Tuesday, January 31, 2017

The nuanced case for labor migration

It has taken Donald Trump and Brexit to make the intellectuals realise that unfettered trade is not desirable. In the aftermath of the global financial crisis, the IMF cautioned against unqualified capital account liberalisation. As I blogged earlier, the same realisation is also dawning on the adverse consequences of automation. Another area that is equally contentious is the impact of migration from developing countries on labor markets in developed economies.

There is a constant in all the four issues - Dani Rodrik. Even as intellectuals and the mainstream academia dug their heels in and refused to acknowledge mounting evidence on the first three, Rodrik was at the leading edge in urging caution. He has now become the mainstream in the first three areas. The fourth one is playing itself out, with the mainstream view downplaying the potentially adverse effects of migration. But there is little to feel that this is going to be any different.

His position on labor migration is articulated nicely in a new paper. The short answer is that significant migration will be bad for low-skill workers in developed economies, but less harmful than further trade liberalisation.

Rodrik puts the magnitude of the barrier to labor migration in perspective, drawing from the work of Clemens et al which documented "place premiums" of gains for migrants from different countries in moving to the US,
Assuming transport costs and cultural disamenities aside, a wage multiple of six for Pakistani workers implies that the ad-valorem equivalent of labor visa restrictions is around 500 percent. In other words, it is as if Pakistani workers were free to move but had to pay a 500 percent tax on their earnings once in the U.S. Contrast this to average U.S. tariffs on manufactured goods, which is about 3 percent, or the prevailing import barriers on sugar, which is the archetypal highly-protected industry with domestic prices exceeding world prices by 80 percent on average – and the asymmetry between freedom to trade in goods and the restrictiveness of trade in labor services becomes strikingly clear. 
Rodrik's case for easing labor restrictions is made in comparison to trade liberalisation. While acknowledging the adverse effect on low skilled labor, he makes the point that the impact in terms of redistribution of income from labor to capital (in developed countries) is likely to be far lower with easing migration restrictions than with trade liberalisation.
While there would likely be adverse effects on low-skill workers in the advanced economies, international labor mobility has some advantages compared to further liberalizing international trade in goods.
He uses a political cost (redistribution of income away from labor) benefit (efficiency gains) ratio is argue that given the very high barrier (a migration tax equivalent many times higher that import tariffs) to migration, the income redistribution needed to achieve a unit of efficiency gain is much smaller. At an intuitive level, while an imported good helps the importer capture all the gains in bulk, in case of a migrant labor, the production cost structure of the developed economy still applies when he produces something as a migrant. Thus the case for easing migration over trade liberalisation. 

Stripped off all empirics and stuff, this is insightful and applies to many other areas of debate on social policies,
Institutions are maintained either through solidarity (I care for you, so I am willing to share with you); social trust (I trust you, and know that you would do for me what I am doing for you), or enforcement (government coercion, requiring in turn legitimacy). All of these things are likely to be undermined by greater heterogeneity and inequality within countries – especially if the numbers involved are large.
So his proposal,
I have proposed elsewhere a temporary work visa scheme, administered bilaterally on the basis of specific home-country quotas. To maximize home country benefits and spread the gains around, the visas would be for a fixed period, say 3-5 years. They would not entail a path to citizenship, although guest workers would have the full protection of host country labor standard and regulations. A mix of sticks and carrots might be employed to ensure the bulk of workers do choose to return to their home countries when their visas run out. For example, a portion of guest workers’ pay may be docked in forced saving accounts, to be returned only upon repatriation. The quotas of home countries could be adjusted in relation to their success in attracting their workers back home. This would give home countries an incentive to provide repatriation inducements, just as they do with foreign capital or skilled expatriates.
I am inclined to agree. 

Monday, January 30, 2017

Stalled projects update

Livemint points to latest CMIE data to show that year-end stalled projects touched a record high by end-2016. The total value of stalled projects was Rs11.70 trillion at this time, accounting for 12.11% of the total projects under implementation.
As to the reasons for stalled projects, a fifth were due to delays in clearances. And its share has remained consistently high despite the governments best efforts to clear stalled projects.  

The failure to make much progress with declogging stalled projects has been accompanied by a decline in new public investment announcements.
This blog has argued that a very large proportion of these projects are not stalled but are fundamentally unviable projects, at least now. They may need to be scrapped and not restored. The true extent of such projects need to be recognised based on both commercial considerations and changed circumstances. A cleaner slate may be a more meaningful place to start monitoring. 

Add to this, the just released RBI's Industrial Outlook Survey of 1221 manufacturing enterprises indicated declining business expectations sentiment in the Q4 2016
Whatever the budget announces, this is unlikely to improve any time soon.

Sunday, January 29, 2017

The automation story will go the free-trade way?

Even just twenty years back, scepticism of free trade would have been scorned upon. Among intellectuals, free trade was an article of faith. It was thought that free trade generated unambiguous aggregate benefits. There may be a few losers, but they would quickly get re-skilled and adjust to the labor market, or, at worst, could be compensated by redistribution from the winners.

As is acknowledged now, this ideological belief was contrary to the reality. Many developing countries, especially the smaller ones, were aggregate losers from free trade. The logic of Ricardian comparative advantage did not play itself out. Labor markets did not adjust as anticipated. And, compensation and redistribution were political non-starters.

Those urging caution, like Dani Rodrik, were considered left-wing. Today, even as the same Dani Rodrik has stayed firm on his convictions, the world has travelled so much that his arguments have become the mainstream.

Much the same story appears to be playing itself out in the context of automation. This rationalisation with the example of rise in human tellers in banks despite the arrival of ATMs is worthy of political rhetoric than academic research. Sample this techno-optimism from David Autor,
Automation does indeed substitute for labor—as it is typically intended to do. However, automation also complements labor, raises output in ways that lead to higher demand for labor, and interacts with adjustments in labor supply. Indeed, a key observation of the paper is that journalists and even expert commentators tend to overstate the extent of machine substitution for human labor and ignore the strong complementarities between automation and labor that increase productivity, raise earnings, and augment demand for labor... The frontier of automation is rapidly advancing, and the challenges to substituting machines for workers in tasks requiring flexibility, judgment, and common sense remain immense. In many cases, machines both substitute for and complement human labor. Focusing only on what is lost misses a central economic mechanism by which automation affects the demand for labor: raising the value of the tasks that workers uniquely supply.
This sophistry conceals the fundamental point that automation, like trade, will most certainly leave the less skilled extremely vulnerable. The negative effects of driverless cars (on drivers), speech recognition devices (on clerical staff), shop floor management devices (on retail, hospitality etc) and so on do not require any rigorous RCTs or sophisticated statistical analysis.  

Like with the unrealised labor market adjustment and redistribution to cushion the losers from free trade, the promised mitigating factors against automation like adjustments in labor supply, re-skilling, and emergence of complementary job creators are likely to remain largely unfulfilled. There is nothing to suggest that this time will be any different.

Saturday, January 28, 2017

Accounting standards and pension liabilities

I had blogged earlier explaining the rise of Trump and similar movements elsewhere on the lack of elite leadership to address egregious excesses.

The FT reports that an analysis by pension consultancy JLT Employee Benefits of 2015-16 showed that UK blue-chip companies could have cleared their pension deficits with payment of one year's dividends,
An examination of the latest annual accounts for FTSE 100 companies found the UK’s leading listed businesses paid £68.5bn to shareholders, more than five times the £13.2bn they made in pension contributions... According to the research, based on accounts published up to June 30 last year, only six FTSE 100 companies paid more in contributions to their defined benefit pension schemes than in dividends to their shareholders... However, of the 60 companies that disclosed pension deficits, 46 could have cleared their shortfalls by withholding a year’s dividends, according to the analysis.
This highlights attention on the need for regulatory oversight on the issue of balancing pension accounts. For more than a generation, coinciding with the Great Moderation, equity markets were trending upward and asset returns were stable and high enough. In such times, pension plans made their returns even with the high management fees and relatively risk-free investing.

That is now history. The average annual returns on equities and fixed income assets have been on a long declining trend and likely to remain at the low levels. Pension funds everywhere are facing the heat from the declining returns and have been accumulating liabilities. It is surprising that the rise in liabilities has been accompanied by a rise in shareholder payouts. 

It is Accounting 101 that profits are calculated after excluding all costs from revenues, and that employee costs includes wages and other commitments. And pension payouts are the largest part of non-wage payments. One of the principles of corporate finance is that equity has a charge on profits only after all the liabilities are paid off. It is therefore baffling that accounting standards do not mark-to-market the pension liabilities and provision for all those liabilities before profits are calculated. Pension liabilities are no less a liability that they are superseded by the claims of equity holders.

In the aftermath of the Enron debacle, regulations were amended to introduce mark-to-market accounting in many areas. Funny that they were not extended to liabilities like pensions. Such egregious excesses are simply a blot on capitalism and underlines the point about saving "capitalism from capitalists".

Manufacturing fact of the day

The off-shoring wave and loss of jobs in manufacturing conceals important facts
The UN Industrial Development Organisation (UNIDO) reckons that, in 1991, 234m people in developing countries worked in manufacturing. By 2014 the number was 304m—and there were just 63m manufacturing jobs in the rich world. But the sixth of the workers in the rich world added two-thirds of the final value.

In terms of the perception that manufacturing moved to poor countries lock stock and barrel, it hasn’t helped that the low-value work which did go overseas often involved the final stages of assembly. Putting the components that make up a product together looks like the essence of the manufacturing process. But it often adds little to the finished product’s value. Even for as complex and pricey a machine as a passenger jet, assembly is a low-value proposition compared with making the parts that go into it. By some estimates, putting together Airbus airliners in Toulouse accounts for just 5% of the added value of their manufacture—even if ensuring the aircraft were put together in France has been a non-negotiable point of national pride for the French government. Similarly, assembly in China accounted for just 1.6% of the retail cost of early Apple iPads.
And on the growing importance of post-production services, 
A study published in 2015 by the Brookings Institute, an American think-tank, reckoned that the 11.5m American jobs counted as manufacturing work in 2010 were outnumbered almost two to one by jobs in manufacturing-related services, bringing the total to 32.9m. A British study conducted by the Manufacturing Metrics Experts Group in 2016 came to a similar conclusion: that 2.6m production jobs supported another 1m in pre-production activities and 1.3m in post-production jobs.

Friday, January 27, 2017

It's baaaack - the return of industrial policy!

Theresa May's ten pillar vision for Britain's industrial future signals the definitive return of industrial policy to the mainstream in developed economies. The symbolism is unmistakable. Nearly four decades after Ms Margaret Thatcher led the global movement to get governments out of business, another female British Prime Minister has signalled a reversal. 

Details may vary, but it cannot be missed that government is baaaack in the business of "picking winners". The green paper identifies life sciences, ultra-low emission vehicles, industrial digitalisation, nuclear and creative industries as potential priorities and has sought strategy documents to promote growth in these sectors. Dress it up as "sector deals" or "challenges" to industry, it cannot hide the fact that the ideological shift from generalised policies to industry specific ones constitutes a definite reversal.  

It is equally interesting that Ms May's policy turn coincides with a reversal of Reaganite policies across the Atlantic! The surprising thing about this round of historical cycles has been the short duration between the tides. 

Wednesday, January 25, 2017

Free-market capitalism's assault on economics, politics, and society

Unfettered free-market capitalism has distorted price signals, rules of the game in democracies, and shifted social frames of references for the worse. In simple terms, it has distorted economics, politics and the society. 

1. It is now widely accepted that while there are pockets of market failures in an economy, the markets in the aggregate are efficient and reflect the interests of the society at large. Accordingly, a rising stock market, for example, reflects promising aggregate economic prospects.   

But consider the recent gyrations in global equity markets during the US Presidential elections and its aftermath. The same markets which were initially spooked at the prospect of a Trump White House, rebounded with vengeance on the realisation that the new President's pledge to reduce corporate tax, ramp up public spending on infrastructure, and indulge in protectionism would all boost the incumbents in corporate America. If someone landed up straight from Mars and saw the post-election US equity market rally, they cannot but not get the impression that the markets are rejoicing at an expected result.

Never mind the contradiction in the prospect of reduced tax revenues and increased public spending at a time when national debt is touching record high. Never mind that protectionism, apart from "cosseting the losers", would increase prices and lower the real incomes for the vast majority of Americans. And never mind, the uncertainty associated with a capricious President Trump, including the potential for unleashing very destabilising geo-political forces. Though political and economic uncertainty has become the norm for the US, in a convergence with the developing countries, markets seem non-plussed. 

Clearly the health of Wall Street is no longer a credible touchstone for that of Main Street. 

2. The Economist, the conscience keeper of free market capitalism, commenting on the effusive response of stock markets and investors to the rise of protectionism and industrial policy that will "cosset losers" (instead of "pick winners") under right-wing leaders in UK and US, lets this slip
Imagine the reaction of investors if left-wing leaders were in charge. If President Bernie Sanders were berating American companies on Twitter, or Jeremy Corbyn was pledging unquantified British government support to manufacturers, markets would be plunging.
This is profound. It simply means that equity markets and investors are biased against non-right wing governments. So much so that right-wing governments can adopt completely non-right policies and still get support from investors and the market. Quite simply, the remorseless march of free market capitalism has dramatically shrunk the space available for political action. 

Consider the example of policies to address widening inequality or excessive financialization. Any meaningful effort to address widening inequality has to, perforce, involve redistribution, in some form or the other. But markets will recoil at even the mention of the R-word. Similarly, any reasonable attempt at addressing financial market imbalances will have to involve greater regulation, which would immediately arouse adverse market reaction.  

Democratic politics has become the captive of financial markets and the space for political action has receded dramatically. 

3. Finally, markets have distorted our social frames of reference. Consider the reams of stories that have been circulating around the global activities of Goldman Sachs. The tenacious and indefatigable  Matt Taibi captures these pretty undisputed facts,
Goldman has been implicated in the trafficking of toxic mortgages, a sprawling state corruption case in Malaysia, the manipulation of world commodity prices and a heinous episode involving Greece in which the bank helped to mask the country's ballooning debt while simultaneously working with JPMorgan Chase to create an index for betting against Greece's economy.
One can add the disgraceful duping of Libya and many more. None of these appear to have had any effect on Teflon Goldman Sachs. After promising to "drain the swamp", the "vampire squid now occupies the White House"! The lack of social indignation in the US is stunning. 

This takes us to the point about actions of Wall Street institutions in the lead up the sub-prime crisis. Goldman again led the pack, with the dumping of its toxic portfolio of failing mortgage investments as collateralized securities on its unsuspecting clients. In simple terms, Goldman was betting against its clients. And this had the knowledge of everyone in its Firmwide Risk Committee. The Levin-Coburn report of the Senate Permanent Subcommittee on Investigations clearly documents these transactions by Goldman. After its investigations, instead of pressing criminal charges on the Goldman leadership, the Justice Department and the Securities and Exchanges Commission (SEC) agreed for a financial settlement.

In a world of twenty or thirty years back, Goldman's actions would have seen unambiguously as criminal transgression, shaken up the public conscience, and triggered mass outrage. The Justice Department would have been been forced into pressing criminal charges against Goldman executives. Instead, the public reaction is easily deflated with a financial settlement. Never mind that the executives do not shell out even a penny and shareholders took the tab. Heads I win, tails you lose.

Today, eight years after the sub-prime crisis, not one top executive of a big financial institution has been indicted on criminal charges, leave alone gone to jail. Instead shareholders of these institutions have paid hundreds of billions of dollars in fines, while the same executives have risen further and fattened their purses.

The moral hazard has become entrenched among financial market executives that leave aside risk taking, even unethical and fraudulent practices have only has an upside - make money if the it pays off, or let shareholders take the hit if the transaction is exposed. Criminal indictment, leave aside prison terms, are off the table. And all this hardly elicits any more social indignation. Settlements, financed with somebody else's money, are the new normal for a financial market executive as well as for the society at large.

Now that the social frames of reference on financial sector misdemeanours has shifted dramatically, it may be interesting to get a social pulse about what constitutes a financial crime? 

Monday, January 23, 2017

"Breakouts", "hidden hands", and policy reforms

The demonetisation is a teachable moment for public policy. In particular, it offers insights about the role of "breakout" decisions in paving the path for addressing fundamental challenges. 

There are two problems with addressing fundamental economic or social challenges like pervasive informality or poor urban management or a culture of harassment corruption. One, its resolution requires bringing to play several complementary policy levers. The sheer complexity of the challenge generates enormous inertia against any action. In fact, even thinking through and identifying the various reform interventions, sequencing them, and formulating an action plan, can be a massive challenge. Two, at least some of the policy changes are likely to be unpopular or would have to overcome entrenched and powerful vested interests. As we all know, they can be very difficult opponents. This twin challenge of inertia and unpopularity or opposition are most likely behind all such problems.

It is in this context that demonetisation assumes significance. Much has been debated about demonetisation in India, its reasons and intentions, the implementation failings, and its costs and benefits. Reasonable people can have differences about all these. However, it would be far less contentious if I were to claim that it has succeeded in pushing structural issues like pervasive informality, low tax base, and predominance of cash transactions to the top of the agenda, like no other conventional approach could have done in rambunctious democracies like ours. Some measures, though far from adequate, have been initiated in all these areas, and it would not again be contentious to claim that even these would have been unlikely without the demonetisation "breakout".

This is not to elevate demonetisation as an end in itself, but to view it as an instrument to call attention and gain political engagement to the resolution of fundamental problems, which would otherwise have been difficult, even impossible. It is also not to overlook the need to follow-up such "breakouts" with substantive policy action, the absence of which would defeat the very purpose of the "breakout".

If the political leader keeps in mind these concerns and pursues such "breakouts", then they present a politically expedient and practical strategy to initiate reforms on complex structural issues. The breakouts can provide the rallying platform, overcome opposition, and help generate the momentum to carry through the tough and unpopular reforms. Further, once the trigger is pulled, and we have to live with it, new opportunities and possibilities, that were either invisible or considered long-shots, suddenly appear on the horizon, for whatever reasons. So disruptive "breakouts" may be a prudent strategy to take on deep structural reforms.

Consider the issue of administrative reforms and lateral entry. Any exploration of this would open up several threads of uncertainty. How do you ensure that the quality of entrants is ensured? How do we ensure that the revolving door approach does not worsen corruption? How do we align incentives of the entrants to long-term considerations? How do we manage the career progression challenges of existing bureaucrats? How do we mobilise support among employees for this?

Or consider the issue of poor urban management. Several chicken-and-egg conundrums emerge. Where do you start? Directly elected mayors though providing long-term perspective and local ownership, may worsen administrative discipline and increase corruption? Higher FAR may worsen carrying capacity problems, which in turn cannot be tackled over the short-term? Cascaded planning, while useful, may impose restrictions that end up adversely affecting the middle class and those who cannot afford housing in the city centres? 

Or easing business environment through deregulation. Flexible labor regulations are likely to be abused by the empowered employers? Given the poor corporate governance standards, wouldn't businesses be tempted to abuse the freedom from reduced inspections and self-reporting compliance? Wouldn't businesses be encouraged to socialise their costs and pollute more?

Such apparently insurmountable and paralysing challenges are inevitable with all fundamental or paradigm redefining policy shifts. There is very little likelihood of policy action on any of these fronts, especially given the deep political polarisation in most democracies. "Breakouts", with all the aforementioned caution, provide a silver lining.

Critics may argue whether demonetisation, with its attendant suffering, concentrated among the poorest, was necessary to achieve the same objective. This is a matter of debate. The challenge, therefore, is to figure out what can be potential "breakout" interventions for these areas.  

So what are other possible "breakouts"? In this era of parliamentary logjams, "breakouts" have to be largely executive decisions. Here are a few to mull over. Immediately earmark 25% of central funding in education to be spent on learning outcomes (currently nothing) and not inputs, with it increasing to 75% by 2020. Embrace outcomes-based funding for all central government program allocations, with at least 50% to start with. Mandate far higher FAR, say, in the range of 7-10, in city centres and along the most important transit corridors, as a requirement to receive funding under the Smart Cities project. Target hiring 50 Joint Secretary and above level officials as lateral entrants over the next five years. Radical restructuring of UGC and Medical Council of India to allow greater administrative and academic autonomy for institutions under them.

The "breakout" approach resonates with Albert Hirschman's "theory of the hidden hand". Hirschman said that governments are most often either too risk averse or too intimidated to undertake very large and complex endeavours, given the enormity of the execution challenges and the opposition it would arouse. He therefore argues that in such cases, it helps to have a "hidden hand" which encourages policy makers and politicians to under-estimate the challenges and nudge them into pulling the trigger. 

In the context of large infrastructure projects in developing countries in the sixties and seventies Hirschman had this to say,
If the project planners had known in advance all the difficulties and troubles that were lying in store for the project, they probably would never have touched it, because a gloomy view would have been taken of the country's ability to overcome these difficulties by calling into play political, administrative, or technical creativity... We may be dealing here with a general principle of action. Creativity always comes as a surprise to us; therefore we can never count on it and we dare not believe in it until it has happened. In other words, we would not consciously engage upon tasks whose success clearly requires that creativity be forthcoming. Hence, the only way in which we can bring our creative resources fully into play is by misjudging the nature o[ the task, by presenting it to ourselves as more routine, simple, undemanding of genuine creativity than it will turn out to be.
Hirschman's examples were largely about massive infrastructure projects with long construction times, site acquisition and rehabilitation challenges, and massive expenditures. But the "hidden hand" reasoning applies just as well to fundamental process reforms. 

Does demonetisation provide the "hidden hand" for the government to venture aggressively into tilting at the informal sector and expanding the tax base? And does it offer guidance for embracing the "breakout" approach to reforms? I am inclined to answer in the affirmative.

Sunday, January 22, 2017

Weekend reading links

1. FT has this graphic of the transformation that is happening in the music industry.
The speed with which this transformation appears to be happening is staggering.

2. For those in India who wail about the lack of government initiatives to broaden and deepen capital markets, Larry Fink's call for Europe to do the same should provoke some thought,
“In the years since the crisis, much of Europe’s economic potential has been locked up. Strengthening capital markets and retirement systems can help unlock that potential, and doing so will be vital to Europe’s economic future,” he said. While the US, where BlackRock, the world’s largest asset manager with about $5tn under management, is based, has much more developed capital markets, European companies are highly dependent on bank lending, which provides about 70 per cent of their funding. European bond markets are also complicated by different insolvency laws across member states. “The lack of a unified European corporate bond market raises costs for companies, deters investors and holds down liquidity,” Mr Fink said... the European Commission in 2015 put forward a range of proposals for unifying and broadening European capital markets, known as the “capital markets union”.
I have blogged several times about the difficulty of developing capital markets. Despite extensive efforts across the world, especially in Latin American countries, bond markets have remained still-born. They are a reasonably large share of corporate financing only in the US. 

3. Livemint points to India's marginal income tax rates being lower than in developed countries but higher than in its emerging Asia peers.
These tax rates pose a conundrum. Developed countries started with very high marginal tax rates than their EM peers today. This allowed them to lower the tax rates progressively and still have a large enough government spending as a share of GDP, a necessity as countries develop and the demand for high quality public goods and social safety net increases. In contrast, the EM economies start out with much lower tax rates, leaving them with limited cushion to lower rates further and struggle to find the resources required to finance social safety and public goods. This is going to be yet another difference in the development trajectory of the EM economies compared to that of their now developed counterparts. 

4. Even as Xi Jinping positions China as the global leader in defending globalisation, the graphic below on the balance sheet of globalisation is interesting.
It is clear that the only substantive gainers of globalisation were those belonging to emerging Asia (China, India, and SE Asian tigers), whose PPP adjusted share of the world economy almost trebled from 12.53% to 31.84% over the last quarter century. For the others, even in the aggregate, it has been disappointing. This does not mean that they gained nothing since even retaining their existing growth shares on the face of the spectacular growth of emerging Asia would have been better than business as usual growth. 

5. India has 4% of the global unicorns, or 8 among 186. And no surprises, all of them are cut-and-paste companies. Entrepreneurs they are (it is a test of great skill to do business here), but innovators they are not. And I would not be one bit surprised if none of the eight survive the coming five years. 

6. Greece is a very sad tale. The country is paying a very heavy price for "decades of mass tax evasion, lavish public sector salaries, inefficient social spending and generous state pensions". Despite three EU bailouts, including the last for 86 billion euros, the eight years of economic pain has battered the economy and the society,
Today the country has become a byword for the brutal economic, political and social fallout that followed the 2008 crisis. The economy shrunk almost a third in the ensuing years, and the government is effectively bankrupt without outside support: it owes about €320bn — not far from double its gross domestic product of €181bn... Unemployment is at 23 per cent and 44 per cent of those aged 15-24 are out of work. More than a fifth of Greeks get by without basics such as heating or a telephone connection. n 2015, 15 per cent of the population lived in extreme poverty compared with 2 per cent in 2009, according to a recent study by Dianeosis, a Greek NGO. There are families that do not have anything to eat... Spending on hospitals, schools and social safety nets has been slashed, leaving increasing numbers of Greece’s most vulnerable without support... Many local schools have been shut or had budgets trimmed. Bus routes, an essential link to nearby towns, have been axed, forcing villages to operate community taxi schemes...
Last year pension payments were cut by as much as 40 per cent, while this year will bring €1bn worth of new taxes on cars, telecoms, television, fuel, cigarettes, coffee and beer, and a €5.7bn cut to public sector salaries and pensions. It is a drastic return to reality for many in a country where, for decades, tax enforcement has been lax and social benefits generous... Fifty-two per cent of Greek households rely on pensions to pay their monthly expenses, according to a 2015 study. Yet Greece has only 2.7 million pensioners — 25 per cent of the population. Austerity measures mean that close to half of pensioners now have a monthly income that puts them below the country’s poverty line, according to a recent report by a group of retiree associations. New taxes have eroded disposable incomes still further. Value added tax has increased to 24 per cent on food, disproportionately hurting the poor, for whom living costs represent a far higher proportion of income. Most detested is the Enfia property levy, which brings in €2.65bn a year — roughly €650 from each of Greece’s four million households.
When taxes are rising and incomes are falling, such suffering is inevitable. The more disturbing thing is that the scale of the country's indebtedness makes repayment almost impossible. Greece needs less of debt rescheduling and more of debt write-downs.

7. Amidst all the dismal news, something encouraging from Gambia. The decision by Yayha Jammeh, who ruled Gambia for 22 years, to step down and hand over power to Adama Barrow, who won the democratic elections in December, should count as a red-letter day in the history of the country as well as West Africa. The outcome is a tribute to African diplomacy, especially the Economic Community of West African States (ECOWAS) which had mounted intense pressure on Jammeh to resign. Now, the ball is with Barrow to fulfil the faith repose on him.

8. Finally, a fascinating video about Venice, a conglomeration of 124 islands and a city without automobiles!

Friday, January 20, 2017

India "missing middle class" fact of the day

I have blogged earlier here, here, and here highlighting the point that India's consuming class may be far smaller than anticipated. The big story about India's middle class may be that it is "missing". 

The latest exhibit is this article in Livemint which questions whether Amazon went wrong with its $5bn bet on India's massive middle class making India its second largest market,
Amazon’s expansion was fueled by an unprecedented spending spree - it has already pumped in more than $2 billion and has promised to invest $3 billion more. However, most or all of Amazon India’s gains in 2016 came at the expense of Flipkart and Snapdeal and not from an expanding market, raising questions about its massive capital commitment to India and whether it is generating enough bang for its buck. E-commerce sales in India were just around $14-14.5 billion in 2016, little changed from 2015... unless the online retail market bounces back, Amazon may take much longer to realize its stated objective of making India its second-biggest market in the world after the US over the next few years. Already, analysts’ estimates of a $60-100 billion e-commerce market in India by 2020 are looking fanciful.
I had also written about the difficulty of Amazon being able to make $3 bn worth investments. I had argued that the only way to spend this money was to capture market through deep-discounting. 

But this standard market capture strategy successfully adopted by e-commerce and aggregator firms across the world too may not work in India. India's extremely price sensitive consumers are most likely to exit the market if firms try to raise prices once they achieve market dominance. 

Thursday, January 19, 2017

The "American Dream" in two graphs

David Leonhardt points to the latest analysis from Raj Chetty and Co about intergenerational mobility, the archetype of the "American Dream". The headline finding is that while in 1940 a child born into the average US household had 92% chance of making more money than his or her parent, the same had fallen to just 50% by 1980.

The first graph shows that the percentage of children earning more than their parents (at the age of 30) has been declining steadily since 1940. 
The second graph shows a secular decline, across the entire income percentile.  

Analysing the market in kidnappings

Fascinating article by Anja Shortland that seeks to explain the motivations and dynamics of the market in kidnappings, 
The first principle that insurers adopt is that safe retrieval of hostages is paramount. The second guiding principle is that kidnapping cannot become too wildly profitable, for fear of further destabilization. In the language of economists, there must be no “supernormal profits.” If victims’ representatives quickly offer large ransoms, this information spreads like wildfire and triggers kidnapping booms... Insurers have therefore created institutions to make sure that ransom offers meet kidnapper expectations and produce safe releases but that do not upset local criminal markets... Because insurers can communicate outcomes confidentially, they can stabilize ransoms — as well as discipline rogue kidnappers. One kidnapper summarized this perception in the criminal community as “No one negotiates with a kidnapper who has a reputation for blowing his victims’ brains out.” Crisis responders also manage the ransom drop, removing a further obstacle to a successful conclusion. About 98 percent of insured criminal kidnapping victims are safely retrieved.
Of course, this “protocol” for ransom negotiations is costly. Tough bargaining takes time, imposing huge psychological costs on negotiators and on the victim’s family and tying up productive resources in firms. Experienced consultants are paid a substantial daily fee. It is very tempting to conclude negotiations early. Most of the cost of quick ransoms that are bigger than they ought to be is borne by future victims and their insurers, not the current victim’s stakeholders...
It would be impossible to prove beyond reasonable doubt that an insurer’s crisis responder deliberately cuts corners because ransoms are naturally variable. This makes it impossible for insurers to formally contract with each other and punish those who “overpay” kidnappers. Insurers resolve this through an ingenious market structure. All kidnapping insurance is either written or reinsured at Lloyd’s of London. Within the Lloyd’s market, there are about 20 firms (or “syndicates”) competing for business. They all conduct resolutions according to clear rules. The Lloyd’s Corp. can exclude any syndicate that deviates from the established protocol and imposes costs on others. Outsiders do not have the necessary information to price kidnapping insurance correctly: Victims are very tight-lipped about their experiences to avoid attracting further criminal attention. The private governance regime for resolving criminal kidnappings generally delivers low and stable ransoms and predictable numbers of kidnappings. Most kidnappings can be resolved for thousands or tens of thousands of dollars. This makes profitable kidnapping insurance possible. When the protocol fails, insurers sustain losses and must innovate to regain control.
This should count as one of the very rare examples of how the market has addressed the co-ordination problem that is pervasive in such situations. 

Monday, January 16, 2017

The missing investment recovery in India

An examination of the credit-to-GDP gap data released by the BIS reveals an interesting picture. The data captures the difference between the actual credit-to-GDP ratio and its long-term trend of borrowings from all domestic and foreign sources to the private non-financial sector.
The BIS uses credit-to-GDP gap to assess systemic risks from excessive credit flows, having found this a useful early warning indicator. In particular, it has found that a credit gap in excess of ten percentage points was found to be associated with a two-third likelihood of a serious banking crisis within the next three years. Accordingly, as per the Basel III regulations, the counter-cyclical capital buffers for the banks should be raised as soon as the country's credit-to-GDP gap exceeds two percentage points. Three observations.

1. China is flashing red big time. Since late 2008, when the country triggered off its stimulus package, the credit to private non-financial sector has rocketed. Since late 2011, it has risen nearly five-fold to touch 30% of GDP. No country even comes close in terms of the scale of such excess credit build up.

2. India presents the other side of the spectrum, a stark contrast with China in terms of private sector investment activity. Its credit-to-GDP gap has been in continuous decline since the crisis, and is now in the negative territory and the lowest among all major emerging economies. In fact, from this and other data (the IIP has been on declining trend), it becomes clear that the private sector investment cycle did not recover after the crisis. Growth has largely been driven by public investment and consumption. 

3. The weakness in investment activity is surprising given that the balance sheet problems constrain only the infrastructure sector firms and certain large corporate groups. Aggregate corporate indebtedness, as measured by the private non-financial debt service ratio (ratio of debt repayments to income), has been very stable and under well below danger levels. 
Consider this. Two of the three growth drivers, business and households, have stable balance sheets. The government's Make in India campaign has doubtless done its part in stoking the animal spirits. But investment activity, even in consumer durables and other cyclicals, and intention to invest remains muted. 

There can be three explanations. One, businesses do not feel that the excess capacity built up during the boom years of 2003-08 have not been wrung out. There is some evidence to this effect in the RBI's OBICUS survey. Two, businesses do not find the prospects of growth in demand promising enough. Three, there is some other constraint holding back investment activity.

Saturday, January 14, 2017

Weekend reading links

1. John Thornhill captures the age of "dataism",
Gartner, a tech research company, estimates that 5.5m connected devices a day came online in 2016. It forecasts that their total number will more than triple to 20.8bn by 2020 as the “ internet of things” becomes a reality. According to IBM, we already generate some 2.5 quintillion bytes of data every day, meaning that about 90 per cent of all data in the world has been created in the past two years. To see the effect that this data use can have, just take a look at the advertising industry. Facebook and Google sucked up an astonishing 85 cents of every new dollar spent on digital advertising in the US in the first quarter of 2016. Their success is based on their ability to use data to target advertising at the likeliest consumers.
2. Economist argues in favour of Vienna as the "city of the century", built on the fecundity of ideas and art that emerged in the late Hapsburg era of Franz Joseph I. Sample this,
Often the Viennese intellectuals leapt ahead by transferring knowledge gained in one discipline to others, gloriously indifferent to the mind-forged manacles that have come to stifle modern academia and research. In America, several Viennese-trained devotees of Freud used the tools of psychoanalysis to revolutionise business. Ernest Dichter, author of “The Strategy of Desire,” transformed the fortunes of companies through marketing that purposely tapped into consumers’ subliminal desires.  
Another example was Paul Lazarsfeld, the founder of modern American sociology. Born of Jewish parents, he studied maths in Vienna, completing his doctorate on Einstein’s gravitational theory, and thereafter applied his expertise in data and quantitative methods to what became known as opinion, or market research—finding out what people really feel about anything from television programmes to presidential candidates. In Vienna in 1931 he conducted the first scientific survey of radio listeners, and also co-wrote a revolutionary study of the devastating social and psychological impacts of unemployment. His team of investigators conducted what is now called “field research”, meticulously recording the results of face-to-face interviews with laid-off factory workers in the town of Marienthal. Moving to America in 1933, Lazarsfeld went on to found the Columbia University Bureau for Social Research. His team was the first to use focus groups, developed with Dichter, his one-time student, and statistical analysis to delve into the mysteries of voter and consumer preferences or the impact of the emerging mass media. Lazarsfeld and others thus helped revivify moribund, antiquarian modes of inquiry, and re-equip them with the latest Viennese techniques, often saving entire Western intellectual traditions from decrepitude, or possibly extinction.
3. Most, if not all of Donald Trump's bombast is plain disgusting. But his tweet campaign on automobile manufacturers operating plants in Mexico may be a not fully undesirable antidote for a business world where commercial considerations override all else. If initial signs are any indication, this could provide a tipping point in getting businesses to incorporate non-financial considerations in their investment decisions.

In recent days Trump has initiated a similar tirade against predatory pricing techniques of pharmaceutical companies. His comments that pharma companies were "getting away with murder" wiped off $24 bn from the value of Nasdaq listed biotech market capitalisation. Even if you do not agree with his approach, one cannot but feel like supporting Trump on this campaign. 

In other words, Trump would have turned back the remorseless march of the market's logic in economic decision making. A desirable outcome, though achieved through questionable means and with potential path dependent incentive distortions!

4. FT reports that China invested $103 bn on renewables in 2015, more than double next-placed America's $44 bn.
5. The cost of carrying cash in India, even without demonetisation, is very high!
6. One of the stories going on around demonetisation has been about the Jan Dhan bank account being used to launder black money. This, advocates argue, has been a major reason why the vast majority of black money has found its way back to the formal banking system, as reflected in the near complete return of 500 and 1000 rupee notes.

But a Livemint analysis appears to refute this. It finds that the Jan Dhan deposits rose from Rs 46,636 Cr on 09.11.2016 to Rs 74,322 Cr on 30th November and Rs 70,070 Cr on 4th January, 2017. To put this share in perspective, it increased from 0.05% to 0.45% of the aggregate deposits of schedule commercial banks between September 2014 and October 2016, reached a peak of 0.71% in November 2016 and declined to 0.68% again in December 2016. Rounding error!

7. Sundeep Khanna has a nice article which argues that instead of courting Apple, the Government of India should be trying to attract Tesla to invest in the country. I had blogged earlier about the futility of trying to attract Apple. But this is a teachable point about the problems with industrial policy. It is deeply vulnerable to ongoing fads, which leads to governments backing the wrong horses,
If concessions have to be given to persuade global companies to set up manufacturing in India, they are better off given to those at the forefront of technologies that will drive the future... There are many... companies pushing the boundaries of technology, which may be both easier to woo and whose multiplier effect may be far greater in the long term. As an example there is Cortex Composites, the Draper Associates-funded California-based developer of a new type of cement called Cortex which has uses like canal lining, ditch lining, slope protection, erosion control and lining ponds. It replaces expensive mixing trucks in places that need just thin layers of cement. There is also a clutch of innovative 3D printing companies like 3D Hubs, Carbon, Made in Space or Voxel8. For hardcore manufacturing there is Daijiang Innovations (DJI), the world’s most successful consumer drone-maker based in China. Country strategies have to be based on a long-term vision. The smartest countries are now looking at building ecosystems around artificial intelligence (AI), which is expected to have the same impact on the world as the internet or electricity before that.
8. Mint examines the case for a Universal Basic Income (UBI) guarantee for India. The different scenarios are captured below.
I have been coming to the view that a UBI may be worth considering in countries or areas where state is virtually absent or so weak as to be missing. This would not apply to India. Apart from the numerous very compelling substantive arguments against UBI and the politics surrounding the substitution of existing in-kind subsidies, some of these numbers being estimated (including in the Economic Survey) are like the optimistic "expectations-stretching" that happens when you are pushed against the wall and have no other hope.

For example, consider the math surrounding the 5.2%. The assumption is that you would squeeze out all those increments to the tax-to-GDP ratio (itself questionable) and then divert them all to a UBI, over-riding other far more important claims like increasing the share of GDP spend on health care, infrastructure spending etc. It is not only snake-oil policy prescription, it is also plain bad economics. 

9. FT has an excellent investigation on the maritime ambitions of China. The importance of China in the global maritime market is stunning,
Investments into a vast network of harbours across the globe have made Chinese port operators the world leaders. Its shipping companies carry more cargo than those of any other nation — five of the top 10 container ports in the world are in mainland China with another in Hong Kong. Its coastguard has the globe’s largest maritime law enforcement fleet, its navy is the world’s fastest growing among major powers and its fishing armada numbers some 200,000 seagoing vessels...
Beijing’s shipping lines deliver more containers than those from any other country, according to data from Drewry, the shipping consultancy. The five big Chinese carriers together controlled 18 per cent of all container shipping handled by the world’s top 20 companies in 2015, higher than the next country, Denmark, the home nation of Maersk Line, the world’s biggest container shipping group. In terms of container ports, China already rules the waves. Nearly two-thirds of the world’s top 50 had some degree of Chinese investment by 2015, up from about one-fifth in 2010... And those ports handled 67 per cent of global container volumes, up from 42 per cent in 2010, according to Lloyd’s List Intelligence, the maritime and trade data specialists. If only containers directly handled by Chinese port operators are measured, the level of dominance is reduced but still emphatic. Of the top 10 port operators worldwide, Chinese companies handled 39 per cent of all volumes, almost double the second largest nation group... since 2010, Chinese and Hong Kong companies have completed or announced deals involving at least 40 port projects worth a total of about $45.6bn

The modus operandi is simple - give loans and construct ports in developing countries, invoking some commercial interests. But its military and political dimensions are undeniable,
“There is an inherent duality in the facilities that China is establishing in foreign ports, which are ostensibly commercial but quickly upgradeable to carry out essential military missions,” says Abhijit Singh, senior fellow at the Observer Research Foundation in New Delhi. “They are great for the soft projection of hard power.”...

China’s naval strategy is aimed primarily at denying US aircraft carrier battle groups access to a string of archipelagos from Russia’s peninsula of Kamchatka to the Malay Peninsula in the south, a natural maritime barrier called the “first island chain” within which China identifies its strategic sphere of influence. Another focus is the string of artificial islands that Beijing has dredged out of coral reefs and rocks to help reinforce China’s claim to most of the South China Sea, putting it on a collision course with neighbours from Vietnam to the Philippines, as well as the US. The artificial islands have been equipped with landing strips and a US think-tank recently said, after analysis of satellite images, that Beijing appeared to have installed anti-aircraft guns, anti-missile systems and radar facilities on them.
India, in particular should be concerned at the Chinese built ports in Gawdar (Pakistan) and Hambantota (Sri Lanka), both of which have undeniable security and force projection dimensions. Forget a "string of pearls" around India, China appears to be a stringing one to encircle the globe itself!

10. Even as MS Dhoni relinquished captaincy, I came across this Mark Nicholas article,
He talked about chasing as if he were a Roman imperator waiting upon Nearer Gaul. Take it to the point where they are more scared than you, was his theme. ... the power of his personality... imposes himself upon you. It is an intimidation of sorts, a sense of ownership of the moment that creates doubt, fear and awe in the opponent. If you are left bowling to Dhoni at the death, you are not - consciously or subconsciously - backing yourself. Worse still, you are probably backing him.
11. Finally, Virat Kohli is the flavour of the cricket season. I've been reluctant to bracket him with Tendulkar for a reason. If you watch Virat close enough, apart from admiring his breathtaking stroke play, you could also come away with the feeling that those strokes are born out of a talent for exceptional hand-eye co-ordination. I can think of only Brian Lara and Virender Sehwag with comparable talent. But such talent based skills atrophy far quickly with age than a more learned technique. Just watch Virat execute the cover drive (especially on spinners) with quick-silver reflexes and compare it with the same stroke of say, Tendulkar, which is simpler (and graceful) and has fewer moving parts. 

To put Kohli in perspective, Sehwag was no less influential and feared, and arguably more destructive, in the 2008-10 period.  Sehwag was aged 30-32 in this period. To be fair to Kohli, he appears to have realised his potential earlier than Sehwag, at the age of 27. So, maybe he will have a longer period of dominance. But contrast this with Tendulkar's last period of influence, 2007-10, when he was 34-37. 

The one area where he seems to clearly score over even Tendulkar is, surprisingly, his temperament and his ability to play the percentage game in the shorter and far riskier formats of the game. This graphic of T20 performance (as well as his average in successful one day chases) is no less stunning than Bradman's average.

Thursday, January 12, 2017

Mathiness and the narrowing of economics

Lars Syll has a nice post with several interesting links on the ongoing debate on the "intellectual regress" in macroeconomics. In particular, the post discusses the problem with the Lucas-Prescott-Kydland-Sargent "calibration" models. 

Calibration modelling involves identifying uncertain parameters and revising the model coefficients using actual historical data with some measure of goodness-of-fit. See Paul Krugman here and here on calibration modelling. 

Stripped off the jargon, the issue at hand is that one school of thought advocates using a model arrived at based on their theory of change whose parameters are refined (or calibrated) by testing it against actual data. But another group critiques this approach arguing that such calibration is barking up the wrong tree if the theory of change and, therefore, the model itself is flawed. They also argue that unlike scientific models which are generally time and path invariant, the dynamics of change in social science are time and path dependent.  

Also Paul Romer's scathing attack on how "mathiness" and excessive deference led macroeconomics astray,

a general failure mode of science that is triggered when respect for highly regarded leaders evolves into a deference to authority that displaces objective fact from its position as the ultimate determinant of scientific truth.
The complement of "mathiness" is the narrowing of the study of man in the ordinary business of life from its older version of "political economy". On a related note, Economist has a nice year-end article on the Cambridge school of political economy founded by Alfred Marshall. The contrast between the multi-disciplinary school of political economy of Alfred Marshall and AC Pigou and the modern "mathy" econometrics-heavy instruction is seen in their respective student instruction and assessments,

The goal can be seen in the exam questions of the time. Students were expected to combine economic principles with a strong grasp of current affairs. In 1927, for example, one paper on public finance asked students to explain the size and reasons for the main areas of British government spending. They were expected to have the skills of an essayist, spending one three-hour exam on a single question such as the future of gold, the rights and duties of shareholders, or alternatives to democracy. Cambridge economics considered itself to be an analytical science but calculation was not of the essence. A module in statistics produced a page-long test for final-year students; all the other papers were bare of mathematical symbols. Compare this with the exams of today. Charlotte Grace, a student in the third year of the economics tripos (as undergraduate degrees are known in Cambridge), says she could have passed all the questions she faced in her first year without reading a newspaper. And though the five-page final-year macroeconomics exam that was set in 2015 asked about some contemporary policy conundrums, like which features of the euro zone may have contributed to its sovereign debt crisis, most of the paper sought to test students’ knowledge of tricky, algebra-heavy models. Three-hour pontifications on a single topic have been ditched in favour of a compulsory dissertation in which original empirical analysis is encouraged.

These tests reflect changes in the discipline. Students must master the technical apparatus of a highly specialised field. The maths they need to know and apply is sufficiently taxing as to barely leave time for history. Evidence-based conclusions are preferred to arms-length analysis; economists should know the limits of their expertise, and shy away from political judgments as they think through the effects of whatever policy tweaks providence might throw at them.

Tuesday, January 10, 2017

State capacity weakness and addressing black money flows

I had argued in an earlier post that the success or failure of the campaign to curb black money and expand the tax base initiated through the demonetisation decision would depend on how the flow problem would be addressed

Indira Rajaraman has an excellent article which argues that the path to increasing tax revenues is to detect and reduce flows of tax evasion. She advocates the use of presumptive methods for identifying tax evasion - focus on occupation categories with high incomes and high value purchases of goods and services, and track individuals for tax payment proportionality.  

It is plain obvious that there is massive tax evasion at the highest levels of income ladder. It is also a reasonable premise to argue that the same is concentrated in a few areas. A few occupational and economic activity categories come straight to mind - lawyers, doctors and hospitals, professional colleges, tuition centres, entertainers, construction contractors, real estate developers etc. And purchases to target include vacations (hotel bookings, air travels etc), gold, real estate, luxury durables (vehicles, designer wear, antiques and art, etc), management quota college seats, club memberships, wellness services (spas, therapeutic, cosmetology etc), entertainment services, and general transactions beyond a certain value. These two should be coupled with data on credit card spends, savings account transactions, financial market investments etc. 

Evidently, this would require accessing multiple data bases, most of which are unlikely to be readily available. One way to ease the identification challenge is to link up transactions with the Income Tax PAN. Once the individuals concerned are identified, a first order scrutiny would be to check for proportionality with their tax payments. 

To begin with, it may not even be necessary to adopt rigorous enforcement actions. Merely intimating the respective individuals about the observed discrepancy between their expenditures and income tax payments and seeking their explanation may be adequate to nudge significant compliance. This would avoid the inevitable harassment and corruption associated with enforcement based tax campaigns, which generally brings disrepute to such well-intentioned efforts. 

So why have we not been able to do this? My strong belief is that it can be traced back to state capacity weakness. Indira Rajaraman too appears to say the same,
We live in a country where utility companies are not able to collect their dues, leaving public-sector banks groaning under default. A simple administrative requirement for PAN numbers attached to electricity dues or leasing of generators (for lavish marriages) would have led to higher revenue for both the income-tax department and power distribution companies. Large-scale tax evasion has long been practised right in the face of the income-tax authorities through political connections. Those without political connections have had to pay their way out. Either way, unless these features of the taxation system are reformed, there is nothing demonetisation can do for tax revenue. 
Assembling and analysing the data required to identify such leakages is no mean task. For a start, it is painstaking work to extract data on the occupational categories and purchases. There are no single, readily available databases for any of them. Assembling this information would be a massive exercise in inter-departmental co-ordination and engagement with various market participants at different levels. Apart from overcoming strong resistance from entrenched interests, legal constraints and privacy concerns would have to be addressed. It would also require reconfiguring compliance and other reporting formats by businesses. The Revenue Department of the Ministry of Finance, on its own, simply does not have the capacity nor the convening power to pull this off. 

Then there is the matter of their analysis with respect to actual tax assessments. This too is far from being just some sophisticated software based analytics. As Rajaraman cites with the example of Israel's use of presumptive taxable income estimate linked to transaction value, such analytics has to be built on painstaking ground work. 

Such plumbing challenges demand strong state capacity at all jurisdictional levels. Unfortunately, state capacity weakness is no less acute in Revenue Department and the Central Board of Direct Taxes (CBDT). Compounding the problem is the institutional and incentive structure of the CBDT, which is seen and sees itself largely as an implementation agency - tax assessment, collection and enforcement. Systemic transformations of the kind discussed above demand entities with strong policy conceptualisation, design, and research focus. This may be a good opportunity to pivot and build a strong focus in this dimension. 

Monday, January 9, 2017

Firm size and productivity

One of the most interesting areas of recent research is that which explores the reasons for the wide differentials in establishment-level productivity within a country as well as cross-country aggregate productivity. Poorer countries have been characterised by lower establishment level productivity which translates into lower aggregate productivity.

In a new working paper, Pedro Bento and Diego Restuccia uses data of manufacturing establishments from across 12 countries and finds a "clear positive relationship between aggregate productivity and average establishment size". They write,
We calibrate a benchmark economy to US data and show that reasonable variations in the extent of correlated distortions have substantial negative effects on establishment size, establishment-level productivity, and aggregate output per capita. In order to provide a quantitative assessment of this channel in explaining productivity differences across countries, we first document evidence from cross-country micro data for the elasticity between distortions (wedges) and establishment productivity, using establishment-level data from the World Bank's Enterprise Surveys.
We show that the elasticity of distortions with respect to productivity in the micro data is strongly negatively related with both average establishment size and GDP per capita across 53 countries... Compared to the calibrated U.S. benchmark economy, increasing correlated distortions to 0.56 (the elasticity between wedges and establishment productivity found for India) generates a reduction in establishment size to 3.4 workers versus the 22 workers in the US economy (a 6-fold difference), and a similar reduction in establishment-level productivity. 
Their sample finds the income elasticity of establishment size to be 0.26 - a one percentage increase in income is associated with an increase in establishment size by 0.26 percentage. This climbs to 0.33 when small countries with population less than half a million are eliminated. 

Industrial policies pursued by governments have largely been confined to fiscal concessions, cheap credit, and subsidised inputs. An encouraging development in recent years has been the increasing salience of policies to prune regulatory and transactional thickets that improve the ease of doing business. Another area that demands immediate attention is informality and small firm size. An industrial policy that seeks to help firms start formal and encourage informal firms turn formal, and then create the conditions for even 10-20% of them to grow in size, has the potential to unlock large gains.