Tuesday, September 30, 2014

The widening US income inequality in two graphs

The two graphics in an Upshot article, extracted from a paper by economist Pavlina R Tcherneva, emphatically convey the dramatic trends in income distribution within the US society.

The first graphic shows that the share of income going to the bottom 90 percent of earners in economic expansions has risen from just 20% in 1949-53 to 116% in 2009-12 (the later reflecting the fact that incomes actually fell for the bottom 90%).
The same distribution for the top 1% shows that their share of income gains from expansions rose from just 1% to 95% in the same two periods.
It would be interesting if some one could come up with similar trends of the respective shares of wealth destruction during downturns. In any case, given that the wealth increases far outstrip wealth subtraction during regular economic cycles, the overall widening of inequality is undeniable.  

Friday, September 26, 2014

Indian economy and its "crony capitalism risk"

Business Standard reports that the Supreme Court's recent decision to cancel 194 coal block allocations made since 1993, coming on the back of the cancellation of 3G telecom spectrum licenses, "reminds all investors that India is a country fraught with political risk". A more appropriate characterization of the risk would be "crony capitalism risk".

As the Indian economy liberalized in the nineties, the old license permit raj, which was underpinned by an unhealthy relationship between businesses, officials, and politicians, contrary to popular perception, got strengthened rather than weakened. A far more entrenched, pervasive, and corrosive nexus emerged as economic growth surged and private participation in many sectors expanded dramatically. Several forces were at play in accentuating this trend.

On the one side, the rising tide of private participation led to the opening of several sectors and hugely valuable public resources - land, coastline, minerals, water, spectrum, airline routes, public sector bank credit, etc - were allotted to corporate groups. The commercial stakes associated with these transactions were on a qualitatively different scale compared to anything done before. Apart from resource allocations, private participation increased in several other areas - project and facilities management, operation and maintenance, quality control, routine services, and so on - often directly substituting public personnel.

On the other, these allocations and contracting were, most often, not only done in an ad-hoc manner without a transparent, competitive, and fair policy framework, but also by system which did not have the institutional capacity to effectively design and manage these contracts. One-sided contracts which very adversely affected public interest passed through the gates of ill-equipped and compromised gate-keepers with minimal due diligence. Corporate greed, the exploding cost of electoral politics and campaign finance, and incentives within the bureaucracy aggressively fueled these forces. India's version of crony capitalism had taken stage.

History teaches us that this phase has been a feature of economic development and structural transformations across the world. The "robber barons" of the gilded age in the United States had their counterparts in East Asian "crony capitalists". The only difference from these experiences may be that our version has had egregious excesses involving massive amounts of public losses, over a very short time, and in an environment where judicial and media activism are at their peaks.

In the late nineties and most of last decade, the massive profit opportunities in opaque and customized resource allocations and public contracts helped corporates, Indian and foreign, enjoy a very high "crony capitalism premium". Then as the tide turned and the backlash started, the premium has been replaced by a steep discount. This should not come as a big surprise. Common sense tells us that there are no free lunches - disproportionate returns are always accompanied by high risks.

It is a tribute to the country's democratic institutions and checks and balances that these excesses are being corrected. It is certain that this cleansing would result in the emergence of a more healthy and stable politico-economic business environment in the country. What is not certain though is how many more cancellations and uncertainty will have to pass before that environment emerges. It is likely that more of such cancellations will happen in the months ahead. Which of oil blocks, airlines routes, space spectrum, and land is coming next?

Wednesday, September 24, 2014

Industrial Policy and Renewables Market

NYT has a nice essay on how Germany transformed the global solar and wind power markets. The article documents the adverse impact of renewables on the conventional power generators. A more interesting insight is how German public policies have incentivized a dramatic breakthrough in global renewables market,
Over the past decade, the Germans set out to lower the cost of going green by creating rapid growth in the once-tiny market for renewable power. Germany has spent more than $140 billion on its program, dangling guaranteed returns for farmers, homeowners, businesses and local cooperatives willing to install solar panels, wind turbines, biogas plants and other sources of renewable energy. The plan is paid for through surcharges on electricity bills that cost the typical German family roughly $280 a year, though some of that has been offset as renewables have pushed down wholesale electricity prices. 
The program has expanded the renewables market and created huge economies of scale, with worldwide sales of solar panels doubling about every 21 months over the past decade, and prices falling roughly 20 percent with each doubling. “The Germans were not really buying power — they were buying price decline,” said Hal Harvey, who heads an energy think tank in San Francisco.
In many respects, this is classic industrial policy and an example of why government initiative is critical to enable mass adoption of completely new technologies. For a long time the renewables market was stuck in a grid-lock. On the one hand, the lower price of conventional power made renewables an unattractive option for users, while on the other, the price of renewables could decline only as economies of scale kicked in and the market expanded and matured (leading to technological innovation).

The governments of countries like Germany and Spain took the initiative to break the stalemate by subsidizing the cost of production and guaranteeing an assured and growing demand. The result was a sharp convergence in the prices of conventional and renewable power. By this, they may have done more than any other country to advance the cause of renewable power sector and in fighting climate change.

The Chinese government too deserves some credit for this. Spotting the opportunity, the Chinese government supported domestic solar and wind equipment makers, who established dominance in the global market. The massive competitive advantage enjoyed by Chinese firms came by way of cheaper (subsidized) cost of capital and utility services, lower cost of land, fiscal concessions etc which made them runaway leaders.

While in both cases, these policies often resulted in wasteful and inefficient allocation of resources, its overall outcome has been undoubtedly positive. In other words, the industrial policies of German and Chinese governments have, unwittingly, subsidized and provided the thrust for the sustainable development of global renewables market. 

Monday, September 22, 2014

Business at the Bottom of Pyramid and secular stagnation

The Times has a nice story about how multi-national companies are investing in developing lower cost consumer durables besides exploring channels to reach out to consumers at the "bottom of the pyramid".

Two things stood out. The first is the trend of innovations for the "bottom of the pyramid" finding an even bigger market in developed economies. 
Many products are transcending their original markets and appealing to a more affluent consumer... G.E. realized more than a decade ago that products devised for the Indian market might appeal to more developed markets, and planted the company’s largest and first international research and development center here. The lab has 4,500 engineers, 1,600 of whom work on health care innovations.  “There has been a shift,” said Shyam Rajan, chief technology officer at Wipro GE Healthcare. “Before, it was in India for India. Today, it is in India for the world.” 
The MAC 400, an electrocardiograph machine, was the first product G.E. moved from here to the rest of the world. About one-third the price of the company’s higher-end EKG machines, it is battery-operated and portable. It also is made of parts that can be bought in local electric and home supply shops, rather than the proprietary components G.E. typically uses. Of the 15,000 Mac 400s that G.E. has sold, 60 percent were sold outside India. The Lullaby baby warmer, now used in Europe, was built with feedback from Indian doctors and nurses in the field.
The second observation relates to the nature of transformation in these markets which already have established and profitable products. Businesses have come to accept a two-tier market, even at the cost of their existing business lines. 
Is G.E. sacrificing sales of its Cadillac baby warmer, the Giraffe, to the Lullaby? “It’s better to cannibalize yourself than let someone else do so — and that was going to happen with these products,” he said. “Anyway, the amount of market we created that was not there before more than makes up for it.”
The larger point is that proponents of secular stagnation - average is over, lack of profitable investment opportunities etc - surprisingly overlook the role that trade and globalization can play in reviving economic growth in developed economies. The market at the bottom of the pyramid, as the article highlights, is a potentially excellent opportunity for greater innovation (low cost, environment friendly, and sustainable) and business profits.    

Friday, September 19, 2014

QE and Fed's verbosity!

For long Central Bankers had a reputation for being laconic and inscrutable. Then came the global financial crisis and unconventional monetary policies, which made Chairman Bernanke deploy the Fed's communication strategy as an instrument of monetary policy.

Interestingly, as this striking correlation between the expansion of Fed's balance sheet and the length of FOMC statements show, this strategy effectively meant a dramatic increase in the volume of Fed communications.
It is a matter of great interest whether this verbosity, as it generally does, ended up confusing than clarifying.

Thursday, September 18, 2014

Metro rail fact of the day

The Atlantic has farebox recovery figures for New York transit system,
In 2012, $7.7 billion dollars of state and local tax revenues went to New York City Transit, not counting what when to the commuter railroads and other operations. That's a lot—nearly $1,000 for every man, woman, and child who lives in New York City. Why didn't it feel like enough? Because less than half of it, roughly $3.2 billion, was reinvested in the system. The majority, about $4.5 billion, was used to keep fares low by paying operating costs. On average, each New York City transit rider paid only 43 percent of the cost of his or her ride; every $2.50 swipe of your Metrocard gets matched by $3.31 in tax dollars.
And, this about the Hong Kong model, whose self-sustainability is widely acclaimed,
Between 2001 and 2005, property development produced 52% of Mass Transit Railway Corporation's (MTRC) revenues. By contrast, railway income, made up mostly of farebox receipts, generated 28% of total income. MTRC's involvement in property-related activities - development, investment, and management - produced 62% of total income, more than twice as much as fares. 

Clearly, a subway dominated urban mass transit is not cheap and imposes a massive fiscal strain. And this is despite two of the largest passenger volumes, higher relative tariffs, and very efficient operations. 

Tuesday, September 16, 2014

Observations on the Reliance gas pricing issue

Swaminathan Aiyar proposes that the government allow Reliance to sell the gas produced from KG Basin at the market price, which is the marginal price of gas supplied or the prevailing import price.

Supporters of a market-based pricing model argue that it encourages investments in natural gas exploration, thereby curtailing India's growing gas imports. Aside from the numerous controversies surrounding the Reliance project, I have two concerns with this argument.

1. The United States which apart from being one of the largest gas producers is also a large importer does not appear to have embraced this principle in aligning incentives. In 2013, its LNG import prices varied from $6-15 per mmBTU, whereas benchmark Henry Hub natural gas prices (which is not regulated and is market-determined) averaged $3.73 per mmBTU. In other words, the market-determined domestic price for natural gas in the US was far lower than the marginal price as represented in the import price. And it continues in 2014.

This emergent general equilibrium pricing of domestically produced natural gas, which is less than half the price of the imported LNG, questions the logic that production incentives are optimized when producers in India are able to sell their produce at the import price. The far lower price in the US market has not in any way deterred massive exploration in shale gas (whose exploration cost is incidentally more than that of conventional natural gas).

In fact, while the domestic prices in the US are in the $3-4 per mmBTU range, the LNG export prices have nevertheless been in the range of $12-15 per mmBTU. Given than the combined cost of liquefaction, transportation, and re-gasification is no more than $2.5 per mmBTU, this wide differential is itself a pointer to the inefficiencies in the global natural gas markets.

2. This brings me to the objective of any gas pricing policy. Econ 101 teaches us that an efficient market price is one which while encouraging exploration and production also incentivizes investments that generate demand for the gas. In other words, the price should reflect both reasonable profit for the producer and an acceptable cost for the consumer.

This trade-off maximizes the total producer and consumer surpluses and not just the producer surplus. Therefore, instead of just "encouraging domestic natural gas exploration by maximizing profit incentives", the objective should be to "encourage domestic natural gas exploration consistent with optimal development of economic activities that use natural gas". The logic that Reliance or any other natural gas producer should get a price comparable to LNG import price so as to incentivize India's gas fields development therefore appears to be flawed. 

Sunday, September 14, 2014

India's biggest immediate public policy challenge

I am surprised why the problems facing our banking sector does not get the attention it deserves. It is arguably the biggest short to medium-term problem demanding the attention of the Government of India. Its resolution is central to realizing the massive infrastructure investments that are necessary to ease important supply side constraints and sustain a reasonable economic growth rate.

ET puts India's corporate debt restructuring challenge faced by its predominantly public sector banks in perspective,
The total of banking system's net owned funds is under Rs 7,10,000 crore as of March-end 2014. The stated non-performing loans (NPLs) are around Rs 3,00,000 crore and the estimated level of NPLs, including restructured assets, is around Rs 10,00,000 crore. 
It is no hyperbole to say that India's banking sector is in a crisis. This "negative equity" situation is compounded by the additional capital requirements placed due to the Basel III norms which are due for implementation by March 31, 2019. There is no substitute for massive capital infusions, either directly from budget resources or through divestment of government equity. The RBI appointed PJ Nayak Committee estimated an additional equity capital requirement of Rs 3.1 lakh Cr over the next four years for public sector banks to comply with Basel III norms, sustain a credit growth of 16%, and provision for 30% restructured assets turning bad.

It is abundantly clear that government does not have the fiscal resources for direct recapitalization. Raising this capital through divestment cannot happen without lowering government stakes below 51%. In any case, without additional capital infusion, the ambitious infrastructure investment plans will remain still-born.

There is no way we can wish away a problem of this magnitude or hope that economic recovery will generate the resources required to tide over. A sustainable economic recovery itself is contingent on supply of infrastructure resources or atleast an expectation of it.

Clearly, any solution has to embrace a mix of both options, coupled with strong commitment to recover impaired loans from corporate defaulters. But immediate action is required since kicking the can down the road will not only increase the cost but also postpone the green-shoots of sustainable economic recovery.

Update 1 (23/9/2014)

Moody's says that the 11 Public Sector Banks rated by it, representing 62% of total loans in Indian banking system, will need to raise additional equity of upto $37 bn (Rs 2.2 lakh Cr) by March 2019 to meet the Basel III requirements. 

Saturday, September 13, 2014

Larry Summers on US crude exports and disagreements in public policy

In a brilliant speech at the Brookings Institute Larry Summers makes out a very well-reasoned and cogent case for why the US should lift the four-decade long ban on crude oil exports. The speech itself is a great example of persuasive argumentation. But in particular, I found this philosophical conclusion profoundly insightful and relevant to many other areas of public policy (and other) debates,
With respect to most areas of public policy... I don't have any difficulty understanding why somebody might disagree with me and how they would understand the world which would cause them to disagree with me. I have certain views on financial regulation. I have no difficulty understanding why somebody else would have a view that was different from mine. They have a different understanding of how the world works or they have a different set of values. This issue (restrictions on export of crude oil from US) is quite extraordinary in my experience because I don't understand what are the values that you could have that I don't have that would cause you to want to maintain the restriction nor do I understand what your theory of how the world works is that would cause you to have a different view.
I have one more thing to add to this nugget of wisdom. In either case - different understanding of the world (mechanism conflict) or different set of values (values conflict) - convincing the other side is a massive challenge, though in case of the latter, I am inclined to believe that even getting their attention, leave along convincing them, may be beyond the powers of human reasoning. In such (latter) cases, the best approach may be to create the conditions (or let it emerge) for the other side to themselves realize, if at all, the deficiencies in their value system.

Therefore, I believe that the first step in public policy debates should be to clearly distinguish whether it is a mechanism or values conflict. This alone could go a long way towards creating the conditions for a dialogue that is sensitive to all shades of opinions. 

Thursday, September 11, 2014

Apple Pay and the future of shopping

Ten years down, historians may look at the launch of Apple Pay this week as a giant step in the direction of digital wallet. An iPhone equipped with Apple Pay software can potentially become a platform to undertake friction-less transactions using all kinds of virtual assets - money, loyalty and reward points, airline miles, cellphone minutes and so on. Times has this peek into the future of such exchange transactions,
Let’s say you want to buy an audiobook from Best Buy. It costs $16, or 1,000 My Best Buy points, or M.B.B.P.s. Your wallet contains several hundred dollars and 200 Best Buy points. The wallet software automatically determines that, at the current exchange rate between M.B.B.P.s and dollars, it is better to buy using the points. But then let’s say you only have 50 M.B.B.P.s. The wallet system searches its clients and finds someone - call her Hannah - with enough M.B.B.P.s for the transaction. It buys the audiobook with her points and sends it to you, and sends Hannah dollars from your account. Following Bitcoin’s protocol, the wallet software broadcasts these transactions to the network, and every wallet in the world updates the M.B.B.P.-to-dollar exchange rate. The idea is that you can buy anything, with anything. The wallet will find the best deal and execute it. In so doing, it will ignore the historical and cultural differences between dollars, points, coins and virtual property. 
Such transactions pose a big challenge to regulators. In particular, such seamless transactions, carried out without any intermediaries (like banks), leaves regulators with limited enforcement power. Who would be responsible for stopping a transaction? There are likely to be many other emergent problems that regulators will have to grapple with when mobile wallets take hold.

Another thing of interest will be its effect on consumer behavior. As Cass Sunstein highlights, Apple Pay could end up exploiting people's cognitive biases and leaving them poorer. There is enough evidence from research in behavioral psychology that credit card and other non-cash transactions, by reducing the cognitive salience of the transaction, nudge people into spending more than would have been the case with cash transactions. A highly versatile application like Apple Pay is a fertile ground for businesses to manipulate these cognitive biases and exacerbate the hidden social and economic costs associated with such less salient transactions. 

Wednesday, September 10, 2014

Changing international trade patterns

MR nudged me into reading the work on the changing nature of international trade. This paper by Pol Antras and Stephen Yeaple captures the change starkly,
In 2000, for instance, the top 1% U.S. exporters accounted for 81% of U.S. exports. The involvement of these large firms in the world economy goes well beyond the mere act of selling domestically produced goods to foreign consumers. According to 2009 data from the U.S. Bureau of Economic Analysis, the sales of domestically produced goods to foreign customers account for only 25% of the sales of large American firms.The remaining 75% (nearly U.S. $5 trillion) is accounted for by the sales of foreign affiliates of American multinationals. Furthermore, data from the U.S. Census Bureau indicates that roughly 90% of U.S. exports and imports flow through multinational firms, with close to one-half of U.S. imports transacted within the boundaries of multinational firms rather than across unaffiliated parties. 
The out-sized role of multi-national corporations in international trade is highlighted by the table. Foreign affiliates of multi-national firms take up a large share of the sales, R&D expenditures, and exports of the host country.
As Antras writes, these trends hold for the US too,
The first thing that one notices when using U.S. related party trade data is how pre-dominant intra-firm transactions are in US trade. In 2011, intra…-firm imports of goods totaled $1056.2 billion and constituted a remarkable 48.3 percent of total U.S. imports of goods ($2,186.9 billion)... On the export side, related-party exports are also pervasive, with their share in total US exports ranging from 28 to 31 percent in recent years... (in 2011) the share of intra-firm trade reached a record 89.6 percent for U.S. imports from Western Sahara... the share of intra-firm trade still varies significantly across countries, ranging from a mere 2.4 percent for Bangladesh to an astonishing 88.5 percent for Ireland.
Clearly, the case for placing MNCs at the center in any analysis of international trade is now compelling. If 92.3% of Ireland's exports come from MNCs, with a few firms constituting the dominant share, then it stands to reason that the Irish government be able to closely monitor their activities. In particular, the monitoring of transfer pricing, or the accounting allocation of firm profits across the different geographical jurisdictions where the firm operates, assumes great significance.

Consider the incentives. While notionally, the parent firm and its affiliates are supposed to conduct arms-length transactions, the tax accountants of the parent firm have the exclusive mandate of minimizing the entire corporate group's tax outflows. In other words, its job is allocate profits across the different entities, consistent with prevailing rules, in a manner than minimizes the tax liability in each jurisdiction. Typically, they end up working accounts to transfer profits from high tax jurisdictions to low tax ones. See this, this, and this.

In the absence of effective regulation, the acrimony and controversies that arise from practices like under-pricing of imports and under-pricing of exports, 'Double Irish and Dutch Sandwich', and 'tax inversion' are only likely to worsen. Even more importantly, it is estimated to cost developing countries around $160 bn in annual taxes evaded. India's sharply rising trade volumes means that its transfer pricing losses are likely to be substantial. For those in India campaigning to recover black money stashed abroad, plugging the far bigger annual leakage from transfer pricing may be a more effective and realistic objective.

Unfortunately, no country, on its own, including the US, is in a position to crackdown on such practices. Unilateral actions are unsustainable not only because such actions require international co-operation, but also because MNCs have the advantage of exiting such countries. But, in the prevailing international environment, the consensus required to achieve an agreement on this issue look remote. A more realistic campaign, one which a country like India could assume leadership, would be to increase transparency through greater disclosure of intra-firm pricing and profit allocation across jurisdictions.   

Thursday, September 4, 2014

Value capture through sale of building rights

The economist Donald Shoup pointed to one of the biggest ironies of development, “Why is it so difficult to finance public infrastructure that increases the value of the serviced land by much more than the cost of the infrastructure itself?” This assumes significance in the context of positive externalities captured by land owners, in the form of increased land valuations, from public investments in infrastructure. As I blogged earlier, governments across the world have tried several approach to capture some share of the value increment from such investments.   

In this context, City Lab points to how the city government of Sao Paulo captures value from changes in zoning regulations to finance infrastructure investments. Brazil, following the French system of land use which separates property rights from building rights, has a basic FAR (generally 1:1 across the city) and a Master Plan permissible FAR for a specific area. In 2002, the Sao Paulo municipality mandated that developers wanting to build over and above the basic FAR (limited to the Master Plan FAR) would have to purchase Certificates for Additional Construction Potential (CEPAC) bonds issued for that area or locality. Each bond entitled the buyer to build one square meter of additional area. The government would sell these bonds (for each area) in a phased manner through an electronic auction, regulated by the nation's financial market securities regulator, thereby raising resources that would be used to finance infrastructure investments. Developers would have to purchase CEPAC bonds from the secondary market to get building permits for additional FAR.

The interesting feature of CEPAC is that it appears to kill three birds with one stone - achieve densification, capture value, and pay for supporting infrastructure. The challenge with densification by way of height relaxations, especially in existing cities, is that it is constrained by the limitations of the existing infrastructure carrying capacity. But improvements in infrastructure carrying capacity require investments, which local governments find difficult to mobilize. Theoretically the CEPACs can guide densification and also raise resources to support it. And by facilitating a transparent price discovery for the additional building right, it also solves, if atleast partially, the value capture problem.

However, the challenge, as it is always the case with such process innovations, is with adherence to the process during implementation. In countries where enforcement of Master Plan is deeply politicized and where regulators do not enjoy much credibility, such innovations generally run into implementation problems. For example, the local government may issue too many CEPAC bonds either in an anxiety to maximize revenues or from political pressure to give-away a potentially valuable resource at a cheaper price. 

Tuesday, September 2, 2014

The distortions from urban vehicle ownership

Two comparative graphics of land-use in downtown Hartford, Connecticut, in 1960 and 2000 illustrate the pernicious effects of motor vehicle ownership and usage. As can be seen, the earmarked parking spaces (in red) have increased dramatically in the 40 years. It rose from 15000 parking slots, covering 7.5% of the land downtown, to 46000 slots, covering 22% of the land.
The explosive growth in vehicle ownership and the very high proportion of private vehicle work commutes over the last 3-4 decades have, in no small measure, been driven by a similar growth of parking facilities. Trends like paid parking have only served to marginally attenuate the growth of vehicle ownership. In this regard, Hartford is pretty much representative of the shifts in land-use across cities of the world.

This has also had distributive consequences. Given the limited and highly valuable land available, the expansion of parking space has come at the cost of other competing claims on land. Even as those who can afford it have benefited, the growth of parking spaces have reduced the space available for affordable housing, community amenities, and even public recreation centers, all of which adversely affect those less well-off. Several of the road-margin parking spaces have come at the cost of decreased road carriageways. Also, road margin parking and parking garages generates less tax revenues for the city than other developments.

A major source of increase in parking spaces have been the minimum parking requirements for both commercial and residential developments. Apart from favoring vehicle owners, such requirements also drive up property prices and rental values thereby crowding out the poor. Further, the high parking charges in such down-town areas have already made private vehicle use affordable only for the non-poor. This, as I blogged earlier, also exacerbates the skewed physical access to employment, for the rich and poor.