Wednesday, March 30, 2022

The demand-supply gap in medical education

The return of Indian medical students fleeing the war in Ukraine has reignited the debate on the need for more medical colleges and increase in medical seats in India. 

The demand supply gap is stark. About 1.6 million students appeared for the National Eligibility cum Entrance Test (NEET) in 2021, of which only 88,120 make it to the 562 public and private medical colleges. That's 19 applicants for every seat. Those numbers are now 89,875 and 596. 

How do you analyse this market? What will be the impact on seat prices due to supply changes of medical seats? How will the supply side react to this situation of large numbers of Ukraine returned students? What will be the profile of supply side?

As usual, in the search for solutions, the mainstream commentary argues for the private sector stepping in to fill the gap. I'm not sure for multiple reasons. 

The biggest constraint to setting up medical colleges is not so much capital, but the acute shortage of good quality teaching personnel. And if you want them outside the main cities, it's an almost insurmountable challenge. But you need strong supply of good quality personnel to support more medical colleges. And more good quality personnel require more medical colleges. So we have a chicken-and-egg situation.

Given the demand-supply gap, unless they come in massive numbers, incremental addition of private medical colleges, while much welcome, will be little more than a blip on the gap and encourage only profit maximisation. And, given that the demand-supply gap was already well-known for years, we know that private interest in medical education will not come in massive numbers just because of the Ukraine returnees. 

In an acutely supply deficient market, the limited marginal supply is likely to bid up the medical seat prices even more. This is a situation reminiscent of the urban housing market, where the limited marginal supply goes at ever higher rates. In both cases, any meaningful dent on the prices can be achieved only through substantial additions. 

Further, we may end up with a lemon problem in such markets. The demand-supply gap has been well-known, and it has over the years attracted several very credible and committed individuals and institutions into medical education. Any concerted policy push for establishment of medical colleges, especially based on a distress supply (from Ukraine), is likely to self-select less than desirable entrepreneurs and promoters. 

There is a precedent here. We have already seen the consequences of rapid pace of colleges and seats in engineering education during the 2000s in the private sector. The very bad toll on quality is now widely acknowledged. So much so that large numbers of colleges have either shut down or their recognition withdrawn. 

Then there is the problem with the belief that the private sector can provide a major share of affordable professional education seats. This belief has its roots in the experience of US, where unique historical evolution trajectories helped the emergence of private colleges. But there too public colleges form a very large share. In Europe, higher education remains largely in the public realm. 

Attempts to scale up using the private sector through Public Private Partnerships (PPPs) are most certain to fail. In a recent oped, Anand Krishnan was spot on in his assessment of the likely problems with such PPPs,

There are many who propose a rapid scale-up of seats by converting district hospitals into medical colleges using a private-public partnership model. The NITI Aayog seems to be moving in this direction. This is a dangerous idea without the government putting in place two things — a functional regulatory framework, and a good public-private model that serves the needs of the private sector as well as the country. We have so far failed miserably in both, largely due to the political-private sector nexus.

If we are to make a significant dent on the problem, the best bet are existing government facilities. Many government District hospitals and certain Area hospitals (300-500 bed hospitals) are well placed to be converted as medical colleges. With some infrastructure augmentation and recruitment of teaching faculty, these facilities can gradually be converted into full-fledged medical colleges. Being government institutions, there will always be some basic minimum assured quality. In order to raise resources to augment infrastructure and finance these institutions, a third to a half of seats can be converted to payment seats and charged the full cost-recovery fees. 

Krishnan in the article quoted above also makes important points about the way forward for medical education,

Recent efforts by the National Medical Council (NMC) to regulate college fees are being resisted by medical colleges. The government should seriously consider subsidising medical education, even in the private sector, or look at alternative ways of financing medical education for disadvantaged students. Quality assessments of medical colleges should be regularly conducted, and reports should be available in the public domain. The NMC is proposing a common exit exam for all medical undergraduates as a quality control measure. 

Finally, this is a teachable example on the reality that though many problems have no immediate solutions, we try to solve them. Part of it is about wanting to do something and also be seen doing something. This is a human reflex and a political economy compulsion. Bridging the demand-supply gap in medical education is one such problem. Given our context and constraints, it's very unlikely that we can bridge this gap in the foreseeable future. Like with other similar problems like affordable housing, agricultural productivity, or traffic congestion, we can only create the conditions required for its mitigation and gradual easing. 

Monday, March 28, 2022

An alternative perspective on the world economic prospects

It's hard to see ahead when there is dense fog. Similarly, forecasting about the world economy when it's clouded by multiple uncertainties is impossible. But deeply uncertain times also bring in a sense of gloom and excessive pessimism, just as good times spawn irrational exuberance on the positive side. 

While there are enough discussions about doom and gloom, pointing to several indicators and patterns with historical parallels, this post will try to provide a different perspective. It is not an argument that we'll continue to have the stable and high economic growth of the period of Great Moderation era, which we should recognise was a historically one-off period. Instead, it's an argument that we could revert to the more commonly observed period of reasonable economic growth amidst episodes of geopolitical uncertainty. 

In other words, instead of pessimism and optimism, I feel that the world economy and world in general could revert back to its normal state of affairs - moderate growth and geo-political uncertainties. 

The three decades of Great Moderation was supported by the tailwinds of globalisation and globalised value chains, trade liberalisation and financial market integration, flush of countries embracing capitalism and liberalising their economies, emergence of China, growth in immigration, rapid and breakthrough advances in digital and communications technologies, other trade promoting factors, and ultra-low interest rate policies. Underpinning all this was a politically stable world order, with its overwhelmingly western dominated institutional architecture. 

On a broad historical sweep, there is nothing normal about forces like global integration, low interest rates, geopolitical stability etc. There is also nothing to suggest that global economic prospects will be weaker just because these forces are retreating. The world economy experienced remarkable growth in the three decades after the War, without any of these factors.

In fact, we may be entering an age of deglobalisation (or at least slowbalisation), protectionism or at least attenuated trade flows, re-shoring, rise of anti-immigration policies, and restoration of normalcy in the credit markets. The big drivers of global growth like China may have lost their steam. And most importantly, the geo-political stability may have given way to a new Cold War involving two blocs. This is in some ways similar to the situation after the World War II. 

What are the possible drivers of economic growth this time? 

The re-shoring and diversification of supply chains is likely to result in a spike in investments. It'll reallocate spending and jobs away from their earlier concentrated locations (read China) towards other developing countries and the west. In particular, the risks arising from the concentration in supply of energy, and critical commodities and industrial inputs, which have become disturbingly evident during the twin shocks of the Covid 19 pandemic and the Ukraine crisis, have generated a very strong imperative for diversification. Investments in LNG terminals and other transportation infrastructure, computer chip manufacturing facilities, health care diagnostics and other critical inputs are already on the train. 

The green energy transformation is likely to be the major investment driver in the next couple of decades. If anything, its importance and urgency will only increase in the years ahead. Besides, it'll be an important contributor to innovation and productivity enhancement. The full possibilities from digital technologies like IoT, AI and ML, data analytics, robotics etc lie in the years ahead. Their productivity improvement potential could be large and likely. The shock provided by the Russian invasion will also boost military spending in the years ahead.

Finally, the recent rise in wages signal a possible recalibration in capital-labour bargaining power. Any inflation due to higher growth in labour wages, which have either crawled up or been almost stagnant over the Great Moderation, should be welcome feature. This coupled with the gathering momentum and regime shift on anti-trust issues, should create the foundations for more equitable and broad-based economic growth. Yes, these forces could reverse and remain still-born. More likely, they'll play out with far less intensity than expected. That would still be progress and creates conditions for sustainable economic growth. 

This is a good article. 

On the debt side, corporate and bank balance sheets in the US and Europe remain fairly strong and, unlike a few years back, does not look alarming on the debt side. For sure, governments have become massively leveraged, and this is an issue which will constrain fiscal policy response in case of recession. However, deleveraging of the kind required without engendering instability is not not without precedent, as the post-war years show. As to the argument that recessions are inevitable with any monetary tightening to cool an overheated economy, as Jerome Powell himself indicated, there have been instances in 1965, 1984 and 1994 when such reversals did not lead to recessions. 

In my views the more serious concern about global economic prospects should arise from the leverage-driven asset market distortions that have emerged over the last decade. What will be the spill-over effects on the real economy from the inevitable bursting of the asset bubbles? Here too there is a case that nearly three-fourths of the bubble valuations come from a handful of very solid technology companies of a new economy, which would anyways command very high valuations, though arguably not as inflated as now. This is not anything like the vapourware of the technology stock bubble at the turn of the millennium. 

Even the possibility of elevated energy prices does not make the case for a recession. A large part of the era of Great Moderation was co-terminus with the commodities Super Cycle. In fact, oil prices have risen above $100 in multiple occasions from 2008-14, even briefly crossing $140 once. High commodity prices can perfectly co-exist with high growth rates, and that too for long periods of time. 

Even if recession strikes, it's not as though all will be bad. As the graphic below shows, unlike the Great Depression and Great Recession, modern US recessions have been short durations (for a few months) and far less frequent. 
On the inflation side too, there are important overlooked factors. For one, it's reasonable to assume that the current supply chain disruptions and commodity shortages are likely to ease, at least in a couple of years. Further, even in the most dire predictions, we're talking about inflation staying elevated at levels like 4-6%. While this is high by the current standards, these are not alarming normals in any historic sweep. Finally, there is the structural view of inflation, about which I have blogged here earlier, which makes the strong case for low inflation over the coming decades. In any case, if the new normal in inflation is 4% and not 2%, it hardly spells doom.

One cannot but help feel that there are two psychological factors at work here among commentators assessing the world economy. One, there is the pall of gloom associated with any envelope of uncertainty, which geo-politics currently presents. Second, there is also the representativeness bias of looking at the future with the anchor of an immediate past which was characterised by an unprecedented long period of low inflation, high employment, and high growth.

In other words, there is enough basis to assume the foundations for reasonable growth in the foreseeable future of a decade or so. At the least, there's no more evidence for an extended period of stagflation than there is on the likelihood of a period with a slightly lower economic growth rate compared to the Great Moderation era. 

Given all these, it's fair to argue that the western economies will not remain stuck in stagnation for long.  For sure, a slow-down, or even a short recession, will most likely happen to wring out the excesses of the credit bubble, the excessive Covid spending (in the US), and also due to the twin shocks of the last two years. But instead of an era of stagflation, we are more likely to have a short period of recession and elevated inflation compared to our immediate history. There is also a non-trivial possibility of a financial cycle induced stagnation or recession, and its impacts could be uncertain. 

Update 1 (07.04.2022)

From the Times on the economic prospects,
A majority of forecasters say a recession remains unlikely in the next year. High oil prices, rising interest rates and waning government aid will all drag down growth this year, said Aneta Markowska, chief economist for Jefferies, an investment bank. But corporate profits are strong, households have trillions in savings, and debt loads are low — all of which should provide a cushion against any slowdown. “It’s easy to construct a very negative narrative, but when you actually look at the magnitude of all those impacts, I don’t think they’re significant enough to push us into a recession in the next 12 months,” she said. Recessions, almost by definition, involve job losses and unemployment; right now, companies are doing practically anything they can to retain workers. “I just don’t see what would cause businesses to do a complete 180 and go from ‘We need to hire all these people and we can’t find them’ to ‘We have to lay people off,’” Ms. Markowska said.

In general, there are too many signatures of economic strength that an outright recession in the immediate future appears less likely. A slowdown looks possible, even most likely. 

Sunday, March 27, 2022

Weekend reading links

1. On reshoring and localisation of production,
Large companies that can afford to own more of their entire supply chain have been moving towards vertical integration as a way to smooth disruptions and the inflationary pressures that result. Companies of all sizes are looking for ways to localise more production wherever their consumers are, no matter which country or region they are in. Many smaller “maker” firms in New York have benefited during the pandemic since they source locally, but the technique is also being picked up by big name brands that simply want more buffers against shocks of any kind — be they geopolitical or climate-related.

2.  Russia and Ukraine's exports of cereals and commodities,

3. TN Ninan questions the rich lists put out by various agencies and points to India's missing millionaires  
India as a whole is said to have 140 dollar-billionaires. According to Credit Suisse, there were 764,000 dollar-millionaires in India in 2019, i.e. those with wealth of Rs 7.5 crore and more... And in the same 2019, all of 316,000 filed tax returns declaring income of over $70,000 (or Rs 50 lakh)... Again, there is no central data point, but checks with companies in the business suggest annual purchases and bookings of fewer than 3,000 residential properties that are individually worth Rs 5 crore and more. Even if one were to lower somewhat the bar for unit value, the number of transactions would remain decidedly modest in relation to the reported numbers of millionaires... Sales for the top three German luxury-car makers peaked at 32,500 in 2017 and have fallen since. In 2021, they were just 22,500 -- affected partly by Covid and then the shortage of chips. Allowing for that, and adding on the numbers for Jaguar-Land Rover and top-end Japanese models like the Lexus, the total is unlikely to cross 40,000. The mismatch with the reported number of dollar-millionaires is obvious.

4. Larry Fink and Howard Marks feel that globalisation is on the retreat. Marks points to the examples of problems created by Europe's dependence on natural gas and oil imports from Russia, and the world's dependence on TSMC for computer chips as important triggers for this retreat. 

5. John Micklethwait and Adrian Wooldridge have an excellent essay in Bloomberg signalling that the war could ring in the close of the current era of globalisation. Two graphs on trade stand out. One on the declining trade share of global GDP

Another on the spectacular growth of merchandise trade since the millennium

They conclude with an exhortation for American leadership,

Biden needs to reinforce the Western alliance so that it can withstand the potential storms to come... Biden needs to recognize that expanding economic interdependence among his allies is a geostrategic imperative. He should offer Europe a comprehensive free-trade deal to bind the West together; it could be a slightly remolded version of the rejected Transatlantic Trade and Investment Partnership, based on regulatory convergence (under which a product safe to sell in the EU is safe to sell in the U.S., and vice versa). He should also join CPTPP... Biden should pursue a two-stage strategy: First, deepen economic integration among like-minded nations; but leave the door open to autocracies if they become more flexible. China could be wooed toward freedom. But nothing will improve unless Biden first glues together the free world. That means freer trade — and the sooner he tells his party that, the better... A global new deal should certainly include a focus on making multinational companies pay their taxes, and the environment should be to the fore. But Biden should also talk about the true cost of protectionism in terms of higher prices, worse products and less innovation.

6. A new study on ride sharing companies (or transportation network company, TNC) like Uber or Lyft has interesting findings,

They found that a TNC trip actually decreases local air pollution, on average, compared to driving a personal vehicle... the team found that, on average, a TNC trip produces just half of the local air pollution costs of a personal vehicle trip, reducing air pollution-related health costs by around 11 cents. However, the team showed in their study that added travel on the road from TNC vehicles also carries major drawbacks. TNC drivers spend much of their time driving between passenger pickups or waiting for new ride requests, known as deadheading. This extra driving means that a TNC's fuel consumption — and by extension its greenhouse gas emissions — are on average about 20% higher than a personal vehicle. More time on the road also means more congestion, more noise, and more potential for vehicle crashes. Considering all of these factors, the team found that opting for a TNC over a private vehicle increases external costs to society by 30% to 35%, or about 32 to 37 cents per trip. This burden is not carried by the individual user, but rather impacts the surrounding community. Society as a whole currently shoulders these external costs in the form of increased mortality risks, damage to vehicles and infrastructure, climate impacts and increased traffic congestion.

7. As the Russian invasion has egregiously surfaced the issue of oligarch's using western capitals to launder and hoard ill-gotten wealth and buy into the elite society, Daron Acemoglu has a very good article where he advocates using the opportunity to clamp down on tax havens and plug tax avoidance clauses that allow the use of these off-shore and on-shore locations. 

8. Janan Ganesh has a brilliant oped where he points out that the ongoing crisis has reminded everyone that it's energy and not technology that continues to be the driver of world history
Of all the illusions, though, the most quietly punctured is the idea that tech is the industry at the centre of the world: the one that makes it go round. Energy, it turns out, is still a worthier bearer of that mantle. This is an education for anyone born in the half-century since the Opec oil crisis. Silicon Valley’s self-image as the Middle Kingdom of the business world (or just the world) comes out in different ways... Tech is relevant in Ukraine; see the propaganda war. But next to the existential role of energy, which keeps Russia solvent, and has the west scrambling for alternative sources, what stands out is the modesty of its bearing on events. Silicon Valley is giving history a nudge here and there, no doubt, but not setting its essential course. That is still the role of people who dig stuff out of the ground for fuel.

Wednesday, March 23, 2022

Demographics and interest rates

How do ageing populations impact the macroeconomy, specifically the interest rates? 

It's well-known that populations in their prime working years save the most, only to draw this down when they age. In simple terms, young and old consume more than they save, thereby forcing down the aggregate pool of savings available, and thereby force up the interest rates. Sample this canonical illustration. So ageing demographics should be associated with higher interest rates. 

The economist Charles Goodhart, with Manoj Pradhan, has been a staunch advocate of the argument that  ageing populations will boost inflation and thereby interest rate argument. They feel that the labour force will shrink, aging populations will spend more (especially on healthcare) than they'll save, and protectionism and reshoring will reduce the disinflationary effects of global market places. This is also the basis for the old dependency ratio argument - there will be more effective consumers than effective producers. The result will be higher wages, increase in prices, and reduced pool of savings. The combined effect will be higher inflation and interest rates.

Goodhart writes about two trends that will influence the future trajectory of interest rates, pushing them upwards,

First, most of the world is now at the point where the support ratio, defined as the ratio of producers to effective consumers shifts sharply from being beneficial to being adverse. Second, we will observe a slower rate of growth in the number of workers globally. Both of these changes will have profound and, in our view, negative effects on economic growth globally. A worsening of the support ratio will lead to lower savings, as the old consume more and will make up a higher share of the overall population. Similarly, the slower growth in the number of workers must slow down the absolute growth rate... The almost inevitable conclusion is that real rates of interest will reverse from their present decline, and go back up. The current negative real rate of interest is not the new normal; it is an extreme artefact of a series of trends, several of which are coming to an end. Where might real interest rates reach? By 2025 they should have returned to the historical equilibrium value of around 2½–3%, with nominal rates therefore at 4½–5%, perhaps somewhat higher by 2050.

If this were indeed the case, then Japanese interest rates should have gone up. Instead, the country, which is at the frontier of ageing, has been stuck in a low interest rates trap for nearly three decades now. What gives? What do others say? What does research on demographics and interest rates, and interest rates in general inform us?

There are at several important threads. 

1. As countries have developed, the average disposable incomes of their populations have increased sharply. Even with the rising health care costs, a large share of their savings are passed on to the next generation. The widening inequality (more on that later) too exacerbates this effect.

2. Then there are the effects due to longer lives and lower fertility rates. Ronald Lee and Andrew Mason write in IMF's magazine,

In the United States and most other countries, the elderly are net savers and hold more assets than younger adults. Longer lives and lower fertility raise saving rates, reinforcing private saving.

3. Globalisation and financial liberalisation means that what happens in one country becomes dependent on what's happening elsewhere. So, even if one country is ageing and running down its aggregate savings pool, in a globally integrated financial market, it has access to capital from elsewhere. 

4. An ageing society needs less investment. Therefore the downward impact on the pool of aggregate savings due to ageing is offset by the upward effect on it due to reduced demand for investment. Lee and Mason write,

Firms may choose to cut investment in the domestic economy substantially, even as interest rates fall, if they think output and consumption growth will slow in response to a declining population and labor force, and perhaps lower total factor productivity (the portion of economic growth not explained by increases in capital and labor inputs and that reflects such underlying factors as technology). Should firms become pessimistic, even if central banks drive interest rates below zero, the economy could remain stagnant, with high unemployment for many years—a condition some call secular stagnation.

Research by Adrien Auclert, Hannes Malmberg, Frederic Martenet, and Matthew Rognlie support this point by arguing that the demographics has driven down long-run real interest rates. Ageing reduces economic growth, which in turn lowers investment by even more. They write,

Combining population forecasts with household survey data from 25 countries, we measure the compositional effect of aging until the end of the 21st century: how a changing age distribution affects wealth-to-GDP, holding the age profiles of assets and labor income fixed... This effect is positive, large and heterogeneous across countries... In a baseline overlapping generations model this statistic, in conjunction with cross-sectional information and two standard macro parameters, pins down general equilibrium outcomes. Since the compositional effect is positive, large, and heterogeneous across countries, our model predicts that population aging will increase wealth-to-GDP ratios, lower asset returns, and widen global imbalances through the twenty-first century... According to our model, this will lead to capital deepening everywhere, falling real interest rates, and rising net foreign asset positions in India and China financed by declining asset positions in the United States.

They find that the compositional effect leads to an increase in wealth-to-GDP ratio by 312 percentage points for India

This effect will be greater in the more likely low-fertility scenarios. 

5. Then there is the dynamics of widening inequality and its impact on interest rates. Amir Sufi et al have shown that rising inequality weighs on interest rates even more than ageing demographics. Robin Harding points to the mechanism -"rich households have a higher savings rate, so when they get a bigger share of total income, overall savings go up". And more saving relative to investment pushes interest rates down. They write,

Downward pressure on the natural rate of interest (r ∗ ) is often attributed to an increase in saving. This study uses microeconomic data from the SCF+ to explore the relative importance of demographic shifts versus rising income inequality on the evolution of saving behavior in the United States from 1950 to 2019. The evidence suggests that rising income inequality is the more important factor explaining the decline in r ∗ . Saving rates are significantly higher for high income households within a given birth cohort relative to middle and low income households in the same birth cohort, and there has been a large rise in income shares for high income households since the 1980s. The result has been a large rise in saving by high income earners since the 1980s, which is the exact same time period during which r ∗ has fallen. Differences in saving rates across the working age distribution are smaller, and there has not been a consistent monotonic shift in income toward any given age group. Both findings challenge the view that demographic shifts due to the aging of the baby boom generation explain the decline in r ∗ ...
The top 10% income households within a given birth cohort have a saving rate that is between 10 and 20 percentage points higher than the bottom 90%. The large difference is present over the entire sample period, and it becomes even larger over time. Furthermore, there was a large shift in the share of income going to the top 10% of the withinbirth cohort income distribution from 1983 to 2019. By the end of the sample period, the top 10% of the within-birth cohort income distribution had an income share that was almost 15 percentage points higher than the top 10% prior to the 1980s. The higher saving rate of the top 10% together with the large shift in income to the top 10% combined to generate a significant increase in savings entering the financial system from high income households. Overall, we estimate that between 3 and 3.5 percentage points more of national income were saved by the top 10% from 1995 to 2019 compared to the period prior to the 1980s. This represents 30 to 40% of total private saving in the U.S. economy from 1995 to 2019. The rise in saving by high income households is likely a powerful force putting downward pressure on r ∗.

6. Finally, in general terms, economists led by Larry Summers (also this) have revived Alvin Hansen's Depression era idea of secular stagnation to explain the persistence of low interest rates. In this Bank of England paper, Thomas Smith and Lukasz Rachel have argued that the combination of lower investment demand, globalisation, decrease of labour's bargaining powers, shifts in demographics, widening inequality etc have shifted downwards the investment demand schedule and outwards the savings supply schedule. 

They have also sought to quantify the effects of all these forces on interest rates.
Their summary, 
When combined, lower expectations for trend growth and shifts in desired savings and investment can account for about 400bps of the 450bps decline in the global long-term neutral rate since the 1980s. Moreover, these secular trends look likely to persist. This suggests that the global neutral real rate may settle at or slightly below 1% over the medium- to long-run... In the face of adverse shocks, central banks are likely to run up against the zero lower bound on nominal interest rates more often, requiring the use of unconventional policy instruments such as quantitative easing (QE). However, uncertainties over the transmission of QE and concerns over the size of central bank balance sheets, might limit the use of such tools in the future. For large adverse shocks, fiscal policy may therefore need to bear more of the burden of business-cycle management. Low rates may also fuel search-for-yield behaviour, posing challenges for macro- and micro-prudential policymakers.

On the topic there have since been several papers. Summers and Rachel have this and this. This graphic captures their calculations of the impact of all these forces on long-term interest rates.

See also this by Mathew Klein.

In conclusion, we can broadly say there are two conflicting dynamics at work. On the one hand, the accepted trend of older people consuming more than saving (or more dependents than producers) puts an upward pressure on the cost of capital. But on the other hand, there is the reduced investment demand in ageing societies, the greater relative share of savings due to widening inequality, and the globalised nature of financial markets which expands the pool of savings available. The combined effect of all the three is to put a downward pressure on interest rates. Financial models appear to suggest that the latter easily dominates the former. 

And the empirical evidence from Japan, which has been at the frontier of ageing and has been stuck at the zero lower bound for nearly three decades, suggests that we may be in for a long era of low interest rates.

Update 1 (22.05.2022)

Olivier Blanchard writes about why the long-term interests will continue to stay down.

Update 2 (08.07.2023)

Alan Taylor et al have a new paper that examines the trend of long-run interest rates in 10 developed countries and finds the following

Mapping our estimates of the natural rate into growth and demographic drivers, we find that these two contributing factors can explain most of the decline seen since the 1970s. Going forward, economic and population projections look stable, and forecasts of continued slow growth and further aging in the advanced economies in coming decades would mean that natural rates will remain lower for longer absent any other major shocks.

Monday, March 21, 2022

The Sri Lankan financial crisis

A major economic crisis has been brewing in Sri Lanka over the last several months. The country has run out of foreign currency reserves triggering shortages of imported items like fuel, power blackouts, and raging inflation. After resisting till now, the government of Gotabaya Rajapaksa has finally sought the help of IMF. This follows help from India, which including that promised last week during the Finance Minister's visit to New Delhi, in the form of credit lines of more than $2 billion. 

Sri Lanka has debt and interest repayments worth about $7 bn due this year, and cannot service it without restructuring the debt. Consider this,

Sri Lanka owes $15bn in bonds, mostly dollar-denominated, of a total $45bn long-term debt, according to the World Bank. It needs to pay about $7bn this year in interest and debt repayments but its foreign reserves have dwindled to less than $3bn. The government’s next big challenge is a $1bn bond repayment due in July. If it fails to pay, it would join countries including Suriname, Belize, Zambia, and Ecuador in defaulting on its debt following the pandemic.

The country has suffered the triple shock of prolonged political instability in 2018, the Easter Sunday bombing of April 2019 and finally the Covid 19 pandemic lockdowns. The last two have devastated the tourism focused economy.  Compounding matters was a large tax cut in 2019. And all this comes on top of the pile of Belt and Road Initiative (BRI) debts to China. 

I pulled up some graphics about the country (from EIU and Fitch). The economic growth rate has been on continuous decline since 2012. The collapse of tourism has been spectacular. 

The country's public and foreign debts have ballooned, especially since the country initiated BRI projects in 2017.

Strikingly, it has the highest public debt to GDP ratios among all Asian economies.

Similar is the trend with foreign debt exposure.

This is a good progress report of the country's several BRI projects

What can be done quickly? One, it's inevitable that there will have to be some debt restructuring. Will the Chinese play ball on this? Given that the Chinese have resisted clubbing of their debt restructuring with those of other sovereign creditors, as was seen during the G-20 efforts to restructure African debts during the pandemic and Zambia's recent debt restructuring, it will be interesting. India should push for the Chinese debt restructuring to be done along with the other debt. This is necessary to also ensure that the Chinese don't strike a bilateral deal with the Sri Lankans at terms that push the country deeper into Chinese clutches. 

The Sri Lankan crisis should be an eye opener for governments everywhere, including state governments in India. Its populist decision in December 2019 to cut VAT by nearly half from 15% to 8% and the abolition of several other taxes like the 2% national building tax aimed at financing infrastructure construction were extremely irresponsible steps.  The steps were taken in response to its manifesto promise. This is what an FT article wrote then

But the sharp tax reduction may alarm investors holding some of Sri Lanka’s estimated $72bn in public debts — equivalent to about 82 per cent of the country’s gross domestic product... “As long as somebody keeps rolling over the debt, you are going to see a massive economic boost in the short term,” said Murtaza Jafferjee, chief of Colombo-based JB Securities. “We are going to have one heck of a party for six months. But invariably the party will end and we will have a very long hangover.” The sweeping tax cuts — which are expected to cost about $2bn, or approximately 2 per cent of GDP — are also likely to put Sri Lanka on a collision course with the IMF. In 2016, Sri Lanka’s previous government agreed to a $1.5bn, four-year structural reform programme to strengthen its public finances... Even before the tax cut, Sri Lanka’s fiscal deficit for 2019 was expected to overshoot the original IMF target of 4.6 per cent of GDP, coming in closer to 5.6 per cent of GDP, due to a sharp fall in tourist revenues after April’s deadly suicide bombings that targeted hotels.

The Rajapaksa government could not have imagined that the consequences of the populism would come back to bite so soon!

Update 1 (1

Feature in the NYT on the Sri Lankan economic crisis.

Update 2 (28.05.2022)

More on the Sri Lankan crisis. A third of the country's debt is owed to foreign sovereign debt holders.

And its share has been increasing sharply since 2013, driven by the entry of China

This puts the problems in perspective
Sri Lanka’s reserves have fallen from $7.5bn in November 2019 to the point where finding $1mn is “a challenge”, Wickremesinghe, the new prime minister, said in an address last week. This has meant shortages of not only fuel but food and medicine, with hospitals forced to postpone surgeries. The country has the worst inflation in Asia at about 30 per cent in April and the currency has almost halved in value since it was floated in March.

Saturday, March 19, 2022

Weekend reading links

1. Germany's energy dependence on Russia in perspective

Oil accounts for 32 percent of German primary energy input and one third of that comes from Russia. Gas accounts for 27 percent of Germany’s primary energy input, of which 55 percent comes from Russia. Of the coal burned in Germany, which accounts for 18 percent of energy input, 26 percent comes from Russia. All told that means that just over 30 percent of Germany’s primary energy input comes from Russia.

Adam Tooze points to a paper which tries to quantify the likely impact of a complete ban on Russian imports. Their findings are that the impact will be limited and not catastrophic.

According to the calculations by Bachmann et al, even in a worst case scenario the impact on GDP would come to 3 percent, which is less than the 4 percent shock that the German economy suffered in the COVID crisis... Purely in the spirit of being conservative, we therefore postulate a worst-case scenario that doubles the number without input-output linkages from 1.5% to 3% or €1,200 per year per German citizen. This number is an order of magnitude higher than the 0.2-0.3% or €80-120 implied by the Baqaee-Farhi model. We should emphasize that this is an extreme scenario and we consider economic losses as predicted by the Baqaee-Farhi model to be the more likely outcome.

However, a prolonged isolation of Russia may not be sustainable for the world economy without serious long-term costs. Consider these

Russia ranks number one, two and three, respectively, among the world’s exporters of natural gas, oil and coal. Europe gets the bulk of its energy from its eastern neighbour. Russia also accounts for half of America’s uranium imports. It supplies a tenth of the world’s aluminium and copper, and a fifth of battery-grade nickel. Its dominance in precious metals such as palladium, key in the automotive and electronics industries, is even greater. It is also a crucial source of wheat and fertilisers.

Even though Russian commodity exports have not been banned, the commodity markets have been spooked after the invasion. 

See also this on the commodity market issues.

2. The Economist points to the TWATS phenomena among office workers in London - going into the office on Tuesdays, Wednesdays and Thursdays! It's reflected in the London Metro commute numbers.

3. The Economist has a crony capitalist index of countries.
Our index uses 25 years of data from Forbes’s annual stock-take of the world’s billionaires. In 2021 the publication listed 2,755 individuals with total estimated wealth of $13trn. We have classified the main source of each billionaire’s wealth into crony and non-crony sectors. Our crony sectors include a host of industries that are vulnerable to rent-seeking because of their proximity to the state, such as banking, casinos, defence, extractive industries and construction. We have aggregated the data according to billionaires’ country of citizenship expressed as a share of its GDP.

Interestingly, India's share of billionaire wealth from crony sectors has risen from 29% in 2016 to 43% by 2021!

4. The rise of digital payments in India

Putin is technically right when he says that Ukraine is not an ancient state. Most states, as we currently think of them, are relatively new. But although Ukraine is not ancient, Kyiv is — hence its importance to his project. Kievan Rus, a federation of mostly East Slavic peoples that was dominated by the city, existed from the 9th century. Kyiv was Russia’s first capital until Moscow was built. The western side of Ukraine, on the other hand, was part of the Habsburg Catholic empire and only incorporated into the Tsarist empire relatively recently.

6. Akash Prakash makes an important point about the Indian equity markets, which has seen a flight of $26 bn of foreign capital since October 2021. 

What has impressed me is the resilience of the markets. Sure we are down by 10 per cent this year, but so are global markets. If someone had told me 12 months ago that India would face Rs 200,000 crore of foreign selling in just six months and oil would be at $130, I would never have guessed that the rupee would be stable at 76-77 and markets down only 10 per cent. In 2008, in the face of far less absolute selling, markets fell by 72 per cent in dollar terms. Markets are telling us something. They are not going down beyond a point and are far more resilient than what one has seen historically. The strength and conviction of the domestic investor base is visible. Few people realise that from 2014 onwards, domestic institutions have actually invested more money into Indian equities than global players.

7. WSJ has a profile of former Bank of England economist, Charles Goodhart, who has predicted inflation in advanced economies to settle at 3-4% by end of 2022 and remain at that level for decades. He attributes this to demographics primarily, and also reversal of globalisation. He feels that the labour force will shrink, aging populations will spend more (especially on healthcare) than they'll save, and protectionism and reshoring will reduce the effects of global market places. The result will be higher wages, increase in prices, and reduced pool of savings. The combined effect will be higher inflation and interest rates. 

As labor becomes more scarce, he maintained, workers will push for higher wages, in turn driving up prices. At the same time, businesses will manufacture and invest more locally to help offset both labor shortages and the nationalist and geopolitical pressures curbing globalized supply chains. That will increase production costs and local workers’ bargaining power. Global savings will fall as older people consume more than they produce, spending particularly on healthcare. All that will push up interest rates, he predicted.

8. Putting the Chinese stock market collapse in recent days in perspective,

Now the entirety of publicly-listed Chinese tech is worth less than Amazon.

9. Interest rate trajectory in Brazil

Brazil’s central bank was already one of the world’s most hawkish, using a series of rate increases to lift its benchmark Selic interest rate from 2 per cent a year ago to 10.75 per cent last month. Economists expect the Selic to rise by a further 1 percentage point to 11.75 per cent on Wednesday, the highest level in five years. Now a survey by Valor, a business media group, of 91 economists’ projections released this week found that the median forecast for the Selic has risen to 12.75 per cent by the end of the year, as Russia’s war in Ukraine has triggered a surge in commodities prices, particularly in oil and agricultural products. This is an increase from the previous consensus of 12.25 per cent.

An increase of over six times over less than two years? 

10. The global stock markets staged a remarkable turnaround this week in the biggest weekly gains since late 2020. After being battered by the Russian invasion, rising inflation, and Chinese Covid resurgence, news that Russians and Ukrainians are talking, a senior Chinese official committed to supporting both the economy and the markets, and Fed's only 25 basis points hike have all been treated as worthy enough to support the turnaround. And all this despite continuing news of economic slowdown, even recession or stagflation, in Europe and US.

Stock markets have a narrative. Bad news comes >> Markets respond by pricing for the worst >> News turns out not as bad or some encouraging news emerges >> Markets respond by pricing for the best. Since optimism generates more positive buoyancy than pessimism generates negative sentiment, the net result is that markets keep moving up even amidst such despair! As the FT columnist Katie Martin wrote, "markets are all about how fears match up to reality, and everything could have been worse"!

Never mind, the global economic uncertainty is so much that OECD has even postponed the publication of its global economic outlook, the stock markets march on.

11. The Business Standard points to the problems faced by Employees Provident Fund Organisation (EPFO). The report notes that the share of state government bonds in EPFO's portfolio has risen from 26.39% in 2016-17 to 42.42% in 2020-21. 
The surge in state government paper comes as the gap widens between what subscribers get as returns for their money parked with EPFO and what the organisation can expect from debt markets—the yield on central government securities being one example. The gap between returns on 10-year central government securities and EPFO’s promised return to subscribers grew to its widest in almost a decade in 2020-21. State government securities typically offer higher interest rates. The difference between state and central government yields was at its highest in 11 years as of 2020-21.
The widening of gap between returns and committed payout is the problem!

12. Finally, Scott Galloway has an excellent post where he makes the distinction between money laundering and money washing. 
A common feature of kleptocracies is that they are unappealing places to spend money. A hundred million dollars in London, Paris, and St. Barts buys a better life than any amount of money will afford you in Riyadh. And you don’t obtain modern economy status with a mansion or a megayacht, but with courtside seats next to Kanye or a position on the board of MoMA. There are forms of washing everywhere. Anna Wintour sells prestige in the form of admittance to the Met Ball, via purchase of print ads in Vogue. Admission to elite society is for sale, but big spenders from autocracies require fabric softener before admission. Just like drug kingpins, oligarchs have money but can’t spend it. Enter the money washer. This is any jurisdiction with strong property rights, ample luxury goods, and a willingness to overlook origins. Also a society that accepts oligarch money for real estate, yachts, and midfielder salaries. 
Money laundering is done in secret, because it requires hiding the source of money. Money washing hides in plain sight, because that’s the point (appearances). Money washers merely ask the broader community to ignore the money’s origins. Money laundering experts outline three components: Placement (getting dirty money into the legitimate financial system), Layering (concealing its source through dishonest transactions), and Integration (making it available for spending). Money washing also has three components: Removal (getting kleptocash out of the kleptocracy), Enjoyment (converting dead money into a luxury lifestyle), and Elitism (entry into the elite cultural and political circles of the adopted country).
The key principle of washing is removal: getting money out of Russia (or Iran or Kuwait or Venezuela) and into the West — the American/European financial system. The first port of call for many oligarchs is a web of shell companies located in places including the Virgin Islands and the Caymans. This converts their cache into dollars and euros and removes it from the grasp of the kleptocracy back home, which could have a change of heart. But ultimately oligarchs want things, not numbers. Buying Western assets, vs. just shifting money into Western accounts, looks more like legitimate business activity, and the purchase can earn a return and garner Western prestige.

UK, which waxes indignation at Russians, have been the biggest beneficiaries of the Russian money washing. A non-trivial share of London's economic growth in recent years have been underwritten by wealth from kelptocracies. The US is only slightly less culpable.

Friday, March 18, 2022

A short recent history of Ukraine

While we are all focused on the trends in the war and the politics surrounding it, it may be useful to step back and examine Ukraine's recent history. Making my work simple, this FT article nicely captures a short post-2000 history of Ukraine,

Ukraine’s birth in 1991 was bloodless to the point of anticlimax: with the Soviet Union beginning to fray, parliament adopted a declaration of independence in August 1991 which was then endorsed by about 90 per cent of voters in a referendum. It was followed by years of dysfunction that unfolded in parallel with the post-Soviet transformation of Russia... Ukraine was also hobbled by a deep rift between the east of the country — largely Moscow-leaning, with a complex network of ethnic and cultural ties to Russia — and the more nationalistic, Ukrainian-speaking, pro-European west. In the post-independence era this split began to deepen, with fateful consequences for the whole country...
Then in 2004 the east-west cleavage triggered a massive political crisis that culminated in an event Ukrainians still call the Orange revolution. In that year’s presidential election, Viktor Yanukovych, a politician from the Russian-speaking east who was backed by Putin, defeated Viktor Yushchenko, a centrist supported by the centre and west of Ukraine. But mass protests over vote-rigging prompted a rerun of the ballot, which was this time won by Yushchenko. Yanukovych came to power anyway, in the 2010 elections. But the east-west tensions intensified and with them the debate about Ukraine’s future direction: should it aspire to be part of Europe or cling ever tighter to Russia? That unresolved question came to the fore in 2013 when Yanukovych unexpectedly pulled Ukraine out of a long-negotiated pact with the EU, triggering months of protests. He ended up fleeing Kyiv as Ukraine’s Revolution of Dignity swept the old order from power... in the chaos that ensued, Russia annexed Crimea and fomented a revolt in Ukraine’s eastern Donbas region, where pro-Kremlin separatists declared two breakaway statelets.
It's worth examining the country's post-independence economic history. Adam Tooze points to this stunning fact in very illuminating blog,
Ukraine’s performance between 1990 and 2017 was not just worse than its European neighbors. It was the fifth worst in the entire world. Between 1990 and 2017 there were all told only 18 countries with negative cumulative growth and even in that select group, Ukraine’s performance puts it in the bottom third. Amongst the four countries that delivered less growth for their citizens than Ukraine were the Democratic Republic of Congo, Burundi and Yemen... A self-determining country with Ukraine’s great human and natural resources, whose polity is fraught but not failed, has experienced a generational stagnation, not at the high level of income enjoyed by Italy, for instance, but at 20 percent below its late-Soviet level.

The IMF article blames it on a combination of low investment and declining population. 

Clearly, the country has been ravaged by civil wars and political instability since its independence. But things did not improve even under its pro-western leaders.  In fact, as the FT article shows, despite his current rightly deserved popularity, public trust personally in President Volodymyr Zelensky and in Ukrainian public institutions has been very low. In fact, as recently as July 2021, nearly 55% of population did not trust him, and less than 20% had any trust in him! Trust in critical public institutions is minimal or negligible. 

In light of these, it's hard not to feel that Ukraine has been Europe's failed state. This makes it all the more easier for the likes of Putin to meddle in the country's affairs. And this also means that, if a compromise happens and Russians pull back, one should be cautious about putting too much faith in President Zelensky's ability to create a new Ukraine. Zelensky's track record does not offer any confidence. Any western strategy towards Ukraine should keep this in mind - don't put all eggs in the Zelensky basket. 

As the FT writes, the invasion appears to have forged a remarkable unity across the country and boosted Ukrainian nationalism. The Russians clearly miscalculated the depth of Ukrainian nationalism, as opposition and anger at Russians have become all too evident even in Russian speaking cities like Kharkiv. Perhaps things may have been different if Ukraine had fallen quickly. But now with the prolonged nature, the horrific pictures of indiscriminate bombings, and the brave resistance by President Zelensky, any hopes Russia may have had of putting in place a stable pro-Russian regime has completely disappeared, not only for now but perhaps for at least a generation. Even if Kyiv falls, occupation will 

In fact, given where we are, it can be argued that it's perhaps in Russia's interest to ensure that Kyiv does not fall. The best scenario for Russia now would be to have President Zelensky continue in power with some compromise agreement which amends the Ukrainian constitution (which enshrines the country's aspiration to join NATO) and foreswears any formal military entanglement with the west. For if Kyiv falls and Russia has to install a regime to run the country, the occupation will have to be in the face of deep resistance and limited acquiescence, and will cost Russia an unaffordable cost. It can ruin Russia and put it back decades, both its economy and society. 

Thursday, March 17, 2022

The normalisation of sanctions in foreign policy

An important aspect of the response to the Russian invasion of Ukraine has been the use of co-ordinated sanctions of a comprehensive nature by the western countries. The west has clearly opted to pursue war through sanctions instead of military means. And I'm inclined to think that's the right way to respond to what clearly appears as a senseless and deplorable adventurism by President Vladimir Putin. 

But the use of sanctions, especially their wide range, raises important questions for countries like India. Once sanctions become the norm as an instrument of war, we're on a slippery slope. What actions can India take to mitigate, to the extent possible, from potential sanctions, especially of the economic kind?

First some data. The NYT has an excellent feature highlighting the findings of a Drexel University database on sanctions across the world. There are 1100  sanctions of various kinds currently in place.

The United States is responsible for the most sanctions cases, accounting for 42 percent of those in place since 1950, according to Drexel’s data. Next is the European Union, with 12 percent, and the United Nations, 7 percent.

While they cause definite pain and suffering, sanctions have had a mixed impact in realising their stated objectives. They find that about half the stated goals were at least partly achieved and about 35% completely achieved. 

Financial sanctions have emerged as the primary type of sanctions, thereby validating the view that sanctions are a new means to pursue war. US in particular has accelerated its use of such sanctions in the last twenty years.

This is another database at University of North Carolina at Chapel Hill on actual and threatened sanctions.

The emergence of sanctions should be an important concern for large countries like India whose interlinkages with the world are too many, deep and salient, and which face potential conflicts with the western world on issues like economic policy, labour mobility, and the environment. India will often need to chart out its own specific paths on important economic and social policy issues which will conflict with those of the western countries, thereby become vulnerable to being sanctioned by them. Therefore, given its prominence and widespread use, it's time for India's foreign policy establishment to take serious note. 

The weaponisation of SWIFT is in particular a matter to be noticed. It's a red line which has now been crossed, and therefore the threshold for its use henceforth will be lower. It virtually shuts a country off from transacting with the outside world through any mainstream approach or channel. In this context, India's near completely foreign owned private banking system should in particular be a matter of concern. It's time we put in place ownership restrictions on important plumbing financial institutions like banks. 

In the years ahead sanctions could likely to increase as a tool of economic policy management too. For example, as climate change hastens and we are faced with existential challenges, it's not inconceivable that developed countries force targets on the developing countries. Labour mobility too is an area where India's vulnerability is high. 

The deepening economic linkages with China, especially in terms of dependency on critical minerals and intermediate inputs in manufacturing, should be the matter of the greatest and the most immediate concern. The Ministry of External Affairs and the Department of Commerce in Government of India should put in place a continuous market surveillance mechanism (with granular industry-wise information on trade trends) to consolidate a list of all such trade-related vulnerabilities, especially with China. It should then engage with the industry by putting out quarterly (or some periodic) trade advisories, stakeholder meetings and consultations, facilitation and co-ordination with other GoI Ministries and State government to support industry, and policy advisories to central and state governments. Finally, trade policy should be tailored to respond to these advisories. 

The biggest problem with this strategy is the bootlegger and baptist risk of falling back into the clutches of vested interests and protectionism. The national interest safeguarding baptist policy maker could be used and captured by the protectionism seeking bootleggers to create and perpetuate vested interests.