Wednesday, April 27, 2022

Insights about how people think - Morgan Housel

Morgal Housel points to 17 insights about how people generally think:

1. Everyone belongs to a tribe and underestimates how influential that tribe is on their thinking.

2. What people present to the world is a tiny fraction of what’s going on inside their head.

3. Prediction is about probability and putting the odds of success in your favor. But observers mostly judge you in binary terms, right or wrong.

4. We are extrapolating machines in a world where nothing too good or too bad lasts indefinitely.
Good times plant the seeds of their destruction through complacency and leverage, and bad times plant the seeds of their turnaround through opportunity and panic-driven problem-solving.
5. There are limits to our sanity. Optimism and pessimism always overshoot because the only way to know the boundaries of either is to go a little bit past them.

6. Ignoring that people who think about the world in unique ways you like also think about the world in unique ways you won’t like.
Paul Graham put it this way: “Half the distinguishing qualities of the eminent are actually disadvantages.” Andrew Wilkinson says: “Most successful people are just a walking anxiety disorder harnessed for productivity.”
7. We are pushed toward maximizing efficiency in a way that leaves no room for error, despite room for error being the most important factor of long-term success.

8. The best story wins.
Not the best idea. Not the right answer. Just whoever tells a story that catches people’s attention and gets them to nod their heads.
9. We are swayed by complexity when simplicity is the real mark of intelligence and understanding.

10. Your willingness to believe a prediction is influenced by how much you want or need that prediction to be true.

11. It’s hard to empathize with other people’s beliefs if they’ve experienced parts of the world you have not.
The gap between how you feel as an outsider vs. how you feel when you’re experiencing something firsthand can be a mile wide.
12. An innocent denial of your own flaws, caused by the ability to justify your mistakes in your own head in a way you can’t do for others.
The question, “Why don’t you agree with me?” can have infinite answers... But usually a better question is, “What have you experienced that I haven’t that would make you believe what you do? And would I think about the world like you do if I experienced what you have?”
13. An underappreciation for how small things compound into extraordinary things.
The time, not the little changes, is what moves the needle. Take minuscule changes and compound them by 3.8 billion years and you get results that are indistinguishable from magic.
14. The gap between knowing what to do and actually getting people to do it can be enormous.
So we live in a world where solutions to problems can be shockingly simple but getting people to follow simple advice can be astoundingly difficult. Issac Asimov said, “Science gathers knowledge faster than society gathers wisdom,” which sums up a lot of things quite well.
15. We’re bad at imagining how change will feel because there’s no context in dreams.
If you think of your future self living in a new mansion, you imagine basking in splendor and everything feeling great. What’s easy to forget is that people in mansions can get the flu, have psoriasis, become embroiled in lawsuits, bicker with their spouses, are wracked with insecurity and annoyed with politicians – which in any given moment can supersede any joy that comes from material success. Future fortunes are imagined in a vacuum, but reality is always lived with the good and bad taken together, competing for attention.
16. We are blind to how fragile the world is due to a poor understanding of rare events.

17. The inability to accept hassle, nonsense, and inefficiency frustrates people who can’t accept how the world works.
If you recognize that Bull Shit is ubiquitous, then the question is not “How can I avoid all of it?” but, “What is the optimal amount to put up with so I can still function in a messy and imperfect world?”

A grocery store could eliminate theft by strip-searching every customer leaving the store. But then no one would shop there. So the optimal level of theft is never zero. You accept a certain level as an inevitable cost of progress. A unique skill, an underrated skill, is identifying the optimal amount of hassle and nonsense you should put up with to get ahead while getting along.

Monday, April 25, 2022

Capitalism, Mathew Effect, market failure, and increasing returns to scale

I have blogged on several occasions about certain disturbing features of modern free-market capitalism - widening inequality, business concentration, massive executive compensation, prioritisation of stock market returns, start-up valuation bubbles, efficiency maximisation at the cost of resilience, market bubbles and so on. The underlying dynamic behind each is the same. 

This post will point to four examples that highlight market failures arising from the inherent dynamics of free-market capitalism. 

The first example is about the labour market. In a recent paper, Renjie Bao, Jan De Loecker, and Jan Eeckhout identify the contribution of market power to the salaries of managers. They use a model of executive compensation where firms have market power and the market for managers is competitive, 

We identify two distinct channels that contribute to manager pay in the model: market power and firm size. Both increase the profitability of the firm, which makes managers more valuable as it increases their marginal product. Using data on executive compensation from Compustat, we quantitatively analyze how market power affects Manager Pay and how it changes over time. We attribute on average 45.8% of Manager Pay to market power, from 38.0% in 1994 to 48.8% in 2019. Over this period, market power accounts for 57.8% of growth. We also find there is a lot of heterogeneity within the distribution of managers. For the top managers, 80.3% of their pay in 2019 is due to market power... The best managers are lured by large, high markup firms where they create high profits for the shareholders, but disproportionately little additional value to the economy. The rise in the top 1 percent income is not only of concern on the grounds of equity, it is also of concern for efficiency...

Because of the complementarity between manager ability and firm productivity, the most productive firms can widen the gap even more by hiring a highly skilled manager. This increases their markups even further. The lower productive firms have low markups and hence have little to gain from hiring a superstar manager. Because there is competition for managers, all top firms in their own market who benefit from having a top manager will bid up the top wages. They are paid for increasing the gap between their direct competitors.

They conclude with an important general observation, 

Finally, the central mechanism that links market power to compensation is not restricted to man- agers. A superstar coder who improves an algorithm that is be used by a dominant tech firm for example, will command a superstar salary as her code will help her firm outperform competitors. And in the sports leagues, there is strategic interaction that derives from the zero-sum nature of sports com- petitions. The team that attracts the top players is more likely to win games, and this will make them bid up the compensation for the top players.

This finding builds on the large body of research on superstar effects that end up privileging incumbents in the market for executives. 

Eeckhout and Loecker have an earlier paper where they show how market power translates to price mark-ups in industries characterised by high levels of concentration among the top few producers.  

The second example is about the self-fulfilling nature growth of wealth itself. Consider this,

In his book “Capital in the Twenty-First Century,” the French economist Thomas Piketty notes that the new economic order has made it difficult for the superrich not to get richer: “Past a certain threshold,” he writes, “all large fortunes, whether inherited or entrepreneurial in origin, grow at extremely high rates, regardless of whether the owner of the fortune works or not.” He uses the examples of Bill Gates and Liliane Bettencourt, the heiress to the L’Oréal fortune. Bettencourt “never worked a day in her life,” Piketty writes, but her fortune and Gates’s each grew by an annual rate of about 13 percent from 1990 to 2010. “Once a fortune is established, the capital grows according to a dynamic of its own,” Piketty notes, adding that bigger fortunes tend to grow faster — no matter how extravagant, their owners’ living expenses are still such a small proportion of the returns that even more is left over for reinvestment.

People forget that there are at least two increasing returns to scale forces driving the rich towards getting richer. One, one's wealth or income is an important determinant in that person's risk appetite. So a very rich person has a very high risk appetite, and alongside a much higher risk opportunities. And the immensely rich have the opportunities to take several such risks, at least some of which will invariably strike gold. Second, there is the base effect - a doubling of 10 or 100 or 1000 is altogether different from a doubling of a million or billion in terms of their wealth effects. The result of these two forces (and enabling rules that tax the main income sources of the richest, capital gains, at a lower rate than that of the regular salaried earners) are that the rich by merely being rich find it difficult to not become richer, and that too at a pace much faster than those who are not similarly endowed. 

This dynamic works within markets too and manifest in the form of a resource misallocation problem. Left to the dynamics of the market, certain narrow or elite market segments which are lucrative for the producers end up cornering a disproportionate share of attention, investment, and innovation. The trickle down of market development takes an eternity to reach the mass market. The attraction of demand does not automatically translate to supply especially when a segment in that market offers much larger margins and is itself large enough to absorb the available supply of capital and entrepreneurs. The result is that outside of this small sliver, market development remains largely still-born.

The third example is about failures within markets. Consider the issue of affordable housing. I've blogged here, here, and here, highlighting it as among the most intractable of public policy challenges across the world. 

Sample this about the declining share of affordable housing loans in India. 

In absolute terms too, affordable housing loans have hit a hard rock

In April 2015, the priority sector home loans and the non-priority sector home loans both stood at Rs 3.2 trillion. After that, the non-priority home loans kept growing, whereas the priority home loans took a beating... In February 2020, the priority home loans peaked at Rs 5.2 trillion. Two years later, they stood at Rs 4.9 trillion. This primarily means that banks haven’t given out a single rupee of fresh priority home loans on a net basis during the last two years. So, banks aren’t financing many homes worth less than Rs 45 lakh in cities and less than Rs 30 lakh in other areas... In the last five years, lending to the non-priority sector has grown at 17.3% per year, which means it has more than doubled. In March 2017, the total loans had stood at Rs 4.9 trillion. By February 2022, they had jumped to Rs 10.9 trillion. During the same period, the priority home loans have increased from Rs 3.6 trillion to Rs 4.9 trillion.

The depressed supply of affordable housing in large markets like India is a good example of failures within markets. This applies just as much to markets offering services like affordable education and healthcare. In both, entrepreneurial efforts and capital gravitate to the top of the market, and even when they look beyond, they are confined to the mid-market segments. I recently blogged about medical education

Widely observed trends like the stagnation and decline of many cities and the rise and rise of a few very large metropolitan cities is a national-level macro trend that's similarly driven, at least partially, by the dynamic of modern capitalism.  

Finally, another area of market failure is the pervasive distortions engendered by efficiency maximisation to maximise profits, another issue on which I have blogged extensively. Left to itself, unfettered market competition drives businesses into an inexorable spiral of cost-cutting on everything that contributes to the production cost - inputs, logistics, shop-floor practices, suppliers, labour, capital cost, inventories, treasury management etc. The driver of cost-cutting is to eliminate any cost other than that required for effective daily operations - just-in-time management. Since efficiency maximisation seeks to eliminate any extra cost except that required for  buffers, insurances, and redundancies, it ends up eroding the system's resilience and capacity to absorb disruptions and shocks. 

Worse still, the cost-cutting mantra also extends to seeking opportunities to legally externalise costs while appropriating all benefits. An efficient firm seizes the opportunity to benefit from any legal and regulatory arbitrage. In fact, one could formulate a new firm theory of regulatory arbitrage - a firm's legal form and  practices are shaped by the laws and trends which imposes the least cost. So, if employee salary can be palmed off to social security and the tax payer OR if some of the costs can be outsourced away to a distant  and less visible location, then it's efficient management to do so. 

In the old economy, this was mostly about easily identifiable environmental pollution. Mobilising public indignation and controlling it was easy. Unfortunately, in the new tech-economy, it's diffused and shrouded in arcane legalese, all of which are essentially about shirking obligations in limiting social damage or shrinking market competition. Sample the debates surrounding publisher Vs content carrier (Facebook), employee Vs independent contractor (Uber), seller Vs platform (Amazon), private carrier Vs common carrier (App store) etc. In each of these, the old-economy firm doing substantially the same activity plays by a cost internalising rules of the game whereas the corresponding new economy firm is allowed to externalise those same costs. Worse still, the narrative has been spun such that the latter is lauded by opinion makers and rewarded by the markets for these same practices.

Morgan Housel had a recent blog post

We are pushed toward maximizing efficiency in a way that leaves no room for error, despite room for error being the most important factor of long-term success. The world is competitive. If you don’t exploit an opportunity your competition will. So opportunity is usually exploited to its fullest extent as soon as possible. That’s great – it pushes the world forward. But it has a nasty side effect: When all opportunity is exploited there is no room for error, and when there’s no room for error any system exposed to volatility and accident will eventually break.

These are only four illustrations. There are several markets in which this dynamic is today egregious - individual goods and services market segments, labour market for executives, stock markets, start-up funding, upmarket goods and services etc. They manifest in the form of business practices, salaries and compensation, capital gains, valuations, inequalities and so on.

Markets are not normative. They are agnostic to morals and values. In fact, for all practical purposes one could argue that they are completely transactional. They work through the instrument of price signals and the idea of marginal utility to maximise the material gains of agents. Accordingly, people and businesses prioritise the maximisation of their income or profit or wealth. These actions of individual agents over time engender a collective dynamic which most often (perhaps invariably) ends up serving the interests of those are already ahead (advantaged) while also penalising those who are already behind (or disadvantaged). Those who begin with an advantage increase their advantage whereas those who start with a disadvantage become more disadvantaged. The dynamic of capitalism ends up creating a Mathew Effect (Mathew 25:29) 

For to every one who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away.

In simple terms, the rich get richer and the poor poorer! 

In Econ 101speak, this can be described a case of increasing returns to scale. The more advantaged become even more advantaged and entrenched in their markets. The very nature of the market dynamics invariably creates conditions that become entry barriers by themselves and thereby stifle competition and distort incentives.  

The most damaging consequence of these trends is that it seriously erodes the social contract. Once a group or interest becomes entrenched, it ends up capturing the political system itself. In even the most robust democracies, all the arms of the government get directly or indirectly captured. They then effectively control the rule-making process itself. They get to set the rules of the game. See this and this

The rules of the game of modern capitalism and political systems favour the larger firms disproportionately. The taxation regime (corporate tax, capital gains/buybacks, tax deductibility on interest expenses etc), ease of financing (lower cost of capital for the largest firms), the public bailout backstop (too big to fail), public policy dominance of stock markets health over that of real markets, and so on are examples. Most disturbingly, the setting of these rules themselves are captured by the same elite companies. And therein lies the risk to the sustainability of modern capitalism.

Update 1 (29.04.2022)

FT long read on the acute scarcity of rental housing in the western cities. This about Berlin and housing affordability concerns posed by financialisation,
“Berlin is the new New York: everybody wants to live there,” she says. “And the city never had a co-ordinated land policy in response. Public procurement rules push local government land sales to the highest bidders, often those building the most expensive homes, ignoring the lower bids from not-for-profit associations providing affordable rental housing.” The growing popularity of rental housing to investors is not confined to Berlin. New money flowing into Europe’s rental sector from institutions such as pension funds and insurance companies worldwide increased from $75bn in 2019 to $124bn in 2021; in the US it increased from $193bn to $350bn, according to Real Capital Analytics, a real estate data company. Leilani Farha, a housing campaigner who was UN special rapporteur on the right to adequate housing until 2020, is worried about the social impact of the “financialisation” of housing in this way. She says investment funds are ill suited to owning homes: the need to generate returns for investors must either jack up rents or cut their maintenance costs; either way tenants lose out. In many cases, investors target affordable housing schemes in the US and Europe where people are especially sensitive to price rises. “When you’re a pension fund you’re just looking for a good return,” she says. “Favourable conditions for investors and real estate professionals will not work for tenants.”

Saturday, April 23, 2022

Weekend reading links

1. From Japan Times

... in many parts of Japan... the number of akiya (abandoned buildings) swells to worrying levels nationwide. In 2018, these structures — the result of unsustainable growth for several decades followed by sharp demographic decline — totaled 8.5 million units, or 14% of Japan’s overall housing stock, according to government figures. The Nomura Research Institute has estimated that this figure could exceed 30% by 2033. According to government statistics, the total combined area of uninhabited properties in Japan is greater than the area of land on the island of Kyushu.

2. FT writes how the Russian invasion has united the west. 

3. Interesting question about reviving nuclear power generation in Germany,

With sanctions against Russia likely to disrupt Germany’s energy supply, why, asked MP Marc Bernhard, couldn’t Berlin just restart its mothballed nuclear power stations? “If we reactivate the three plants that were switched off last December they could, together with the three that are still operating, replace all the coal we import from Russia or 30 per cent of the Russian gas,” the Alternative for Germany MP told Olaf Scholz, Germany’s chancellor, in the Bundestag earlier this month.

Clearly the answer in the negative is a measure of the political opposition to nuclear power in the country.

4. Martin Sandbu urges caution at excessive monetary tightening by the Fed. He points to the sectoral shift in consumption away from services (which continues to remain depressed) and towards consumer durables and non-durables, and the need for reallocation away from certain sectors. In this context, he argues for caution with monetary policy,

A recent paper by Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub and Iván Werning shows that if keeping interest rates low makes reallocating resources easier, the optimal stance for a central bank is looser than it would otherwise be. Thus, if it is clear that labour and capital must move from one sector to another — and the faster the better — how can it possibly be right to tighten monetary policy, making investments in new capacity both more expensive and less attractive as demand growth slows... Since insufficient reallocation means lower productive potential in the future than could otherwise be had, it also means an overzealous fight against inflation today will either raise inflation in the future or increase the cost of keeping it low. What these questions together amount to can be put more simply. Today a pandemic, a war and a climate crisis all necessitate huge structural shifts — which may themselves maximise potential productivity and minimise long-term inflationary pressures. In such a situation, how could it be right for central banks to delay investment and jobs growth, and with them the needed reallocations?

5. Is Rajapaksa family in Sri Lanka peak-nepotism?

Before the current crisis, members of the Rajapaksa family headed up a third of Sri Lanka’s 28 ministries, including Mahinda as prime minister, a brother Basil in charge of finance and another brother Chamal holding the irrigation portfolio.

6. FT highlights Germany's reliance on Russia to meet its energy needs

This is an excellent summary of the events that have led to this level of dependence on Russian energy.
As Germany’s energy policy shifted, it grew ever more reliant on Russian gas. Under former chancellor Angela Merkel, Berlin decided to phase out nuclear power in 2011 and later also moved to close all of the country’s remaining coal-fired power stations. Yet with the buildout of renewables stalling, gas as a bridge fuel to a low-carbon future began to loom even larger in the energy mix. “In the last 20 years we have shut down every alternative,” says Birnbaum. “The Germans didn’t want anything . . . no hard coal, no lignite, no nuclear, and all of a sudden we were overdependent [on Russia].” Even as Russia invaded Georgia, intervened in Syria, annexed the Crimean peninsula and fomented a separatist war in eastern Ukraine, Germany continued to expand its energy partnership with Russia. Not only did Merkel’s government back the Nord Stream 2 pipeline to increase the flow of Russian gas pumped directly to Germany across the Baltic Sea, it also stood by as key pieces of Germany’s energy infrastructure were snapped up by Kremlin-controlled companies. One example is the PCK oil refinery in the east German town of Schwedt that is now owned by Rosneft; another, Rehden, western Europe’s largest gas storage facility, is owned by Gazprom. Both acquisitions occurred after Russia invaded Crimea. Meanwhile, Berlin took decisions that locked it into Russian supplies of gas for decades to come, to the exclusion of other sources. The Nord Stream 1 and 2 pipelines destroyed the business case for building import terminals for liquefied natural gas, which would have allowed Germany to diversify its energy inflows.

7.  This is an excellent graphical feature on European dependence on Russian natural gas.

And this on how much of it can be substituted in the short-term.

8. Interesting point about football club ownership in Germany. the 50+1 rule.

In short, it means that clubs – and, by extension, the fans - hold a majority of their own voting rights. Under German Football League [DFL] rules, football clubs will not be allowed to play in the Bundesliga if commercial investors have more than a 49 percent stake. In essence, this means that private investors cannot take over clubs and potentially push through measures that prioritise profit over the wishes of supporters. The ruling simultaneously protects against reckless owners and safeguards the democratic customs of German clubs.

9. There is a lot of evidence to suggest that road widenings and lane additions do not reduce congestion, but creates induced (or generated) demand which worsen congestion. The latest from Todd Litman,

Traffic congestion tends to maintain equilibrium; traffic volumes increase until congestion delays discourage additional peak-period trips. If road capacity expands, peak-period trips increase until congestion again limits further traffic growth. The additional travel is called “generated traffic.” Generated traffic consists of diverted traffic (trips shifted in time, route and destination), and induced vehicle travel (shifts from other modes, longer trips and new vehicle trips). Generated traffic often fills a significant portion of capacity added to congested urban road.

This is a good article in the Times about how Portland, Oregon, one of the leaders in transport planning and promotion of biking and reducing vehicle commutes in the US, is grappling with the issue of whether to add more roads. And it's struggling to curb car growth and their usage.

The highway expansions in Portland illustrate a nationwide truth: Cities, even those with big climate ambitions, don’t always control their own destiny when it comes to transportation. In Texas, the city of Austin plans to invest billions of dollars in a new light rail system. But at the same time, the state is pushing ahead with a $5 billion plan to add four lanes to Interstate 35 through downtown. In Illinois and Washington, state officials are eyeing highway widening projects around Chicago and Seattle even as they set goals for slashing greenhouse gas emissions. Opponents of these projects say traffic can be more effectively managed with tools like congestion pricing, which involves charging fees during peak travel periods, in order to discourage some trips. But others say highway expansions are hard to avoid.

10. Good graphical presentation that puts inflation in the US in perspective. US 10-year Treasury yields are kissing the 3% threshold. 

11. Times long read on how farmers in the US are being impacted by the supply chain disruptions. As shipping containers become extremely scarce in supply, farmers are left struggling to transport produce which has already been purchased by foreign buyers - 1.1 billion pounds of almonds from last year's harvest are sitting in Californian warehouses. As demand for imports from China rises, shipping companies prefer to transport empty containers back to China instead of waiting to pick up goods from US ports. 

This about almonds and California,

Every year, California farmers produce more than three billion pounds of almonds, or about 80 percent of the world’s supply. Nearly all those nuts are harvested on more than 6,000 farms in the Central Valley — a flat, arid zone characterized by relentless sunshine, furnace-like summer heat and some of the most prodigious soils on earth.

12. Aaron Brown in Bloomberg points to an area of growth in US college admissions amidst the general trend of falling admission rates since 2010. 

There is one post-secondary educational sector with gangbuster growth. Enrollment in two-year agricultural sciences degrees rose 41% in 2021. Other hot two-year degrees include construction management - up 18% - while blue-collar technical fields are up an average of 7%... The students in these programs are usually working in their fields of study and looking for advanced instruction in theory and broader business skills so they can move up to management jobs or start their own businesses, taking positions that in the past would likely have been held by four-year college graduates without specific training... students in two-year programs making up about a third of all post-secondary students.

He makes an important point about the role of such education in driving innovation, job creation, and even fostering an equitable society,

Traditional thinking was that blue-collar workers learned rote skills and had to be protected from innovation. White collar workers were supposed to have general skills that could adapt to change, and professionals were the ones who could cause change and exploit its opportunities. But the experience of the last few decades seems to indicate that it was white-collar workers — mainly with college degrees in non-job-specific fields — who lost out to innovation, while blue-collar experience was more readily transported to fast-changing fields. In many cases it was former blue-collar workers and college dropouts driving change, not elite professionals with graduate degrees...

Many people view a traditional four-year liberal arts degree — without a focus on job training — as a cornerstone of an educated citizenry... Some people will demand political fixes to increase four-year liberal arts enrollments, particularly among non-Whites. But perhaps a more egalitarian and progressive stance is to instead to encourage two-year technical degrees that lead to more small business formation, more company promotions from within and a more diverse upper-middle class. Running a business or managing a team of people engaged in technical work may represent a form of education as valuable to society as a four-year degree in literature or sociology. Of course, society needs both, but maybe we overinvested in the latter and underinvested in the former. 

Wednesday, April 20, 2022

Macquarie buys out UK gas business

Even as the perils of one monopolist becomes all too evident in the natural gas market, the British may well be entering into the clutches of another monopolist. 

FT reports that the Australian  infrastructure fund, Macquarie have teamed up with British Columbia Investment to buy a controlling stake of 60% in the UK National Grid's gas transmission and metering business for £4.2 billion (with £3.8 bn of that coming as debt). It involves taking over 7660 km of pipes transporting gas to heat homes and power industry and electricity generation across Britain, and also has an option to take over the remaining 40% stake of NatGrid. Macquarie, through a consortium of Qatari and Chinese SWFs, already owns Cadent, which runs half of the eight local distribution networks after buying them from Nat Grid for £5.4 bn in 2017.

Some observations:

1. Macquarie appears to have got an attractive deal. It has got control over a very stable and low-risk revenue generating asset with enterprise value of £9.6 bn by putting in just £400 million in equity. It has to make this equity sweat and maximise its returns over the coming years. 

2. Macquarie is big into UK utilities infrastructure, having spent about £50 bn on UK utility infrastructure over the past 15 years. It has investments in water, sewerage, electricity, gas, telecoms, airports, and railways. Irrespective of the well-documented problems associated with private equity investments in infrastructure, this is big money and such investors are the biggest sources of mobilising private capital into infrastructure. Given this, it's important to get contract structuring and market regulation right, failing which more of business as usual controversies on debt-loading, investment skimping, asset stripping and dividend payouts will follow. 

3. Apart from its gas investments, Macquarie is also bidding with KKR to buy Britain's largest electricity distributor UK Power Networks which transmits electricity to 8.3 m consumers in the south and east of England. Clearly Macquarie is not being put off by scaremongering about fossil fuel assets. It's assessments about the future of energy transition and commercial risks of fossil fuel does not appear to warrant shunning them. 

4. The National Grid appears to have been short-sighted in pursuing a strategic policy to exit fossil fuels and invest in renewables. This is not an either or situation, the likes of NatGrid should do both. 

It's ironical that even as public companies like NatGrid in UK (and NTPC in India) are exiting fossil fuels, the biggest infra funds are flocking into it. Clearly Macquarie knows what it's getting into. If it thinks fossil fuels continue to be promising enough, don't know what public companies know better to make them shun fossil fuels. This is a reminder for India's power companies to make realistic decisions about their power sector investments and not be led by blind ideologies.  

Monday, April 18, 2022

Private capital update 2021

Bain and McKinsey have their versions of the private market reviews of 2022.

1. Private markets fund-raising recovered by nearly 20% to reach its highest level ever in 2021, with North America and Europe making up more than four-fifths.

2. Private equity, real estate and private debt dominate the sectoral allocation, whereas infrastructure is a very small proportion.

3. Infrastructure forms a really tiny share of the private capital dry powder.
4. Global private capital raised each year is dominated by buyout funds.
5. The total assets under management too mimic these annual trends on destinations and the types of private capital. Buyout, venture capital, and growth investments are the major sources of PE in particular and also private capital flows in general. 
6. Private equity remained the highest earning asset class. Notice that infrastructure is among the lowest earners.

7. The median performing private equity funds have done better than the best funds in real estate or infrastructure.  
8. In terms of returns, venture capital, growth, and buyout funds have returned the highest, and infrastructure the lowest. VC has outpaced the other PE categories in eight of the last ten years.
9. Private equity which made up nearly 60% of the global private capital flows, is dominated by services, energy and healthcare. There is very little of private capital going into areas like manufacturing, thereby revealing the preference for high growth or high valuation sectors.

10. Global infrastructure and natural resources fund raising too recovered and peaked in 2021. However, as seen from the graphic, just $7 bn out of the $137 bn went into Asia (or $119 bn out of $137 bn went to North America and Europe).
11. Within infrastructure too, the vast majority was made up of energy, traditional transport, and telecommunications.
12. Assets under management of private capital in Asia has been growing fast.
The vast majority of these are in technology sector, and there too in e-commerce, software, and online services. 

Saturday, April 16, 2022

Weekend reading links

1. Food inflation illustrated through BLT sandwich. 

War in Ukraine and the resetting of supply chains following pandemic lockdowns mean prices for the ingredients in one of the UK’s most popular sandwiches — the BLT (bacon, lettuce and tomato) — are up by 56 per cent on average since 1 January 2019, according to data compiled by commodity research group Mintec and the Financial Times. That rise is led by a huge spike in the price of sunflower oil, of which Ukraine is the world’s largest exporter. But prices for other ingredients are also surging: wheat and tomatoes have each increased by 63 per cent since the start of 2019, while the cost of lettuce has increased by nearly a quarter. Pork is the only ingredient to have remained level. Food manufacturers and retailers say they have never had to contend with such a rapid surge in all of their input costs. The sandwich, whose assembly and distribution requires fresh ingredients, large factories, labour and prompt, chilled transport, is emblematic of the struggle they face.

2. Branko Milanovic on global inequality reduction prospects,
So if we really want to continue with global inequality reduction, leaving Covid aside for the moment, we need to count on India growing fast and Africa growing very fast. When you translate that into growth rates that are needed for Africa to achieve this, these per capita growth rates are 4 or 5 per cent, which means 6 to 7 per cent overall for the GDP, or even 8 per cent. These are not growth rates that African countries have historically been able to sustain over a ten-year period, much less over a 20-year period. So I became relatively pessimistic about the ability to maintain the trend of declining global inequality.

3. Good explainer by Vivek Kaul in Livemint of US dollar as a reserve currency.

4. Interesting data on autocracies and economic growth from Ruchir Sharma

Looking back in 150 countries to 1950, autocracies account for 35 of the 43 cases in which a nation sustained gross domestic product growth of more than 7 per cent for a decade. However, autocracies also account for 100 of the 138 cases in which a country grew a full decade at slower than 3 per cent — a rate that feels like a recession in a developing country. In extreme cases, 36 countries have been whipsawed for decades by swings between years of rapid growth and years of negative growth: 75 per cent of those were autocracies, many in petro states such as Nigeria, Iran, Syria and Iraq.

5. After all the reforms, the power sector is no better off today. The Business Standard reports that the amount owed by discoms to power producers touched a new high of Rs 1.05 trillion in April 2022 a 20.4% rise over the last two years. Further, 21 out of 34 states and UTs recorded a rise in overdues in that time. 

It's also reported that the overdues position worsened for private producers, whose share of over dues rose from 46% to 55.7%. 

And this is important,
The number of disputes raised by discoms also doubled from Rs 13,576 crore to Rs 25,129 crore. Independent power producers accounted for 80 per cent of the disputed amount owed by discoms.

Thinking aloud here. Why should there not be a merit order for payment of producers dues where private producers are given preferential treatment? After all, those are sovereign contracts of the government. 

6. Importance of gold in the savings basket of middle-class Indians

And this is important,

The consumption, IGPC said, was not affected by demonetisation or goods and service tax (GST) implementation. In the last five years, at least 74 per cent of the households confirmed buying gold with 90 per cent of such households preferring to make the payment in cash while buying the yellow metal, IGPC said.

7. In a welcome step, the Telecom Regulatory Authority of India (TRAI) has recommended a 36% cut in the 5G spectrum auction base prices. However, the industry associations are demanding even further cuts. It's reported that 5G spectrum prices in India are 2.6, 3.8, and 4.4 times higher than that in Germany, UK, and South Korea respectively. 

This raises the classic auctions challenge. How do we reconcile the classic auctions dilemma of reconciling the conflicting risks of leaving money on the table with that of winner's curse? One way would be to have something of a two-tier spectrum pricing - a low base-price, and an increasing block spectrum fee levied on some easily observed and difficult to manipulate commercial parameter (say, like ARPU). This would ensure that the operator is not burdened with the high upfront costs and the government retains its claim on higher profits. 

8. As the French Presidential election hots up FT has a graphic which captures the respective bases of Macron and Le Pen.

9. Fascinating article on the ageing crisis gripping Japan. Large numbers of business owners without heirs face the prospect of their business closing down after they die. 
According to recent government figures, the single biggest cohort of business owners in Japan are 69-year-olds. Demographics have long posed huge challenges to the country’s rapidly shrinking and ageing population. But the national shortage of heirs was largely overlooked. Two years of pandemic restrictions have deepened the sense of urgency. Many owners in their mid-seventies have chosen to accelerate plans to either hand over control or watch their cherished firms disappear. As a consequence, Japan faces what some fear could be the most extensive evaporation of knowhow and institutional memory in modern history. The effect on the country will, Ohashi fears, be huge since so much of Japan’s culture is embedded in its businesses and the skills they have amassed between them. The idea that the country could somehow allow all this to disappear, and that the process may even alienate parents from children, is a source of national sorrow...

Decades of stellar postwar economic growth helped create a large, university-educated workforce. These younger generations have been a source of enormous pride to their parents, but in a culture that has long emphasised filial piety and family cohesion, their determination to turn their backs on the family business has brought disappointment too. Many children of baby boomers have moved into cities and have no interest in taking over the small factories or repair shops started by their parents in their now-depopulating hometowns. More than 40,000 small firms a year are in need of a successor, government data shows.

10. As public support for it rises, Finland and Sweden are contemplating joining NATO. This is another example of how the invasion has rebounded on Russia.

11. AK Bhattacharya has an assessment of the tax revenues trends of government of India. 

12. Good presentation by Eileen Applebaum on the impact of Private Equity investments in businesses. This on PE practices in the US health care sector.  

13. Harish Damodaran writes about the rising fertiliser prices and how the subsidy regime hinders its availability in the Indian market. In case of urea, India produces 24-24 mt out of annual consumption of 34-35 mt and while it's sold at an administered MRP of Rs 5360 per tonne, companies are fully compensated for any import or manufacturing cost differential. However, in case of DAP, MOP, and NPKS, while the MRPs are decontrolled in theory and the subsidy is limited to a fixed per-tonne subsidy based on nutrient content, in practice companies are not allowed to freely set MRPs.

DAP, MOP and the popular ’20:20:0:13′ NPKS fertiliser are currently being retailed at Rs 27,000, Rs 34,000 and Rs 28,000 per tonne, respectively. Companies are further getting per-tonne concessions of Rs 33,000, Rs 6,070 and Rs 15,131, respectively, on these fertilisers — translating into a gross realisation of Rs 60,000, Rs 40,070 and Rs 43,131, respectively. According to the industry, these realisations are too low to manufacture or import at today’s international prices. The quoted price (cost plus freight) of DAP imported to India is about $1,250 (Rs 95,000) per tonne — it is $700-750 (Rs 53,200-57,000) per tonne for MOP and $780 (Rs 59,280) per tonne for ‘20:20:0:13’. The gross realisations, thus, don’t cover even the landed cost of imports.

14. Robots policing Covid lockdown in Shanghai,

Preserved Egg roams Shanghai’s empty streets with a megaphone strapped to its back. The robot dog is about the size of a terrier and barks orders to residents: stay inside, wash your hands, check your temperature.

15. Finally, Scott Galloway has a great post where he highlights how today's business winners tries to keep out competitors once they are on the pole position. 

Nothing threatens today’s competition more than yesterday’s winners... Today’s largest companies offer a masterclass in anticompetitive behavior. Amazon bars sellers on its platform from offering lower prices elsewhere, then uses the information it gleans from them to design and market its own, lower-priced products. It gives favorable search results placement to vendors that use Amazon fulfillment services (for which it’s been fined $1.3 billion by the Italian government). Defenders of the company say this is all business as usual … yet Amazon lied to Congress, repeatedly, about all of it.

Apple takes a 30% cut of app revenue, which it says it needs to run the app store, but it books billions in profit instead of cleaning up obvious frauds or copycats, while giving preference to its own products over competitors. (Can you get your iPhone to stop trying to play music through Apple Music instead of Spotify?) Microsoft charges more for its applications when users run them on a competing cloud provider. Google doesn’t merely sit on both sides of the digital advertising negotiation, it owns the negotiating table. And Facebook has stated that it acquired Instagram to eliminate a competitor.

This is a great snippet which exposes the reality of Big Tech collusion,

In the 2000s tech titans conspired to suppress competition for employees. For example, when Steve Jobs learned that Google was recruiting an Apple engineer in 2007, he emailed CEO Eric Schmidt: “I would be very pleased if your recruiting department would stop doing this.” Schmidt forwarded the email to an underling: “Can you get this stopped and let me know why this is happening?” He was told the recruiter would be “terminated within the hour” and to “please extend my apologies as appropriate to Steve Jobs.” Then a Google SVP chimed in: “Please make a public example of this termination with the group.” (We only know about Jobs and Schmidt channeling their inner Rockefellers thanks to a class action lawsuit former employees brought against the companies, which led to a $415 million settlement.)

Friday, April 15, 2022

Thomas Piketty interview

There is an excellent Thomas Piketty interview in the Times where he makes several interesting points.

On how those who frame the rules of the economy themselves represent the interests of the well-off,  

The Supreme Court for decades made it impossible to create a progressive income tax. They were fine with the racial segregation, but having a progressive income tax was unconstitutional. In the end, it took 20 years to change the Constitution, but then it happened and contributed to reduced inequality. The 16th Amendment, allowing for the levy of federal income tax, was passed by Congress in 1909 in response to an 1895 Supreme Court ruling striking down an income tax. The amendment was ratified into law in 1913.

What are widely accepted practices or norms need not always have been the case. Interesting example about Sweden, 

Sweden until 1910, 1920 was one of the most unequal countries in the world, with a special sophistication in the way inequality was organized. You could have between one and 100 votes, depending on the size of your wealth. This rule, which varied by municipality, excluded all women and approximately 80 percent of men from voting. Even corporations had the right to vote in municipal elections in Sweden until 1910. Sweden was like this but then moved to something else.

About the shockingly regressive nature of taxation in the US,

According to that ProPublica investigation of 2021, the 25 richest Americans paid federal income tax at what amounted to a rate of 3.4 percent. That’s compared with a rate of 14 percent for those American households making the median income of roughly $70,000.
He debunks supply-side economics by pointing to conclusive evidence about its outcomes,
The evidence that we have is that if you take the United States, the growth rate of national income per capita has been divided by two following the Reagan decade. It’s been a little more than 1 to 1.2 percent per year — the national income per capita real growth rate between 1990 and 2020. It used to be more than 2, 2.5 percent between 1950 and 1980. The tax performance in the Reagan decade was supposed to boost growth: Maybe you would have more inequality, but the size of the pie is going to grow so much faster than before that the average wages and income of average Americans will grow like you’ve never seen. This is not what we’ve seen.

The big lesson from this is that the period of maximum prosperity of the U.S. economy in the middle of the century was a period where you had a top income-tax rate of 90 percent, 80 percent, and this was not a problem because income gaps of 1 to 100 or 1 to 200 are not necessary for growth. That is, the top marginal income-tax rate, which peaked in the United States at 94 percent in 1944. From 1932 to 1980, the average top rate was 81 percent. Between 1980 and 2020, the marginal tax rate applied to the highest incomes was, on average, 39 percent.

He talks about the importance of education for economic prosperity,

The key reason the U.S. economy was so productive historically in the middle of the 20th century was because of a huge educational advance over Europe. In the 1950s, you have 90 percent of the young generation going to high school in the U.S. At the same time, it’s 20 to 30 percent in Germany, France, Britain, Japan... There is compelling correlation between income inequality and education: Researchers have found that there is a little more than a 30 percent probability of gaining entrance to an institution of higher learning for young adult Americans whose parents’ incomes are within the bottom 10 percent. That probability rises to 90 percent for children whose parents’ incomes are within the top 10 percent... The story that Reagan tried to tell the country in the ’80s, which is basically forget about equality, the key to prosperity is to let the top become richer and richer — it doesn’t work.

Finally, about oligarchs in the US,

To me, maybe the best comparison between the U.S. is not so much with Russia today but with Europe and the Belle Époque before 1914: a system which is nominally democratic but where the concentration of wealth is so high and lacking proper rules about political finance, political influence, that the democratic system is not enabled to have a common-sense reaction to this excessive level of inequality that, in the long run, is not good for U.S. prosperity.

Thursday, April 14, 2022

Inequality, Billionaires and stealth politics in the US

The NYT Weekend magazine recently covered the issue of inequality in the United States.  

This is an excellent illustration that puts in perspective the extraordinary wealth of Jeff Bezos in the form of nine different ways to view it.

I have blogged here separately about this interview of Thomas Piketty, the foremost chronicler of inequality of our times.  

This on the endurance of the Horatio Alger articulated narrative on the realisation of the American dream,

Perhaps no cultural figure helped to keep the American dream on life support longer than Horatio Alger, the 19th-century novelist who wrote adventure stories for boys. Alger commanded enormous popularity in his time, and his novels became integral to the enduring fantasy of American egalitarianism. His name is synonymous with the “rags to riches” narrative we seem unable to relinquish... 

Today, whether or not they realize it, the wealthy tell the stories of their lives — and our class structure — within the framework that Alger articulated. They all cast themselves as scrappy entrepreneurs who start at the bottom, climb to the top and step into a benefactor role, transforming from Ragged Dicks into versions of Mr. Whitney. Rather than memoir, the autobiographies of billionaires are couched as business advice, self-help, policy prescriptions or even quasi-religious texts, all united by an Alger-inflected fantasy of class mobility that is increasingly imperiled, often by the political agendas of the very billionaires writing these books.

This on the rise of billionaires,

In the 1950s, the economist Simon Kuznets popularized the idea that inequality was an unfortunate but self-regulating side effect of economic growth; whenever it got too high, Kuznets reasoned, the political process would rein it in. This was known as the Kuznets curve, a parabola that showed inequality soaring before being slowly brought back to Earth through redistribution. Kuznets believed that the richest societies would eventually be the most equal. 

But in the last 12 years, the American political system has delivered Citizens United, a top marginal tax rate of 37 percent (down from a high of 94 percent in Kuznets’s day) and a billionaire president openly hostile to the democratic process — along with 332 new billionaires. The Kuznets curve has fallen out of favor, too, replaced by something called the Kuznets wave, which shows successive peaks and valleys of inequality. Branko Milanovic, the economist who put forward this revised model, thinks it might take at least a generation to tamp down the current peak.

And the nature of the modern knowledge-based economy,

This shift to a highly financialized, postindustrial economy was helped along by the Reagan administration, which deregulated banking, cut the top income tax rate to 28 percent from 70 percent and took aim at organized labor — a political scapegoat for the sluggish, inflationary economy of the ’70s. Computer technology and the rise of the developing world would amplify and accelerate all these trends, turning the United States into a sort of frontal cortex for the globalizing economy. Just as important, the tech revolution created new ways for entrepreneurs to amass enormous fortunes: Software is by no means cheap to develop, but it requires fewer workers and less fixed investment, and can be reproduced and shipped around the world instantaneously and at practically no cost. Consider that the powerhouse of 20th-century capitalism, Ford Motors, now employs about 183,000 people and has a market capitalization close to $68 billion; Google employs about 156,000 people and has a market cap of around $1.8 trillion. This new economy would be run by, and for, knowledge workers, who would reap most of the gains, and therefore have more money to spend on services — a sector that would come to sort of, but never fully, replace the manufacturing this transformation did away with.

And wealth accumulation in that economy, of a capitalism that's dominated by asset price appreciation, 

That is, an economy in which the rising price of assets — stocks, bonds, real estate — would be, somewhat counterintuitively, a fuel for economic growth. It has been a good time, in other words, to own a lot of assets. And owning assets is mostly what billionaires do. In his book “Capital in the Twenty-First Century,” the French economist Thomas Piketty notes that the new economic order has made it difficult for the superrich not to get richer: “Past a certain threshold,” he writes, “all large fortunes, whether inherited or entrepreneurial in origin, grow at extremely high rates, regardless of whether the owner of the fortune works or not.” He uses the examples of Bill Gates and Liliane Bettencourt, the heiress to the L’Oréal fortune. Bettencourt “never worked a day in her life,” Piketty writes, but her fortune and Gates’s each grew by an annual rate of about 13 percent from 1990 to 2010. “Once a fortune is established, the capital grows according to a dynamic of its own,” Piketty notes, adding that bigger fortunes tend to grow faster — no matter how extravagant, their owners’ living expenses are still such a small proportion of the returns that even more is left over for reinvestment.

Jaime Lowe writes about the influence the rich wield on the American political system and their practice of "stealth politics", which involves actively working behind the scenes to shape government policies. He draws on the work of Benjamin Page, Jason Seawright, and Matthew Lacombe who have investigated the impact of the superrich Americans on congressional and presidential policies. 

Much of the “stealth politics” practiced by America’s ultrarich is happening at the state and local levels, where many crucial pocketbook issues are decided, often outside the scrutiny of the national media. In some states, that has meant a reduction in the pensions and collective bargaining rights of public-sector workers and the rejection of Medicaid extensions... David Koch invested heavily in conservative causes for decades before his death in 2019. He and his brother Charles recognized the importance of exercising influence in state legislatures and city councils. “That’s where voting rules are established,” Lacombe says. “That’s where congressional districts are drawn. So, a lot of the sort of rules of the game are established on those levels.”.. “A lot of really wealthy Americans probably can pick up the phone and talk to somebody on a high-level position in Washington pretty much anytime,” Page says.

Benjamin Page on the American version of oligarchs,

“The evidence has piled up in such a way that it’s maybe not unreasonable to call some of America’s wealthiest people oligarchs. I think that’s the way I’d put it.” He pauses. “Lots of evidence.” What makes American oligarchy different from its Russian counterpart is that it operates at significantly greater arm’s length, driven by lobbying and campaign contributions rather than outright corruption... Page acknowledges that American oligarchy is different — it is embedded in the political system.

Finally, some numbers on campaign finance in the US,

Multimillionaires who made political contributions gave on average around $4,500 annually; for billionaires, the amount was $500,000... Among Americans overall, roughly 18 percent make political donations, usually in amounts between $25 and $100. Forty percent of all political donations come from the top 1 percent of the 1 percent.

The landmark work in the area of impact wealth and political influence is by Martin Gilens, who used years of survey data to show that policy makers responded almost exclusively to the preferences of the affluent Americans.

Tuesday, April 12, 2022

The failure of autonomy - case study of IIMs

TT Rammohan has an oped in Business Standard where he asks for a revisit of the IIM Act of 2017 which provided significant autonomy to IIMs by drastically reducing the government's role in their Boards and functioning. 
The IIM Act has given a fillip to the erosion of faculty governance at IIMA. The leading IIMs had enjoyed considerable autonomy even before the IIM Act. The Act gave formal shape to such autonomy and enhanced it by leaving the appointment of the chairman and the director to the board. The crucial change that has come about after the IIM Act is that the government decided not to influence the working of the IIMs. The central government and the state government have one representative each on the boards. These nominees play a passive role where they used to be active. Earlier, faculty could expect the government to intervene if the chairman was unresponsive. Now, they have little recourse... 

We thus have a serious governance deficit in the IIM system. There is no meaningful accountability of the director or the board. The governance deficit needs to be addressed... the government must jettison its hands-off attitude towards the IIMs. Until such time as a regulator for higher education is created, the government will be required to play the role of umpire at the IIMs. The IIM Act must be amended to revert to the earlier position of four government nominees, two each from the central and state government. These nominees need not be from the Ministry of Education. The government may appoint qualified persons to represent it in the same way it appoints independent directors at public sector enterprises. Once the government nominees start playing an active role, comatose boards will spring to life.

The amendments were done in response to criticisms then that the government was interfering excessively in the functioning of IIMs. There were strong demands for autonomy. The intent of the Act was to limit the government nominees and its channels of control, in the expectation that the IIMs being institutions of repute and with people of management expertise would be better off managing themselves. The Board was allowed the power to appoint both the Chairman and Director of the IIM. It was also thought that having alumni nominees etc would strengthen the Boards and bring in greater accountability. Finally, the belief was that unaccountable exercise of power by governments through their nominees should be curbed and replaced with accountable exercise of power by autonomous Boards, and the governance of IIMs would improve. 

But in reality, it appears that the autonomous Boards, with only a passive role by government nominees, have failed to be responsive or accountable. While the government exited, the Boards failed to step up. As Rammohan says, they've become "comatose". Therefore, he's now demanding a restoration of the more active engagement by the Government, including restoring the old number of four nominees of the government!

At the outset, I think the decisions taken by the government through the IIM Act 2017 remains good. And its broad direction should be continued and deepened. We should allow it to play out over a longer time and intervene to address egregious failures.

Some observations:

1. The issue also highlights the complex nature of state capacity building. Ideas like autonomy work effectively only when the systems have the capacity to absorb the autonomy. Else, the cure can become worse than the disease itself, at least initially.

2. Interestingly, opinion makers become very critical of failed policy actions (as in the case of an institution that we have imparted autonomy), but overlook those which are failures due to inaction (as with so many of our own institutions that have poor or no governance even with all government nominees etc). The latter is fine, but the former is excoriated.  

3. These experiences have the potential to create a double whammy. One, they reinforce the entrenched opinions among officers/politicians about the need for active government role. Second, they also makes it difficult for officials in future to suggest such reforms.

4. This is also a lesson on the limitations of principles-based or non-prescriptive reforms or regulations in the Indian context. For example, the autonomy guidelines did not mandate the mode for appointment of the two faculty nominees to the Board nor the norms for appointment of the dean nor did it tightly prescribe the norms for appointments of Board members. It was thought that broad principles and wisdom of the Boards will take care of these. The result is that some Directors started to use their discretion to make unwise choices. And the Boards failed to hold those Directors accountable for their actions. 

5. Opinion makers cry hoarse at government intervention arguing for greater alumni representation in Boards to ensure greater accountability. As can be seen with this experience, these are all noble-sounding ideas. But in reality they are just that, noble-sounding ideas with little substantial relevance.  

6. Another idea that modern management theories advocate is the use of transparency enhancing measures to improve accountability. For example, management theories consider making mandatory (or pro-active) disclosures on websites, conducting independent performance audits/evaluations, having performance MoUs and their reviews etc as accountability enhancing measures. Accordingly, the IIM Act too contained the provision for the IIM Boards to evaluate the performance of the institute once in three years through an independent agency, submit an action taken report to government, and place the report in the public domain. But, it now appears that no IIM has conducted such reviews. 

For sure, all of these ideas have their uses and should be implemented. But, in environments where lack of accountability and whimsical decision-making is the default norm, we should not expect these measures to make much difference. Most often, they are likely to be ignored by the audience. There cannot be a substitute for some form of traditional top-down governance.