Spillovers in the global over-kill with inflation-fighting

I had blogged earlier expressing hope that the unmistakably clear and co-ordinated monetary tightening by central banks could have the effect of shaping inflation expectations downwards. 

But like with all such actions, there is also the possibility of over-shooting with the tightening. Excessive tightening and associated reshaping of expectations could have the effect of tipping the world economy over into a recession. This is what the World Bank worries in its latest report about the possibility of a global recession. 

But this is also a teachable moment in understanding macroeconomics in a financially integrated and globalised world economy. 

Adam Tooze points to some graphs from the latest World Bank report. On the monetary policy side, the report informs that we are now seeing the most widespread tightening of monetary policy since early 1970s.

On the fiscal policy side too, the share of countries tightening their fiscal spending is greater than ever.

And the fiscal tightening is universal

Tooze writes,

The level of real interest rates - nominal rates adjusted for inflation - remains low. But this is the most dramatic shift in the stance of policy we have witnessed since the 1980s. The risk is that it will be excessively contractionary and will trigger a worldwide recession.

But this global over-kill towards monetary (and fiscal) tightening can be traced to the US Federal Reserve's delayed reversal of its monetary accommodation. After falling behind the curve big time, the Fed has been catching up with some vengeance. Its collateral damage has been in the form of spillovers to developing countries, forcing those central banks to respond with their own tightening. The spillovers have not spared even those central banks who responded early enough to the inflationary trends and tightened. In fact, those countries, like Brazil, are now being forced to respond with further tightening, thereby adversely impacting domestic growth. Not to speak of the inflationary effects from depreciating currencies. 

There is nothing new in this script. The globalisation of the US monetary policy and its spillovers (especially on developing economies) was a central theme in The Rise of Finance. This is just one snippet,

BIS economists Peter Hordahl, Jhuvesh Sobrun and Philip Turner find that ‘central banks in small economies have only a very limited ability to influence the long-term interest rate in their own currencies’. In other words, taken together, the monetary policy autonomy of small open economies has been progressively declining. They not only have less ability to influence their own interest rates but their long-term interest rates are also vulnerable to shifts in US long-term yields. Another paper by Robin Koepke of the Institute of International Finance (IIF) examined the impact of changes in US monetary policy in 27 emerging economies, specifically in terms of currency and banking crises and sovereign defaults. The paper studied 154 such crises over the 1973–2014 period and claimed that ‘US monetary policy is often just as important as domestic factors in explaining the incidence of EM crises, if not more important’. In other words, US monetary policy is not just a trigger, but one of the underlying factors that amplify EM vulnerabilities. More specifically, it finds that the ‘probability of crises is substantially higher when the federal funds rate is above its natural level (stance), during Fed policy tightening cycles (direction), and when market participants are surprised by signals that the Fed will tighten policy faster than previously expected (surprise)’.

Claire Jones summed it up very nicely,

In March 2021, when the US Federal Reserve was still buying $120bn-worth of securities a month, Brazil’s central bankers raised their benchmark rate by 0.75 percentage points on the back of concerns that a surge in global commodity prices would trigger inflation. It took another year for the US central bank to catch on to the fact that price pressures would prove far from transitory and finally raise the federal funds target from near zero. By then, Brazil had increased borrowing costs to 11.75 per cent. Time has proven Brazil’s monetary guardians right. Yet the Fed’s tardiness in keeping inflation in check is unlikely to leave the South American country — or, indeed, anywhere — unscathed.

The Fed, which on Wednesday made its third 75 basis point increase in a row, is playing catch-up. While that may be the best course of action for the US economy, its aggression is triggering what Maurice Obstfeld, of the Peterson Institute for International Economics, labels “beggar-thy-neighbour” policies. The consequences of the Fed‘s mistakes are effectively exported from the US, burdening America‘s trade partners. Higher US rates have bolstered the dollar, exacerbating inflation elsewhere by raising the cost of commodities which are, more often than not, priced in the greenback. A “reverse currency war” is in full flow, with monetary authorities across the world now ditching their standard quarter-point increases in favour of 50, 75 and — in the case of Sweden and Canada — 100 basis point moves in order to stem dollar declines. Rate rises, while necessary to quell inflation, have become so aggressive the World Bank warned last week they risk sending the global economy into a devastating recession that would leave the world’s poorest countries at risk of collapse. The World Bank described the situation now as akin to the early 1980s, when the surge in global interest rates and slump in world trade sparked the Latin American debt crisis and a wave of defaults in sub-Saharan Africa.

Tooze points toADB's Chief Economist Shang-Jin Wei,

For the 66 smaller economies that peg their currencies to the US dollar – especially those without significant capital controls, like Hong Kong, Panama, and Saudi Arabia – local interest rates tend to rise automatically whenever the US raises its interest rate, even when higher rates are harmful to their economic prospects... an interest-rate hike by any major central bank has the effect of exporting inflation to other countries, forcing other central banks to raise interest rates more than they otherwise would have done... The result is an interest-rate spiral that is more damaging to world output and employment than these countries may wish to see collectively.

And this excellent graphic from Peterson Institute 

This is only the latest example of how the dominance of the US Fed and the Dollar has led to the demise of monetary policy autonomy of central banks elsewhere. The impossible trilemma has been replaced by the impossibility of monetary policy autonomy. This also means that exposure to vulnerabilities have to be reduced in the first place. Based on this reality, this was our conclusion in The Rise of Finance,

Given integrated capital markets and the unipolar importance of the US dollar to the international payment system, commodities and capital markets, spillovers from policies pursued in developed countries to developing countries is inevitable. Developing countries lack instruments and coercive power to dissuade advanced nations from pursuing domestic policies that have negative spillover effects for them. Since the world has no alternative to the US dollar presently, the only option left to avoid spillovers is to reverse integration of capital markets and free capital flows. In the absence of restrictions on capital flows, both the impossible trinity and the financial market trilemma have been reduced to the impossible duality and financial market dilemma, respectively. Therefore, capital controls cannot be the policy of last resort to be deployed in the event of financial instability. It is central to ensuring financial stability. Developing countries must be cautious in liberalizing external commercial borrowings for their domestic borrowers and in inviting foreigners to invest in domestic debt.

This episode is a cautionary note to policy makers in countries like India. Policy makers, entrusted with protection of national interests, should be cautious with the advice and wary of lobbying on capital account liberalisation from market intermediaries and ideological enthusiasts whose incentives are aligned differently. This is especially important since the pressure from foreign institutional investors and their domestic supporters to liberalise capital account in the guise of deepening bond markets will be the highest now, also because India appears to be the only big EM game in the town for now. Policy makers should resist this temptation. 

Update 1 (01.10.2022)

Central bank real rates are negative across most countries

Update 2 (03.10.2022)

FT reports that bond investors have pulled out over $70 bn from EM bond funds this year, the highest ever.

The investor flight underscores how emerging markets are facing mounting risks from surging interest rates in developed markets, which make the typically high yields on EM debt look less attractive... Rather than weighing the relative risks of currency exposure, investors are simply getting out. It marks a sharp turnround: flows were positive into both types of bond funds for each of the previous six years, at a combined average of more than $50bn a year.

No matter how strong the domestic economic fundamentals, sudden stops and capital flights from developing countries to the safe haven of dollar assets are inevitable in times of global economic crisis. This cannot be avoided. The only way to mitigate its adverse effects is to limit exposure to the global financial markets in the first place to only what's required to manage macroeconomic balance. This is a cautionary note on capital account liberalisation.

The stability premium of large economies

FT has a feature on the success of Indonesia under Joko Widodo,

At a time when the global economy is being battered by the war in Ukraine and the global energy, food and climate crises, Indonesia has emerged as an unlikely outlier, boasting both a booming economy and period of political stability. Gross domestic product expanded 5.4 per cent year on year in the second quarter, well above forecasts. The country’s inflation rate of 4.7 per cent in August, prior to a recent petrol subsidy cut, is one of the lowest globally. Its currency, the rupiah, is among the best performing in Asia this year and its stock market is hitting record highs. The resource-rich archipelago, south-east Asia’s largest country with 276mn people, is riding high on soaring commodity prices. Exports rose 30.2 per cent year on year to $27.9bn last month, the most on record. The world’s largest producer of nickel, a critical component in electric vehicle batteries, Indonesia is putting in place plans to benefit from the upcoming boom in EVs… 

With inflation relatively low, Indonesia’s central bank only raised interest rates for the first time in three years in August to 3.75 per cent. Banks are also still lending and exports are booming, not just from commodities. Widodo’s signature “omnibus law” that loosened employment regulations to help job creation has encouraged more foreign investment, as some producers diversify manufacturing away from China... One of Widodo’s principal achievements has been to expand infrastructure on an unprecedented scale for Indonesia, a vast country of more than 17,000 islands. His governments have constructed 2,042km of toll roads in eight years, he says, compared with about 780km in the prior 40 years, as well as 16 airports, 18 ports and 38 new dams.

And the main reason for this success has been the political stability under President Widodo,

Much of the credit for this boom has gone to President Joko Widodo, who has managed to maintain popularity with both ordinary Indonesians and investors alike after eight years in power. A poll released this week by research firm Indikator Politik Indonesia showed 62.6 per cent of Indonesians approved of the charismatic former furniture salesman’s performance... Support for Widodo, who is known as “Jokowi”, is so strong that at one point his supporters were pushing to change the constitution to allow him to stand for a third term in office.

Coupled with opportunistic policies, 

Yet by far the flagship industrial policy of Widodo’s second term has been his attempt to use Indonesia’s giant nickel reserves — which are tied with Australia as the world’s largest — to create a domestic electric vehicle industry. In 2020, the government banned outright the export of nickel ore, forcing foreign companies, many of them Chinese, to begin refining it onshore. While most of the end-product is going into the stainless steel industry, the aim is to begin extracting more higher grade material for use in batteries. Indonesia is expected to provide a significant part of the new nickel supply needed by the global EV industry but its reserves of laterite ore require more processing... Widodo credits the restrictions with lifting the value of nickel ore-related exports from $1.1bn annually five years ago to nearly $20.9bn last year. “After [this], we can export maybe more than 40 times or 60 times [more],” he says. “Indonesia has the largest nickel reserves in the world, around 21mn tons, [or] around 30 per cent of world reserves.” He adds that the next step could be to extend the policy to Indonesia’s large reserves of bauxite and copper. Demand for the materials, used for aluminium production and renewables, is also growing globally...

The plan to refine Indonesian ore into battery-grade material is still just starting, with one refining plant commissioned in May last year and seven more in the pipeline, all on the island of Sulawesi... Near Jakarta, South Korea’s LG Energy Solution and Hyundai Motor Group are building the country’s first electric vehicle battery cell plant while Hyundai is building an EV plant nearby. Indonesia says China’s CATL, the world’s biggest EV battery maker, has agreed to invest in an EV battery plant and Widodo says he was also wooing Tesla.

There are striking similarities with India. 

There is a strong case that political stability by itself contributes to economic growth. And if the government does not mess around with the macroeconomy and allows things to play out, even without any major reform there comes a growth premium with political stability. Further, if the country is a large enough market, the premium becomes substantial. 

For investors used to policy flippancy in developing countries, the familiarity of nearly a decade of the same government is an under-appreciated factor. Even without any Big Bang reforms, a government that does not rock the boat and provides reasonable policy predictability is a boon for investors. In fact, the stability premium explained a significant part of foreign investor interest in China in the last three decades. 

Into this mix, if governments can focus on the plumbing issues - human capital development, infrastructure provision, and enabling policies for economic growth - then the stage is set for sustainable growth. 

This is the main takeaway from my first book, Can India Grow. Forget the fetish with high growth rates and Big Bang reforms. Neither does the country have the foundations to sustain high growth rates for extended periods nor are there any such implementable Big Bang reforms. In the circumstances, the preferred strategy should be to target the baseline growth of 5-6% for the next three decades, while also opportunistically grabbing the occasional short high-growth episodes. This requires hunkered down execution to painstakingly expand the physical, human, and financial capital foundations.  

In so far as economic growth is the biggest poverty eradication strategy, India and Indonesia have lucked out with political stability, at least for now. They need to focus more on the plumbing to build sustainable and higher growth foundations. 

Weekend reading links

1. Fascinating graphic which shows how the US and UK resemble societies where the poor are poorer than the developed country average, and the rich are richer.

While the top earners rank fifth, the average household ranks 12th and the poorest 5 per cent rank 15th. Far from simply losing touch with their western European peers, last year the lowest-earning bracket of British households had a standard of living that was 20 per cent weaker than their counterparts in Slovenia... In 2007, the average UK household was 8 per cent worse off than its peers in north-western Europe, but the deficit has since ballooned to a record 20 per cent... The rich in the US are exceptionally rich — the top 10 per cent have the highest top-decile disposable incomes in the world, 50 per cent above their British counterparts. But the bottom decile struggle by with a standard of living that is worse than the poorest in 14 European countries including Slovenia.

2. I have blogged here about the difficulties presented in evaluating the current episode of economic slowdown. As the graphics show, on most parameters of labour market health, the current situation is far better than in any recession over the last ten years. 

The picture is mixed on the consumption

... and production sides.

3. Indian cinema industry fact of the day

Affluent southern states often have more cinema screens than the Hindi-speaking heartlands. Tamil Nadu, with a population of less than 80mn, has 1,104 screens; Hindi-speaking northern Uttar Pradesh, India’s most populous state with nearly 230mn inhabitants, has just 539.

4. Local government financing vehicles (LGFV) in China have stepped in as buyers of last resort in the property market, thereby allowing cash strapped local governments raise money by selling lands and also backstopping the real estate market from crashing.

According to official data, land acquisitions by LGFVs rose to Rmb400bn ($57bn) in the first half of the year, up more than 70 per cent compared with the same period in 2021. This is despite overall land purchases, which have previously been dominated by private developers, falling by almost a third as Beijing cracks down on real estate speculation. The buying spree is intended to help cash-strapped local authorities, for whom selling land is an important source of income. But the LGFVs, which play a critical role in funding long-term infrastructure development, are being forced to borrow more from state banks and issue bonds to finance the deals... Most LGFVs, which typically have little experience in property development, are leaving their newly purchased plots idle. This, combined with the larger housing market meltdown, means the short-term relief that local authorities get from the financing vehicles’ land purchases ultimately risks bigger problems for China’s already faltering economy...

Official data show LGFVs accounted for almost a quarter of land sales in the first half of this year, compared with 9 per cent in the same period a year ago. The ratio exceeded 50 per cent in some less-developed small cities... To make up for the lack of bidders, many cities have raised the minimum price for land auctions. That has often forced LGFVs to pay a premium even as the market is weakening... Most LGFVs face cash flow constraints as they derive the bulk of their income from government-backed infrastructure projects with long-term horizons for returns. In the meantime, state lenders are willing to either issue loans to LGFVs against land as collateral or buy the latter’s bonds in the hope authorities will step in if a crisis occurs.

5. The global race to dominate semiconductor manufacturing

The article outlines what China is doing to achieve self-sufficiency in the cutting-edge technology sectors. It's packing its bureaucracy with technocrats instead of bureaucrats, and picking winners among emerging businesses and supporting them with fiscal concessions.

At a national meeting held this month in the eastern province of Jiangsu, China named 8,997 enterprises as “little giants”, putting them in line for tax breaks so they can help China compete with the US and other western powers... In the past few years, China has overseen the establishment of more than 1,800 so-called government guidance funds, which have raised more than Rmb6tn ($900bn) to invest largely in tech sectors that Beijing deems “strategic”. The funds’ salient feature is that they are mostly run by provincial and local governments or by state-owned enterprises... Companies had to be vetted by local governments in the first instance, opening up the potential for favouritism and corruption. At the same time, government officials can be poor assessors of a company’s prospects, especially when it involves technology that is hard to understand.

6. Tamal Bandopadhyay has some interesting snippets about government bond market in India,

Till the last week (September 16), the government has raised Rs 7.72 trillion without any hiccups. Net of redemptions, the net borrowing has been Rs 4.39 crore... In FY2019, it had borrowed Rs 5.71 trillion gross amount (net Rs 4.23 trillion). The next year, the gross borrowing was Rs 7.10 trillion (Rs 4.74 trillion). In the Covid-hit FY2021, the gross borrowing zoomed to Rs 13.7 trillion (Rs 11.43 trillion). Last year, it dropped to Rs 11.27 trillion (Rs 8,63 trillion) before rising to its historic high of Rs 14.31 trillion this year (Rs 11.61 trillion)... In FY2019, the gross SDL was to the tune of Rs 4.78 trillion (Rs 3.49 trillion); in FY2020, it rose to Rs 6.35 trillion (Rs 4.87 trillion) and further to Rs 7.99 trillion (Rs 6.52 trillion) in the next financial year. Last year, the states raised Rs 7.02 trillion (Rs 4.92 trillion). Till September 16 this year, the states have raised just Rs 2.44 trillion (net Rs 1.29 trillion) from the market, much less than the estimated Rs 4.01 trillion in the first half of the financial year.

The article also had an interesting factoid which underlines the problem of low investment appetite among corporates

Till June, the net corporate bond issuance has been negative. This means, redemptions of old bonds have been higher than fresh bond floats. Contrast this with Rs 4.04 trillion net issuance in FY2022 and Rs 3.59 trillion in FY2021.

7. Fascinating set of stats about Roger Federer, Novak Djokovic, and Rafael Nadal.

More on Roger Federer. Barney Ronay in The Guardian

And with Federer greatness was as much about style and form and texture. There was a sense in his talent of something that never quite reached its end point. Even at its most concentrated pitch one never felt one got to the limits of what Federer might do. There is probably still a bit in there, Rog, if you ever feel like giving it another go... His backhand was frankly ridiculous, overblown, hilariously good. This, one thought, watching that thing – the flex of the knee, the flourish of the wrist – is a kind of artefact, a European cultural treasure, like a Bach cantata or a complete acorn-fed Iberian ham, the kind of backhand a power-crazed Bond super villain might try to steal from its laser-guarded case and transport to the moon... It was not the styling, the deep, piercing (woof) eyes, the balletic grace in his movements. The real Federer hit was the way these things were combined with accuracy, power, shot selection, competitive will. Federer was never just getting the ball back or staying in the rally but challenging to live at this pitch, to exist in his sporting world.

8. In an interview with CBS News, President Joe Biden has clearly indicated that the US would defend Taiwan from a Chinese attack by sending US forces to defend Taiwan. 

Whether he intended it or not, there is a game being played out here. Hitherto there was a strategic ambiguity about the likely American response in case of a Chinese invasion. This and the three previous statements by President Biden should serve as sufficient enough indication to the Chinese that there may no longer be any ambiguity about US response. To this effect, it has atleast significantly reduced, if not removed, from the Chinese calculations the possibility of US staying out in case of an invasion. One can reason that this, coupled with the outcomes from the ongoing Ukraine crisis, would have significantly reduced, at least for now, any possibility of a Chinese invasion.  

9. From Martin Wolf, in the context of UK economy, the point about limited correlation between tax rates and economic prosperity.

And this about product and labour market regulation among western economies.

10. Business Standard reports that the RBI has cracked down on outsourcing of loan recovery operations by lending institutions. 

The Reserve Bank of India (RBI) on Thursday barred non-banking financial services company Mahindra & Mahindra Financial Services(MMFSL) from outsourcing recovery agents, days after a 22-year-old pregnant woman died in Jharkhand’s Hazaribagh while trying to block loan recovery agents from taking away her father’s tractor and was crushed under the vehicle. The loan was taken from M&M Financial. “The RBI has… in exercise of its powers under Section 45L(1)(b) of the Reserve Bank of IndiaAct, 1934, directed MMFSL, Mumbai, to immediately cease carrying out any recovery or repossession activity through outsourcing arrangements, till further orders,” the RBI said... This is probably the first time the regulator has cracked down on lenders on recovery by coercive methods, which is typically a hallmark of outsourced recovery agents.

As the report says, given the widespread use of this practice, it remains to be seen how the RBI will be able to enforce its circular. 

It has become an increasingly common practice among banks to outsource its two critical activities - credit-worthiness assessment and recovery operations. In the circumstances, the lender becomes a fund manager who takes deposits, manages it, and transacts through the third parties. If you add securitisation of the loan book, the lender has limited skin in the game. 

11. Following concerns raised by Amundi Asset Management's Chief Investment Officer Vincent Mortier a few weeks back, now Mikkel Svenstrup, the CIO at ATP, Denmark's largest pension fund has compared the private equity industry to a pyramid scheme. 

Mikkel Svenstrup... said he was concerned because last year more than 80 per cent of the sales of portfolio companies by the private equity funds that ATP has invested in were either to another buyout group or were “continuation fund” deals, where a private equity group passes it between two different funds that it controls. “We’re a big fund investor, we have hundreds of funds and thousands of portfolio companies,” he said. “This is not good business, right? This is the start of, potentially, I’m saying ‘potentially’, a pyramid scheme. Everybody’s selling to each other . . . Banks are lending against it. These are the concerns I’ve been sharing.” ATP is a major investor in private equity funds. It has $119bn under management and has committed money to 147 buyout funds, according to PitchBook data...Mortier said some parts of the private equity industry “look like a pyramid scheme in a way”. Svenstrup said the “exponential growth” of the private equity industry in recent years, as investors have poured cash into its funds, would stop “at some point”, adding that this was “just a question of time”.

These calls may be the canary in the coal mine with respect to the PE industry. 

12. In The Rise of Finance, we discussed the adverse effects of US monetary policy spillovers on developing countries. The ongoing rate hikes and consequent strengthening of dollar, and associated sudden stops and capital flows reversals and imported inflation into developing countries is only the latest instance. 

The Fed, which on Wednesday made its third 75 basis point increase in a row, is playing catch-up. While that may be the best course of action for the US economy, its aggression is triggering what Maurice Obstfeld, of the Peterson Institute for International Economics, labels “beggar-thy-neighbour” policies. The consequences of the Fed‘s mistakes are effectively exported from the US, burdening America‘s trade partners. Higher US rates have bolstered the dollar, exacerbating inflation elsewhere by raising the cost of commodities which are, more often than not, priced in the greenback. A “reverse currency war” is in full flow, with monetary authorities across the world now ditching their standard quarter-point increases in favour of 50, 75 and — in the case of Sweden and Canada — 100 basis point moves in order to stem dollar declines. Rate rises, while necessary to quell inflation, have become so aggressive the World Bank 

warned last week they risk sending the global economy into a devastating recession that would leave the world’s poorest countries at risk of collapse... Since the 2008 global financial crisis the Fed and other major market central banks have deployed wave after wave of stimulus. That left global interest rates at ultra-low levels for years on end. The result of that — plus the pandemic — is international debt levels are close to all-time highs. As financing costs rise, more and more of the world’s poorest countries are seeking support from the IMF and the World Bank.  

13. On gastronomy and air travel,

Business and first class account for about one-third of all airline seats but generate up to 70 per cent of revenue. The promise of a better meal is part of what motivates passengers to buy a premium ticket... At 35,000ft, the human tongue goes partially numb, causing you to lose about one-third of your taste buds. The microclimate of an aeroplane is drier than most deserts, which has an effect on the nose roughly equivalent to stuffing one nostril with toilet paper. Even the sound of the engine changes the way food tastes. Exposure to the background noise of an aeroplane, which can reach 80-85dB, dulls your sensitivity to salty and sugary flavours, while enhancing your perception of the proteinous fifth taste, umami. This explains the enduring love affair between air passengers and tomato juice, which is ordered as much as beer in flight. If you drink it in the sky, it will taste richer, more savoury, and less acidic.

14. Finally, Andy Mukherjee calls for greater scrutiny of the drivers of wealth creation of Gautam Adani.

Adani’s commodities, energy and transportation empire the $255 billion stock-market juggernaut it is today, even when the combined annual net income of its seven publicly traded firms is less than $2 billion... Elara India Opportunities Fund, which has amassed $4.2 billion — practically all of its assets under management — from three stocks: Adani Transmission Ltd., Adani Enterprises Ltd., and Adani Total Gas Ltd. APMS Investment Fund Ltd., whose $3.6 billion portfolio also includes Adani Power Ltd., has done it with four. There are three more of these Mauritius-based entities among major shareholders: Cresta Fund Ltd., LTS Investment Fund and Vespera Fund Ltd. A sixth, Albula Investment Fund Ltd., has exited Adani firms, with its portfolio shrinking to about $240 million from $1.6 billion in December, according to Bloomberg data. Between them, these publicity-shy investors own a combined $12 billion of Adani stock.

And the staggering reach of the conglomerate

The coal he mines, moves through his ports, and burns at his power stations provides electricity to Indians. Adani supplies families with piped gas when they’re sitting down to dinner, in which the cooking oil is also his, and the wheat probably stored at his warehouses. The new structures that will adorn the landscape of an underbuilt India over the next couple of decades will take construction materials from Adani, who just acquired 70 million tons of cement capacity and now wants to double it in five years. The businessman will collect toll on roads in the states of Gujarat and Andhra Pradesh, and host Indians’ data when they’re browsing the internet, waiting for a flight to take off from one of his airports. He’ll also help book the airplane tickets. And before you complain about the impact of coal, cement, palm oil and data centers on the environment, Adani says he’ll invest $70 billion into “cooling the planet down” with green hydrogen, wind turbines and solar panels. Throw in forays into media and money-lending to small businesses, and Adani may soon command a bigger share of an average Indian’s life than Amazon will ever garner from a typical American’s wallet.

A Note for funders of development impact evaluations

This post will provide a list of suggestions and checklist for funders of international development impact evaluations. 

First, the suggestions:

1. An important parameter for categorising impact evaluations should be whether they emerged from the primary policy maker’s side or not. Funders should make this an important point of diligence when they are funding impact evaluations. They should incentivise researchers to engage closely with policy makers, understand their real needs (as against hypothesising their perceived needs), and work together to design and present the evaluation proposal. Is the evaluation arising as a demand from a policy maker and whose outputs will feed into a program design or redesign? Or, is it primarily a proposal from a researcher, which also happens to have taken the consent of the policy maker? 

2. In the normal course, the highest priority impact evaluations should be those arising directly from policy makers about impact evaluation issues agitating them and whose evaluations can be done within their expected time frames. In this context, the highest value impact evaluations are of the quick but rigorous A/B testing kind which help with changing the design of an intervention to improve its operational efficacy or implementation fidelity. 

3. Also, in the normal course, concurrent evaluations which feed into program design or implementation should have greater preference than post-facto evaluations of headline efficacy. For example, an evaluation question which emerges from a deep-dive of an ongoing implementation and on a proximate cause of likely implementation effectiveness (say, the periodicity or the manner of a cash transfer; or converging an intervention in agriculture with another ongoing program; or a procedural change or small add-on to an ongoing program) should be considered high value and prioritised. Such evaluation proposals also reflects active engagement by the researchers with policy makers to surface an important factor which impacts the program effectiveness. 

4. Any impact evaluation of an intervention/idea in a context should necessarily be preceded by a deep-dive that also includes examination of the history of same or similar interventions/ideas in the particular local context (and not merely based on theory and evidence from other contexts). What are the examples of such interventions in that context in the last three decades? What have been their outcomes? Do the government and other local stakeholders know about them? How have they been received by the system?

5. Impact evaluation should always be associated with qualitative research (key informant interviews, focus group discussion etc), which should help in interpreting the quantitative study findings relating to design and implementation issues.

6. Encourage (or in certain cases mandate) enlisting a local researcher as Principal Investigator in impact evaluations. Despite all its possible flaws and distortions, this is perhaps the only way in which local researchers can become involved in a meaningful enough manner in impact evaluations in their own countries and develop evaluation expertise. 

7. On a similar note, philanthropic donors like BMGF should prioritise local researchers, and that too working in local institutions, in the impact evaluation projects they fund. 

8. Large scale and long-drawn research projects (eg. RISE, Young Lives etc) should necessarily enlist a local institution as the anchor/host institution in the country. Encouraging local researchers and institutional capacity building in developing countries should be an explicit primary objective of such funding. 

9. Large funders should also incorporate some features and parameters that capture capacity building and knowledge transfer when they approve impact evaluation proposals. For example, funders should insist that outsourced services like surveys should be given on open competitive bids to preferably local providers instead of being given on nomination to captive foreign partner institutions. Or a clear plan (with accountability) that explains how the government partner is actively engaged in the evaluation design, the conduct of the evaluation, and how the evaluation findings are used. 

10. Encourage and incentivize studies to explore and reference impact evaluations and studies of impact evaluations done by researchers, government agencies, and non-government institutions in developing countries (and not just those in foreign think-tanks and by foreign researchers). For example, the Directorate of Monitoring and Evaluation Office (DMEO) in India has a rich expertise on the challenges and issues with impact evaluations, and have very useful things to say about what type of evaluations could be used where and when. 

11. Multilateral and bilateral funders, who have the credibility of government backing, should make available model procurement documents and contracts for hiring evaluation agencies; and templates of evaluation designs, survey instruments etc which can be drawn by evaluation agencies of governments and local evaluation providers. There should be something similar to the World Bank’s PPIAF in case of impact evaluations. This will help atleast those interested government leaders who are committed to undertaking impact evaluations, thereby also creating a local supply-side for it. It’s important that this be housed in a bilateral or multilateral institution (and not in a philanthropic entity or think tank) to allow government leaders the freedom to draw and use. 

A checklist for diligence of proposals considered by funders of impact evaluations

1. Is the primary demand arising from policy makers, with a commitment to incorporate the results? What are its signatures and how credible are they?

2. Has there been extensive stakeholder engagement by the impact evaluators?

3. Is cost-effectiveness of the intervention a consideration in the evaluation?

d. Is bureaucratic feasibility (or state capacity consideration) a factor in the evaluation?

4. Is the evaluation to improve design/implementation or to assess headline efficacy?

5. Is it a concurrent or post-facto evaluation?

6. Does the evaluation team have a local PI based in the subject country?

7. Does the evaluation proposal have meaningful partnerships with local institutions?

8. Does the evaluation involve some signatures of capacity building or some form of knowledge transfer?

9. Does the evaluation involve procurement of services from local providers?

10. Does the report reference and document the work done by local researchers, government agencies, and non-government institutions?

More on the dissonance between the reality and international development research

I have blogged on several occasions about the disconnect between international development actors and the messy realities of development. In this post, I'll argue that some of the most important assumptions of development economics research and development funding not only have little basis but also distorts the debates. 

In a recent article Dani Rodrik alluded to the diversity problem in development economics research. 

Nearly 90% of authors in the top eight journals are based in the United States and Western Europe. Moreover, the situation seems similar with these publications’ editorial board membership... East Asia produces nearly one-third of global economic output, yet economists based in the region contribute less than 5% of the articles in major journals. Similarly, the shares of publications from South Asia and Sub-Saharan Africa are minute, and significantly lower than these regions’ already small weight in the world economy.

This is the elephant in the room. From the perspective of practising insiders within governments in developing countries, despite their salience in international development conversations, it's stunning how little recent development research has contributed to improving actual development practice. In the spirit of provoking, I cannot recall any insight or instrument generated and popularised mainly by development research over the last three decades that would be of meaningful enough value to a practitioner in a developing country.  

For all practical purposes, the main contribution of international development research is to have built an eco-system which has built careers and reputations of well-intentioned but ill-informed foreigners. This stands no chance of any change without the geographic composition of researchers changing dramatically.

This post will try to clarify on some common misconceptions associated with the idea of evidence-based policy making, the latest fad in international development. 

The idea is that since much of public policy is made based on whims and fancies of politicians and bureaucrats, and therefore invariably falls short on outcomes, there is a strong case for using evidence of impact to design new policies. This narrative assumes that existing policy is free of evidence, most public policy fails to generate desired outcomes, and policies get made on fresh slates as altogether new interventions. As I have blogged earlier, while there is an element of truth in each, it's completely wrong to accept these assumptions as the default in development practice.  

These assumptions themselves emerge from the wrong belief that new interventions are a major part of the universe of development programs. Instead, the universe of interventions possible in any sector are mostly well-known, as also the implementation pathways and methods, and failings and deficiencies associated with implementation. Novelty and uncertainty, which demand innovation and rigorous evaluations, are relevant only at the margins. 

In other words, in its essentials, basic development in practice, in large measure, is about doing more of the same, albeit marginally better and quicker. Often technology can help. 

Contrary to the conventional wisdom which underpins these assumptions, instead of treading into unknown territory, most of basic economic, political, and social development is about treading the well-known path. The likes of innovation and efficacy evidence come at the margins. At the least, given the prevailing level of outcomes, the challenge is about getting from poor to average or at best satisfactory, and hardly about moving from good to great. And, this does not generally demand significant departures from standard practice. 

Consider the two most important sectors of education and health. The delivery of education requires the availability of schools, teachers, instructional materials and pedagogy techniques. Similarly, the delivery of health care requires focus on public sanitation and personal hygiene, and the availability of diagnostic facilities, hospitals, doctors and medical personnel for treatment. Realisation of outcomes in both health and education demands provider capacity, rigorous monitoring, and behaviour or attitude changes among all stakeholders. Again in the spirit of provoking, the likes of (most of what's peddled as) Edtech and (disproportionate focus on) health insurance, at least in the low income settings of developing countries, are costly distractions. 

Or take the examples of increasing property tax revenues and reducing electricity distribution losses. As I have blogged earlier, instead of focusing on the messy plumbing issues like physical audits and enforcement actions, opinion makers find comfort in the neatness of technology solutions like SCADA, GIS, and smart meters whose value is, at best, marginal. Evaluating these through rigorous research does not add much of relevance to the body of development practice. 

In this context, it's also worth drawing attention to the role of inputs. In many sectors, the focus on inputs have become a pejorative terms among development opinion makers. It's widely believed that somehow if you throw in innovation and align incentives through outcomes-based financing, magically everything will fall into place and outcomes will be delivered. I have blogged here, here, here, here and here about the failings with such thinking.

Just as adoption of Edtech depends on access to a tablet or computer, the delivery of education depends on schools with infrastructure and teachers. In either case, these are basic requirements and only take you to the starting line. In both cases, the realisation of outcomes depend on the quality of inputs and the manner of their use or implementation.

(If anyone is thinking of Edtech as an innovation to significantly improve the quality of public school education in realising student learning outcomes at scale, I disagree strongly. But that's for another post.)

Some other examples of this obsession with innovation and outcomes measurement include the questioning of prioritising public spending on roads and electricity, favouring the generation of electricity by kicking soccer balls instead of setting up thermal or hydro plants, prioritising subsistence entrepreneurship through micro-loans and income generation through the likes of chicken and cattle instead of wage employment creation, and advocating cash transfers instead of ensuring food security through public distribution of food grains.  

Even if researchers are not suggesting simple dichotomies, their research and its advocacy have had the effect of influencing the narrative of international development discourse for the worse by favouring such "kinky development" ideas as Lant Pritchett describes them.  

Despite this reality, there is a reason why this paradigm dominates international development discourses despite the dominant reality of doing more of the same. Instead of funding ongoing national programs, for a variety of reasons, multilateral and bilateral aid organisations and philanthropic funders generally prefer supporting something new. It's a different matter that there are very few meaningful enough "new" things, and most often the ostensibly "new" donor funded programs are mere repackaging of existing programs with cosmetic variations. 

In simple terms, the priorities of donors and imperatives of foreign funding coupled with the dominance of foreign researchers has distorted the discourse on international development.

Weekend reading links

1. Adam Tooze has a good post on the troubles facing the Chinese economy. He links to an article by Matthew Klein.

Homebuilders sold an average of 156mn sq m a month of residential floor space from April to June 2021. This year in the same period, Chinese developers have sold just 106mn sq m a month. The plunge in demand has flowed through to new building, with the amount of “residential floor space started” in April-June 2022 down by nearly half compared to last year. The pace of homebuilding has not been this slow since 2009... According to China’s ministry of finance, local government revenues from land sales so far this year were 31 per cent lower than in the first six months of 2021... Chinese consumer spending in the first half of 2022 was barely higher than in the first half of 2021 after accounting for inflation, and is now running more than 10 per cent below the pre-pandemic trend. Chinese oil refiners have been processing 10 per cent less crude oil since April compared with last spring thanks to the plunge in petrol demand. Electricity consumption, which had been expanding by about 7 per cent a year before the pandemic, is now growing just 2 per cent... In dollar terms, spending on imports has been flat since the end of last year. Factor in rising prices, and China’s real import demand is down about 8 per cent since the lockdowns began, according to estimates from the Netherlands Bureau for Economic Policy Analysis.

At a time when the global economy is grappling with supply constraints and rising inflation, lower demand from China is very helpful.

Chinese debt to GDP ratio has doubled since 2013, with the biggest contributor being the local government financing vehicles, who in turn leverage real estate to raise debt. 

2. Energy market risk diversification illustration

Berlin Brandenburg airport, newly opened after decades of delays, depends heavily for its kerosene jet fuel on the nearby Russian-owned Schwedt oil refinery. Authorities have been warning that a complete German embargo on Russian oil will threaten the airport’s operations. By contrast Berlin’s former airport, Tegel, was more resilient even during the cold war: a diversification rule meant aeroplane fuel arrived by a variety of means including truck and train.

3. Rana Faroohar points to inequality being a contributor to US consumption spending not declining as much as expected,

To the extent that the wealthy in the US are not yet cutting back on spending, they may be an important and under-explored factor driving the inflation felt by all. The top two-fifths of income distribution in the US accounts for 60 per cent of consumer spending, while the bottom two-fifths accounts for a mere 22 per cent, according to 2020 BLS statistics... The American Enterprise Institute, a right-leaning think-tank, estimated in February that the wealth effect of both asset gains and cash extraction from the refinancing of property (which hasn’t corrected yet, like stocks) represented $900bn, with a consumption impact that started last year and will continue through 2022... when the top quintile of Americans as a whole enjoy 80 per cent of the wealth effect from rising stock and home values (the AEI’s estimate), I suspect it starts to have a real impact on inflation, and on the overall structure of our economy, which over the course of the past 30 years of real falling interest rates has become highly financialised.

4. Businessweek points to the rise in college tuition fees in the US

5. The FT has a graphic that shows how European countries are reducing their reliance on Russian natural gas. 

By weaponising natural gas, Vladimir Putin is under-cutting Russia's strategic leverage over Europe for short-term gains. 

6. Ruchir Sharma draws attention to the counter-intuitive point of whether the world can produce robots "fast enough to save the world economy from labour shortages". 

Labour shortfalls are at historic highs in advanced economies, including the UK and US. There are now 11.2mn openings for 5.6mn job hunters in the US, the widest gap since the 1950s... The working-age population is shrinking in nearly 40 nations, including most of the major economic powers, up from just two in the early 1980s... underlying demographic trends foretell continuing shortages. Among the hardest hit nations are China, Japan, Germany and South Korea — all are expected to see the working age population drop by at least 400,000 a year through to 2030. Not coincidentally, these countries already host high concentrations of robots, and are rolling out more. Japan’s manufacturers deploy nearly 400 robots per 10,000 workers, up from 300 just four years ago. China, in its top-down way, is heavily subsidising robot makers, aiming to boost their output by 20 per cent a year through 2030. Even at that pace, Bernstein analysts predict, robots cannot fill all the holes in the labour force, which China expects will shrink by 35mn workers in the next three years.

7. Queen Elizabeth's passing away takes away a constant anchor for the last seven decades. This graphic is striking.

8. When we talk in general about inflation, so much is lost in the translation. FT has a superb graphic which looks at how the consumer price inflation in UK in July 2022 varied for different population categories compared to the national CPI average of 8.8%.

9. On the reemergence of unions among US companies, albeit in a different form,

The upstart union, Starbucks Workers United, is one of a new breed of organised labour that has emerged in the US in recent months. The movement has traditionally been dominated by large, sector-specific unions such as the United Auto Workers, the Service Employees International Union and the Teamsters, which have maximised their scale and reach to fight for better conditions for workers. Instead, the Starbucks employees have taken a different approach — forming smaller groups led by workers on a store by store basis, in the hope that it will build to a broader movement. The strategy has attracted a younger, more politically engaged type of worker, and has helped unions gain a foothold not just in the coffee giant, but also in Amazon, Chipotle and others following a similar path...

Since baristas in Buffalo, New York, founded Starbucks Workers United last December, some 233 other locations have followed suit. Workers at Amazon, Chipotle, and Trader Joe’s have all cited the union’s speedy rollout as the inspiration behind their own drives. But none of the new Starbucks unions have successfully completed what labour scholars say is the most important step on the path to unionisation: negotiating a collective bargaining agreement, the legally binding contract that unions rely upon to improve conditions for its members.

10. Mahesh Vyas points to interesting trends in India's labour market - increasingly ageing and less educated workforce.

Estimates from CMIE’s Consumer Pyramids Household Survey (CPHS) suggest that in 2016-17, 17 per cent of the labour force was of the 15-24-year age. By 2021-22, this proportion had dropped to 13 per cent... In 2016-17, a quarter of the total employment in India was of people below the age of 30. This fell to 21 per cent by 2019-20 and then to 18 per cent by 2021-22. The proportion of the workforce in their thirties has also fallen from 25 per cent in 2016-17 to 21 per cent in 2021-22. As a result, what is left in the workforce is mostly people in their forties and fifties. In 2016-17, 42 per cent of the workforce was in their forties and fifties; by 2019-20, this had risen to 51 per cent... 

A related problem is that the educational qualification of the workforce is deteriorating. The share of graduates and post-graduates increased from 12.5 per cent in 2016-17 to 13.4 per cent by 2017-18. Then it fell to 13.2 per cent in 2018-19 and then to 11.8 per cent in 2019-20. It recovered but only partially to 12.2 per cent... India’s workforce comprises mostly people whose maximum educational qualification is of secondary education (those who cleared their 10th – 12th examinations). They accounted for 28 per cent of the workforce in 2016-17 and in 2021-22, their share went up to 38 per cent. There is a similar increase in people whose maximum education was between 6th and 9th standards. Their share went up from 18 per cent in 2016-17 to 29 per cent in 2021-22.

11. Finally The Ken has a good story on the struggles with the Ayushman Bharat Digital Mission (ABDM), the giant project to introduce electronic health records in India - “unified health system for every citizen and the central verifier of all truths in healthcare”. The article says that the project is being implemented at a cost of $200 million. 

I don't think it's a good idea to plunge into such an ambitious project at such scale. This requires very carefully phased out and gradual progress up the electronic medical records value chain. It'll probably require at least decade to even have the rudiments of an effective EMR system in place. And it'll cost several multiples of the $200 m, besides serious engagement on its adoption down the public health referral chain.

Thoughts on lateral entry

There are four levels of government in India - national, state, district, and sub-district. It's my view that mainstream public commentary has very limited understanding of the last two levels. When we talk about weak state capacity, while it's a problem at all levels, it's most acutely felt at the lowest two levels. I'll call these below the iceberg levels.  

Outsiders engaging with the government, including consultants and researchers working with government, see very little or hardly any of the parts below the state-level. Their exposure to districts, leave aside the block and villages, are confined to, at best, sanitised visits. There is only so much (or so little) that such visits can help. Those from the private sector, whose exposure is limited to reading newspapers/books and watching television which reinforce cliched and nuance-free (and very often misleading) perceptions, have even less understanding of what lies below the iceberg. 

These workplaces are unbelievably different environments from what one encounters in the formal private sector. Officials have to manage with acutely scarce financial and physical resources, not to mention poor quality of manpower. They have to overcome challenging,  often hostile, local environments with entrenched vested interests to get anything done. They are heavily over-burdened, cover vast (often inhospitable) geographical jurisdictions, and face unrealistic expectations from public and their superiors. Compounding these are some problems of the times - a media prone to sensationalisation and defamation, and the toxic virality of social media and WhatsApp based opinion formation.

The best management theories on managing time, people, and situations break down when you are faced with meetings, people, and events which/who are beyond your control. After you travel 100 km, you are lucky if the District Collector's or Project Director's meeting is actually held. Your immediate sub-ordinates are more likely to owe their allegiance to the local legislator. As to events, you can face anything from riots to floods to a disease outbreak to an industrial dispute to elephants running amok, all within a span of a week or less. There are also the endless series of events, where some program/scheme or other is launched or celebrated, leaving you with little time to "plan" and execute.

In any theory of the world that you are exposed to, if you give clear and written directions and provide all the logistics, it's inconceivable that some action is not done. It can be of poor quality, but the response happens. Not so in weak public systems. If you put in place an end-to-end work-flow automated software with single source of truth, it's difficult to believe that the purpose would not be met. But not so in these sub-state layers of the government (It's a different matter that even in the state layer, several things follow the same path of failure).

Outsiders talking about lateral entry and wanting to enter laterally generally only see the apparently glamorous world of policy making. They feel that it's an opportunity for them to contribute with their logically coherent but 36000 feet high opinions. Little do they realise that not only is this macro view sorely inadequate to formulate any meaningful policy, leave aside navigate the system (political, bureaucratic, oversight, and judicial) to get it approved. And I am not even talking about executing the policy, so that it does not remain a good oped or research paper. 

In this context, I want to point out that taking any technically sound policy (formulated with the help of a consultant, experts etc), filtering it for political acceptability and bureaucratic execution feasibility, navigating the system to secure its approval, and managing the execution in challenging environments is also a specialisation. It's the hardly discussed but critical specialisation of the generalist bureaucrat. I would venture to argue that, apart from a few areas like macroeconomic and certain infrastructure policy making, this specialisation is more important to get meaningful things actually done in public systems much more than any form of technical specialisation. More on this in State Capability in India.

To conclude, for any lateral entry to be effective, it's required that they have at least some limited understanding of the context and how things happen below the iceberg. This cannot be understood in any meaningful manner except through some immersive experience. You have to put in the hard miles to become an effective public administrator. Further, in the vast majority of public policy space, the greatest value of lateral entry lies in entering below the iceberg and at the lower levels of the government. And even if the lateral entry is at the level of central and state governments (outside of a tiny space), it's essential to have had some immersive experience of below the iceberg. I have written about it here and also in State Capability in India.