Minimax capitalism

The second principle of justice enunciated by the late John Rawls involves the maximin rule (or difference principle). It states that social and economic inequalities should be arranged so that "they are to be of the greatest benefit to the least-advantaged members of society".

As an extrapolation, a maximin society would be one where the incomes of the least disadvantaged rises the most. So which are the maximin societies?

This gets amplified when we see the trends for income growth at the top of the income ladder, which is most likely to be a mirror image, but with the orders reversed and magnitudes scaled up significantly, especially in countries like the US. For another example see the trends with hourly minimum wage.

What is it about American capitalism that makes it so much inegalitarian, so much of a minimax society, than any other capitalist society? And given that the country has one of the lowest inter-generational mobility among developed economies, it is not even as though it is a meritocracy. 

But for all these flaws, it continues to remain the "land of opportunities", if only for those equipped with the skills to be able to compete and embrace them. In other words, it remains the go-to place for the elites. No wonder then that Andrew Sullivan calls the rise of Donald Trump as an "extinction-level" even for American democracy and liberal order. 

Weekend reading links

1. Livemint points to latest IMF figures which paint a dismal picture of rising inequality and poverty reduction in India. Net of taxes and transfers, India has the one of the highest inequality rates in the world at 51.36 in 2013, higher than even Latin America, and lower than only Papua New Guinea and China. And inequality rates rose faster than any place other than China. Reflecting on the possible causes, it finds that India does far worse in poverty reduction than China, Indonesia, Vietnam and others

And does a similarly bad job with middle class creation.

Taken together with the fact that China has produced a much larger middle-class, albeit also a much richer top 1%, India's inequality is worser than even China's. It is an inequality borne more out of the richest 1% becoming richer with stagnant incomes elsewhere. 

2. Charles Assisi has a very good longform analyzing Apple's intentions in the backdrop of Tim Cook's recent visit to India. I agree with him that manufacturing, which is what India hopes to convince Apple, may be a long shot. As to whether India can become a China-like market for Apple's premium products, I am not sure. In fact, given the figures above, the Indian premium market is likely to be no more larger than Indonesia's for the foreseeable future. 

3. Despite the high headline growth rates Indian Express, drawing on evidence from cement, steel, and passenger vehicle sectors, has this not so sanguine report about economic recovery in India,

In 2009-10, the operating rate of the companies was about 85%, and in the next two years, it varied between 75% and 78%. In 2015-16, latest data suggests, it was just about 69-70%. The average annual capacity addition then was 35-40 mtpa and now is just 10-15 mt. In the south, the industry actually shrunk by 1% last year... the industry is operating at an abysmal 55% capacity utilisation... The cement industry - which traditionally grew 1.1-1.2 times the GDP growth rate - grew just about 5% last year. In steel, which is more a globalised sector unlike cement, monetary and fiscal stimulus led to huge capacity addition and steel firms were operating at 80-83%. A dramatic shift has brought the operating rate down to 73%... The problem is huge capacities were set up during 2011-12 premised on much higher domestic demand and also external demand. But both slumped in the last couple of years... In 2010-11, car sales stood at 25.01 lakh units. Last year, it was 27.89 lakh. Even after five years, the industry has grown just 10% against a long-term average growth rate for cars has been 12-13% every year. The robust numbers in medium and heavy commercial vehicles too are largely driven by fleet replacement by big operators.

4. Excellent consolidation of the electoral map of European countries based on the ideological predispositions of their parties. As can be seen, the far right has made impressive strides in Austria, Denmark, France, Finland, Hungary, Poland and Switzerland.

In Austria, Norbert Hofer of the Nazist Freedom Party came close to winning 50% of the vote and narrowly lost the Presidential election run-off. Viktor Orban, the Hungarian Prime Minister, and his Fidesz Party have won the last two elections.

5. Business Standard reports that distressed assets sales have run into problems with very few deals consummated. Among the 33 assets worth $12.29 bn (Rs 82,343 Cr) put for sale since April 2015 by the Credit Suisse's ten most indebted corporate groups, just six (the value of four is just $379 m) have found buyers.

Such deals face pressure from both sides. On the one hand, the owners are hoping that a revival of the commodities and economic cycle will restore growth back to the heady days and repair their balance sheets. Creditors are reluctant to take haircuts for various reasons, including scrutiny by vigilance authorities. On the other side, buyers are wary of the regulatory concerns, including their ability to control the assets given that most of them are on lien to creditors, not all of whom agree on the way forward. Further, some of the projects are ab-initio unviable and would require significant markdowns.

6. A RBI survey has found that a third of the ATMs in India are not functional. Indian banks expanded their ATM network spectacularly, from 27000 in 2007 to nearly 200,000 by April 2016. As to the reasons for the non-working ATMs,

Bankers in India say that ATM machines may be out of order for a variety of reasons, from mechanical failure and paper jams, to software malfunction or lack of electricity, a common occurrence in India. If the ATM has run out of cash, then also it becomes temporarily unavailable for use.

One more reminder about the perils of rapid growth in any area in an environment where the capital base (human and physical) to support such expansion is not available.

7. In its efforts to achieve a better work-life balance, the Swedish town of Svartedalens has been experimenting with six hour work week (from eight hours) with no pay cut for nearly a year now. The Times writes,

Many Swedish offices use a system of flexible work hours, and parental leave and child care policies there are among the world’s most generous. The experiment at Svartedalens goes further by mandating a 30-hour week. An audit published in mid-April concluded that the program in its first year had sharply reduced absenteeism, and improved productivity and worker health.

Apparently, as people get more leisure and less work time, they tend to focus more and shirk far less. The net result is higher productivity, which more than makes up for the reduced work hours.

8. While I am no outright China bear, I completely agree with everything that Christopher Balding has to say about the implications of China's debt problem. It is very unlikely to have a soft-landing. The RMB-USD crawling peg is a binding constraint on policies to inflate away debt or further increase debt and stimulate the economy.

9. Switzerland will next month vote on handing out an unconditional basic income of SFr30,000 ($30,275) a year to every citizen, regardless of work, wealth or their social contribution. The idea has been championed earlier in 20th century by thinkers on the left, such as John Kenneth Galbraith and Martin Luther King, as a means of promoting social justice and equal opportunity, and on the right, including Milton Friedman, as a way of restricting the coercive state and restoring individual choice and freedom.

The emergence of technological changes and digital revolution presents both the threats (in terms of job losses and need for social security) and opportunities (in terms of ability to target and transfer cash) for initiating a universal basic income scheme. The Swiss referendum will in all likelihood fail this time. But the underlying idea of a robust social safety net to assure a dignified life for everyone in a world economy buffeted by uncertainties arising from forces like globalization, skill-biased technological changes, and automation is only likely to strengthen with time. 

10. Livemint shines light on credit rating agencies in India. The recent examples of Amtek Auto (CARE) and Ricoh India (India Ratings), where rating agencies abruptly downgraded the firms without assigning any reason have been big blows to the credibility of rating agencies. This is not one bit surprising given the poor corporate governance standards and pervasive corruption. 

11. I have blogged earlier about the Thames Tideway Project. Bazelgette Tunnel Limited, the project company established by Thames Water, London's monopoly water supplier, and the UK Government, has launched a bond sale to to raise £200m-£400m to finance the £4.2 bn Thames Tideway (or "super-sewer) project. The 25km long and 7.2 m wide tunnel, to be completed by 2024, will be built under the Thames and will supply sewerage services to Thames Water on a 125 year concession. About a quarter of the cost of construction will comes from Thames Water through an increase in customer's water bills, and the remaining £2.8 bn will be raised by the project company whose shareholders include Allianz, Dalmore Capital, Amber Infrastructure, DIF, Swiss Life Asset Managers and International Public Partnerships, all of whom have invested £1.2 bn of equity themselves. The remaining finance is to be raised by the company and includes a £700m 35-year loan from the European Investment Bank granted earlier this month, the largest ever for a water project.

Such projects are most certain to suffer delays and cost over-runs. Investors generally bear a major share of the construction risk given that project revenues start to kick-in only after the construction is completed. In order to mitigate these construction risks, the Tideway project is structured in a manner that the investors will receive an income, funded through consumer water bills, from the first day. In other words, the consumers act as "the backstop or insurer on the project, bearing the brunt of any cost overruns or incidents during construction". 

12. Conservative commentator Andrew Sullivan finds a parallel in Trump's rise to Plato's Republic. At the 'late-stage democracy', when democracy has widened enough to make elites lose authority, the populist demagogue enters the vacuum and seizes the opportunity, and democracy turns into a tyranny. He feels that the rise of media democracy during this century by "erasing any elite moderation or control of democratic discourse" strengthens the trend,

And what mainly fuels this is precisely what the Founders feared about democratic culture: feeling, emotion, and narcissism, rather than reason, empiricism, and public-spiritedness. Online debates become personal, emotional, and irresolvable almost as soon as they begin. Godwin’s Law — it’s only a matter of time before a comments section brings up Hitler — is a reflection of the collapse of the reasoned deliberation the Founders saw as indispensable to a functioning republic... We have lost authoritative sources for even a common set of facts. And without such common empirical ground, the emotional component of politics becomes inflamed and reason retreats even further. The more emotive the candidate, the more supporters he or she will get.

He draws historical parallels and concludes with a scathing assessment of the Trump phenomenon,

To call this fascism doesn’t do justice to fascism. Fascism had, in some measure, an ideology and occasional coherence that Trump utterly lacks. But his movement is clearly fascistic in its demonization of foreigners, its hyping of a threat by a domestic minority (Muslims and Mexicans are the new Jews), its focus on a single supreme leader of what can only be called a cult, and its deep belief in violence and coercion in a democracy that has heretofore relied on debate and persuasion. This is the Weimar aspect of our current moment. Just as the English Civil War ended with a dictatorship under Oliver Cromwell, and the French Revolution gave us Napoleon Bonaparte, and the unstable chaos of Russian democracy yielded to Vladimir Putin, and the most recent burst of Egyptian democracy set the conditions for General el-Sisi’s coup, so our paralyzed, emotional hyperdemocracy leads the stumbling, frustrated, angry voter toward the chimerical panacea of Trump... Trump is not just a wacky politician of the far right, or a riveting television spectacle, or a Twitter phenom and bizarre working-class hero. He is not just another candidate to be parsed and analyzed by TV pundits in the same breath as all the others. In terms of our liberal democracy and constitutional order, Trump is an extinction-level event. It’s long past time we started treating him as such.  

I am inclined to believe that this rationalization belies Sullivan's conservative bias. In fact, he equates widening of democracy to "our increased openness to being led by anyone; indeed, our accelerating preference for outsiders". The fundamental trigger for Trump's rise is the discontent and anger that the vast majority feel about an establishment that they feel has been captured by the elites. Trump has been peddling his policies to fuel this discontent. The American democracy could have matured without allowing such dramatic widening of inequality and egregious elite capture of the establishment. The conservatives should take the biggest share of the blame for this.

Talk about drawing wrong lessons from a crisis. 

The essay though is a great read.

13. Finally, Ananth is spot on with his assessment. No matter which way you look, the collateral damage inflicted by one individual is immense. If commentators start attributing motives to monetary policy actions and if the same echoes with popular gossip, then monetary policy making becomes fraught with dangers. In a country with a very noisy and cantankerous media, the incentive distortion for future central bankers can be damaging. 

India though is not alone in this. Look no further than the vilification campaigns by the like of Rand Paul, some of which even threatened physical harm on the Fed Chairman, Ben Bernanke, for allegedly debasing the currency with ultra-low rates. Maybe Andrew Sullivan has a point about the debasement of democracy by the democratisation of media. 

Asymmetric ignorance and monetary policy

Forward guidance has assumed a central role in monetary policy making in recent years as central banks try all possible means to stimulate economic growth. The forward guidance literature makes the distinction between Delphic guidance about public statements about “a forecast of macroeconomic performance and likely or intended monetary policy actions based on the policymaker’s potentially superior information about future macroeconomic fundamentals and its own policy goals,” and Odyssean guidance that involves clarifying ex-ante on the policymaker’s professed commitment. 

In this context, Ippei Fujiwara andYuichiro Waki argue that unlike Odyssean guidance, the Delphic guidance on private information available with central banks can be destabilising. Using a New Keynesian model, they find,

The underlying mechanism is simple and operates through the forward-looking, price-setting behaviour of sellers, i.e. the New Keynesian Phillips curve. Imagine that the sellers also receive some (private) information that is useful in predicting future cost-push shocks. Such information influences their inflation expectations and, therefore, the prices they set today. Their price-setting decisions become more susceptible to future cost-push shocks, and, everything else being equal, inflation becomes more volatile. Conveying news about shocks to the central bank’s loss function and shocks to the natural rate of interest has the same effect. In contrast to Odyssean forward guidance that helps stabilise inflation and the output gap, Delphic forward guidance can destabilise them in New Keynesian models.

A little asymmetric ignorance would help.

In this context, this GMO study by James Montier and Philip Pilkington assume relevance. They document very significant positive effect on equity prices over the past 30 years on FOMC meeting days after the meetings announcements. Their analysis found that since around 1985 the markets started to react significantly to FOMC days. Using a strategy of going long (buying) on the meeting days and zero on all other days of the year, over the years, they find

The authors write,

This means that we removed around 18 days a year in the 1960s, 14 days a year in the 1970s, and 8 days a year from 1981 onwards. During the period 1964 to 1983 there was absolutely no effect from removing these days. But, from 1985 onwards, removing fewer days began to have a major and increasing impact on the market. In fact, FOMC days account for 25% of the total real returns we have witnessed since 1984... the chance of this occurring randomly was only 0.0086% (that is, 86 out of 1 million).

Breaking down the effects over periods, they find that the average returns on FOMC days in the 2008-12 period were 29 times higher than the average on non-FOMC days!

In fact, the result was not, in a statistically significant manner, any different even when the Fed was tightening.

As the authors say, "it appears that the stock market reaction wasn’t driven by easing so much as it was by the fact that the FOMC was meeting at all!" Their monetary adjusted CAPE (cyclically adjusted price-to-earnings ratio), obtained by replacing the FOMC day returns with non-FOMC day average, leaves the markets significantly lower than today.

Campaign finance fact of the day

From Rana Faroohar,

Washington, too, is so deeply tied to the ambassadors of the capital markets—six of the 10 biggest individual political donors this year are hedge-fund barons—that even well-meaning politicians and regulators don’t see how deep the problems are.

I have blogged earlier about how the most corrosive effect of widening inequality may not be the inequality itself, but its effect in terms of how it enables capture of political decision making. The truism that "he who pays the piper calls the tune" is no different today than earlier.

The most telling example of this was the response in the US to the sub-prime mortgage crisis which left both financial institutions and homeowners fighting for survival. While the vast majority of the TARP was directed mainly at the financial institutions to save the TBTF institutions, the homeowners with negative equity were left with marginal assistance. It should not have been a surprising outcome given the grossly skewed participation in the discussions leading up to the finalization of TARP. The result,

A lack of real fiscal action on the part of politicians forced the Fed to pump $4.5 trillion in monetary stimulus into the economy after 2008. This shows just how broken the model is, since the central bank’s best efforts have resulted in record stock prices (which enrich mainly the wealthiest 10% of the population that owns more than 80% of all stocks) but also a lackluster 2% economy with almost no income growth.

It is in the political and social battleground that inequality wreaks its greatest damage. And it assumes even greater significance for India, which already has one of the highest and fastest rising net Gini index, since the antecedent social and other practices are likely to exacerbate the political capture problem.

The power of mild preferences

I have blogged earlier, pointing to the famous Schelling chessboard experiment, about how even mild preferences (among agents) can have surprisingly large macro-level general equilibrium effects. 

My examples focused on school choice and the use of vouchers - this on the dynamics associated with how school choice ends up enfeebling public systems and this on how voucher advocates confuse the merits of vouchers with the relative superiority of private schools. Intuitively school vouchers should be great - they enable choice and lets parents seek out the best schools, thereby fostering school competition and generating desirable outcomes all round. Surprisingly, the evidence from across the world (US, Chile, Colombia, Mexico, Sweden etc) in terms of improving learning outcomes (test scores), retention rates, and years of schooling is very mixed. In fact, in the most recent study from New Orleans (post-Katrina) reveals that it lowered learning outcomes. 

Now, Allison Shertzer and Randall Walsh examine neighborhood-level data to study segregation in US cities over the 20th century and comes to similar conclusions. They point to a similar trend contributing to the distinct US urban segregation pattern of white suburbanization and black core, 

Whites began resorting themselves away from black arrivals in the first decades of the 20th century, decades before the opening of the suburbs. Our analysis isolates the channel of white flight from institutional barriers that constrained where blacks could live in cities. We argue that accelerating white population departures in response to black arrivals at the neighbourhood level can explain up to 34% of the increase in segregation over the 1910s and 50% over the 1920s. Importantly, our analysis suggests that, while discriminatory institutions faced by blacks were clearly important, segregation may have emerged in US cities even in their absence simply as a consequence of market choices made by white families... Our results indicate that one exogenous black arrival was associated with 1.9 white departures in the 1910s and 3.4 white departures during the 1920s.

Their conclusion is very important,  

Policies that reduce barriers faced by blacks in the housing market may not prevent or reverse segregation as long as white households continue to resort themselves away from potential black neighbours.

But there may be one more wrinkle to this story. Such policies, whether in housing or schooling, is unlikely to directly achieve its desired objective of increased mixing among communities. But what if the desegregation contributes to attenuating preferences and making mixed habitations less unacceptable? What if it contributes to greater social integration? What if, over a long period of time, the general equilibrium effect in favor of social integration is greater than the similar effect towards segregation? 

Globalization and taxation

In recent times, amidst weak global economic prospects and rising protectionist sentiments, an intense debate about globalization has resurfaced. Peter Egger, Sergey Nigai, and Nora Strecker have a new paper which adds to the debate by raising the possibility that globalization may have had the effect of increasing the reliance of governments on less mobile middle-class tax bases. They examined a taxation database of 65 countries in the 1980-2007 period, and find significant effects as globalization gathered pace post-1994. 

Their narrative is simple. As economies open up and globalises, businesses and high-income individuals become footloose or to paraphrase Charles Tiebout, "vote with their feet". One way countries compete to retain and attract them is by lowering the corporate and marginal tax rates. In the process, among developed economies, on the average and when there is limited induced economic activity, tax revenues from these sources decline, forcing governments to rely more on the relatively immobile middle-class incomes. The authors write,

When goods and factors became relatively more footloose after 1994, evidence suggests that OECD governments found it more difficult to tax (arguably highly mobile) high-income earners. Moreover, in light of competition for such often high-skilled individuals, countries have further sought to decrease those individuals' personal income tax rates and compensated the foregone revenues by increasing taxes on individuals with middle incomes (and lower bargaining power than high-income earners)... under the threat of flight of high-skilled workers, governments reduced taxes for mobile high-income earners and increased them for the immobile middle- and upper-middle-income classes. 

Consider this. Middle-class income tax rates have increased by around two percentage points across 65 countries, whereas corporate and marginal tax rates have declined significantly. 

And, for the OECD countries, the burden has been carried by those at the middle, especially post-1994.

This effect is likely to get amplified as other technology-driven trends like e-commerce and remote working gains ground. The losers of globalization will perceive that their jobs are being taken by foreigners and their tax rates are rising. The widening inequality will exacerbate the discontent and generate more backlash against globalization.

There are no easy solutions. A two-pronged response may be the only way forward. One, the losers will have to be compensated by way of a stronger social safety net complemented with re-skilling programs that equip them with occupational mobility. The corollary of this though is to increase tax rates on the winners so as finance the benefits for the losers. But this redistribution runs into the Tiebout problem.

This brings us to the second response, which is about international coordination on taxation policies to prevent a race to the bottom. More so at a time when the global economy is weak, investments anemic, and international trade stagnant, and income growth confined to the highest earners, any competitive tax reduction is most likely to be a zero-sum game for all countries put together. No country gains without hurting others. In other words, tax reduction merely increases arbitrage opportunities without any commensurate increase in productive efficiency and output. In the absence of some form of global coordination or restraint, economies will be encouraged to indulge in competitive tax reduction that would only increase the relative tax burden on the middle-class everywhere. 

Shaping expectations - taming inflation and corruption

Both inflation and corruption are a function of expectations. Further, both have high levels of hysteresis and the resultant tendency to get entrenched. Once internalized, dismantling requires vigorous efforts to reshape expectations. In the process, collateral damage is inevitable.

In an environment where inflation expectations were unhinged, India's central bank Governor Raghuram Rajan has sought to cement low inflation expectations through an extended period of monetary tightening, even at the cost of economic growth. It has been acclaimed by experts, who have hailed him as India's Paul Volcker. 

On a similar vein, in an environment where corruption in senior level postings had become pervasive, the Government of India's Department of Personnel and Training has sought to reshape expectations by adopting an extremely rigorous process of screening. Unsurprisingly, the multiple levels of due-diligence for integrity and efficiency have come at the cost of causing delays and leaving many posts vacant/unfilled for long periods. Senior level positions in banks and public sector units have remained unfilled for long periods. The same experts complain that the delays in filling up posts have caused administrative paralysis.    

While the jury is still out on whether inflation has been slain or not, it can be fairly confidently asserted that the expectations on personnel deployments have been favorably reshaped. But not if you have been following the mainstream media. Clearly what is sauce for the goose is not sauce for the gander!

Weekend reading links

1. Excellent interactive in the Economist on incomes, annual economic growth, and inequality across several countries during the 1980-2015 period. China is already the second most unequal society in the world, after South Africa, even as its middle class has grown richer than Brazil's. In the 35 years, median income has growth at an annual average pace of nearly 12%, to just 3.5% in India. Assuming past growth rates, median incomes will catch up with the US in 10 years for South Korea, 25 years for China, 60 for Brazil, and 100 for India. 

2. Nice article on Venezuela. The decline has been stunning,

the government led first by Chavez and, since 2013, by Maduro, received over a trillion dollars in oil revenues over the last 17 years. It faced virtually no institutional constraints on how to spend that unprecedented bonanza... In the last two years Venezuela has experienced the kind of implosion that hardly ever occurs in a middle-income country like it outside of war.

3. Are debt-financed dividend payouts and share buybacks that boost stock prices a massive Ponzi scheme? Yes, says Rana Faroohar in her new book. ExxonMobil's ratings downgrade, first time since 1949 it is not AAA, has a lot to do with its stockpile of debt accumulated to finance share buybacks

4. More news of the damage from weak global economic prospects comes from the woes of container shipping liners,

The industry... is suffering what could well turn out to be the deepest and longest downturn in its 60-year history. Container shipping lines have made a series of investments in new, giant vessels, and this glut of capacity has sent freight rates tumbling. The Shanghai Containerised Freight Index — one of the few public sources of information on what lines are charging to ship a container — last month reached the lowest level since its inception in 1998... Amid a slowing world economy, 2016 could be the fifth straight year of subpar expansion in trade.

The industry which has expanded aggressively into larger sized ships is now undergoing a phase of consolidation,

In the first quarter of 2016, Maersk generated $1,857 of revenue for each 40ft container it carried on its ships, 25 per cent less than one year earlier, and $203 below the average cost of moving each box.

5. Fascinating pictorial essay chronicles life in the United States since 1870 as told in Robert Gordon's excellent new book. Here's a description of 1870s life,

They ate pork. Lots and lots of pork — 131 pounds of it per person per year in 1870 (that number was half as much by 1929 and is around 55 pounds today). Unlike other meat-producing animals, pigs could live almost anywhere and could survive largely on food scraps. Their meat, easily salted or smoked, could be preserved in an era without refrigeration. Fresh vegetables were scarce; farmers emphasized crops that could be stored or preserved, like turnips, pumpkins, beans and potatoes, instead of leafy greens that would deteriorate quickly... Instead of a toilet, you used a chamber pot or an open window in the city, an outhouse with an open pit underneath in the country... Boston had 700 horses per square mile. The average horse produced 40 to 50 pounds of manure and a gallon of urine daily, which made the streets of major cities no pleasant place to be.

By today’s standards, entertainment options were limited. Total circulation of newspapers was 2.6 million in a country of 40 million people. There was no telephone, record player, movie or radio. Men could go to the local saloon to drink; women generally couldn’t. Vacations and weekends were not really a thing.  

Childbirth usually took place at home, and deaths were common both at birth and during early years from diseases like yellow fever, cholera and many others. There was no licensing of doctors, so quacks were common.

And what changed in the 1870-1920 period,

The most fundamental shift over those decades was that the American home became, in Mr. Gordon’s word, “networked.” Houses that were once dark and isolated were becoming intertwined. They were starting to be connected to electric grids, providing clean, bright light without emitting smoke. Urban water networks supplied clean water, and sewer systems removed waste without the pungent odors of chamber pots and outhouses. Telephones allowed people to converse with distant friends. These advances were enabled not just by technological innovation in plumbing and electricity, but also by urbanization. In 1870, 23 percent of the United States population lived in cities, which rose to 51 percent by 1920.

6. The consortium hired to reconstruct and operate a new terminal at LaGuardia for 35 years secured $2.5 bn of financing through a municipal bond offering which attracted considerable interest. The Baa3 rated (one notch above junk) 30-year 2046 bond was priced with a yield of 3.27% and a 5% coupon. A Bank of America Merrill Lynch index of triple-B-rated munis across multiple maturity dates yielded 2.88%. This is against 2.6% yield for 30 year US Treasuries. The consortium, LaGuardia Gateway Partners, includes airport operator Vantage Airport Group, construction company Skanska, and Meridiam Infrastructure, an investor and asset manager of infrastructure projects.  

Two observations. One, the very low rates and spread between the Treasuries and risky bonds, despite the near-junk nature of the muni, underscores the point that this is a truly unprecedented opportunity for governments to borrow and invest in improving infrastructure. Two, the consortium presents the ideal mixture of contractor, operator, and financier, a partnership with clearly defined roles and risk allocation which allows for seamless changes in shareholding patterns. In contrast, in countries like India, the concessionaires are invariably construction contractors who develop and then try to either sub-contract maintenance or exit by selling stakes. Apart from creating perverse incentives, such arrangements may, ironically enough, end up increasing life-cycle costs.  

7. How can rising cash reserves and debt burden subsist together? A new Moody's report shows that the US corporate cash reserves rose to $.17 trillion by end-2015, with $1.2 trillion held overseas. For the first time ever, the top five cash hoarders with $504 bn were tech companies - Apple ($216 bn, 93% held overseas), Microsoft, Alphabet, Cisco, and Oracle. 

The rising hoard is a reflection of two trends - tax arbitrage and avoidance, and weak economic expectations and the consequent reluctance to invest. In fact, the report points out that expenditures on things like new equipment declined 3% to $885 bn on the face of lower commodity prices.  

Interestingly, the rising cash reserves have accompanied rising debt. Overall debt rose nearly $850 bn to $6.6 trillion by end-2015. In fact, over the past five years, while cash reserves increased by about $600 bn, debt obligations surged by $2.8 trillion. While the top tier firms too leveraged up, the increased indebtedness was concentrated in smaller and lower quality groups who took advantage of the record low borrowing costs.

8. Citylab points to stunning visualization of property price trends developed by Trulia of 100 largest US metros. The biggest increase was in San Francisco, where the percentage of million dollar homes rose by a staggering 37.8 percentage points from 19.6% to 57.4% of all houses in the 2012-16 period.

Some of the increases in the city neighborhoods have been jaw-dropping - in Westwood Park the percentage rose from 2.9% of homes to 96%!

9. Upshot puts New York's restrictive nature of zoning regulations in perspective by pointing to a study of 43000 buildings which found that 40% of buildings in Manhattan could not be built today. These restrictions include height, limits on residential and commercial space, limits on the number of dwelling units and parking lots, setback rule that mandates buildings to step back in order to rise (saw-tooth structure) etc.

Relaxation of zoning regulations is arguably one of the very few low hanging fruits in public policy space. It is also possibly the only way in which cities, especially in developing countries can avoid extreme gentrification and accommodate the millions of urban migrants.

10. Upshot reminds us about the critical role of luck in determining life outcomes,

According to a 2008 study, most children born in the summer tend to be among the youngest members of their class at school, which appears to explain why they are significantly less likely to hold leadership positions during high school and thus, another study indicates, less likely to land premium jobs later in life. Similarly, according to research published in the journal Economics Letters in 2012, the number of American chief executives who were born in June and July is almost one-third lower than would be expected on the basis of chance alone. Even the first letter of a person’s last name can explain significant achievement gaps. Assistant professors in the 10 top-ranked American economics departments, for instance, were more likely to be promoted to tenure the earlier the first letter of their last names fell in the alphabet, a 2006 study found. Researchers attributed this to the custom in economics of listing co-authors’ names alphabetically on papers, noting that no similar effect existed for professors in psychology, whose names are not listed alphabetically.

11. The growth dynamics of the newly constituted Bank Board Bureau (BBB) in India may be a teachable example of how institutions can go astray. The BBB was notified in February 2016 primarily to "recommend for selection of heads of financial institutions". The popular former Comptroller and Auditor General of India, Mr. Vinod Rai, was appointed its chairman.

After assuming charge, Mr. Rai has waxed on the bank bad assets resolution process, reassured that bank chiefs will not be questioned over the bad asset resolution decisions, and discussed consolidation of PSBs. I am confused. Is the BBB's mandate so wide enough to cover all these complex regulatory issues? If BBB, which advises on appointments, assumes a role in operational management, then isn't there a serious conflict of interest? If so, where do the BBB's role end and the banking regulator's begin?

Or is it a case of "Mission Creep" by BBB, a feature that, once the judiciary showed the way with its liberal interpretation of Public Interest Litigations (PILs), has come to characterize institutional development in India? The hyper-active media have obviously only been too eager to nudge a willing Mr. Rai into these transgressions.

12. Finally, Ananth links to Michael Lewis's review of Mervyn King's new book. Lewis describes the central idea of the book on regulation of banks, the King Rule,

Deposits and short-term loans to banks simply need to be separated from other bank assets. Against all of these boring assets, banks would be required to hold government bonds or reserves at the central bank in cash... The riskier assets from which banks stand most to gain (and lose) would then be vetted by the central bank, in advance of any crisis, to determine what it would be willing to lend against them in a pinch if posted as collateral... The banks would decide, before any crisis, which of their risky assets they would be willing to pledge to -- basically, pawn with -- the central bank. The riskier the asset, the less the central bank would be willing to lend against it. Any asset so complicated that it couldn’t be explained satisfactorily to the central bank in three 15-minute presentations wouldn’t be eligible as collateral. Everyone would know, if any given bank ever required a loan from the central bank, the size of the loan the central bank would be willing to extend. The central bank would go from being the lender of last resort to what King calls the pawnbroker for all seasons.

It would also have a handy, simple rule to determine if any given bank is solvent: the difference between its “effective liquid assets” and its “effective liquid liabilities.” The effective liquid assets would consist of the securities the bank held against its deposits (government bonds, cash), plus the collateral value of its riskier bets as judged by the central bank. The effective liquid liabilities would be the money that could run from the bank at short notice -- deposits and loans of less than one year made to the bank. The rule -- call it the King Rule -- would be that a bank’s effective liquid assets must exceed its effective liquid liabilities. If they don’t, the bank is insolvent, and its deposits would be moved without any panic or trouble to a bank that isn’t.

This is certainly going to generate much discussion in the days ahead. A few quick observations. Clearly, depositors are ring-fenced off and that takes bank runs off the table. Fundamentally, this is substantively the same as directly mandating higher capital reserves, though framed very differently. Is the framing, in terms of informing the creditors and shareholders their 'haircuts' upfront, likely to be more acceptable? Most importantly, the critical issue here would be the normal time price-discovery with riskier assets. It assumes that central banks can more accurately assess the real value, especially when they become stressed, of these assets than the financial institutions themselves. Further, it also assumes that the central banks can avoid the cognitive bias and environmental pressures that force banks to systematically under-estimate and underprice risks during good times. In fact, it assumes that the 'pawnbroking price' would be a more accurate signal than even those of rating agencies. 

Chasing chimera - credit rating for infrastructure projects

The Business Standard informs that six credit rating agencies are working together on a new rating system for infrastructure projects that is a more accurate signal of its credit-worthiness. It writes,

The new ratings system will look at variable risk factors in public-private partnership projects to assess their viability. The new ratings will differentiate between credit rating of contractor versus the project.

Unfortunately, I am afraid that like with all such search for simple solutions to complex problems, this too is unlikely to work. The fundamental premise is that the reckless lending and borrowing of the last decade with the attendant current banking sector woes could have been avoided with better signalling. In other words, the rating agencies and their ratings could have made up for the banker's failure in accurately assessing project risks. Alternatively, the banks could have outsourced the due-diligence activity to rating agencies. 

It is facile to assume that such ratings can be a substitute for painstaking and rigorous due-diligence by lenders. For a start, it assumes that it is possible to make accurate ex-ante assessments of project risks and betrays an ignorance of the manner in which those risks surface. No type of ex-ante ratings, concluded even before the financial closure, could have been any more reliable in predicting the construction delays and cost over-runs. The commercial risks are project specific, readily identified, and amenable to being assessed with greater certainty than construction risks. Emergent market risks are in any case uncertain by their very nature. Such risk assessments and environment surveillance is extremely costly and require competence that goes far beyond those available with rating agencies. There is simply no substitute for building good risk due-diligence institutional competence in lenders. It just cannot be outsourced.   

As to differentiating between the contractor and the project, it is a first order distinction between corporate finance and project finance. In case of the former, the contractor's rating assumes significance, whereas in the latter, the project gets rated. It cannot be helped if the lenders relied on the wrong rating!

It does little to address the fundamental problem with the prevailing ratings model - the conflict of interest arising out of the rating agencies being paid by their clients. Further, recent experiences with rating agencies give us no reason to repose such faith in their ability and intent to make reliable assessments about project risks.  

Finally, experience from across the world and across history provide ample evidence that financial markets cannot be insulated from credit risks at all times even with measures that mitigate information asymmetry. It has been a feature of these markets that they lose their discipline when credit is plentiful and financiers indulge in risky lending. This would be all the more likely in the context of countries like India, with its massive capital investment requirements and large available shelf of infrastructure projects, and intense pressure on governments to get them rolling.  

A more reliable assessment of the project risks is to use the concept of "optimism bias" that countries like Australia and UK have used to calibrate project risks. As I have blogged earlier, this can be extended to discount the delays associated with individual contractors as well as nature of projects. This may be a more relevant information for creditors, contractors, as well as governments in assessing project risks. And it does not require any rating agency, but can be consolidated and maintained by an institution like the envisaged P3 Institute. 

The rising tide of social intolerance

Nicholas Kristof draws attention to the stunning ideological skew in US universities,

Four studies found that the proportion of professors in the humanities who are Republicans ranges between 6 and 11 percent, and in the social sciences between 7 and 9 percent. Conservatives can be spotted in the sciences and in economics, but they are virtually an endangered species in fields like anthropology, sociology, history and literature. One study found that only 2 percent of English professors are Republicans (although a large share are independents). In contrast, some 18 percent of social scientists say they are Marxist. So it’s easier to find a Marxist in some disciplines than a Republican.

He makes the case for more tolerance of diversity of opinions, especially of conservative views,

When perspectives are unrepresented in discussions, when some kinds of thinkers aren’t at the table, classrooms become echo chambers rather than sounding boards — and we all lose... Universities should be a hubbub of the full range of political perspectives from A to Z, not just from V to Z.

This echoes the speech Micheal Bloomberg made at the 2014 Harvard commencement in praise of tolerance. Incidentally, Bloomberg and Charles Koch make the case for free speech on campus,

Stop stifling free speech and coddling intolerance for controversial ideas, which are crucial to a college education—as well as to human happiness and progress... By doing so, colleges are creating a climate of intellectual conformity that discourages open inquiry, debate and true learning... The purpose of a college education isn’t to reaffirm students’ beliefs, it is to challenge, expand and refine them—and to send students into the world with minds that are open and questioning, not closed and self-righteous. This helps young people discover their talents and prepare them for citizenship in a diverse, pluralistic democratic society. American society is not always a comfortable place to be; the college campus shouldn’t be, either... 

Whether in economics, morality, politics or any other realm of study, progress has always depended upon human beings having the courage to challenge prevailing traditions and beliefs. Many ideas that the majority of Americans now hold dear—including that all people should have equal rights, women deserve the right to vote, and gays and lesbians should be free to marry whom they choose—were once unpopular minority views that many found offensive. They are now widely accepted because people were free to engage in a robust dialogue with their fellow citizens... such dialogue is now disappearing on college campuses... It will also create graduates who are unwilling to tolerate differing opinions—a crisis for a free society. An unwillingness to listen to those with differing opinions is already a serious problem in America’s civic discourse. Unless colleges reverse course, that problem will worsen in the years ahead, with profoundly negative consequences. Administrators and faculty must do more to encourage a marketplace of ideas where individuals need not fear reprisal, harassment or intimidation for airing controversial opinions. 

This is a problem not just in the US, but across the world. One of the possible reasons for the sudden eruption of the dormant strain of social intolerance may be the emergence of social media. This has given the aggressive proponents of any view a platform to disseminate their opinions immediately, very widely, and in an easily digestible (and manipulatable) form. It also allows them to be able to mount attacks on alternative viewpoints with similar ease and effectiveness. Further, unlike with newspapers articles, the accuracy of facts gets heavily discounted in social and electronic media discussions, leaving the field open to insinuations, half-truths, and lies. The fact that the vast majority of users of these platforms are young people more likely to be swayed by the aggressive and provocative peddling of view points may potentially exacerbate collective intolerance.

Update 1 (04.06.2016)

Nicholas Kristof has more. He describes three reasons for more diversity in universities,

First, stereotyping and discrimination are wrong, whether against gays or Muslims, or against conservatives or evangelicals. We shouldn’t define one as bigotry and the other as enlightenment. When a survey finds that more than half of academics in some fields would discriminate against a job seeker who they learned was an evangelical, that feels to me like bigotry.

Second, there’s abundant evidence of the benefits of diversity. Bringing in members of minorities is not an act of charity but a way of strengthening an organization... I’ve often denounced conservative fearmongering about Muslims and refugees, and the liberal hostility toward evangelicals seems rooted in a similar insularity. Surveys show that Americans have negative views of Muslims when they don’t know any; I suspect many liberals disdain evangelicals in part because they don’t have any evangelical friends... Third, when scholars cluster on the left end of the spectrum, they marginalize themselves. We desperately need academics like sociologists and anthropologists influencing American public policy on issues like poverty, yet when they are in an outer-left orbit, their wisdom often goes untapped.

More on QE distortions - the business of business is finance

FT points to the irony of top tier US corporates, who are flush with more than $2 trillion in cash reserves, borrowing heavily to finance share buybacks that boost stock prices and in the process contributing to the inflation of a bond bubble. And this is not all,

The buyback bubble is only one part of a larger trend, which is that the business of corporate America is no longer business — it is finance. American firms today make more money than ever before by simply moving money around, getting about five times the revenue from purely financial activities, such as trading, hedging, tax optimisation and selling financial services, than they did in the immediate postwar period. No wonder share buybacks and corporate investment into research and development have moved inversely in recent years. It is easier for chief executives with a shelf life of three years to try to please investors by jacking up short-term share prices than to invest in things that will grow a company over the long haul. It is telling that private firms invest twice as much in things like new technology, worker training, factory upgrades and R&D as public firms of similar size — they simply do not have to deal with market pressure not to... the financial industry... has roughly doubled in size as a percentage of gross domestic product over the past 40 years. As finance grew, so did its profits — the industry creates only 4 per cent of US jobs yet takes around 25 per cent of the corporate profit share.

The distortions engendered as non-finance firms seek to emulate their financial sector counterparts at a time when the economic prospects look none too attractive serve to destroy long-term value and further weaken economic prospects,

Airlines, for instance, often make more money from hedging on oil prices than on selling seats — even though it undermines their core business by increasing commodities volatility, and bad bets can leave them with millions of dollars in sudden losses. GE, America’s original innovator, only recently stopped being a “too big to fail” bank. The pharmaceuticals industry, perhaps the most financialised of all, has cut nearly 150,000 jobs since 2008, most in R&D, as companies focus instead on outsourcing, tax optimisation, inversions and “creative” accounting in ways that make them look suspiciously like portfolio management companies — a group of disparate firms operating separately and trying to make as much money as quickly as possible, with little thought to the long-term impact of their decisions. Even Silicon Valley is not immune. Apple and other tech behemoths now anchor new corporate bond offerings as investment banks do, which is not surprising considering how much cash they hold. If Big Tech decided at any point to dump those bonds, it could become a market-moving event.

Granted that many of these trends pre-date the post-crisis quantitative easing. But only the naive would not concede that the QE, with its flood of cheap capital with no end apparently in sight, has sustained and amplified these trends. 

Update 1 (04.11.2017)

John Plender points to the misalignment between CEO compensation and business performance and highlights research by Robert Ayers and Michael Olenik which presents an assessment of share buybacks,

In a data set of 1,839 US firms they noted that 535 firms that repurchased less than 5 per cent of the market value saw their market value increase by an average of 248 per cent over the latest five-year period. The 64 firms that repurchased 100 per cent or more of their market capitalisation experienced a 21.7 per cent decline in value over the same period. That group included such well-known names as Sears Holdings, JC Penney, HP Inc, CBS, Macy’s, Nordstrom, Motorola, IBM, Symantec, Xerox, Office Depot, VeriSign and Target Corporation.

A summary of latest evidence on education research

Simon Burgess has an excellent compilation of all the latest research on various aspects of human capital formation and education. No surprises anywhere. Nevertheless, a few of the important findings copied below. 

1. Woessmann highlights a set of five practices of effective schools, from close analysis of high-performing charter schools. Thet are “increased [teaching] time, better human capital [i.e. more effective teachers and administrators], more student-level differentiation [i.e. supplemental tutoring], frequent use of data to alter the scope and sequence of classroom instruction, and a culture of high expectations”. 

2.  What creates an effective school system? Accountability, even relatively low stakes one, which requires some common and consistent form of assessment (generally centralized exit exams), when coupled with operational autonomy for schools, have been found to improve pupil attainment. But it is important to ensure that the assessment is well designed and captures the skills that society wants pupils to have, and does not end becoming the standard case of "teaching to the test". 

3. On the same line of analysis, we need to have more research on what effective teachers do that makes them effective. In particular, how to structure, implement and incentivise take-up of effective initial teacher training and continuing professional development, as well as a pre-hire screen that is usefully selective on effectiveness. 

4. Publication of rankings showing schools are better performing can in principle increase socio-economic sorting of pupils, though the evidence on this is mixed. It is also not clear as to whether it does so depends on the admissions process to schools and whether this is manipulable by parents.

5.  While there are a few robust studies showing positive effects of higher resources for schools and lower class sizes, there are more studies showing little or no effect of class-size on outcomes. So inputs, especially in countries like India, should be less of a focus area. 

6. There is little strong evidence that adding more IT hardware to classrooms raises attainment. There are stories of what brilliant teachers can do with IT, but brilliant teachers raise skills without IT as well. This does not seem a cost-effective education strategy.

7. Non-cognitive skills is an area of which very little is known -  a better understanding of, and measurement system for, non-cognitive skills; a better understanding of how the cognitive and non-cognitive skills discussed above map into workplace skills (such as knowledge skills, problem-solving skills, critical thinking skills, and social skills) and how they are valued 

8. Finally on vouchers, the jury is still out. There are two main research and policy questions: what is the impact of the voucher on the individual who receives it? And what is the impact on the system as a whole, on those ‘left behind’ in the low-performing schools? There appear to be no definitive answers to the two core empirical questions yet. In a substantial recent review, Epple et al argue that the bulk of the findings suggest no significant effect, yet “multiple positive findings support continued exploration”. The evidence on the impact on the voucher-using student from the US is mixed, though there are positive effects on non-academic outcomes and the reason that parents enter school lotteries rather than for attainment improvements.

China robot fact of the day

FT points to a study by Mirae Asset Management which finds a remarkable similarity between the robot penetration trends in China and Japan.

It calculates that robots will displace 3.5 million Chinese workers over the next five years. This comes on the back of other findings that three-quarters of China's jobs are at a "high risk" of computerization. And given the rapidly increasing Chinese wages - rising at an annual rate of 17% in the decade to 2012 - its manufacturers believe that automation is the only way to increase productivity and retain their competitiveness. 

India's judiciary turns policy maker

It is difficult to view the Supreme Court's directions to the Government on drought management as anything other than a series of egregious transgressions of the constitutional balance of power and therefore a violation of the very Constitution which it is supposed to uphold. 

It has directed that all (not just the below poverty line) households in drought prone areas be provided heavily subsidized foodgrains; the mid-day meal scheme be expanded to cover the summer vacation period too and provide eggs or milk three days a week; a commission be constituted to monitor the implementation of the National Food Security Act within two months; and the existing system of drought management be abandoned and a new transparent rules-based framework be evolved. Most remarkably, it has intimidated (what else can its rhetoric signal) democratically elected governments in Bihar, Gujarat, and Haryana into declaring drought, despite these state governments, in their wisdom, feeling otherwise. 

All these are clearly political or executive decisions and it is very difficult to justify any of them as being within the judiciary's constitutionally mandated domain. Assuming that the government concerned is not doing its job properly, which in any case would be true with most governments across the world, the judiciary is within its jurisdiction to pull up the government for defaulting on its statutory responsibilities. But it has gone far beyond that and entered the domain of policy making. In fact, it is no hyperbole to say that judiciary threatens to usurp the mantle of being the highest policy-making body in the country. The list of such transgressions is growing very fast.  

Its rhetoric on the issue of compensating NREGS workers (at 0.05% of wages per day) whose wages were delayed more than the stipulated 15 days would have been appropriate as a stump speech and surely lowered the dignity of the highest court of the land,

We are quite pained to note that the Government of India has made no provision for this compensation while releasing the wages for 2015-16 of Rs. 7,983 crores. This is extremely unfortunate and certainly does not behove a welfare State in any situation, more so in a drought situation. Social justice has been thrown out of the window by the Government of India.

Shouldn't there be some restraint on the Lordships that force them to be more dignified with their words and not stoop down to indulge in such inflammatory rhetoric? It strains credulity if this is not an attempt at populist grandstanding. Would the Lordships have made such sweeping statements if there was no media coverage?

The other day the Chief Justice of India (CJI) made an emotional appeal to the Prime Minister to increase the number of judges in the country from the current 15 to 50 per million population over the next five years. A fair point when seen in isolation. But isn't this same with every other regulatory and statutory position in India? For example, District Collectors are today responsible for delivering on a vastly expanded functional jurisdiction and management of a budget which has increased manifold, with pretty much the same personnel (of much inferior quality) as three decades back. This is not to undermine the CJI's valid point, but just an attempt to put it in perspective and also highlight the governance challenges faced by a country like India.  

In this context, one cannot but applaud Mr Arun Jaitley's speech this week in the Lok Sabha,

We have the National Disaster Response Fund and the State Disaster Response Fund and now we are being asked to create a third fund. The appropriation bill is being passed. Now outside this appropriation bill, we are being told to create this fund. How will I do that? India’s budget-making is being subject to judicial review... Step by step, brick by brick, the edifice of India’s legislature is being destroyed... With the manner in which encroachment of legislative and executive authority by India’s judiciary is taking place, probably financial power and budget making is the last power that you have left. Taxation is the only power which states have.

Clearly the patience is wearing thin. It may only be a matter of time before the creeping usurpation of executive and legislative powers create an acrimonious stand-off, one which would leave everyone worse off. The emotion prone CJI would do well to shine light within and introspect, and take urgent measures to address the corrosive tendencies that have gripped the judiciary so as to stave off any unpleasant face-off.  

Estimating the value addition from urban civic infrastructure

Marco Gonzalez-Navarro and Climent Quintana-Domeque have an interesting paper which studies the impact of a randomized allocation of residential non-arterial streets (8-15 m) for asphalting in Acayucan municipality of Mexico,

Within two years of the intervention, households whose streets were finally paved, and were present both before and after its implementation, increase their consumption of durable goods and acquire more motor vehicles. These effects are driven in part by street pavement boosting housing wealth, which fuels a rise in collateralized credit use. The effects appear to be present for both the relatively poor and the relatively rich households in our sample... Our main conclusion is that provision of street pavement reduces poverty, at least as measured by the increases in the acquisition of durable goods, motorized vehicles, and property values.

Finally, we estimate a lower bound for the total benefit to cost ratio of street pavement at around 1.09, which justifies serious consideration of cost-sharing mechanisms in the provision of localized benefit public goods. In the absence of credit constraints, property taxes triggered by public goods that increase land value could be used as a funding device for localized impact urban infrastructure, such as Colombia’s urban improvements tax or U.S. road paving special assessment districts. 

The acute financial constraints faced by municipalities in developing countries prevent them from making these basic investments whose beneficial effects are undoubted. In the circumstances, such resource allocation - which streets get selected on priority - becomes a political decision, with its set of perverse incentives. This goes back to the irony that Donald Shoup posed evocatively, “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?” In this context, the adoption of value capture finance strategies like tax increment financing and impact fees assume significance. 

This time was no different - picking pieces from the deflated African bond bubble

This post may well be worth revisiting once every few years. I had earlier cautioned about the irrational exuberance (Zambia raised $750 m in 2012 at a yield lower than Spain!) surrounding African Eurobond issuances. In particular, my concern was that, apart from misuse and pilferage, depreciating currencies, revenues-repayment currency mismatch due to investments in infrastructure, and inadequate due-diligence posed insurmountable credit risks.

Now the African sovereign Eurobond bubble has burst and the consequences are becoming evident. The poster child was Mozambique's $850 m Tuna Bond issue of 2013 to finance state-backed fishing fleet to develop a fishing industry. The bond was issued by Ematum, a tuna-fishing company, backed by the government and attracted considerable global interest and is currently held by some of the world's most reputed institutional investors. Instead, atleast $500 m was used to procure naval boats and other logistics for maritime security, with the inevitable associated rents. The result,

Mozambique was viewed latterly as a burgeoning African success, partly in anticipation of production at vast, offshore gasfields. It now stands among the first instances of fallout from the boom in emerging market debt which has driven billions of dollars into countries with poor credit profiles. Foreign reserves are dwindling, the fiscal deficit is yawning and devaluation of the metical could drive debt to gross domestic product ratios above 100 per cent this year

The expected problems surfaced. The currency depreciated,

... and the yields surged

In March this year, in the first round of inevitable restructuring, $700 m worth of 2020 Tuna Bonds were swapped for 2023 sovereign bonds. In the process, it came to light that certain state entities had assumed $1.4 billion worth of undisclosed external debt. It adds another 10% of GDP to the country's debt burden. Donors, including the IMF, were predictably furious. The IMF temporarily suspended ongoing lending. The prognostications could not have been any more accurate!

Much the same is happening or likely to happen with the others in Africa. The expected oil bonanza has not happened, economic growth has tanked, and the yields have risen. And, most likely, the money has been misspent or even siphoned away. This is also confirmation that the original sin hypothesis is alive and strong.