step in the implementation tests the assumptions that went into the design, and it produces new information that can and should be used to inform planning for the rest of the project. The people who want to be able to procure technology the way they would procure pencils often ignore both of those informative functions.

About excessively ambitious and optimistic project planning and implementation schedules, 

Assuming basic technical competence, the essential management challenge for all large technology projects is the same: how best to balance features, quality, and deadline. When a project cannot meet all three goals simultaneously... something has to give, and management’s job is to decide what. In such cases, if you want certain features at a certain level of quality, you have to move the deadline. If you want overall quality by a certain deadline, you have to simplify, delay, or drop features. And if both the feature list and the deadline are fixed, quality will suffer, and you have to launch and fix after the fact. 

I think much the same applies to all complicated projects, ones where there are too many "unknown unknowns". They span the full spectrum to running good schools and hospitals to rolling out large transportation projects like a new airport of a mass transit service. The challenge is compounded by the inherent nature of large bureaucracies - with its limited tolerance for failures, impersonal reporting systems, limited operational flexibility, aversion to taking judgment calls, incentive incompatibility of managers, and so on. Navigating this challenge is not easy and explains why many ambitious projects bite the dust. 

Urban Transformation - New York City Edition

Fascinating time-lapse video on the renewal and transformation that has happened in different parts of New York City over the past ten years.



All of them have involved reclamation of urban spaces, either for bicycle users or pedestrians, in a manner than have made those areas more attractive and worthy of visiting and spending time. 

Inequality and returns to capital

One of the strands of the story about widening inequality is that of increasing returns to capital at the expense of labor. This graphic of US wage and salary as share of GDP is striking.

One thing is very evident. In every recession, the share of income going to labor has declined. Further, not only has the share not rebounded during recoveries, but continued to decline as the benefits of economic growth have accrued disproportionately to the owners of capital.

In this context, Paul Krugman has a nice explanation, using the simple Solow model of economic growth, of Thomas Piketty's argument that the current decline in share of labor returns indicates a return to the historic trend where returns to capital has dominated the return to labor. The graphic highlights that, apart for a period in 20th century, the rate of return on capital has always exceeded the global economic growth.

In the long-run when a steady state of growth is achieved, economic growth converges to the sum of rate of population growth and rate of productivity growth. In the same horizon, the rate of capital accumulation converges to the savings rate. Taken together, in the long-run, the stock of capital as a percentage of national income should approach the ratio of the national savings rate to the economic growth rate. The same can also be derived from the simple Solow model as Krugman does here.

The importance of this comes from the fact that as the economic growth falls, the stock of capital as a share of national income would rise. In other words, as the rate of return from capital is more than the rate of economic growth, concentration of wealth follows. The current state of the world economy appears to provide the conditions required for this. Population growth, which has contributed roughly half of average global GDP growth in the 1700-2012 period (the other half coming from productivity growth, given that in the long-run the economy converges to the steady state rate of growth), is likely to decline in most parts of the world in the years ahead. Productivity growth, as people like Robert Gordon and Tyler Cowen have been arguing, too has been declining.
This just means that we are likely to see a long period where income from wealth would grow faster than wages.

As Piketty writes (from Free Exchange here and here),

Whenever the rate of return on capital is significantly and durably higher than the growth rate of the economy, it is all but inevitable that inheritance (of fortunes accumulated in the past) predominates over saving (wealth accumulated in the present)... wealth originating in the past automatically grows more rapidly, even without labor, than wealth stemming from work, which can be saved...

In a society where output per capita grows tenfold every generation, it is better to count on what one can earn and save from one's own labor; the income of previous generations is so small compared with current income that the wealth accumulated by one's parents and grandparents doesn't amount to much. Conversely, a stagnant, or worse, decreasing population increases the influence of capital accumulated in previous generations. The same is true of economic stagnation.

The debate generated by Piketty's book comes on the back of recent studies, which find that low-inequality countries did better at sustained economic growth and that redistribution appears generally benign in terms of its impact on growth. In the US, the top 1% own 35% of national wealth, more than all the bottom 90%, and the top 1% corner more than a quarter of the national income. For sure, inequality is back with a vengeance and looks likely to be the most dominant economic theme in the years ahead. The Economist, of all institutions, has already kicked off a fascinating debate with articles on how the rising inheritance wealth and financial market returns worsens inequality.

Update 1 (26/3/2014)

John Cassidy reviews Thomas Piketty here.

Update 2 (17/5/2014)

Lawrence Summers reviews Piketty here. He summarizes Piketty's central thesis,

Whether or not his idea ultimately proves out, Piketty makes a major contribution by putting forth a theory of natural economic evolution under capitalism. His argument is that capital or wealth grows at the rate of return to capital, a rate that normally exceeds the economic growth rate. Thus, economies will tend to have ever-increasing ratios of wealth to income, barring huge disturbances like wars and depressions. Since wealth is highly concentrated, it follows that inequality will tend to increase without bound until a policy change is introduced or some kind of catastrophe interferes with wealth accumulation...

So slow growth is especially conducive to rising levels of wealth inequality, as is a high rate of return on capital that accelerates wealth accumulation. Piketty argues that as long as the return to wealth exceeds an economy’s growth rate, wealth-to-income ratios will tend to rise, leading to increased inequality. According to Piketty, this is the normal state of capitalism. The middle of the twentieth century, a period of unprecedented equality, was also marked by wrenching changes associated with the Great Depression, World War II, and the rise of government, making the period from 1914 to 1970 highly atypical... It presumes, first, that the return to capital diminishes slowly, if at all, as wealth is accumulated and, second, that the returns to wealth are all reinvested. 

Summers' reservations about Piketty's thesis derives from his belief that the current American economy is characterized by diminishing returns to capital invested (average is over - the low hanging technology advances are past us and the returns from marginal investments in technology are far lower) and the reduced opportunities for reinvestment of the capital (Google and Apple, the touchstones of modern capitalism, sit on cash unable to identify opportunities for re-investment; though Sony and whatsapp have the same $18-19 bn valuation, the later has many times less capital invested than the latter). Taken together, Summers describes this as evidence of a secular stagnation - a new normal of low trend growth gets established.

He also attributes trends like the rising share of profits in national income (in developed economies) and the consequent widening inequality not so much to the process of inexorable capital accumulation but to the increased mechanization of work (which raises returns to capital than labor) and the abundance of cheap foreign labor. 

Measuring learning outcomes

I have an op-ed in Indian Express co-written with Professor Lant Pritchett on the need for measuring and rendering learning outcomes in multiple ways that speaks effectively to the three critical stakeholders - educators (teachers and head masters), supervisors, and parents.

Land titling reforms

My latest Governance Agenda column in Pragati explores land titling reforms in India.