Saturday, December 31, 2022

A graphical summary of 2022

1. A headline story of the year was the return of inflation and high interest rates.

US inflation hit 9.1% in June, the highest since 1981. After lagging behind, core inflation rose sharply, pointing to the broad-based nature of inflation.
US interest rates have risen from 0.25% on March 17, 2022 to 4.5% by December 14, 2022, the fastest rate hikes ever.
2. The other headline story was the performance of the capital markets. It was the worst year for the 60/40 investment portfolio since 1930.
Not just in the US, globally too bonds and stocks both had a disastrous year, breaking the inverse correlation. 
The bond market returns for the year till end-November were already the worst for over a century.
As regards the stock markets,
3. In general, it was a bad year for everything other than dollar and commodities
4. Commodity prices spiked and then retreated
European natural gas prices had risen above 300 euros per megawatt hour, or more than $500 a barrel in oil equivalent, but has now settled back though still elevated compared to normal times. 
5. Pandemic induced supply chain squeezes eased, despite the Ukraine invasion
6. The Ukraine invasion galvanised the comatose western coalition, and nowhere was this most visible than in the unprecedented exit from Russia by western corporates.
By the end of April itself, 70 percent of the Fortune 500 companies operating in Russia prior to the invasion opted to leave or scale back their business once the conflict began.

7. The year saw the re-emergence of America as the pre-eminent global superpower. Scott Galloway has this graphic which shows that US has pledged $47 bn in military aid, more than the combined contribution of all others.
In terms of all financial aid to Ukraine too, things don't change much

8. Livemint's asset returns quilt

BlackRock's asset returns map shows how bad has 2022 been for asset markets.

9. Chinese property market has been on the downswing since the pandemic, and it fell steeper this year.

10. Finally, a pointer to a list of links

Thursday, December 29, 2022

India income distribution graphic of the day

Fascinating graphic on income distributions and income gaps in 16 countries.

India has the highest income gap between the 90th and 99th percentile, the most closely bunched distribution between 20th and 80th percentile, the poorest first quintile, and the lowest median income. It points to an important insight about the nature of India's income distribution - the extremes of wealth and poverty, much higher than elsewhere, and a very narrow base of consumers.

This squares us with data from elsewhere. The Pew Research Centre, using the updated ProvcalNet household consumption based income database also used by the World Bank, found that at the end of 2020 while only 5% of Indians live on less than $2 per capita (at PPP) per day, 87% live between $2-10, 7% between $10-$20, 2% live between $20-$50, and just 0.2% (or 3 million people) earn more than $50 per day. 

All this points to the very narrow base of India's consumption class and the large base of those requiring welfare support. As I have blogged on several occasions, and also written in Can India Grow, the growth of the consumption class requires making the nature of economic growth more broad-based. 

Tuesday, December 27, 2022

Ambition and achievement in perspective

Lucy Kellaway has a brilliant article about her impressions of relocating to the poor North East of England  from London (HT: Ananth). It will count as one of my reads of the year. 

This contrast between the students in her schools in Hackney and up North East is fascinating, 

The first difference is that in my last school barely 2 per cent were white; in this one it is about 90 per cent. The second is that they have lived in the same place for generations. One day I was talking about structural unemployment and giving an example of the region’s defunct coal mines, shipyards and steel plants. On a whim, I asked them if all four grandparents were born nearby — almost three-quarters of the class raised their hands. I remembered a related question being put to my Hackney school where an assembly hall of students were asked if both parents were born in London. Out of 200, barely 10 put up their hands, most of them of African-Caribbean heritage... According to the University of Essex’s Understanding Society study, the North East is the least mobile place in the country, with 55 per cent of survey respondents living within 15 miles of their mother — more than three times as many as in the capital... It seems to me that London’s extreme mobility and the North East’s lack of it explain so much about the differences between the two places and the best and the worst things about each.

She writes about its consequences,

This stability cuts across everything. It may account for the lack of curiosity. It may also lead to insularity and innocence in how they view the world. All London schoolchildren know a lot about different cultures; my students know only their own. When last year their beloved Newcastle United football club was bought by the Saudis, in a surge of joyous exuberance some of them took to the streets wearing tea towels on their heads. They were baffled when the club put out an announcement telling supporters to leave all tea towels at home. Any London teenager could tell them about cultural appropriation, but when I tried to explain, one shook his head in disbelief: “Miss, we were showing respect! We were saying thank you for buying our club.” A bigger difference concerns competition. In London every day 9 mn people fight it out for scarce resources: for a seat on the Tube, a flat to rent, success, jobs, money or fame. Everyone is striving for something — and immigration intensifies this. When families travel thousands of miles from their homes to make a better life for their children, they don’t let them sit around doing the minimum. 

The Hackney schools I taught in were monuments to striving and, as a result, the children did very well indeed. Last month, I did a Zoom call with some of my most driven students and heard how they were applying to Oxbridge and the London School of Economics and Russell Group universities. I felt a sudden pang for my current students who, despite going to one of the best schools in the area, have few such ambitions. They mostly do the work I set them and mostly do it more or less adequately. But, for most of them, that’s as far as it goes. Early on, in a bid to change this, I told my Year 12s that to do well at A-level they would need to do six hours’ independent work a week per subject. The class gawped in disbelief. Patiently, one explained he couldn’t do that because he worked weekends in a restaurant in the Metro Centre and needed to see his mates and watch football. I replied that, in that case, the best grade he’d get would be a C — or maybe a B if he was very lucky. “What’s wrong with a B?” he said. “I’d much rather get that than spend six hours every week on business studies.”

And the toll associated with pursuit of ambition and achievement,

In my current school the teachers seem happy and have no plans to quit. Many have taught there for 20 or 30 years and educated the parents of the current students. Indeed, teacher turnover is so low that I very nearly didn’t get a job. When I started looking last spring, there were 120 vacancies for business studies and economics teachers in London; in the whole of the North East there were only three. In the highest-achieving London academies a quarter of the staff quit every year — not just because they can’t afford flats but because they are wrung out by the scale of the work. This is the trade-off: this sort of system gets the best possible GCSE results, but the teachers, and sometimes the students, get burnt out achieving it.

The dynamics and structures of free market capitalism elevate the unbridled pursuit of ambition, efficiency, incomes/profits, and wealth. There is an increasing monotonicity associated with these pursuits. This, in turn, is fuelled primarily by excessive individualism. 

The problem with all these four pursuits is that apart from their increasing monotonicity, they are almost unconstrained. The extant norms are self-reinforcing. Prevailing management theories and econometric models are primed to maximise efficiency, incomes, wealth etc. Resilience, sustainability, social stability, and other qualitative considerations of human well-being are absent in these narratives. 

Sunday, December 25, 2022

Weekend reading links

1. From an FT long read about how Germany's search for profits and efficiency had led to outsourcing of core national interests

Constanze Stelzenmüller, director of the Center on the US and Europe at the Brookings Institution, has said Germany is a case study of a western state that made a “strategic bet” on globalisation and interdependence — and was now suffering the consequences. “It outsourced its security to the US, its export-led growth to China, and its energy needs to Russia,” she wrote in June. “It is now finding itself excruciatingly vulnerable in an early 21st century characterised by great power competition and an increasing weaponisation of interdependence by allies and adversaries alike.”

And things have changed sharply,

“The German business model has to change,” Christian Lindner, the country’s finance minister, tells the Financial Times. “It was based on low energy prices . . . on an abundance of skilled workers, and open markets for Germany’s high-tech products.” But “this model doesn’t really work any more because many of the core elements have changed.”

2. Is a spate of sovereign debt restructuring around the corner?

The World Bank projected this year that about a dozen countries could face default in the next year, and the I.M.F. calculated that 60 percent of low-income developing countries were in debt distress or at high risk of it... The Council on Foreign Relations said this past week that 12 countries now had its highest default rating, up from three 18 months ago... Brad Setser, a senior fellow at council, estimates that $200 billion of sovereign debt in emerging markets needs to be restructured... Restructuring debt can include providing grace periods for repayment, lowering interest rates and forgiving some of the principal amount that is owed... However, the emergence of commercial creditors that lend at high rates and prolific loans from China — which has been loath to take losses — has complicated international debt relief efforts.

3. On the faculty shortages in India's premier higher education institutions

Over 11,000 faculty positions are vacant in central universities, IITs and IIMs across the country, according to Ministry of Education (MoE) statistics... In 45 Central Universities, a total of 6,180 posts of Professor, Associate Professor and Assistant Professor, out of 18,956 sanctioned posts are vacant. Similarly, in Indian Institutes of Technology (IITs), a total of 4,502 posts out of 11,170 sanctioned posts are vacant. In Indian Institutes of Management (IIMs), 493 posts out of 1,566 faculty posts are vacant.  

The idea of establishing too many higher education institutions with the objective of enabling geographical access is only limiting access to quality, since these new institutions are unlikely to be able to attract high quality academics.   

4. The ongoing chaos in airports is a teachable moment. The opeds and opinion makers have predictably lost no time to lay the blame on the doors of the government. 

On the contrary, I believe this is a classic problem of private sector failure. In the aftermath of the pandemic, the airport operators immediately cut down their staff in response to reduced demand. Now that demand has recovered and spiked with holiday season, the operators, true to their style, have been slow in expanding their services manpower. And governments and regulators get the blame

5. Physicists at the US Government's Lawrence Livermore National Laboratory in California announce a major breakthrough in fusion reaction. The breakthrough is that of producing more energy in the reaction than was use to trigger the reaction, or net energy gain. 

... uses a process called inertial confinement fusion that involves bombarding a tiny pellet of hydrogen plasma with the world’s biggest laser, had achieved net energy gain in a fusion experiment in the past two weeks... Although many scientists believe fusion power stations are still decades away, the technology’s potential is hard to ignore. Fusion reactions emit no carbon, produce no long-lived radioactive waste and a small cup of the hydrogen fuel could theoretically power a house for hundreds of years... The fusion reaction at the US government facility produced about 2.5 megajoules of energy, which was about 120 per cent of the 2.1 megajoules of energy in the lasers, the people with knowledge of the results said, adding that the data was still being analysed.

6. Russia copes with its international trade isolation. As imports decline a lower quality Soviet-era import substitution regime is emerging, coupled with an active illegal trade system. 

7. Ruchir Sharma has some sobering observations about the private markets,

The rage for private investing began in the early 2000s, after the success of the Yale University endowment fund led by David Swensen, who embraced private investments to diversify away from stock and bond markets and stabilise returns in the long run. Swensen’s definition of “long” was decades... Unlike Swensen and other pioneers of private investing, who bought low in private markets and sold high in public markets, private managers — flush with an overabundance of new funds — are chasing deals, buying high and hoping to sell even higher and running up record debt in the process. The typical company owned by a private equity firm has debts of more than five times its earnings, versus one to three times for publicly traded companies. Today, nearly 100 per cent of the loans private funds use to finance buyouts are “covenant lite”— condition free — up from about zero per cent a decade ago. Investors are piling into private deals which the doors are closing on, as the market for initial public offerings evaporates... Since 2000, the assets managed by private markets have risen elevenfold — over four times faster than stock markets. That gap has widened particularly fast since 2018, when a period of market volatility ended with the Fed abandoning a turn to tighter monetary policy. 

Though many investors are drawn to private funds due to their superior reported returns, those returns are juiced by heavy leverage and the valuations are often based not on market prices but on guesstimates by private firms of what the companies they own will be worth years from now. These calculations are drawing scepticism for both overstating and “smoothing out” results. Private equity firms reported gains of about 3 per cent this year, when public markets were down 20 per cent or more and tighter money battered all markets similarly. Use realistic returns, subtract fees, and private funds may end up returning less than public funds. Yet private equity funds raised more than $1tn last year, up a record 20 per cent, according to the most recent data. Investor Cliff Asness wrote recently of the “mind blowing” possibility that investors now knowingly accept lower returns “for the privilege of not being told the prices”. Hiding from reality creates an illusion that private investments are less risky than their debts clearly demonstrate, which draws in more money, raising risk further. The moment of reckoning likely comes when and if the downturn drags on, and private markets have to finally reveal losses in a down market. 
8. Japan ramps up defence spending

On Friday, Prime Minister Fumio Kishida’s cabinet also approved a record budget totalling ¥114.4tn ($862bn) for the next fiscal year from April as Japan significantly increased its defence spending to counter China’s military rise. As part of an ambitious five-year plan to expand its military capabilities, the government will increase its defence spending by 26 per cent from a year earlier to ¥6.82tn in fiscal 2023. The spending plan includes ¥211.3bn to buy Tomahawk cruise missiles from the US, ¥250bn to buy 16 of Lockheed Martin’s F-35 stealth fighters and ¥105bn for a new fighter jet programme with the UK and Italy.
9. Fascinating Virtual Reality site that tries to reconstruct Rome

Monday, December 19, 2022

A model of economic transitions

I'll argue that any forced transitions to formality or higher labour or environmental standards is a supply shock induced demand compression, which invariably lowers the output. In general, any economic transition increases costs which if not supported by associated increases in demand, will necessarily lower output.  

I have blogged earlier in the context of formalisation of the economy that formality introduces layers of production costs which increases the market prices, which in turn reduces market demand. At the higher price, only a smaller number of customers can afford the good or service. The cost structure of the formal market can be met by only a small proportion of the total demand. The market settles down to a lower equilibrium output. 

In fact, it can create perverse incentives. In case of goods and services which are essential (or which have inelastic demand), the reduced affordable formal supply has to invariably result in substitution with lower cost informal supply. If formality is tightly enforced (as in case of certain goods and services), the informal market supply becomes an illegal (or harmful) market supply. 

Supporters will point out that increased formality will raise wages, productivity, profits, and quality which in turn will benefit workers, firms, and consumers in a virtuous loop. But this simplified belief assumes away the considerable adjustment requirements on all sides, which in the real world takes an inordinate time, and in many cases never materialises. It's for these reasons that such transitions have historically taken time, as with the developed countries of today. This ain't an area for leapfrogging. 

The supply will be constrained at both the intensive and extensive margins. At the intensive margin, the informal workers will not be able to acquire the skills required and the informal businesses will not be able to put up the capital for the increased production costs. At the extensive margin, supply of both new sets of workers and businesses will not expand as required. And, in any case, demand cannot expand enough in quick time to create a market which can absorb the higher production costs. 

This dynamic is just as true of labour or environmental or any other set of standards, which can all be seen as dimensions or aspects of formality. Each of these standards adds a layer of production and supply cost to the industry. And these costs must be passed through in the form of higher costs. 

In fact, we can extend this logic to economic growth itself. Economic output can grow sustainably only if the demand side can grow at the same pace as the expansion in supply. While it's possible for the supply to expand rapidly (say, with foreign capital), it cannot do much in the short-run to increase demand. In other words, sustained high economic growth requires the growth to be broad-based enough as to support growth in demand. 

The exception, which China and East Asian economies benefited from, is if the increased demand can come from an external market. In this case, the local economy can benefit with more investments and jobs, and greater productivity and higher incomes, without the proportionate expansion in demand. This positive supply shock will, in course of time, create the foundations for sustained broad-based economic growth. But this opportunity appears to have shrunk considerably. 

In the circumstances, any action plans for economic transitions, like that involving informality or renewables, should acknowledge its limitations and financial costs.

Sunday, December 11, 2022

Weekend reading links

1. The Adani Group has won the bid for the 259 Acres (2.5 sq km) Dharavi redevelopment project with an offer of Rs 5069 Cr. The Rs 20000 Cr project would rehabilitate 650,000 people over a period of 7 years. The redevelopment would have an FAR of 4, though there will be height restrictions given the proximity to the airport. The second highest bidder, DLF, could offer only Rs 2025 Cr. The Adani Group will construct the public housing project and subsidise it with commercial and residential developments. 

This will be the main challenge for the developer,
"...more than the technical challenges about densities and height restrictions, social rehabilitation of the slum residents shall be the biggest stumbling block and Adani has to handle it delicately to succeed in this redevelopment plan," said Gulam Zia, senior executive director at Knight Frank, a property consultant... Besides supporting the residential needs, Dharavi has thriving small sector units that sustain the needs of the residents and provide for a huge consumer base. Any negative impact on the livelihood of these residents can meet with tremendous resistance like in the past, Zia said. Dharavi is home to the potter community and leather goods makers who have been doing business in the shanty-town for decades... Prashant Thakur, senior director and head of research at Anarock Property Consultants, said that the challenge with the redevelopment of Dharavi is that too many stakeholders are involved and managing them is a big task. This is a key reason why it did not take off in the past. “The key to the success of one of the largest redevelopment projects in the world is to re-align the development scope with a more sensitive rehabilitation programme flexible enough to incorporate an interdisciplinary approach that suits the local socio-economic conditions," said Thakur... there is no template to rehabilitate such large scale tenements, including finding temporary accommodation for the residential, commercial and cottage industry occupiers.

2. Interesting long read about the four-day work week,

Advocates for the four-day week point out that unlike a season or a day, there is nothing natural about the working week. The two-day weekend — dispensing with working on Saturday morning — did not take off in the UK until after the second world war, quashing arguments that too much leisure time could spur political activism among the working classes.
3. Business Standard reports that Adani Electricity Mumbai Ltd (AEML) has been given permission under Section 14 of the Electricity Act 2003 to operate as a distribution licensee. This is the first such approval for distribution licensee, which brings in competition in the electricity supply side. The permission has been given for the Navi Mumbai area which covers nearly 500 sq km with 880,000 households (2011 census) and has a current demand of 1600 MW and 9.5 billion units. The AEML is already one of the discoms in Mumbai where it took over operations from Reliance Infrastructure in 2017. 

The area, apart from including the Adani Group owned Navi Mumbai airport, also has the JNPT and Navi Mumbai SEZ, where several large power consuming industries like data centres are being established (AdaniConneX, a JV with EdgeConneX, is developing data centres). 

The beginning of supply competition on the distribution side is welcome and an important step in ushering discipline into the sector. The concern though would be that the AEML would end up capturing all the high vale consumers, leaving the incumbent discom with all the smaller and difficult customers. What market design can mitigate such cherry picking?

In China and Taiwan, industrial policy was always a priority: the consequence of the need to survive in an industrialised world with much richer foes. Technological catch-up was a necessity for successful nation-building... In the developed west, industrial policy pushes have come not as a grand crescendo towards modernisation, but in loud and quiet cycles, peaking during periods when one power is afraid of losing out to the others. The US space race against Soviet Russia is a prime example, as well as American consternation over Japan’s ascendancies in the 1980s. Now that we are back in a period of global order-shaking, the discussion is back on loud. Western fear over China’s rise, and concerns over supply-chain security in the wake of pandemic shortages, all spurred the new EU and US chips policies. As a result, governments in the west are abandoning their taboos around talking about industrial policy, or orientalising it as only fit for east Asia. The economist Dani Rodrik remarked that the US Chips Act was significant for being “a sign that we have moved well beyond market fundamentalism and because it shows there is now bipartisan support for industrial policies”.

5. FT reports that an ILO report has found that global wages have fallen in real terms this year for the first time since records began. 

The UN agency’s annual report on pay showed that global monthly average wages in the first half of 2022 were 0.9 per cent lower in real terms than a year earlier, marking the first outright fall in worldwide living standards in the 15 years for which the ILO has published data. The drop was steepest in the developed world, where inflation picked up earlier. The ILO said that among G20 economies, which account for about 60 per cent of the world’s waged employees, real wages had fallen 2.2 per cent year on year in advanced economies. Across G20 emerging economies, wage growth slowed but remained positive at 0.8 per cent — but this was in large part due to China’s resilience, with other major countries such as Brazil hit hard.

6. Political polarisation in the US pervades everything. Consider this about jeans

Levi Strauss and Wrangler both got their start as the go-to jeans for cowboys, railroad workers and others who pioneered the American West. Today, they are on opposite sides of a political divide that is affecting not only how people votebut what they buy. Consumer research data show Democrats have become more likely to wear Levi’s than their Republican counterparts. The opposite is true with Wrangler, which is now far more popular with Republicans. There is no simple explanation behind those consumer moves. Some of it is due to social and political stances companies are taking, such as Levi’s embrace of gun control. Some is tied to larger geographic shifts in the political parties themselves, as rural counties become more Republican and urban areas lean more Democratic. Wrangler is popular in the cowboy counties of the West and Midwest while San Francisco-based Levi’s resonates more with city dwellers... 
Levi Strauss & Co. has embraced liberal causes such as gun control and support for immigrants. Wrangler has stayed out of politics but has burnished the cowboy aspects of its brand by supporting rodeo... From 2004 to 2018, the partisan split within Levi’s customer base to the Democrats grew by 3 percentage points, while Wrangler’s customer base moved 13 percentage points toward the Republicans... Nearly 60% of 1,000 Americans surveyed by Edelman last year said they would choose, switch, avoid or boycott a brand based on its stand on societal issues. That is up from 47% in 2017.

And this about cars (HT: Adam Tooze)

Wednesday, December 7, 2022

Free-market in action - online gambling edition

Free market orthodoxy would have it that markets are self-correcting and strongly oppose government interventions. They reject the possibility of market failures and argue that such apparent failures arise from government regulations or   thatthe market dynamics would correct these failures in due course. 

This orthodoxy flies in the face of reality. The real world is full of examples where market dynamics left to itself creates distortions and perversities which persist for long times, if not forever. A friend pointed me to this article in Bloomberg on the corrosive social effects of online gambling in the UK. 

UK was a pioneer in allowing online gambling in 2005. The market has since had a free-run attracting consumers and selling innovative products in a largely unregulated market. It's social costs are now becoming apparent and appear similar to the opiod problems in the US.

For four of the past five years, British punters have lost more than £14 billion on online casino games, sports betting and other forms of gambling. Fully 60% of the industry’s profits come from only 5% of its customers, according to a House of Lords’ report. As many as 138,000 people in England are classified by British regulators as problem gamblers, as well as 36,000 children aged 11-16, UK government statistics show. About 400 suicides — or around 8% of all suicides — in England are estimated to be linked to gambling each year, while it disrupts the lives of many more through broken marriages, bankruptcy, homelessness, and crime. During Covid, about 20% of higher-risk gamblers increased the time they spent gaming.

This explains how unregulated industry led to addiction,

The explosion in online gaming in the UK can be traced to the Gambling Act of 2005. Gambling firms were allowed to advertise sports betting, online casinos and poker on TV and radio for the first time, and until 2014 remote operators selling to British customers weren’t even required to hold a UK license. The law predated the technological revolution that was the smartphone. Betting firms have been exploiting that blind spot ever since, developing aggressive habit-forming games tailor-made for obsessive gambling, and cashing in while a significant subsection of their customers racked up huge losses, according to interviews with dozens of current and former employees, reformed addicts, lawmakers, consumer advocates, and academics. Firms including Bet365 Group Ltd., Ladbrokes and Paddy Power then enrolled their biggest losers into so-called VIP schemes and showered them with gifts that typically included free bets, cash deposits, tickets to sports games, flights to Las Vegas, and other inducements to keep them hooked.

On the nature of addiction and how betting companies promote this addiction,

Cooper would log in to games with names like Starburst, Gonzo’s Quest and Book of the Dead. Totally absorbed, he would lose track of time as he pressed the spin button, and the multiple reels covered in brightly colored symbols began to spin wildly. Cooper would gamble feverishly for hours without moving from his couch, sometimes wagering £100 per spin and only stopping once he’d burned through nearly all his money. He once gambled, and lost, a month’s wages in 20 seconds. If he hit a winning streak, he would gamble through the night, until his casino balance hit zero again and he stumbled to bed. Some days he would gamble for 12 hours straight, stopping only to go to the toilet or to eat...

But despite losing on average around £3,000 a month, Cooper says he only received one phone call from a gambling company checking that he was alright. None of the operators asked him if he could afford to lose that much, or checked the source of his wealth or income. But if he stopped gambling for longer than a couple of days — usually because he had lost nearly all his money and could barely scrape enough together to eat — then he would be bombarded with emails, text messages and phone calls offering him free bets, bonuses, and cash to return to their site.

With the social costs are now apparent and public pressure to tightly regulate the market and limit social damage mounting, the government has tried to intervene. But, given its profitability and well-entrenched market structure, the industry has responded with aggressive lobbying and other practices to stave off regulation. These other practices have included political capture of the most egregious nature,

Successive UK governments have done little to tighten the rules in the last decade, as an ever-increasing number of politicians have developed closer ties to the industry. Many lawmakers who have spoken out against increased regulation have also accepted thousands of pounds in hospitality from gambling companies, and regularly receive free tickets to top-flight sporting events, as well as lucrative speaking gigs and even second jobs, according to a Bloomberg News analysis of lawmakers’ financial disclosures. The government announced a review of gambling legislation in 2019, but has delayed publishing its findings at least four times. This summer, after intensive lobbying, officials in Boris Johnson’s administration watered down or removed several measures originally contained in the review, according to people familiar with the situation.
The gambling and horseracing industry has spent hundreds of thousands of pounds cultivating lawmakers of nearly every British political party, no matter who is in power. That lobbying has intensified since the end of 2019, when the ruling Conservative Party promised in its election manifesto a review of the 2005 Gambling Act. Since then, the sector has spent more than £300,000 on wages and entertainment for at least 37 UK lawmakers. On numerous occasions, they spoke in favor of the industry in parliamentary debates within weeks of being schmoozed in hospitality suites at sporting and social events.

This political capture has been complemented with regulatory capture,
In subsequent meetings with officials from the Gambling Commission and its overseers in government at the Department for Digital, Culture, Media & Sport, Prest and his colleagues discovered that the regulator was looking for something similar: It had told operators that it wanted an industry-wide tool to track their customers’ activity, known as a “single customer view.” It seemed a perfect fit. But the regulator, on a shoe-string annual budget of about £20 million, handed the job of selecting the most effective solution to the industry lobby group, the Betting & Gaming Council. The BGC told Prest and his partners at the firm they set up, called BetterRisk, that it was running the tender process and would invite them to submit their proposal. Prest says it struck him as odd that he kept being referred to the lobbyists, but he didn’t think much more of it at the time... 
As they were applying the finishing touches earlier this year, though, the bankers received an email from the BGC: They would not even get to submit their proposal because the lobby group had picked Gamstop to help develop the new system. Ten months on, Prest is still extremely frustrated. He says it’s wrong “the industry gets to be the gatekeeper controlling the scope, design, functionality and delivery timeline of a harm-prevention system which is to stop harm that they themselves are causing by their commercial activities.”... Behind the scenes, gambling firms and their lobbyists meet with government officials on an almost weekly basis, according to documents obtained under Freedom of Information requests. In the 12 months to February, ministers and officials at the Department for Digital, Culture, Media & Sport met with representatives of the online gambling industry about 35 times, or around three times a month.

It's been reported about a proposal to regulate online gaming in India. The proposed regulation made the differentiation between games of skill and chance, and wanted to confine regulation to only the former. This was apparently overruled by the Prime Minister's office which wanted to regulate both. It may be the right thing to do. 

It has been a consistent argument in this blog that corruption and venality are not restricted to developing countries and the public sector. They are inevitable whenever there is money involved. Thanks to the institutional strength and maturity, harassment corruption (on delivery of statutory public services, for example) is minimal or absent in developed countries. See this and this

But in the case of the highest-value businesses, corrupt practices are common place in the west as in the east. In the former, it's less in the form of egregious bribery and more in the form of quid-pro-quo influence peddling to capture the rule makers, set rules of the game, and erect preferential policies. Given the stakes involved and the universality of human character, these practices are unavoidable. We need regulations to limit them

In case of the private sector too, as long as the stakes are high and sufficient corporate governance restraints involving the principals (shareholders) and the agents (management) are not in place, there will be corrupt practices. The scale of such practices is likely to be bigger in the larger companies and those where the institutional restraints on senior executives is limited (for example, in companies with star chief executives). For sure, there is no loss of public resources, but these qualify as violations of fiduciary responsibilities. See this and this

This paper describes how executive visits to the White House to meet the US President led to preferential policy changes that boosted the share prices of the company concerned. 

Using novel data on White House visitors from 2009 through 2015, we find that corporate executives’ meetings with key policymakers are associated with positive abnormal stock returns. We also find evidence suggesting that following meetings with federal government officials, firms receive more government contracts and are more likely to receive regulatory relief (as measured by the tone of regulatory news). The investment of these firms also becomes less affected by political uncertainty after the meetings. Using the 2016 presidential election as a shock to political access, we find that firms with access to the Obama administration experience significantly lower stock returns following the release of the election result than otherwise similar firms. Overall, our results provide evidence suggesting that political access is of significant value to corporations.

This paper shows that Federal Reserve insiders systematically engaged in insider information trading with financial market actors the day before FOMC meetings.  

In this paper, I employ anonymous New York City yellow taxi records to infer variation in interactions between insiders of the Federal Reserve Bank of New York (New York Fed) and insiders of major commercial banks around Federal Open Market Committee (FOMC) meetings. Taxi rides between the vicinities of the New York Fed's and the major commercial banks' buildings serve as indicators of meetings at those institutions, and coincidental drop-offs of passengers picked up around those institutions serve as indicators of offsite meetings. Cieślak, Morse and Vissing-Jørgensen (2016) posit systematic leakage from the Federal Reserve around FOMC meetings along unofficial channels, and, in line with that hypothesis, I find highly statistically significant evidence of increases in meetings at the New York Fed late at night and in offsite meetings during typical lunch hours.

There are too many examples of fiduciary failures and criminal conduct in private sector in India and elsewhere to worth specifically linking them.

Finally, in all these cases, developed or developing country, public or private sectors, despite all institutional restraints and management-speak, the absence of corrupt practices boils down to the character of the individuals concerned.

Monday, December 5, 2022

Expenditure ideas are fine, but what about revenues?

As the Union Budget 2023-24 approaches, talking heads in television channels get busy with their wish lists of new types of tax concessions and spending proposals. All these ideas are invariably focused on the expenditure side. Some of them are doubtless good, but difficult to implement without the required resources. 

However, apart from the usual proposals on privatisation and selling of government lands (both of which face under-appreciated implementation challenges), ideas for revenues augmentation are scarce. In fact, among the long list of spending ideas, one struggles to come across even a handful of meaningful revenues mobilisation proposals. 

One can understand businesses and citizen groups talking only about tax cuts and public spending, but academicians and public commentators? Take academic research. There have been countless research papers which propose new programs and projects. But I cannot remember any which propose a new public revenue stream or increase in a tariff or user fees.

It's as though everyone wants to become a populist by spending money and avoid raising taxes and fees. 

It's perhaps not incorrect to say that there are at least a hundred times more expenditure ideas on the table than there are resources to spend. In the circumstances, I would imagine that any social optimisation of ideas generation and academic research should prioritise revenues generation over expenditure. 

Consider the following. India has one of the lowest property tax, utility tariffs, and municipal user fees in the world. I struggle to find even one paper which examines the magnitude of this problem, much less aggressively advocate reforms to raise rates and fees. 

Land registration in India suffer from several channels of leakages. Why doesn't anyone want to do a study to assess the extent of revenue leakages from land registration process? What are ideas and innovations to plug the different channels of leakages?

Where are the ideas to expand the shockingly low income, corporate, and GST bases? In particular, GST itself is a fertile ground for large-scale evasions - how can they be detected? How can  practices like cross-border transfer pricing distortions, under-invoicing of imports and over-invoicing of exports etc be avoided? How can IT be used to meaningfully (not the questionable ideas like GIS mapping of properties) plug revenue leakages? See this.

Even with selling of government lands or privatisation, the standard prescriptions on the revenue mobilisation side, there are hardly any insights on the small details of their execution. 

Actually, this reluctance of commentators and influencers to engage on the less popular issues goes beyond revenues mobilisation. For example, we're now witnessing the trend among state governments to revert to the defined benefit Old Pension Scheme (OPS) for public employees. Most people would agree that it's one of the most damaging public policy decisions of the last several decades. I'm surprised at the lack of engagement on the issue by the normally strongly opinionated public commentators and academicians (especially those based in the west).

Or consider the issues of fiscal sustainability and incentive distortions in developing countries like India of good-to-have tertiary education scholarships and tertiary care health insurance programs. I have not come across a single oped urging caution on the ever-expanding scope of such first-world welfare state. Nor have I seen serious research and sustained commentaries on the chronic problem of burgeoning manpower costs of state governments in India. 

Or rigorous scholarship on the real value of industrial incentives in business investment decisions. I have not seen a study on the marginal value of fiscal and input incentives in the determination of business investment decisions, especially in cases of large businesses, compared to say, business environment or ease of doing business reforms.

What explains this vacuum of ideas on revenues mobilisation? 

I can think of at least two simple explanations to this skewed preferences. One, we see so many problems around the world and thinking up ideas to spend more to address them is easy enough. Two, just as governments are easy targets to criticise for not spending (and thereby not solving the problem), it's as much or more difficult to criticise businesses, consumers, and taxpayers for not contributing their fair share. 

Taken together, given the pervasiveness of problems facing the world and high psychological cost of proposing pain, everyone piles on the spending bandwagon. Everyone becomes a populist to score brownie points. 

Saturday, December 3, 2022

Weekend reading links

1. Definitive signature of greening nature of global economic growth

In 2007, when China’s economy was roughly as big as India’s is today, it emitted around twice as much carbon dioxide. India and Vietnam are still powered by coal. The difference is they are making much more efficient use of it.

2. Wind power fact of the day,

One turn of an “SG 8.0-167 DD” turbine generates enough electricity to run a British home for a day and a night. SG stands for Siemens Gamesa, a subsidiary of the German industrial giant, which makes the machines in Hull. The 8.0 is the turbine’s maximum output in megawatts (MW). The 167 is the diameter of its rotor in metres: it sweeps out in a circle equivalent in area to about three football pitches. And the DD stands for direct drive, an electricity-generation technology with no fiddly gears to wear out. At Hornsea 2, a wind farm located off the Yorkshire coast, 165 of these vast turbines form a field of steel stretching farther than the eye can see. Hornsea 2, which became fully functional in August, is now the largest wind farm in the world. When the wind really blows it can power 1.4m homes... By 2010 there were 1.3 gigawatts (GW) of wind power in British waters. Today there are 14 GW... About 36% of British electricity now comes from wind, the majority of it offshore... In the process, the cost has fallen sharply. In 2015 new offshore wind cost £120 ($155) per megawatt hour; today it costs well below £40.

3. Rana Faroohar has a perceptive guide on the deglobalisng world.

After decades of a “winner take all” trend, in which the majority of prosperity has been located in a handful of cities and companies, look for business and policymakers to be more focused on ensuring that wealth and place are re-moored. This will come with costs — such as inflation. The old “efficiency” models, which assumed that people, goods and capital would move seamlessly to wherever they were needed, were cheap. Creating more opportunity at home, while still remaining connected to the global economy, will require building more resilient models — that involves better education, infrastructure, higher local wages, and less focus on the short-term bottom line. Efficiency was cheap. Resiliency will cost more. Who pays for it is up for grabs...

But as Harvard academic Gordon Hanson, one of the figures within this movement to reimagine free-market capitalism, puts it: “When workers without a college degree lose their jobs, few choose to move elsewhere, even when local market conditions are poor.” One reason for that is that they depend on the family and community ties of place to buffer them in difficult times. Hanson and his colleagues are building new, highly localised models of how economic growth happens in different areas.

About the costs of reshoring and localisation of supply chains, 

While some worry the shift would be too costly, a 2021 BCG analysis found that more localised production networks would add only a 2 per cent mark-up on a $35,000 car, a 1 per cent increase in the price of a smartphone, or 3 per cent more for a $200,000 home. This, coupled with precision data technologies that allow for extremely precise tracking within supply chains (a textile retailer can now identify the provenance of cotton down to a particular farm or field), and a younger consumer geared towards buying fewer things of better quality, will both encourage more localisation and help the planet.

4. Marianna Mazuccato has four requirements for industrial strategy involving procurements, grants, loans, and tax incentives,

Where affordable and equitable access is a policy priority, products and services with public funding should be priced accordingly. For example, the AstraZeneca Covid-19 vaccine, developed with the help of government investments in R&D, manufacturing, and advance sales, included provisions to keep prices low, limit profits during Covid and ensure knowledge-sharing for public health... Conditions can also shape the goals — or “missions” — behind investment and impose standards on companies. Decarbonising existing industries and expanding green innovation and growth is a priority... Conditions associated with a just green transition should cut across all industrial strategy investments: for example, requiring new manufacturing capacity to minimise carbon emissions and create jobs that meet labour standards. 

In addition, receipt of public funds should be conditional on sharing a proportion of royalties, equity or intellectual property with the government. This would enable the state to take a portfolio approach to investments, knowing some will succeed and some fail... Last, governments can prompt companies to channel their own investments into productive activities. Biden’s Chips and Science Act, which seeks to boost US semiconductor innovation and manufacturing, includes “guardrail” provisions that prohibit funds from being used for share buybacks. It does not yet, however, prohibit companies that receive chips act funding from engaging in such buybacks — a loophole that has led to calls for tougher rules.

5. India's labour cost and size advantage

6. The sheer scale and nature of corporate governance breakdown at FTX is staggering. FT has a good article
... an environment where employees’ every need was catered for, and where a circle of senior executives in their late twenties and early thirties splashed millions of dollars on everything from travel to sport sponsorship deals and luxury homes. A lack of internal controls that are typical of large financial companies meant FTX’s spending went largely unchecked, according to former employees and filings in the group’s Delaware bankruptcy case. “[It was] kids leading kids,” said one former employee. “The entire operation was idiotically inefficient, but equally mesmerising,” they added. “I had never witnessed so much money in my life. I don’t think anybody had, including SBF.”... Concerns about value for money from employees with marketing experience were brushed off by Bankman-Fried and the company’s top executives, this person said. Bankman-Fried or one of two other executives signed off hundreds of millions in spending on sponsorship deals. “It just kinda went crazy,” the employee said. “If Sam said OK, it was good to go. Regardless of the amount.” John Ray, the new FTX chief executive leading the exchange through the bankruptcy, said he had never seen “such a complete failure of corporate controls”.
Some should surely attract criminal liabilities
“The [company] did not have the type of disbursement controls that I believe are appropriate for a business enterprise,” he said in filings, adding that company money was spent on buying homes and personal items for FTX employees and advisers. “There does not appear to be documentation for certain of these transactions . . . and certain real estate was recorded in the personal name of these employees and advisers,” Ray added... Bankman-Fried’s companies also extended loans to executives, bankruptcy filings show. His trading firm Alameda Research loaned $1bn to Bankman-Fried himself, $543mn to head of engineering Nishad Singh and $55mn to Ryan Salame, co-chief executive of FTX Digital Markets, its entity in the Bahamas.

Sample this about poor quality of due diligence by venture capital investors,

The boring process of checking that potential investments can live up to their promises has fallen completely by the wayside. Due diligence once meant sending bankers to check that a mining company really had a working gold mine, hiring accountants to scour the books and asking lawyers to identify contracts that could prove troublesome in a bankruptcy. These days, it is hard to know what due diligence actually means. Ontario Teachers’ Pension Plan, which put $95mn into FTX, insists that its professionals “conduct robust due diligence on all private investments”. Tiger Global, which tossed in $38mn, pays outside consultants including Bain & Co to do the work. Yet both missed what FTX’s new chief has described as a “complete failure of corporate controls”. Sequoia Capital, which handed FTX founder Sam Bankman-Fried $214mn even though he played video games during his pitch to them, has walked a fine line... Veteran Silicon Valley dealmakers say there has been a gradual erosion of standards, as venture capitalists stopped trying to select and nurture the smartest entrepreneurs and started spraying cash around... decades of easy money and a lack of decent yields from safer alternatives mean this approach has spread from early investment rounds involving a few million dollars to gigantic deals involving billions.

7. No matter the details, the six year old public procurement website Government eMarketplace (GeM) is an outstanding success 

Prashant Kumar Singh, chief executive officer of GeM, recently said the portal would be the largest e-commerce platform in India by the end of the current financial year, crossing Amazonand Flipkart. Singh pegged the FY23 GMV target for GeM at Rs 2 trillion (around $25 billion). In FY22, GeM recorded a GMV of $14.2 billion, as against Amazon India’s $17 billion and Flipkart’s $23 billion.

8. To say that Morgan Stanley is bullish on India is an understatement

We see over the coming decade to 2031, India’s GDP more than doubling to over $7.5 trillion, the stock market compounding annually at 11 per cent to around $10 trillion, a discretionary consumption boom led by a rise in per capita income from $2,000 to over $5,000 and a quintupling of households earning in excess of $35,000/year to over 25 million, a rise in credit to GDP from 57 per cent to 100 per cent, causing a 17 per cent annual compounding of credit growth, and a doubling of India’s share in global exports.

Let's see how much of this materialises by 2031. 

9. Qatar World Cup 2022 

Since winning the competition to hold the World Cup in 2010, Qatar has spent more than $250 billion on soccer-related development, a figure that dwarfs the estimated $42 billion that China spent on the 2008 Beijing Olympics and the $55 billion that Russia spent on the Winter Olympics in 2014. Ten billion has gone on eight soccer stadiums. The rest was devoted to a wholesale transformation of the country: the complete remodeling of downtown Doha; the construction of nearly a hundred new hotels; the expansion of the port and the airport; a revamped road system; the creation of three metro lines; and a new city with homes for more than a quarter of a million people.

10. Adrian Wooldridge on Sweden

The Swedes combine the best features of German and American capitalism. German-style Swedish companies dominate global niches through a combination of engineering excellence, high-quality training and constant innovation... Swedish society at large is remarkably pro-business. The government allows private companies to run bits of the state such as schools and hospitals. The Swedish stock market is Europe’s largest, with 950 listed companies (mighty Germany comes second with around 800). Half the adult population has savings in the Swedish mutual fund account. Sweden has more venture capital investment as a share of GDP than any other European country, much of it drawn from America, and venture capital-funded investment is thought to have increased GDP by six percentage points since 2005.

11. India has received strident criticism from western politicians and commentators about buying oil from Russia. But contrary to the impression of India's purchases bailing out Russia, even today its purchases are a small share of those by Europeans

12. Janan Ganesh has an excellent article that captures the times,
If you tell me what you think about, say, the return of the Benin bronzes, I can infer with some confidence your views on public spending, the EU, rail strikes, immigration, working from home, climate change, Meghan Markle and much else. Nothing connects these subjects. It should be possible to be a small-government Remainer who thinks imperial loot is better off in western museums and who loses sleep to visions of a burning planet. But such a person would stand out now. To take a more concentrated example, lots of people should be anti-lockdown and pro-vaccine mandate. How many do you know?... People do not work out their beliefs and then join the corresponding tribe. They join a tribe and infer their beliefs from it. The sense of belonging, the group membership, is what hooks people, not the thrill of being right or pursuing a thought on its own terms. Politics has become a team sport, goes the line on this.

13. Finally, FT has an article on India's emergence as a major creditor to its neighbours, nearly tripling in value since 2014 to $32.5 bn. 

India’s cumulative “development assistance” since its independence in 1947 has nearly doubled from $55bn to $107bn since 2014, according to the government-backed RIS think-tank. The scale is far below what China is attempting through the BRI launched nine years ago, which the American Enterprise Institute think-tank estimates reached $838bn last year. Yet the foreign ministry said India has extended more than 300 lines of credit for around 600 projects, ranging from a cement factory in Djibouti to the Maldivian bridge. India has also funded everything from training courses to restoring overseas cultural sites such as mosques and temples.

Lending through India’s development partnership administration, by which it offers other governments lines of credit, has nearly tripled in value since Modi came to office in 2014 compared to the previous eight-year period, according to the foreign ministry, totalling $32.5bn.

In contrast with China, as the article points out, Indian credit is concessional and comes in the form of partnerships involving private companies. 

Monday, November 28, 2022

A proposal for unlocking bank finance in infrastructure projects

Opinion makers and experts on urban finance in India focus disproportionately on municipal bond issuance and Public Private Partnerships (PPPs). I believe that instead they should prioritise encouraging cities to increase their municipal revenues and also access non-recourse bank debt. Given the very nature of these works and the limited capabilities within local governments, both municipal bonds and PPPs are likely to be marginal contributors compared to other sources for the foreseeable future. 

In this context, there have been two very informative recent reports on municipal finance, from the Reserve Bank of India (RBI) and the World Bank (WB). The RBI report shows that in 2019-20 property tax as a share of GDP in India is among the lowest at 0.11% of GDP, with own tax revenues being 0.22%, own revenues (tax and non-tax) being 0.45%. Disturbingly, capital expenditure by cities was just 0.32% of GDP whereas revenue expenditure was 0.58%. Strikingly, own source revenues declined from 84.8% to 64% over 1960-61 to 2019-20, whereas property tax as a share of total revenue receipts declined from 60.9% to 15.5%. See also this from the WB report
One graphic from the WB report caught my attention. 
The RBI report informs that while cities are the engines of national economic growth, contributing 63% of national GDP, ULBs received just 5% of the credit by Scheduled Commercial Banks (SCBs) and gross municipal borrowings was less than 0.05% of GDP. In simple terms, the most important growth driver is the least leveraged and thereby employing capital in a most inefficient manner.  

This draws attention to the problem of sorely inadequate commercial debt mobilisation by ULBs. Within commercial debt, as I have written in detail here, the role of capital markets have been marginal outside of US (unique and long historical reasons) and China (where it can be better described as land bonds than municipal bonds). As is the case elsewhere, banks will have to be the predominant source of commercial debt. 

It's important that public policy prioritise the removal of barriers that come in the way of ULBs accessing bank debt, and to expand the envelope of municipal projects that can be bank financed. I'll outline a proposal in regard to the latter. 

One way to do this is to make the project self-financing and thereby unlock private capital through debt financing. Certain categories of projects can be made financially sustainable or commercially attractive with some bridge financing support. Infrastructure services which generate revenue – mass transit, water and sewerage, solid waste management etc – are good examples. In a rapidly urbanising and chronically infrastructure deficient country, while the demand for these urban infrastructure projects is massive, the available public finance is scarce. Besides, the small volume of municipal finances as aforementioned means that very few of these projects find the light of day. 

The Government of India’s (GoI’s) Viability Gap Funding (VGF) scheme already provides bridge grants (of upto 40% of project cost) to PPP projects to make them commercially attractive for private investors. But, as experience from across developed markets show, for a variety of reasons relating to risk appetite of private capital and limited supply-side, a major share of these projects will have to be public managed. The challenge is to ensure its management is efficient. 

In the circumstances, it’s proposed that the GoI expand the scope of its existing VGF scheme beyond PPPs to also include public financed revenue generating projects that become bankable once the viability gap is bridged. This can be called the Project Finance Fund for Infrastructure (PFFI). 

The Fund should be accessible to all eligible infrastructure projects. Eligibility can be defined in simple terms – projects financed by bank debt or bonds, bridge finance restricted to 40% of the project cost, non-guaranteed by state governments, and repayments to be met only from project revenues. There should not be any other restriction. Essentially, the Fund can be catalytic to crowd-in institutional finance. 

The requirement that the debt not be guaranteed should be sufficient to ensure that the proposal is not abused or subverted to push through routine public financed projects. 

Accessing the fund should also be easy and simple, so as to allow state and sub-state entities to access it without onerous conditions and administrative hassles. Simplified eligibility requirements and easy accessibility are critical requirements for the success of PFFI (an issue underlined by the failure of VGF scheme). In order to realise synergies and expertise, it can be considered to have the scheme's administration be with any of the existing or newly created development finance institutions (DFIs). 

As regards concerns about debt recovery given that a water or solid waste project are non-appropriable public goods, we only need to look at national highway projects, for example, for which bank loans are among the main source of financing. Or the case of weaker section public housing projects where too similar concerns exist. On the issue of asset-liability mismatches (ALM), many projects require loans with only 5-7 years tenor which can be managed by banks. Further, mechanisms like syndicated takeout financing can mitigate ALM risks. 

This would help kick-start several bankable urban and other infrastructure projects undertaken by public agencies that are currently unable to attract institutional finance. Institutional finance, like private participation through PPPs, can be a strong efficiency enhancing and sustainability factor in such projects.

The case for restricting VGF to PPPs rests on the premise that private management will bring in discipline and improve operating efficiencies. A comparable discipline and efficiency can be realised by mobilising project finance debt. In fact, project finance model can also help commit governments to maximise project revenues generation, thereby encouraging good practices like higher connection charges, tariffs, user fees etc and ring-fencing of such project revenues. 

The PFFI would be a good complement to the GoI’s focus on capital expenditure in general and the national infrastructure pipeline in particular. Further, it would be a welcome stimulus to support state and local governments at a time their revenues are squeezed due to the pandemic. Given that state and local governments make up two-thirds of capital expenditures, any compression in their capital expenditures would adversely impact the economic recovery from the pandemic and also medium-term economic growth prospects. 

The Fund’s proposed eligibility requirements contain easily identifiable restrictions which may be sufficient to limit its possible abuse. It can be made explicit that bank financing be limited to project finance, and not state government guarantee or general revenues of the public entity/agency. In order to ensure their skin in the game, the sponsoring public agency can be made to contribute a small minimum percentage of the project cost.

Needless to say, such financing initiatives will have to be complemented with measures to increase revenues - property taxes, non-tax revenues, and utility tariffs. The Government of India could mandate that cities seeking to access PFFI should undertake a well-defined set of reforms relevant to enhancing the commercial viability of the project being financed. The WB report consolidates the well-known list of regulatory and enabling requirements to facilitate project finance like debt mobilisation.