Thursday, February 21, 2019

Global fund raising summary

The summary of unlisted infrastructure fund raising in 2012-18
There were 67 unlisted infrastructure funds which closed in 2018 raising a combined $85 bn, a record capital raise. Of them 22 N America focused funds raised $44bn and 33 Europe-focused ones raised $35bn. The average fund raise was $1.3 bn, with 71% which closed this  year exceeded their targets. Four funds raised more than $5 bn, of which each of Brookfield Infrastructure Fund IV and Global Infrastructure Partners IV are targeting $20bn,. With this, the total dry powder available is at a new record $172 bn as at December 2018. In early 2019, there are 208 funds raising $193 bn.

Of the 2454 infrastructure deals in 2018, Asia accounted for just 12.1%. Further, US, Europe and China form the vast majority of infrastructure deals. And 64% were secondary market deals. 
There were 1175 PE funds which raised $426 bn, down from $552 bn in 2017. Of them, funds focused on N America raised $240 bn, Europe $90 bn, and Asia $80 bn. The average fund size was $363 mn, with the largest fund closed being a $18.5 bn by Carlyle Partners VII. The dry powder available was $1.2 trillion as on end-December 2018. Beginning 2019, there are 3750 PE funds seeking a total of $977 bn.

The global alternative assets under management stood at $8.8 trillion in end-2017 and is expected to touch $14 trillion by 2023. 
The global VC industry, at 21% of global PE, was $660 bn in 2017. US, Europe, and China dominate the global VC industry.
In 2018, alternative assets raised $757 bn.

Monday, February 18, 2019

China uses technology in judicial reforms

Among all the arms of the government in India, perhaps the one most antiquated, both in terms of use of technology and application of process re-engineering, is the judiciary. In fact, very little of the "information revolution" that has touched all other aspects of life has influenced the country's legal system. And the result is an almost antediluvian system which fails to deliver on its objectives. And very little discussion about serious reforms.

For lessons, it needs to look no far than what neighbour China has done. 
China has livestreamed more than 2.4m trials since introducing the technology in 2016. It also has three online courts, in Hangzhou and Beijing, which have opened in the past two years, while another court in Shanghai has an online mediation platform to resolve disputes before they go to trial. There is also a “central” online mediation platform, with more than 1,400 Chinese courts listed... “You [can] just turn on a computer to complete an entire legal procedure,” he said. “You don’t have to have internet-based evidence notarised any more ... for example, if you find a pirated copy of a movie online, you only need to [screenshot] the page.” On the other hand, livestreamed hearings and trials were intended as a way of educating the public, he added. “By showing how [judges] rule on one case, it tells the public what the court’s attitude is towards those types of case.”... China is forging ahead with applications that are replacing lawyers’ functions and even assisting judges. “Many courts are using smart ruling systems [that] categorise and analyse previous cases to help judges draft their verdicts,” said Mr Zhang. For similar, repetitive types of case, some of those systems can be “very reliable”.
And it seems to have done this by channeling private enterprise,
According to new figures from Thomson Reuters, the number of patents related to legal technology, or “lawtech”, filed globally has risen more than fourfold over the past five years, from 202 in 2013 to 933 last year. More than half — 51 per cent — were filed in China last year, while 23 per cent were filed in the US and 11 per cent in South Korea. Western law firms and other legal service providers tend to concentrate on how to automate their operations in the name of efficiency and cost savings, not least because their biggest clients — corporate legal departments — are insisting on lower bills. By contrast, Chinese innovators are more focused on ordinary citizens, with courts now livestreaming trials — from traffic incidents and small financial disputes to drug offences and theft — and enabling claimants to file cases, submit evidence and resolve disputes online. More sensitive issues, including anything deemed to involve national security, are kept away from public scrutiny.
Clearly this is a very impressive achievement. Like with other areas, the impressive achievement is with figuring out solutions, their effective execution within a finite time, and with channeling private entrepreneurship. 

There are perhaps two ways of engaging on this. One is public production of solutions - government agencies make the solutions and implement them. The other option is publicly co-ordinated private production - co-ordinate the market to engage with them problem and develop a solution eco-system.  

The exemplar of the former was the erstwhile Soviet Union. Most developed countries of today addressed many of their basic plumbing challenges largely through public production. China is clearly an example of the latter. It appears to have perfected the use of industrial policy to co-ordinate private enterprise even into some of the most difficult areas for private engagement. This is the case of industrial policy to both address a critical plumbing issue as well as catalysing a market. And this is what makes its achievement exceptional.

Saturday, February 16, 2019

Weekend reading

1. Talk about likely Cheshire cats and Uber edition, as the company prepares for its IPO,
Excluding certain one-time items, including the sale of some of its businesses, Uber’s losses for the quarter rose 88 percent from the previous year, to $842 million. The losses were a result of Uber’s increasing its spending as it tries to outmuscle competitors, many of which have intensified their efforts to add riders and drivers. Uber has responded by offering bigger incentives and more promotions to fend off rivals like DoorDash, Lyft and other ride-hailing and food-delivery services... Some of the company’s losses have been overshadowed by its explosive growth. In 2018, Uber increased its total bookings — what it charges customers for rides and food delivery — to $50 billion, up 45 percent from 2017. Net revenue was $11.3 billion, a 43 percent increase... But Uber’s profit margins have declined as it cut prices to match competitors and spent money on expanding its food-delivery business, Uber Eats. The margins are also smaller on Uber Eats orders because the company pays commissions to restaurants as well as delivery drivers.
Despite this the company is valued at $70 bn, with investment bankers suggesting even $120 bn.

More likely this is a pricing of Uber than its valuation. When asked about Uber's astronomical 'valuation', valuation guru Aswath Damodaran had this to say,
Pricing. It’s a pricing issue. The reason people pay $60 Billion for Uber is because they think that when it goes public it will be worth $100 Billion. There doesn’t need to be a fundamental rationale for value. All you need in the pricing game is someone else willing to pay a higher price for the company. As long as momentum is on their side, it’ll keep pushing the pricing up. It’s got very little to do with fundamentals, and everything to do with “is there somebody else out there who will pay me a higher price for this company”.
Btw, Aswath Damodaran values Uber at between $25 bn and $35 bn


2. So Amazon has pulled the plug on its Queens second head quarters which promised 25000 new jobs and $3bn in local tax concessions. What does it say about modern capitalism that its favourite corporate brand is forced to abandon its plans to establish its second headquarters in a city which is perhaps the capital of modern capitalism?

Now what happens to the vast trove of data that Amazon has accumulated about cities during the bidding process?

3. Special economic zones (SEZs) come in several forms, and there is little to suggest that, in general, they offer value for money. Consider this about 'opportunity zones' in the US, 
Based on recommendations from state governments, the United States Treasury has designated more than 8,700 eligible census tracts in urban, suburban and rural areas across the country. The opportunity funds are the vehicles for investing in these zones. The idea is that investors get federal tax breaks, while the neighborhoods get new businesses and upgraded properties, like apartment buildings, retail shops and hotels... Opportunity funds let investors postpone federal taxes on recent capital gains until the end of 2026; they can also reduce the taxable portion of those gains by as much as 15 percent, after seven years. Further, investors can eliminate taxes on additional gains from investing in the fund itself, if they hold the investment for 10 years. So, if you have investments that have appreciated, you can defer capital gains taxes by selling the investment and reinvesting the money into an opportunity fund within six months. Almost any sort of capital gain qualifies, whether from the sale of stocks or mutual funds, or other investments, including the sale of real estate or a business. Just the gains on an investment — rather than the entire proceeds of a sale — must be reinvested in the opportunity fund.
But the zones, notified last year, are already there are serious question marks about whether many of the notified zones deserved to get any fiscal concessions since they were already gentrifying. 

4. Leveraged loans, borrowings by those with relatively high debt, which has more than doubled to over $1 trillion since 2010, have for some time been signalling red. 
Highly leveraged loan deals (when debt is more than five times earnings before interest, tax, depreciation and amortisation) account for about half of new US corporate debt. That growth is partly a result of securitisation. Roughly half of investor demand today comes from packaging loans into collateralised loan obligations, or CLOs, and slicing them into different tranches of risk. Rising demand has shifted the balance of power from investors to borrowers, and contributed to a watering down of covenants embedded in loan agreements that traditionally protect investors. According to Moody’s, about 25 per cent of the leveraged loan market was considered “covenant-lite” before the global financial crisis. Now that figure is 80 per cent. The implications in a downturn could be severe. Covenant-lite lending is like swimming without the ability to spot seals (where there are seals, there are sharks looking to feed). Stricter covenants improve transparency and help investors identify underlying problems with borrowers; now some covenants are so weak that nothing short of insolvency will trigger a default. If problems finally show up, investors will stampede out of the asset class, creating a systemic liquidity crunch... Leveraged loans probably won’t spark the next recession, but they will almost certainly deepen it, because they are an important source of corporate funding for deals and share buybacks.
5. The debate about the merits and distortions associated with universal basic income (UBI) is likely an endless one. And it is also an activity that is likely to keep academics busy for generations. The present stage of evidence generation is focused on its efficacy, and given the need to tease out general equilibrium effects, this is the likely agenda for at least the coming decade. The evidence is likely, as is mostly the case with such problems, to be mixed. The next stage of debate will move to what is the right amount, then what is the right amount for a particular context, and so on.

Echoing this, a new paper for UBI in advanced countries finds,
A UBI would direct much larger shares of transfers to childless, non-elderly, non-disabled households than existing programs, and much more to middle-income rather than poor households. A UBI large enough to increase transfers to low-income families would be enormously expensive. We review the labor supply literature for evidence on the likely impacts of a UBI. We argue that the ongoing UBI pilot studies will do little to resolve the major outstanding questions.
6. It is a well-known fact that infrastructure contractors bid aggressively to bag the contract since they are confident that they can come back and renegotiate the contract. There is a massive body of literature on this. The latest addition is on the renegotiations in power generation contracts in India. 

7. What if users of Facebook were shut off from accessing the social media site? An RCT evaluation of the welfare effects of US Facebook users show,
Using a suite of outcomes from both surveys and direct measurement, we show that Facebook deactivation (i) reduced online activity, including other social media, while increasing offline activities such as watching TV alone and socializing with family and friends; (ii) reduced both factual news knowledge and political polarization; (iii) increased subjective well-being; and (iv) caused a large persistent reduction in Facebook use after the experiment.
8. Finally nice article by Pilita Clark bemoaning the disappearance of (now politically incorrect) bluntness in offices, and the mistaking of bluntness for unacceptable behaviour. 

Friday, February 15, 2019

Tax avoidance fact of the day

This about Alphabet is reflection of the extent of tax avoidance,
Google’s parent company Alphabet paid $5.1bn in EU fines in 2018 compared with $4.2bn in worldwide tax, or 11 per cent of pre-tax income.
The company's 2018 revenues stood at $136.8 bn. 

Thursday, February 14, 2019

The Japanese model in Railways

FT has a nice article on the Japanese Shinkansen railway network. Since its privatisation starting in the mid-eighties, Japanese railway network has come to be managed as a super-efficient system and with no subsidy for the bulk of the network.

1. And despite the lack of subsidy, prices have rarely been increased over the past three decades.
2. The big difference in the models of privatisation,
In Britain, the tracks were split from the trains, and the rolling stock was split from railway operations. Today, the tracks are publicly owned by Network Rail. Companies regularly compete for franchise areas such as the West Midlands, leasing their rolling stock from another company. In Japan, however, the former Japan National Railways was split up along regional lines and then everything was sold together. JR East, centred on the city of Tokyo, owns its tracks, its trains and its stations outright. A private JR Central operates from Nagoya and JR West from Osaka, but the unprofitable JR Hokkaido, which operates many rural lines on Japan’s northernmost island, is still 100 per cent publicly owned... 
Perhaps even more important than the difficulty of managing operations, however, are the effects this system has on investment. Network Rail, as a publicly-owned infrastructure company, does not gain directly if passenger revenue goes up. Nor does it face direct commercial pressure to keep down costs. The rail franchises, meanwhile, have a declining incentive to invest as the period of their 10-year franchise runs out... Japan’s famous shinkansen high-speed railways actually operate on something close to the UK system: the tracks are built and owned by a government fund. However, the government hands them over to the JR companies to operate on fixed-price, 30-year leases, so the companies treat them as their own. However, Britain split up its system for a reason, and that reason was competition.
3. The ideological underpinnings are important,
“The basis of railway companies in Japan is they think they will contribute forever. They feel they have a responsibility to local societies,” says Hironori Kato, a professor of civil engineering at the University of Tokyo. “This kind of mindset is quite important to make a successful railway business.”... One... feature of Japan’s railways is noteworthy: the ability of rivals to co-operate. Touch-and-go payment cards work interchangeably across the country. In Tokyo, suburban trains now run straight into subway tunnels and out the other side of the city; a single journey may use the tracks of five different railway companies. Even then, the companies do not run rival trains, but share rolling stock and run a fully integrated service. The motivation for each company is adding value to its own stretch of railway, helped by some robust pressure from the transport ministry... Britain, meanwhile, had an ideological goal in mind: competition. The vision of those who privatised the service was not just to introduce a profit motive, but for different companies to run trains on the same tracks, competing for customers. It was hoped that the regular fight for franchises would drive down costs. 
A powerful reminder to those who view profit maximising self-interest and competition as the driving force behind effective markets.

4. As also the importance of strong regulation, especially important given the monopoly status of each rail operator in their areas,
The ministry collects detailed information on costs from all of Japan’s private railways. Based on that information, the ministry sets an upper limit on fares. “How do we determine the upper limit? It’s set based on an appropriate profit and appropriate costs under efficient management,” he says. If a company can cut costs and run itself more efficiently than rivals it can earn greater profits: this is known as yardstick competition. One important consequence is ruling out the complicated fare structures found in the UK. Since prices cannot go above the cap, even for last minute booking or at the height of the rush hour, companies instead operate a simple, distance-based fare.
5. And competition,
Japan’s railways may be organised along geographical lines, but they are not a series of regional monopolies. Rather, many companies run lines in the same area, interlaced with each other, which sometimes offers a choice. For example, between Tokyo and Yokohama there are three competing routes, as there are between Osaka and Kobe. For an individual traveller, one operator is usually more convenient, but higher prices are noticed. There is a third, more abstract, but still crucial form of competition. Every line radiating out of a city such as Tokyo serves a particular slice of suburbs — and those suburbs compete. Since new construction is much easier in Japan than in the UK, the rivalry is fierce, especially as the population starts to drop. Overprice or underinvest in your railway and passengers will ultimately move elsewhere.
6. The revenue streams from integrated rail and property development,
This competition between railway areas is linked to another vital part of the business model for Japanese railways: real estate. “The railway is about one-third of our total sales,” says Mr Shiroishi. “By name we’re a railway company but that’s just one of our functions.” Another one-third of revenues comes from real estate development along the Tokyu lines, especially at its Shibuya terminus. The final third comes from services to passengers such as supermarkets, convenience stores and hotels. These other arms allow the railways to capture some of the land value that their passengers create. Every station in Japan is a real estate opportunity and many have a shopping mall built above or below them.
7. Finally, the equivalence with road transport,
Another economic strength of Japan’s railways, particularly the shinkansen, is a level playing field with roads. A one-way shinkansen ticket from Tokyo to Osaka costs ¥13,620 ($124) but the motorway toll is similar. It is unlikely Japan could run profitable high-speed rail if the state provided free roads as an alternative. There are no urban congestion charges but parking is all off-street and formidably expensive. Added to the sheer density of Japan’s population, the result is ample demand for railways, letting them run frequent trains and cover their costs at reasonable prices.

Wednesday, February 13, 2019

Poverty graphics of the day

I had been thinking about how to get a graphic that captures the underlying point being made here - poor people have multiple livelihoods. This CGD essay has the graphic on the median number of livelihoods of poor people in different countries.
And its variability across the year is very high.
The article itself, like with a lot of CGD stuff (apart from a few affiliated scholars) which tries to straddle the divide between academia and practice, is off-the mark on several counts.

Tuesday, February 12, 2019

The case for business development services

Forget tax incentives and input subsidies, supporting business development services is perhaps the most effective jobs-creation and productivity enhancing intervention that governments can do. I have blogged earlier making the case here

Dani Rodrik points to a recent analysis of private-sector jobs growth by Timothy J Bartik of the 105 manufacturing-intensive labour markets in the US with a population of over 200,000 for the 2000-15 period makes for interesting reading. 

It finds “no evidence that job growth in these areas is significantly spurred by cutting business taxes or increasing business tax incentives”. Instead, it finds significant boost to job growth from “customised job training programs” and “customised manufacturing extension services”. The latter delivered “small and medium-sized manufacturers with consulting advice on improving technology, product design, and marketing”. These manufacturing extension services were offered by public agencies through a mix of subsidies and client fees, in co-operation with university and private sector.
My analysis measures an area’s intensity of manufacturing extension services by the job creation or retention due to manufacturing extension, as reported in client surveys. Reported extension-induced job creation or retention is a significant predictor of an area’s overall job growth, holding constant other growth determinants.
In terms of cost-effectiveness too, such customised business development services trump conventional industrial policy interventions like fiscal concessions and input subsidies.
Clearly the time has come for governments to embrace business development support as a priority industrial policy lever. 

Monday, February 11, 2019

Weekend reading links

1. FT points to 'fauxtomation', coined by Canadian activist Astra Taylor, the gulf between the myth of workless future and reality,
Take McDonald’s. I can now order my burger using giant touch screens, pay for it on the contactless card reader and then saunter up to the counter to collect it. This could be thought of as automating the work of a waiter; in reality, though, the company has convinced me to become an unpaid member of staff. The tasks I do — inputting an order into the system, sorting payment and then collecting the food from the kitchen — are all jobs that would normally be done by someone earning at least minimum wage. It’s the same when I use a self-service checkout at the supermarket, or check myself in and print out my own ticket for a flight. Technology has facilitated a shift in who is working, not eradicated it... Technology, Taylor argues, contributes to an illusion that human effort can be simply substituted by machines — like the famous “ Mechanical Turk” machine that could supposedly play chess but in reality contained a hidden chess master, or the dumbwaiters in Thomas Jefferson’s mansion that relied on hidden slaves.
And its impact on measured productivity,
“Fauxtomation” fits into a tradition of unpaid work being overlooked — work such as caring for the elderly or children, often done by women, that does not appear in official measures of economic output. The economist Diane Coyle argues that some of the extraordinary economic growth in the middle of the past century was probably due to women doing more paid work and less unpaid; if the latter had been valued properly in the first place, the postwar boom would not have been as large as it appears in the official figures. Similarly, the recent slowdown in productivity growth may be due to a move the other way, as everyone starts producing more outside working hours, whether on laptops at home or at supermarket checkouts. And then there’s what Coyle calls “do-it-yourself digital intermediation” — online platforms acting as our bank tellers, estate agents and insurance brokers. The benefits of these services getting cheaper ought to be reflected in higher spending elsewhere. But, Coyle argues, official measures of economic output are missing the value of our unpaid work, meaning the slowdown in productivity growth may not be as bad as it appears.
2. The collapse of the tailing dam in southeastern Brazil owned by mining giant Vale which killed at least 157 people, with 182 missing, is a classic case of socialising costs and privatising the benefits and one where criminal culpability should be traced right up to the top of the mining behemoth.

Vale knows that it can contain its costs by avoiding the construction of strong tailing dams and relying on shoe-string mud structures. The costs can be externalised and the savings can be appropriated privately. And when you add up several such externalities, it all begins to assume significant proportions. In simple terms, Vale, and other multinationals know that it can get away with a mud-dam and its attendant risks. 

What can be easily predicted is what will follow. There will be righteous indignation everywhere for the coming few weeks. Some junior employees on government and Vale's side will be sacrificed. And then everyone will forget and go on with life till the next incident happens. Incidentally, a similar accident on a tailing dam co-owned by Vale killed 19 people in 2015!

3. Some snippets about unemployment trends in India,
Instead of dropping out at a very early age, the percentage of women in the education system is very high until the age of 23-24. Earlier, it used to be only up to 17 years. So, there is a five-year shift; these people are no more in the labour force because they are still in the colleges. So that will reduce the labour force to some extent because they are out of the labour force. And earlier, the unemployment used to start at 20 onwards, now basically it is 24 onwards, so 20-24 they are in colleges and all that. So there’s a shift in the employment pattern from the report. Once they come out from the colleges, they are no more prepared to work on their father’s farm or looking after something and then get married and become housewives... This immediately will pick up the unemployment ratio because they are not showing up in the unemployment-numerator.
4. Livemint graphic on the unemployment problem among the educated,
A recent report by the Centre for Sustainable Employment at Azim Premji University, State Of Working India 2018, noted that unemployment among the well-educated is thrice the national average. There are roughly 55 million people in the labour force who hold at least a graduate degree, and about 9 million of them are estimated to be unemployed, the report added.
5. Nice Economist article on the extra-territorial reach of American policies that seek to penalise global companies for violating American domestic rules. 
Since the turn of the century, America has ramped up judicial programmes whose reach is not restricted by its borders. Focused on enforcing its sanctions, reducing corruption in poor countries and fighting money-laundering and terrorism financing, it has found ways of prosecuting companies and their executives far beyond its shores... Most of the companies caught in its legal net are foreign, often European. Some come from countries in which doing business with Iran, for example, would be no problem were it not for America’s stance... There are instances where America’s long legal reach may have given an edge to its own firms over foreign rivals, as in the case of General Electric’s purchase of Alstom of France in 2014... 
Several elements tie together America’s various legal forays abroad. The first is their creeping extraterritoriality. American law starts with a presumption against application of its statutes beyond its borders. But prosecutors have wide authority over how the laws are interpreted. They have adopted an ever-more-expansive interpretation of who is subject to American law, lawyers say. A banking transaction that ultimately passes through New York—as many do, given the centrality of American dollars to global trade—can give prosecutors a toehold to inspect it. If two executives outside America use Google’s Gmail to communicate about a bribe, say, American prosecutors can claim that the Americanness of the email provider can make it their business. The global banking system also gives America an advantage. Lenders have been hit hard by American prosecutors, notably BNP Paribas, a French lender walloped in 2014 with an $8.9bn fine for facilitating trade with Sudan, Cuba and Iran. Deutsche Bank was fined $425m in 2017 for helping launder $10bn from Russia...
It seems plain to foreign critics that America disproportionately targets foreign companies. Over three-quarters of the $25bn it has exacted in fines for money-laundering, sanctions-busting and related offences has been against European banks, 15 of which have paid over $100m each, according to Fenergo, a consultancy. American banks have been fined less than $5bn over such misdeeds. Anti-corruption probes also fall disproportionately on foreign firms. Of the ten biggest FCPA fines, only two have fallen on American companies.
6. Finally, an article on the decline of bus commuters across UK,  
Since 2009 the number of bus journeys in Manchester has fallen by 14%. Austerity has played a role. Councils in England and Wales have slashed bus subsidies by 45% since 2010, resulting in 3,347 routes being cut back or closed... The average delay caused by congestion in Britain’s cities has increased by 14% in the past three decades... Manchester is badly affected: the 43 bus now takes nearly 80% longer to cover its route in rush hour than it did 30 years ago. The average speed of Stagecoach’s buses fell by 4.9% in 2014-16; one route which took just nine minutes seven years ago now takes 27, according to the company.

Friday, February 8, 2019

Are the current unicorns actually only Cheshire Cats?

Innovations backed by venture capital has come to become the touchstone for entrepreneurship. But how credible is this trend? Martin Kenney and John Zysman calls this to question in an excellent paper.

Sample this,
In recent years, the amount of capital available to private firms has grown immeasurably, allowing firms such as Uber, Spotify, and Dropbox to continue to lose money and remain private far longer than previously – in the hopes apparently of going public or being acquired at even greater valuations. As a result, money-losing firms can continue operating and undercutting incumbents for far longer than previously – effectively creating disruption without generating profit. Arguably, these firms are destroying economic value. This new dynamic has social consequences, and in particular, a drive toward disruption without social benefit. Indeed, in some cases, they may be destroying social value while also devaluing labor and work in the enterprise.
And this about the emergent 'proto-monopolies' of winner take all (WTA) markets involving platform companies,
In each case, the dominant firm captured nearly the entire market and had become very difficult to dislodge. The start-up process in such WTA environments assumes that the startup will initially be cash-flow negative as it grows and competes against other startups and incumbents that are also seeking to restructure the new business space that the technology’s progress has made possible. Such startups begin by “bleeding” money: Investors are wagering upon the firm establishing a powerful market position—or what could be termed a “proto-monopoly.” These firms are not expected to win via early and sustained operating profit, but by absorbing operating losses during their growth phase financed by venture investment with the aim of driving incumbents and other new entrants out of the market. Investors are increasingly comfortable with absorbing the exceptional losses, if convinced that it will be possible to lock in a position to generate quasi-monopolistic profits and, by extension, enormous capital gains. The current technological and financial environment has created remarkable dynamics. For any given platform or Internet-related idea, low-entry cost and plentiful capital results in very low entry barriers. As a result, there are an enormous number of entrants. Because of this and because many of these markets will have WTA characteristics, the competition ignites an equity-capital consuming race to establish market leadership. The result is that ever-increasing amounts of capital must be raised. With the WTA opportunity beckoning, these startups have been able to raise ever-larger amounts of money at ever higher private valuations. The result is the “unicorn” phenomenon – private companies valued in excess of $1B in their last funding round. This growth-at-all-costs dynamic is reinforced at each stage of the capital-raising process (post-seed) for venture-backed companies because the metrics used by each investment stage to determine investment potential is growth – growth in users, engagement, and conversion for consumer-focused startups or monthly growth in customer acquisition and revenues. As long as the growth metrics are accepted by investors as proxies for value, then valuations can increase. Paradoxically, a sustainable business may not be the objective and may not matter, if earlier investors, founders, and management can sell their stakes in the business at higher valuation multiples to later-stage investors or through an IPO or trade sale before the actual unit economics and profit-generating potential of a company are clarified through repeated performance. The present entrepreneurial finance logic with low startup costs, emphasizes on disruption that will result in a new WTA industrial organization and abundance of finance, that not just encourages, but demands, a drive to breakneck expansion. In fact, a startup that does not grow as quickly as possible is soon overwhelmed by the startup with more capital and more reckless investment.
Some observations.

1. It has become an entrenched narrative that the success of technology solution companies is attributed to the exceptional genius of geeky entrepreneurs. Then there is also the story from the Silicon Valley folklore of college drop-outs in garages founding remarkable companies (though they were exceptional exceptions than any norm). This overlooks the reality that the present winners were the luckiest among a group of entrepreneurs who were at the right place at the right moment in time to be able to exploit the low-hanging fruits from an emerging technology wave and benefit from the inherent dynamic of network effects which privileges the first-movers. 

In terms of sheer sharpness of intellect required, one could just as well objectively argue that designing a massive civil engineering structure is at least as much challenging, if not much more, as developing a complicated software solution.

2. The facts do not support the conventional wisdom that these start-ups have been leading the innovation-edge in areas like nano-technology, robotics, artificial intelligence, facial and speech recognition, bio-technology, digital IDs, driverless vehicles etc. Of the 290 unicorns which have attracted $980 bn, less than a tenth are working on truly innovative solutions. Most of the cutting edge innovation work is happening in well-funded government-financed laboratories and universities and large and established companies who have the deep-pockets to support such innovations.

3. The most disappointing feature of the tech-entrepreneurship world has been the lack of success with innovations which have made a meaningful impact on persistent development challenges. Despite all its promise, areas like tele-medicine, Edtech, Agtech, and Fintech remain almost completely hype without any substance. Instead the landscape in developing countries is littered with me-too solutions which are straight copies of versions in developed countries.

4. It is not a stretch to argue that the entire unicorn world is like the man riding the tiger who cannot afford to dismount for fear of being eaten up by it. The unicorns have raised vastly inflated expectations as reflected on their valuations, and investors desperately want to at least preserve their mark-to-market share valuations. The only way to do this is to keep growing. And in most cases, since growth is built on bleeding capital to acquire customers, just to grow requires more capital, attracting which makes the story of rising valuations even more important.

5. Finally, this time is no different from previous times. Including the infamous tulip mania, history is replete with examples from previous eras of new arrival and innovation disruptions which led to such irrational exuberance. The paper talks about the bubble in optic fibre cables. Similar bubbles have been associated with every major large scale general purpose technology from railroads to electricity to automobiles to Internet.

Wednesday, February 6, 2019

The 'experience' discount in development

Knowledge about a subject is of two types - theoretical and experiential. 

The former is accumulated through reading, observing, and discussing the issue or thing (learnt knowledge). You could learn about traffic congestion, including its relationship with network theory etc at say, Massachusetts Institute of Technology or Madras Institute of Technology. Here a logic or hypothesis or theory is used to draw inferences about a problem or a situation. This application of deductive logic or positivism is also what characterises a computer.

The latter is accumulated by doing the thing in question (lived career) and/or being part of the thing itself (lived life). You experience traffic congestion either as a daily commuter or as a practitioner trying to resolve traffic congestion in a particular place/city. This accumulation is the experience of what one comes across in daily life. Here priors arising from countless empirical observations is used to draw inferences about a problem or a situation. This application of inductive reasoning is also what characterises a human being.

In the world of impact investing and innovation-focused development, one comes across very smart people, with limited or no experiential knowledge (nor even reference to priors), trying to draw inferences about a problem (and its solutions) using purely deductive logic.

So, the wonder App which gives information (weather, agronomy, market etc) to farmers can boost farm productivity and incomes. The adaptive learning solution can transform the learning outcomes of students in public schools. The fintech solution can cut transaction costs and increase the savings of the poor or provide micro-pensions and micro-insurance products. The blockchain solution can address the problem of poor land records in developing countries. The smart meter or GIS mapping or SCADA can cut the persistent distribution losses in water and electricity utilities. The nifty labour market matching solution can connect households with cooks, housemaids, and drivers. 

This approach glosses over the context as well as the complex practical challenges associated with the actual realisation of impact. It is motivated by the neatness of logical reasoning. In other words, it overlooks priors or experiential knowledge. It overlooks the reality that the theory of change to realise impact in each of the aforementioned examples is very complex. In simple terms, it is the deductive analysis of a computer for a problem which requires inductive analysis. 

So, theory says that farm productivity is constrained by informational factors. Relax them, and you have increases in farm incomes. Theory informs that children have differential learning trajectories. So an algorithm can customise instruction to the specific needs of each child and lead the child up the most optimal learning trajectory. But in practice, the pathway from theory to realisation of impact is filled with numerous risks and uncertainties.

The academic trends of our times exacerbate the problem. Consider the example of RCTs. It gives power to the appealing belief that one could juxtapose a solution against the business as usual counterfactual and establish efficacy without any consideration for the priors, experience, and history surrounding that intervention. So you could publish an RCT study in a reputed journal about the efficacy of an Agtech App which ostensibly delivers agriculture extension services, without any exploration of the rich history of the programmatic delivery of such extension services (and its failures/struggles) and the associated priors.

This also parallels the general marginalisation of the study of economic history and philosophy in development economics courses of the day and the elevation of data analysis using statistical techniques. It manifests in the form of important debates on critical issues that face us today like inequality (which Thomas Pikkety triggered off with his book in 2014) being reduced to technical debates on an inequality or the relative importance of different contributory variables

This also has the effect of distorting the debate in other ways. Consider the exploration of whether rural roads and rural electrification provides value for money. Some researchers have come out in the negative, even suggesting that the expenditure could have been better made on some of the more fashionable 'kinky' development initiatives. Leaving aside its morality, it is astonishing that well into the 21st century, we are debating the merits of all-weather roads and three-phase electricity, the two basic requirements to be able to meaningfully engage with modern civilisation, and are debating making choices between them and 'kinky' stuff like cash transfers or providing chicken or kicking Soccket balls!!!

Tuesday, February 5, 2019

India state capacity fact of the day

Is the Election Commission of India (ECI) the most efficient bureaucracy, public or private, anywhere in the world?

As of January 2014, the ECI had a sanctioned strength of just 641, of which 276 posts were vacant. In other words, the ECI conducts the world's largest democratic elections, perhaps one of the largest logistical exercises in the world, with a mere 365 people! And this number has hardly changed over time - 327 and 319 respectively in January 2006 and 2010. 

Yes, it relies on the entire central and state government machinery to conduct the electoral process. But given the highest fidelity in execution required, zero-defect as they say, this is truly a staggering achievement. And the electoral process is not just about holding the elections itself, it is about the always-on preparatory process like updation of electoral rolls. 

This is perhaps the most efficient leveraging of bureaucratic resources. 

It is an example of the paradox of India's state capacity that it can execute well-defined tasks like elections, census, disaster relief etc with unparalleled proficiency and do the simplest things like running mid-day meal kitchens in the most appalling manner.

Monday, February 4, 2019

Researchers discover the value of telephone-based monitoring

This paper is an excellent example of misplaced research priorities around RCTs.

In brief telephone calls based feedback was elicited on the quality of implementation of the Telangana government's Rythu Bandu Scheme where cash transfers through cheques were made to  eligible farmers - did farmers get the cheque, did they get in time, did they encash etc. An RCT evaluation of the telephone calls revealed that 83% of farmers received and encashed their cheques, farmers in areas with such monitoring were 1.5% more likely to receive and enchase their cheques, and among the bottom quartile land holding farmers percentage was 3.3% higher. The call centres delivered an additional Rs 7 Cr to farmers at a cost of Rs 25 lakh.

Did this require an RCT or any research? It has long been conventional wisdom in bureaucracies. Several public agencies across states have had citizen feedback electing mechanisms in place for years. Neighbouring state of Andhra Pradesh has even made this central to performance assessments by making  everything that government does evaluated by telephone feedback through its Real Time Governance System (RTGS). The power discoms in Andhra Pradesh has had such telephone call centers to elicit feedback for more than a decade. 

I can’t imagine even one reasonable bureaucrat who would dispute the hypothesis of the paper - citizen feedback, especially one using random sample telephone calls, is a useful way to assess implementation quality.

The real challenge is not about getting feedback. Not even about getting granular and actionable feedback and that too in real-time. It is about the ability of the system to act on any feedback in a meaningful enough manner. That is the real binding constraint and that is critically dependent on the state's capacity to engage actively on a basic governance issue - monitor and act effectively on information. And most often with all such interventions, this gets glossed over.

Further, establishing the call centre exhausts the bandwidth and cognitive energies of the officials leaving them with limited mental space and energy to engage actively for the much more important institutionalisation of follow-up actions. And the officers responsible also likely get transferred by then. Unfortunately, while it is easy to plan for these things in a comprehensive manner, the actual work happens when the rubber hits the road and the plans have limited value in actually getting the follow-up institutionalised.

Furthermore, we should not discount the scale scenario where such monitoring, without the follow-up requirements, is most likely to become a routinised one-more addition to the monitoring paraphernalia without any incremental benefit. 

In fact, one could very easily imagine the best case narrative of change with the RCT finding. IVRS-based feedback systems can improve implementation efficiency. So let's establish telephone call centres in each district/state. And in five years, we would have another development innovations graveyard littered with dysfunctional call centres and vast amounts down the drain.

Instead, this was an opportunity to both highlight attention on state capacity and figure out how the state's capacity to monitor implementation could be improved.

What is a more effective monitoring approach to review development programs? Consider some (there could be more) of the variables associated with such reviews – who is reviewing and who is being reviewed, frequency of review, specific parameters being reviewed. So a District Collector (or a Block Development Officer) could once a week (or once a fortnight) review BDO (or Village Revenue Officer) on some process (approvals processing) or output (receipt or encashment) indicators.

How about optimising this? Let’s say all blocks divided into two treatment arms and two different review methods of/by BDOs or VROs (with a none-too-onerous deep-dive you can figure out these options), against the business as usual monitoring control group.

This would immediately spotlight attention on the importance of the quality of monitoring and the role of state capacity improvements (in a more objective manner the likes of which has never been done before by researchers) in generating value for money. For example, if it shows that BDOs who review VROs once a week as against those who review once a fortnight are associated with x% higher receipts for the poorest quartile, then that is a high value insight for someone like a Secretary, Rural Development or Agriculture. In fact, it would have actually delivered more returns at virtually no cost.

Further, the gains go beyond just improving the efficiency of the specific intervention. It would likely apply to most interventions. It would have genuinely spotlighted attention on state capacity, specifically how better monitoring would have increased the efficiency of public service delivery. This may appear self-evident, but in a world where everyone is searching for innovations and different ways of doing things, what is so obvious often actually ends up not being so obvious! 

If this insight is then written up in an oped, one could be reasonably confident that some Secretary or other of Rural Development would have tweeted this, and following his tweet, several District Collectors would have rushed to embrace this monitoring approach. The researcher would have, through their research, triggered off the dynamics to improve state capacity.

On a side note, the specific numbers on the value for money analysis associated with establishing and maintaining a call centre are questionable, even disingenuous. But that is not relevant for this post. 

Actually, with the call center, what would be high value would be to do high quality data analytics to elicit actionable insights that are granular-enough to keep field functionaries (the BDO, VRO etc) on their toes. 

To summarise, two points. One, I don’t think that it needed high quality research effort to establish this. Two, instead this was an opportunity to spotlight attention on the importance of state capacity
and offer actionable insights to improve state capacity. So, loss double-time. 

Saturday, February 2, 2019

Weekend reading links

1. The $3 trillion hedge fund industry is facing strong headwinds. Fund raising is stagnant or declining, institutional investors are increasing own-management, fund closures outnumber new launches, fee rates and returns are declining, once large funds with LP investors are retreating to become family funds to manage the GP's wealth.

Sample the decline and decline of hedge fund returns,
And changes in the traditional 2-20 fee structure
2. Russell Napier points to a structural shift in the demand for US Treasuries,
The roughly $10tn rise in world foreign exchange reserves between 1999 and 2014 resulted in the forced purchasing of US Treasuries. Foreign central bankers owned just 13 per cent of the Treasury market in 1995, but held a third of it by 2014. This monetary system thus provided a funding holiday for global savers, freeing them to focus on funding the private sector instead. Meanwhile, central bank liabilities increased by $10tn. What could be better for global investors than a monetary system that depressed the global risk-free rate while boosting growth through an explosive rise in the money supply of emerging markets, particularly China? For equity investors the combination of a low discount rate and high growth rate drove prices and valuations higher until 2014. Since then, though, as foreign exchange reserves have stopped climbing, the job of funding the US government has fallen to savers, not central bankers. Foreign central bank ownership of US Treasuries has fallen from a third five years ago to just under a quarter today. Savers must take up the funding slack, while also buying the Treasuries now being sold by the Federal Reserve. 
3. The Economist proclaims the arrival of "slowbalisation" or the slowdown in globalisation. Of a dozen measures of globalisation, eight have been retreating or stagnant, with seven starting from 2008.
As to reasons,
After sharp declines in the 1970s and 1980s trading has stopped getting cheaper. Tariffs and transport costs as a share of the value of goods traded ceased to fall about a decade ago. The financial crisis in 2008-09 was a huge shock for banks. After it, many became stingier about financing trade. And straddling the world has been less profitable than bosses hoped. The rate of return on all multinational investment dropped from an average of 10% in 2005-07 to a puny 6% in 2017. Firms found that local competitors were more capable than expected and that large investments and takeovers often flopped. Deep forces are at work. Services are becoming a larger share of global economic activity and they are harder to trade than goods. A Chinese lawyer is not qualified to execute wills in Berlin and Texan dentists cannot drill in Manila. Emerging economies are getting better at making their own inputs, allowing them to be self-reliant. Factories in China, for example, can now make most parts for an iPhone, with the exception of advanced semiconductors. Made in China used to mean assembling foreign widgets in China; now it really does mean making things there.
For example, the share of cross-border supply chain sourcing from neighbourhood has risen since 2012,

Multinational activity is becoming more regional, too. A decade ago a third of the fdi flowing into Asian countries came from elsewhere in Asia. Now it is half. If you put Asian firms into two buckets—Japanese and other Asian firms—each made more money selling things to the other parts of Asia than to America in 2018. In Europe around 60% of fdi has come from within the region over the past decade. Outside their home region, European multinationals have tilted towards emerging markets and away from America. American firms’ exposure to foreign markets of any kind has stagnated for a decade as firms have made hay at home.
And the extent of cross-border integration has been deceptive,
Typical American Facebook users have 70% of their friends living within 200 miles and only 4% abroad. The cross-border revenue pool is relatively small. In total the top 1,000 American digital, software and e-commerce firms, including Amazon, Microsoft, Facebook and Google, had international sales equivalent to 1% of all global exports in 2017. Facebook may have a billion foreign users but in 2017 it had similar sales abroad to Mondelez, a medium-sized American biscuit-maker.
4. It is not all gloom about the Chinese economy,
the pace of debt accumulation has slowed sharply. In 2015 it took more than four yuan of new credit to generate each yuan of incremental gdp. In 2018 that multiple fell to 2.5, in line with China’s average over the past 15 years.
5. There are more people living in extreme poverty in the middle-income countries than in low income countries.
6.  As the US tightens sanctions on Huawei and talk of a new Cold War rises, it is worth looking at this graphic which shows how much China is exposed to advanced economies in terms of exports. While less than 10% of US exports are destined for China, more than half of Chinese exports are destined for advanced economies.
7. Good article on Chinese industrial policy involving using state-funds for strategic acquisitions that helped local industrial capacity development on micro-electromechanical systems (MEMS), the components embedded in chips that are increasingly central to everything from mobile phones and medical devices to self-driving cars.

Friday, February 1, 2019

The slippery slope with accounting standards dilution

It is a feature of historical evolution that what was abnormal and abhorrent some time back becomes normal and desirable today. There is perhaps no more striking example about this than how people view the idea of taking another person's life (murder or killing). It is most likely that Donald Trump's actions have irreversibly changed and normalised several hitherto abhorrent behaviours and practices in US politics and global diplomacy.  

Gaming rules is par for the course in the corporate world. Even more pernicious is how gamed rules gradually become the norm. 

An examination of how "tax evasion" has come to become dignified and legalised as "tax avoidance" would be interesting. One could imagine a series of creative interpretations of tax regulations, either by stretching the boundaries of legality or being plain illegal, to favourably manipulate what constitutes profits. They have over time become the normal practice and legalised.

The latest example of "creative interpretation" of rules comes in the context of the recent European rules that mandate companies change their auditors every twenty years. The FT reports that Goldman Sachs intends to embrace "rotation in form but not in substance" by "top-slicing" their audit  - hire a small accountancy firm for a small part of its European audit while continuing to rely on PwC, its auditor since 1922 (yes!), for the bulk of the work.

The world of auditing and advisory/accounting is a cosy club. Most major firms (97% of UK's largest firms, for example) are audited by one of the Big Four (EY, PwC, KPMG, and Deloitte), and also buy consulting services from the other three. The Big Four have been at the vanguard of helping businesses achieve a new normal with corporate accounting. Transparency and safeguards for protection of shareholder capital are no longer the guiding principles. Instead obfuscation and creative interpretation to minimise tax outgo are both the guiding principle in corporate accounting as well as the value proposition of the Big Four accounting firms. One could easily add manipulation and fraud to the list of their service offerings. 

Sample this on the progressive dilution of accounting standards,
In the UK in the past three decades, standards setters have progressively dismantled the system of historical cost accounting, replacing it with one based on the idea that the primary purpose of accounts is to present information that is “useful to users”. The process allows managers to pull forward anticipated profits and unrealised gains, and write them up as today’s surpluses. More recently, it is behind a string of accounting scandals involving overstatements of profit, including at the UK supermarket chain Tesco and the software company Quindell. It hangs over the insolvency of the UK outsourcing group Carillion, where sudden contract restatements in 2017 erased the previous six years of dividend-bearing profits. In the US, the conglomerate GE is under investigation over the way it accounts for its contracts...
The principle that assets were valued at the lower of cost or net realisable value (or the price at which it was thought they could be sold) did not rule out estimates. But they only came into play when values had fallen. It was not possible for managers to conjure up unrealised gains and profits and present these as fact... From the 1960s, academics such as William Beaver at Stanford University advanced the notion that for markets to channel capital efficiently to the most productive outlet, accounts needed to give traders of securities a clearer understanding of the current valuation of a company. That meant abandoning inconvenient notions such as prudence and conservatism; instead, accounts had to be “neutral” and use more up-to-date values for balance sheet items... From the 1990s, fair values started to supplant historical cost numbers in the balance sheet, first in the US and then, with the advent of IFRS accounting standards in 2005, across the EU. Banking assets held for trading started to be reassessed regularly at market valuations. Contracts were increasingly valued as discounted streams of income, stretching seamlessly into the future... auditing firms have used their lobbying power to erase ever more of the discretion and judgment involved in what they do. Hence the explosion of “tick box” rules designed to achieve mechanistic “neutral” outcomes. It is a process, says Prof Karthik Ramanna, that is tantamount to a stealthy “socialisation or collectivisation of the risks of audit”.
Pretty much every major corporate scandal in recent years, and there have been too many of them, has failures of auditors and accountants as an important contributor. Several reforms have been suggested - break-up the Big Four, separate their auditing and advisory services, have two auditor with one from outside the Big Four, rotation of auditors, independent appointment of auditors, cap on market shares of the Big Four, stronger regulatory oversight etc.

The recent controversy over e-commerce regulations in India is a rare example of failure of corporate gaming of rules. Extant regulations explicitly mandate e-commerce firms to be marketplaces and prohibit them from holding inventory or having equity stakes in on-sellers. But even major firms like Amazon have sought to game the existing rules, only to have been caught out. Unlike in most cases of gaming, here they got caught out partly because of the power of local interest groups in a large economy like India as well as perhaps the tacit backing of a corporate behemoth like Reliance