Weekend reading links

1. Following pension funds and a growing list of institutional investors, the Carlyle Group, one of the four largest PE firms, is pulling back on its hedge fund investments. No wonder, given this,

Over all, hedge funds have underperformed the broader Standard & Poor’s 500-stock index for seven consecutive years. The average hedge fund returned 4.14 percent this year through September, according to the Hedge Fund Research Composite Index, the broadest gauge of hedge fund performance. The Standard & Poor’s 500-stock index gained 8 percent over that period, accounting for reinvested dividends... More than $50 billion has flowed out of the industry this year, according to Hedge Fund Research. In the latest financial quarter investors took $28 billion, the biggest quarterly outflow since the depths of the financial crisis in 2009.

2. Much of state and national industrial policy in developing countries like India are centred around fiscal and other concessions that benefit the largest firms. In fact, industrial and investment promotion itself is focused on the larger firms. As evidence, one only needs to verify how many small entrepreneurs or firms get called for consultations by governments or the high-profile business meets.

This flies against the fact that small enterprises form the major share of job creation and gross output creation. Not just in India, but even in the US. Consider this,

Out of 252,000 manufacturing companies in the United States, only 3,700 had more than 500 workers. The vast majority employ fewer than 20.

The difference with a developing country like India being that the vast majority of small enterprises are informal and grossly unproductive.

3. This high-profile working paper has created quite a stir and may have turned the tide in favour of Teaching at Right Level (TaRL) in primary school education. Here is from the paper,

The core element of all Pratham’s Programs discussed here is the pedagogy: it is called Combined Activities for Maximized Learning (CAMaL), but is also referred to as “Teaching at the Right Level” (TaRL). We call it TaRL below. This pedagogy has evolved over the years from Pratham’s own intensive experience, internal assessments, as well as external randomized evaluations...

It is interesting that Pratham chooses to call its model TaRL. This begs the question, what is Montessori, Activity Based Learning, adaptive learning etc, all of which focuses on instruction that is tailored to the student's learning level? At first look, the public policy challenge may be to get the right TaRL approach, one which is amenable to being scaled up in a business as usual public system. But I am not sure whether there is one right TaRL approach for every context. 

4. Olivier Blanchard and Julien Acalin have a study which questions the conventional wisdom about Foreign Direct Investment (FDI). They observe three stylised facts about FDI flows in the 1990-2015 period - a surprisingly high correlation between quarterly FDI inflows and outflows (why would domestic investors want to take out their money in a country which attracts high inflows, especially in the same quarter); increase in quarterly FDI inflows to EM economies in response to decreases in US monetary policy rate (why should FDI be so immediately elastic to quarterly changes, whereas portfolio flows would be); increase in quarterly FDI outflows from EM economies in response to decreases in US rates (why would outflows respond so immediately to US rate changes). They write,

These facts suggest two conclusions. The first is that, in many countries, a large proportion of measured FDI inflows are just flows going in and out of the country on their way to their final destination, with the stop due in part to favorable corporate tax conditions. This fact is not new, and, as discussed below, countries have tried to im- prove their measures of FDI to reflect it. But the magnitude of such flows came to us as a surprise. The second is that some of these measured FDI flows are much closer to portfolio debt flows, responding to short-run movements in US monetary policy conditions rather than to medium-run fundamentals of the country. Both have implications for how one should think about capital controls and the exclusion of measured FDI from such controls.

India had the sixth highest inflow-outflow correlation, exceeding 0.6. And of particular relevance,

A number of other statistical facts are also intriguing and suggest the need for a granular look at tax treaties, specific tax rates, treatment of FDI debt versus FDI equity flows, capital controls, and the details of tax optimization. For example, in a few countries (in particular, India), there is a high correlation between FDI equity inflows and debt outflows. This correlation is consistent with the hypothesis that some of the high correlations (between quarterly FDI inflows and outflows) reflect in part hedging of currency and country risks by foreign investors.

In the case of India, it has long been suspected that a significant share of its FDI inflows are round-tripping of domestic capital to take advantage of tax treaties. 

5. The WSJ has this graphic from the IMF's latest that highlights the indebtedness problem facing the world economy.  

The report is spot on in its assessment, 

Anemic global growth is "setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown".

6. Finally, Fareed Zakaria has an excellent article on the rise of populism in developed economies. He highlights the point that while populism has been on the retreat in developing economies, even Latin America, it has been rising in developed economies. He attributes this to the slowing economic growth. Unfortunately, this has been accompanied by declining population growth rates, globalisation and off-shoring, automation and labor market displacement, and pervasive fiscal indebtedness, all of which leaves governments pretty ineffectual in singificantly ameliorating conditions. 

The result of all this, coupled with the convergence between the right and left spectrums of economic ideology (at least in practice, both have gravitated to the centre), has been the decline of economics and the emergence of other factors as driving force of politics. Zakaria points to the work of Ronald Inglehart and Pippa Norris who document the rise of right and left-wing populism in Europe since 1960s,

The most striking findings of the paper are about the decline of economics as the pivot of politics. The way politics are thought about today is still shaped by the basic twentieth-century left-right divide. Left-wing parties are associated with increased government spending, a larger welfare state, and regulations on business... Voting patterns traditionally reinforced this ideological divide, with the working class opting for the left and middle and upper classes for the right. Income was usually the best predictor of a person’s political choices. Inglehart and Norris point out that this old voting pattern has been waning for decades... Today, an American’s economic status is a bad predictor of his or her voting preferences. His or her views on social issues—say, same-sex marriage—are a much more accurate guide to whether he or she will support Republicans or Democrats... Noneconomic issues—such as those related to gender, race, the environment—have greatly increased in importance...

This convergence in economic policy has contributed to a situation in which the crucial difference between the left and the right today is cultural... The shift began, as Inglehart and Norris note, in the 1970s, when young people embraced a postmaterialist politics centered on self-expression and issues related to gender, race, and the environment. They challenged authority and established institutions and norms, and they were largely successful in introducing new ideas and recasting politics and society. But they also produced a counterreaction. The older generation, particularly men, was traumatized by what it saw as an assault on the civilization and values it cherished and had grown up with. These people began to vote for parties and candidates that they believed would, above all, hold at bay these forces of cultural and social change. In Europe, that led to the rise of new parties. In the United States, it meant that Republicans began to vote more on the basis of these cultural issues than on economic ones. The Republican Party had lived uneasily as a coalition of disparate groups for decades, finding a fusion between cultural and economic conservatives and foreign policy hawks. But then, the Democrats under Clinton moved to the center, bringing many professionals and white-collar workers into the party’s fold. Working-class whites, on the other hand, found themselves increasingly alienated by the cosmopolitan Democrats and more comfortable with a Republican Party that promised to reflect their values on “the three Gs”—guns, God, and gays.

Immigration, the "final frontier of globalisation", has become the rallying point for the latest spurt in the rising trend of non-economic populism.