Water privatisation unravelling in the UK

The UK is ground zero on the problems with the private equity-led infrastructure financing model. In early 2018, Carillion, the country's largest outsourcing provider, which provided different services to hundreds of public facilities in the UK, collapsed into compulsory liquidation. The entity had 19500 UK employees and 28500 pensioners had £5 billion in liabilities. The government was forced to step in and assume management of the schools, hospitals, and other public facilities being managed by Carillion. 

Now comes news that Thames Water, the country's largest water utility, serving London and south-east of England and privatised in 1989, may be close to collapse and necessitate a public rescue. As interest rates have risen, the company's ability to service its £14 bn of debt is coming under strain. Besides a new rule mandates that from April 2025 regulated entities could not pay dividends if their credit rating falls below a certain threshold. The parent company, Kemble Water Holdings, 2026 bond plunged as much as 35 pence to 50 pence and distressed territory. The Chief Executive quit abruptly this week, leaving the government to consider the possibility of renationalisation. 

The shareholders, consisting of a dispersed set of infrastructure, pension and sovereign funds, have failed to make good on the £1.5 billion of equity injection promised a year ago. Apart from skimping on investments, the utility, along with other UK water utilities, has come under the scanner for dumping sewerage into rivers and the sea. The FT's verdict on who's to blame is instructive,

Previous owners Macquarie, which helped grow Thames Water’s large debt pile, deserves blame.

The financial engineering that juiced up returns for investors has come at the cost of the utility's financial health, 

Its net debt to ebitda ratio was 14 times at operating company Thames as of September 2022. For Kemble that figure was 22 times. Operating profits did not equal interest costs, with interest cover at 0.6 times and 0.3 times respectively. A high share of index-linked debt hurts, while indexed water rates lag behind interest payments. Whether Thames makes outsized returns is difficult to measure. Cash transferred from the operating company to investors via interest payments and dividends over the past decade comes to about £4.1bn, according to S&P data. Peers United Utilities and Severn Trent have paid out similar amounts. The difference at Thames is that three-quarters of that cash flow went as non-taxable interest payments to debtholders.

This summary of water privatisation in UK makes disturbing reading,

After being sold with almost no debt at privatisation three decades ago, UK water companies have taken on borrowings of £60.6bn, diverting income from customer bills to pay interest payments. The entire sector is now under pressure from rising inflation, including soaring energy and chemical prices and higher interest payments on its debts. S&P, the rating agency, has negative outlooks for two-thirds of the UK water companies it rates — indicating the possibility of downgrades as the result of weaker financial resilience. More than half of the sector’s debt on average is inflation-linked. Ofwat said in December that it was concerned about the financial resilience of several water companies: Thames Water, Yorkshire Water, SES Water and Portsmouth Water. ​ In 2021, Southern Water, which serves 4.2mn customers across Kent, Sussex and Hampshire, was rescued from the brink of bankruptcy after Australian infrastructure investor Macquarie agreed to take control of the company in a private deal with Ofwat.

In this context, FT has a long read which examines the role of Australian infrastructure fund, Macquarie in pioneering PE investments in infrastructure. The article points to two Macquarie UK infrastructure case studies (including Thames Water) that also highlights the problems with the model.

Macquarie first dipped its toe into the UK’s waters in 2003, with its shortlived acquisition of South East Water. After buying the company for £386mn from the French conglomerate Bouygues, Macquarie sold its final stake three years later for £665mn. During that period, debt — some of which was raised via a Cayman Islands subsidiary — increased more than fourfold from £87mn to £458mn. The increase in borrowing was used to pay investors more than £60mn in dividends as well as to pay off most of the costs of acquiring the company so that the final sales price was mostly profit... it was a loss for customers because a greater proportion of their bills — up from 8.7 per cent of turnover in 2002 to 14 per cent in 2006 — began to go towards paying the interest on debt.

... it and its co-investors acquired Thames Water, which now has 15mn customers in London and the Thames Valley, from German utility RWE for £4.8bn in 2006. One of the Macquarie consortium’s first acts was to arrange for Thames Water to pay a £656mn dividend in a year in which profits were just £241mn. Within six years, the group of companies managed by Macquarie had recovered all the money it and co-investors had spent on the acquisition, by borrowing against its assets and paying out dividends. By the time Macquarie sold its final stake in Thames Water in 2017, the company had spent £11bn from customer bills on infrastructure. But far from injecting any new capital in the business — one of the original justifications for privatisation — £2.7bn had been taken out in dividends and £2.2bn in loans. Meanwhile, the pension deficit grew from £18mn in 2006 to £380mn in 2017. Thames Water’s debt also increased steeply from £3.4bn in 2007 to £10.8bn at the point of sale, a sum still being paid off with interest by customers long after Macquarie has moved on.

The article sums up the problem of private finance in infrastructure

Now, more than three decades after privatisation first became popular, governments are faced with a conundrum: how they can use private finance in infrastructure in a way that delivers adequate returns for shareholders and deliver high quality services for the people — their voters — who are paying for them. “This is the issue of the decade,” says Folkman. “We know we want lots of investment to transition to net zero and even just to repair what’s failing. But if we want to make it work for investors as well as the public we need to figure out how to do it better and soon.” 

The first article points to Thames Water's ownership structure

And this graphic highlights the complicated holding structure.

Such complexity serves a purpose from the perspective of the private equity business model. But they distort incentives and set up the entity for failure. 

Note the nature of the shareholders and their widely dispersed shareholdings, and the opacity of ownership and accountability added by the complex ownership holding structures. None of the investors have any water sector expertise. Nor do they have any interest in building an enduring and efficient water utility. All of them are playing the pass-the-parcel game. They are impersonal investors for whom Thames Water sits in their big portfolios as just another investment. Even the holding company, Kemble Water Holdings, is part of the pass-the-parcel game. There is nobody with the long-term stakes to take the life-cycle view and build an efficient water utility that serves its customers. 

There is something to be said about ownership, and long-term at that, for such monopoly assets. It is essential for life-cycle management of such assets, especially those that are monopolies and deliver critical public services. Even if privatised, as the Europeans have done, the asset should be owned for the long-term by a physical company with expertise in the area and which can be held accountable by the government and customers. Regulators should take note of how the complexity of the holding company distorts incentives and comes in the way of life-cycle management of monopoly assets like utilities.  

The problem with private equity in infrastructure should now be obvious. It's largely regulated and as an asset category is characterised by low but stable returns. Private equity firms seek to maximise returns. The returns profile of infrastructure assets do not allow for meeting the objectives of the PE firm and infrastructure funds.

In the circumstances, I am increasingly convinced that the likes of Macquarie are not the right kind of investors for regulated infrastructure assets (like roads and utilities). The returns expectations of their limited partners and the incentives of employees are so badly skewed. In the aggregate and over long run, these structures end up doing more harm than good. 

Start-ups with perceptive entrepreneurs and Boards try to be selective about the nature of their investors . They avoid certain kinds of investors who prioritise returns maximisation above all else. Such investor screening is even more important in essential public service sectors like infrastructure. Private equity and infrastructure funds are not the desirable kind of investors in case of most infrastructure projects. 

Update 1 (02.07.2023)

More on the UK water utilities from a FT Editorial

Thames is the most highly leveraged company in the sector, but the regulator Ofwat last December flagged resilience concerns at four other suppliers too. The simple explanation for the sector’s troubles is that what are in essence simple businesses became playgrounds for financial engineering. Predictable revenue streams made water companies easy to leverage, and so appealing to buyout funds. All but three of England’s originally publicly-quoted water companies have been taken off the market (Scotland and Northern Ireland remain in the state sector, and Wales now has a not-for-profit entity). 

Companies and the regulator tout sizeable efficiency gains since privatisation that they say have kept bills lower than they would otherwise have been; Ofwat says investments have “roughly doubled”. But buyers often adopted complex structures to maximise leverage and minimise tax, and companies have paid out more than £72bn in dividends while a sector that was debt-free three decades ago has run up debts of £60bn. Environmental standards were for too long poorly enforced.

Update 2 (13.08.2023)

UK water privatisation facts of the day

After being privatised without debt in 1989, and given a £1.5bn government handout to make improvements to the network, water companies had ramped up £60bn in borrowing by March 2022 and paid out more than £70bn in dividends while presiding over leakage and pollution failures, including unknown quantities of untreated sewage pouring into coastal waters and rivers.

One Nation, One Tax, One Database

India's Goods and Services Tax (GST) should count as among the landmark economic policy reforms in the country over the last three decades. It has already been bearing fruits in terms of the large expansion in tax base and revenues.

The GST also provides an excellent opportunity to harness the power of data and create a robust decision-support system for both GST administration and economic policy making. This is also important since the low hanging fruits in terms of expanding the tax base may have been harvested, and further increases in GST revenues will be critically dependent on the quality of data analytics to arrest leakages. Further, the GST Network (GSTN) database can form the basis for the creation of a decision-support system to provide insights about local and national economic growth trends. 

The GST’s business intelligence (BI) is currently supplied through a diverse set of entities. The Central Board of Indirect Taxes and Customs (CBIC) has two entities – Directorate General of GST Intelligence (DGGI) and Directorate General of Analytics and Risk Management (DGARM) – and an Advanced Analytics in Indirect Taxation (ADVAIT) portal. The GSTN has the Business Intelligence and Fraud Analytics (BIFA) unit, the National Informatics Centre (NIC) has its GST Prime which is integrated with the e-way bills database, and each state government has its own data analytics units. This patchwork is a legacy of the evolution of the GST system and also arises from the confidential nature of the GST BI.

Further, most data access, especially for state governments, happen on a long-drawn and ad-hoc request mode through file sharing. While the central agencies have access to the entire GST database and some access to outside databases, the state governments rely on the outputs of BIFA and GST Prime. They have limited access to the transactions of even their own taxpayers outside the state. 

The net result is a BI system with multiple silos, differential access to data, limited standardisation of risk analytics, and sub-optimal harvesting of the power of data analytics. 

So what can be done?

Identification of the major sources of GST evasion like fake registrations, fake e-way bills, fake Input Tax Credit (ITC) claims, circular trading, etc., requires access to different data sources. It can also enhance the quality of data analysis on these violations, which maximises the likelihood of detecting evasions while also minimises the likelihood of harassment of honest taxpayers.

For example, an e-way bill generated for cross-border sales can be validated by checking with data from the NHAI toll gates on the passage of the vehicle concerned. Or, in cases of circular trading where the chain involves taxpayers in other states, detection of evasion requires access to GST databases of other states. Similarly, the verification of the rising trend of ITC claims on Inter-state GST (IGST) from the supplies effected from outside the state requires access to returns filed and taxes paid by the dealers outside the state. Or, taxpayers who transact in cash without invoices can be detected through their income tax filings and bank accounts information. 

In this context, a BI system that’s able to draw on the entire GST database, the Income Tax database, the MCA 21 of the Ministry of Corporate Affairs, Vahan database on vehicle registrations, national highway toll gates data, bank account statements etc. can be extremely powerful. 

The granular and high frequency GST data, when linked with other databases, can be extremely valuable in macroeconomic policy making. It can address the acute deficiency of good quality current data on economic indicators which has been a major handicap in economic policy making in India. For example, using the Harmonised System of Nomenclature (HSN) Code, we can get information on the sales trends for important goods and services like automobiles, fast moving consumer goods, healthcare services etc. The granularity of the data allows to construct indices which are credible and real-time proxies about the health of the local and national economies. The National Data and Analytics Platform (NDAP) could be entrusted such analysis.

How can this be achieved?

First, it’s important to be clear about what constitutes access. The GSTN Back Office (BO) Portal workflow should be linked with different databases through Application Programming Interfaces (APIs). This would institutionalize equal access to the databases for the central and state GST units. It would also ensure that access is restricted only to defined fields and for specific purposes defined in the BO Portal’s BI. This can overcome the risk of leakage and abuse of this data. This data access can be standardized by limiting access only with sufficiently strong reasons, clearly defined sharing protocols, high enough authorization levels, to the least required data fields, data use trails are digitally available etc. This would address concerns of privacy, data safety, and audit.

Given the scope of the work involved, one approach would be for the GSTN to co-ordinate with various Departments and entities of the central government, and link the BO Portal with their respective databases. Another approach would be to create a full-fledged information intermediation entity, with its own portal, to co-ordinate access to different kinds of databases and facilitate its access to central and state GST units. 

In a large country, there will be a varying pace of adoption of any innovation by different states. Accordingly, some states will pursue data analytics more actively. Further, since they administer half the taxpayers and have the largest field presence, state units have the best field intelligence to undertake robust data analytics. The approach proposed will allow states to develop their data analytics from the BO Portal and the different databases linked to it. Those data analytics filters found effective could gradually get scaled up across states. 

Finally, this will also make states, which were encouraged to dispense with their IT systems and migrate to the GST BO workflow, realise the promised benefits of being part of the GSTN. 

Now that the GSTN workflows have matured, it’s time to connect with other databases and enhance the effectiveness of GST’s BI. The GST achieved one-nation, one-tax. It’s now required to achieve a one-GST, one database.

Information, theory, smartness, and wisdom

This is a fantastic visualisation that draws the distinction between data, information, knowledge, theoretical insights (smartness), wisdom (experience), and conspiracy theories. 

This visualisation links knowledge and experience.

The dots represent distinct and stand-alone packets of theoretical knowledge. Theory will also inform how some connections can be formed among the packets. But any kind of applied knowledge requires that theory be overlaid on real world examples to generate practical insights. These insights that emerge from real-world examples (or experiences) aggregate to form the basis of human judgement. The ability to exercise good judgement is wisdom. 

I have blogged here explaining my simple theory of comprehending the world. All comprehension is a combination of learnt knowledge and experiential knowledge (which comes from lived career and lived life). In this framework, the possession of learnt knowledge is a sign of being smart, whereas the possession of both learnt and experiential knowledge confers one with wisdom and the ability to exercise good judgment. 

The smart person uses certain analytical frameworks to apply his/her vast knowledge and theoretical insights into drawing evidence-based inferences and making 'objective' recommendations. The wise person adds the layer of experience to distill knowledge and theory to exercise good judgement and take decisions. A point to note is that experience by itself does not necessarily (or most often) does not translate into an ability to make good judgement and (thereby) wisdom. 

On closely related notes, I have blogged earlier on the importance of experience, "smartness" dominance in development debates, the distinction between being smart and wise, the twin tyrannies of quantitative methods and expert wisdom, challenge of marrying experiential and evidentiary knowledge, the ideology of evidence-based policy making, marginalisation of priors and elevation of evidence generation in policy making, and the trend of ahistoricism and data analytics in economics.

Weekend reading links

1. Graham Allison writes on China's dominance of the solar generation industry

China manufactures 80 per cent of all the solar panels produced globally. And, as the IEA notes, China’s dominance is even more pronounced when one examines the entire supply chain. It produces 85 per cent of the global supply of solar cells, 88 per cent of solar-grade polysilicon, and 97 per cent of the silicon ingots and wafers that form the core of solar cells. China’s rise to dominance in solar has been rapid. In 2005, Europeans led this race, with Germany accounting for a fifth of global solar manufacturing. By 2010, while Europe installed eight out of every 10 solar panels in the world, it produced only one. This year, China will make eight of every 10 solar panels produced worldwide and add five of those to its grid. In 2023 alone, China will install more new solar capacity than the US has deployed since Americans bought their first panels in the early 1970s.

It dominates poly silicon production

And the country's dominance in the market is the anti-thesis of free-market capitalism 101,

The factors driving China’s success in this arena are the same ones that have made it the uncontested manufacturing workshop of the world. These include low-cost capital, rapid regulatory approvals, protection from foreign competition, lower labour costs, an unparalleled network of suppliers, and fast-growing domestic demand.

Rana Faroohar points to a German Marshall Fund paper that points to China's dominance of the rare earths market

As the GMF report notes, China controls 61 per cent of global lithium refining, and 70 per cent of the global supply of cobalt for lithium ion batteries comes from mines in the Democratic Republic of Congo, many of which are owned by the Chinese. China controls 100 per cent of the processing of natural graphite used for battery anodes, and 80 per cent of the total rare earth production and processing.

2. This blog believes that the biggest obstacle to achieving green transition is the high cost of capital in developing countries. Martin Wolf has an article on the issue, that draws on Avinash Persaud's paper here.

In high-income countries, 81 per cent of green investment is funded by the private sector. In emerging and developing countries, the private share is a mere 14 per cent... for a similar solar farm, the average interest cost in leading emerging countries is a prohibitive 10.6 per cent per annum, against only 4 per cent in the EU... the cause of this huge spread is not project-specific risk. A solar farm, qua solar farm, is no riskier in India than Germany. More than all of the risk premium represents market estimates of macroeconomic (specifically, currency and default) risks. He also argues that these risks are not just exaggerated, but cyclically so: in “risk on” periods, overpayment for insurance is smaller than in “risk off” ones. 

The paper calculates this by looking at the cost of hedging foreign currency risk. That is expressed in terms of the difference between the price of buying foreign currency with local currency in future (the forward rate) and today (the spot rate). This gap can then be turned into an annual percentage rate. The conclusion from the evidence is that markets are too risk averse: the risks are not as great as they fear. This is particularly true when the markets are at their most risk averse: on average, “overpayment” for hedges has been 2.2 percentage points when their cost is below the three-year moving average, but 4.7 percentage points when the cost is above its moving average. 

The article has a good graphic illustrating the problem with the example of Indonesia, which shows that the cost of hedging the country's currency is closely linked to global conditions.

Persaud sees a free lunch here, in terms of lowering the risk premia to attract capital to developing countries. 

As Persaud puts it, “private investors are leaving money on the table. But even more significant are the far greater social gains from . . . boosting green growth in developing countries that are being left alongside.” This is a “planet sized” market failure. His proposal then is for a joint agency of the multilateral development banks and the IMF to offer foreign currency guarantees and pool currency risks. Projects could come to the guarantee agency from the MDBs. The guarantee agency could then prioritise projects that have the most significant positive impact on the climate. To limit risks of loss, the agency would wait until hedging costs were above the three-year average and so until risks are deemed large.

3. Vietnam may be the biggest immediate winner from the new Cold War arising from China-US tensions. From a new working paper by Anh Phuoc Thien Nguyen and Sunghun Lim,

Leveraging the US-China trade war episode, we uncover Vietnam’s structural transformation amid a harbinger of the end of globalization. Using Vietnam’s firm census and labor force survey data, we find that regions that were more exposed to the trade war shifted from informal agriculture to formal manufacturing. The trade war also led to increased firm formality and skill upgrading, accompanied by demand for skilled labor, particularly among females. Additionally, the trade war accelerated Vietnam’s urbanization through labor reallocation.

4. China plans more spending programs to revive stalling economic growth and high youth unemployment rate. As earlier, and despite the harsh lessons from it, the policies prioritised are more infrastructure spending and those to encourage people to buy more houses. A WSJ report points out that Beijing is considering issuing $140 billion of special treasury bonds to help indebted local governments and boost business confidence. The bonds would be used to finance infrastructure projects. It's also proposed to scrap purchase restrictions on second homes in smaller cities to boost the property market. Interest rates have already been cut by the PBoC. 

5.  History of the United States over the last sixty years in two graphics. First about the rising profits and stagnant wages.

On the national income gains being captured almost completely by the top quintile.

6. A feature of modern capitalism is how much of the agenda on what constitutes progress is being set by corporate interests. The latest is space travel.

Elon Musk, Jeff Bezos and Richard Branson are racing to establish a presence in space. But what rights and obligations come with that? It’s still not clear what the space laws are, even as the $460 billion industry is growing quickly.

7. Constraints on the electricity grid is becoming a big obstacle to the great transition. The scale is enormous.

One of the big issues... is there is “not enough grid” infrastructure to meet the needs of the changing energy system. BloombergNEF, a data provider, estimates that 80mn km of new grid is needed by 2050, more than enough to replace the entire global grid today... In much of the western world grids were developed after the second world war to serve big power stations burning a fossil fuel such as coal or gas... The green transition will require an overhaul of the current set-up. Several wind and solar farms are often needed to replace a large power plant, partly due to the intermittent nature of renewable energy; the wind doesn’t always blow. These farms all need grid connections, yet typically they are in remote areas or off coasts, where grids are patchier. “The grid is in the wrong place to deliver the power from [renewable energy] to economic centres,” says Peter Crossley, a professor of power systems at Exeter university.

Alongside this obstacle, the rollout of solar panels on homes and businesses that feed into the grid — plus the shift towards electric vehicles and heat pumps — has increased the complexity of managing electricity networks. Grid operators face a tricky balancing act — they must keep the lights on and expand the network without ramping up costs for consumers, while increasingly considering their role in cutting greenhouse gas emissions... In the UK, Spain and Italy more than 150GW of wind and solar projects are stuck in grid connection queues in each country, according to figures from BloombergNEF...

Despite countries setting out legal targets to cut emissions and increase renewable energy generation, operators and politicians have been slow to spend money to upgrade grids... Figures from the International Energy Agency show that rather than capital investment in grids globally increasing following the Paris agreement, it fell between 2017 to 2020 and only recovered to 2016 levels in 2022 at $330bn. Grid investments in Europe were stagnant between 2015 and 2020 at about $50bn per year, picking up only slightly in the past couple of years. In China, after falling between 2019 and 2021, investments in the country’s grids grew by 16 per cent to almost $83bn last year.

This about how California is struggling to overcome environmental and other regulations and build the electricity grid.  

8. Michael Massing has an article that illustrates the elite capture and self-censorship that is pervasive at Harvard Kennedy School

The Kennedy School in general is not hospitable to misfits. Those who too sharply question the established ways or stray too far outside the accepted parameters of thought can find themselves pushed to the sidelines, marginalized, and denied tenure or influential posts. The school’s close ties to Washington and the heavy presence of generals and admirals, intelligence officers and geostrategists, diplomats and thought leaders, create a climate unsupportive of those who are too outspoken on human rights, the Israel-Palestinian issue, or US foreign policy.

This about Meghan O Sullivan is emblematic

On February 21, the Belfer Center for Science and International Affairs—the school’s main foreign policy hub—named a new director: Meghan O’Sullivan. The Jeane Kirkpatrick Professor of the Practice of International Affairs, O’Sullivan served as a special assistant to President George W. Bush from 2004 to 2007, including two years as the deputy national security adviser for Iraq and Afghanistan. She spent a year in Baghdad, becoming a top aide to Paul Bremer, the head of the Coalition Provisional Authority, whose policies helped plunge Iraq into years of sectarian violence... On her Kennedy School web page, she lists among her “outside professional activities” Capital Group (investment management), CEO Academy (training chief executives), Citigroup (banking), the Hess Corporation (oil), Linklaters (corporate law), Macro Advisory Partners (strategic consulting), McKinsey (management consulting), PIMCO (investment management), and Raytheon Technologies. 

Raytheon, on whose board O’Sullivan sits, is one of the five largest US defense contractors... From 2020 to 2022, O’Sullivan received more than $900,000 in compensation from Raytheon for her board service... In an editorial, the Crimson called her connection to Raytheon “a stain on our institution.” ... the Crimson said that by “continuing her involvement with Raytheon, O’Sullivan has demonstrated extraordinarily bad judgment at best and frank, dark immorality at worst,” and it urged her to resign.

See also this about Larry Summer's deeply questionable motivations.  

9.  Most of capitalism with Chinese characteristics is sensible. But not "business valuation with Chinese characteristics"!

Beijing’s bid to persuade investors to value its giant state-owned enterprises according to their socialist credentials, rather than by conventional western capitalist measures, has flopped after a rally in their shares fizzled this month. The stocks rose after officials in November called for the creation of a “valuation system with Chinese characteristics” that departed from traditional market methods by recognising the merits of “Communist party corporate governance”. To bolster the move, government-backed asset managers set up 16 mutual funds, nine of them index-linked, with a mandate to invest in state-owned listed companies.

10. Ruchir Sharma points to the rise of billionaire wealth. This shows the trends in wealth in emerging economies, where India dominates.

11. The ProPublica has an investigation which points to ethics violation and more by the US Supreme Court Judge, Samuel Alito,

In early July 2008, Samuel Alito... was on vacation at a luxury fishing lodge that charged more than $1,000 a day... Paul Singer, a hedge fund billionaire... flew Alito to Alaska on a private jet. If the justice chartered the plane himself, the cost could have exceeded $100,000 one way... In the years that followed, Singer’s hedge fund came before the court at least 10 times in cases where his role was often covered by the legal press and mainstream media. In 2014, the court agreed to resolve a key issue in a decade-long battle between Singer’s hedge fund and the nation of Argentina. Alito did not recuse himself from the case and voted with the 7-1 majority in Singer’s favor. The hedge fund was ultimately paid $2.4 billion. Alito did not report the 2008 fishing trip on his annual financial disclosures. By failing to disclose the private jet flight Singer provided, Alito appears to have violated a federal law that requires justices to disclose most gifts, according to ethics law experts...

This spring, ProPublica reported that Justice Clarence Thomas received decades of luxury travel from another Republican megadonor, Dallas real estate magnate Harlan Crow. In a statement, Thomas defended the undisclosed trips, saying unnamed colleagues advised him that he didn’t need to report such gifts to the public. Crow also gave Thomas money in an undisclosed real estate deal and paid private school tuition for his grandnephew, who Thomas was raising as a son. Thomas reported neither transaction on his disclosure forms... 

Singer’s interest in the courts is more than ideological. His hedge fund, Elliott Management, is best known for making investments that promise handsome returns but could require bruising legal battles. Singer has said he’s drawn to positions where you “control your own destiny, not just riding up and down with the waves of financial markets.” That can mean pressuring corporate boards to fire a CEO, brawling with creditors over the remains of a bankrupt company and suing opponents.

This is another brief summary 

In 2008, Justice Alito accepted a free flight to a luxury fishing resort in Alaska on a private jet owned by Paul Singer, the hugely wealthy hedge-fund owner and major conservative donor. When one of Mr. Singer’s companies later appeared before the court in a multibillion-dollar lawsuit against the Argentine government, it won its case, eventually netting $2.4 billion. Justice Alito voted in the majority. He neither recused himself from the case nor reported the free flight, which could have cost him up to $100,000 on the open market, and which appears to be a violation of a federal lawrequiring the disclosure of such gifts.

And this

Rather than try to square that circle and admit he’d been caught doing something ethically wrong and arguably illegal, Justice Alito went to laughable lengths to lawyer his way out. As far as he was aware, he wrote, the seat he occupied on his private-jet jaunt to Alaska “would have otherwise been vacant” — by which he presumably means to say the gift was valueless. Remind me to try that one out the next time I walk past an empty first-class seat on a Delta flight. Seriously, though: do these guys listen to themselves?

In an unprecedented move, Alito pre-empted the ProPublica expose by writing an oped in WSJ defending himself. And the defence, like that of Clarence Thomas earlier, gave the game away by pointing out that such practices were widespread within the US Supreme Court.

In his op-ed, Alito said that justices “commonly interpreted” the law’s exception for hospitality “to mean that accommodations and transportation for social events were not reportable gifts.”

I'm inclined to argue that such corruption is common among high public officials across countries, developed and developing.  

12.  Good article in the Times about how Russian oil exports have found their way into India. 

The bulk of the crude that goes to India from Russia arrives at ports near Jamnagar in Gujarat State and is piped to nearby refineries. The Jamnagar Refinery, which is owned by Reliance Industries, is the largest in the world, with the capacity to process more than 1.2 million barrels per day... India’s second-largest refinery is less than 10 miles away: the Vadinar complex owned by Nayara Energy. Nayara is half-owned by Rosneft, Russia’s state oil company; a Russian investment group has a stake in the other half. 

This trade has benefited Russia, India, and Europe. And has perhaps played an important role in keeping oil prices down and ensuring supply to Europe. 

Weekend reading links

1. Golf is a test bed for what happens when financial interests end up driving its course. The sport has been hit by three competing global leagues/tours each of which trying to lure players into it and barring non-members from playing its events. The two largest, LIV Golf and US-based PGA tour, have even at each other in recent months and have taken their dispute to the courts.

Into this comes Saudi Arabia, whose SWF Public Investment Fund (PIF) has now infused $3 billion to merge LIV Golf and PGA tour, and also brought the commercial operations of the Europe-based DP World Tour under the umbrella of the joint entity created for the merger. The Saudis were the promoters of the breakaway LIV Golf, which had broken away from the PGA Tour and lured top stars by paying massive signing bonuses. The new entity's Board will be chaired by the CEO of PIF, though the US PGA Tour will have majority voting rights. This is an explainer of the deal. 

This is part of Saudi Arabia's push into global sport. In football, it recently handed over ownership of its top four football clubs to PIF, which also owns Newcastle United. It also has significant interests in Formula One. At a global scale, this is also part of Prince Mohammed Bin Salman's efforts to project the Kingdom on the global stage, something which critics have denounced as "sports-washing". An FT article writes

Sport is one of 13 “strategic” sectors identified by the PIF, partly to deliver more entertainment options for a youthful domestic population, but also to champion Saudi Arabia’s brand overseas... this week’s investment gives Saudi Arabia for the first time partial control of a professional sport circuit. The PIF will have a significant minority stake in the new entity that will unify the commercial operations of the PGA, the European DP World Tour and LIV.

From being a risk-averse vehicle to park the country's reserves, the PIF has grown into a brash international investor with investments in Uber, SoftBank's Vision Fund, gaming companies, and a lot more. But its main focus has been to help boost and shape the domestic economy.

It has created 79 companies, ranging from a coffee producer, to a new airline, a waste-recycling business, a defence firm and even a vape business. The fund and its subsidiaries are responsible for everything from Riyadh’s renewable energy goals to urban regeneration and food security. As well as establishing new industries, the PIF has been tasked with developing a string of megaprojects. The most eye-catching — and controversial — is Neom, a $500bn scheme to create a massive futuristic development along the Red Sea coast with a 170km-long linear city in the desert, known as the Line, at its heart... Some analysts have described the fund — which committed to invest $200bn in Saudi Arabia in the five years through to 2025 — as a state within a state.

2. Interesting oil industry facts - the industry's net income in 2022 rose to $4 trillion, more than double the average for recent years; dividends and share buybacks formed 39% of its spending, a 15 year high; but just 1% of its cash went into clean energy investments; and less than half the cash available was invested into new oil and pipeline, the first time in at least 15 years.

3. With its dependency ratio (the number of people aged 65 and above as a share of its working age population) expected to treble to 75% in the next three decades, South Korea is ground zero for ageing societies. 

4. Couple of graphics on Indian Railways from an FT article. The first on electrification, 

The length of electrified railway lines in India has more than doubled since 2014, from 21,000km to more than 50,000km in 2022. The proportion of electrified lines reached 65.8 per cent in 2021, higher than France’s 60.3 per cent and the UK’s 38 per cent.

And this on the impressive reduction in accidents, notwithstanding the recent tragedy

5. Ruchir Sharma writes that luxury is to European stock markets what Big Tech is to the US

Contrast Europe to the US, where over the past 12 months 10 of the biggest tech firms accounted for 65 per cent of stock market returns — which is itself an alarming sign of industry concentration. The similar signs of concentration are even more concerning in Europe. There, 10 of the biggest luxury stocks, from LVMH to Ferrari, have accounted for about 30 per cent of returns — a share unmatched since records began...

Europe’s list of top 10 companies by market capitalisation, which has historically been dominated by banks, utilities and industrial conglomerates, now features four luxury names, up from zero at the start of the 2010s. Its big luxury brands are even more profitable than big US tech, with earnings amounting to nearly 25 per cent of revenue... The top European brands now account for a third of global sales, up from a quarter in 2010. Europe’s top four luxury companies, by market cap, are all French: LVMH, L’Oréal, Hermès, and Christian Dior (which is owned by LVMH)...

Increasingly, the global luxury industry is based on goods that are still made by small Italian firms but sold by big French conglomerates. Gucci, Bulgari, Fendi — all are Italian brands now under French owners. While US tech firms overshadow all rivals, the same can be said of French luxury. Among the top luxury firms, the French have annual sales three times higher than the Swiss, more than four times the Americans and Chinese and 12 times the Italians.

Sharma argues that the dominance of luxury, in contrast to technology in the US, highlights the problems faced by European economies in terms of productivity growth and economic dynamism.  

6. Daron Acemoglu and Simon Johnson may well have made the most definitive argument against the unimpeded progress of AI evolution. 

Tech giants Microsoft and Alphabet/Google have seized a large lead in shaping our potentially A.I.-dominated future. This is not good news. History has shown us that when the distribution of information is left in the hands of a few, the result is political and economic oppression. Without intervention, this history will repeat itself... The fact that these companies are attempting to outpace each other, in the absence of externally imposed safeguards, should give the rest of us even more cause for concern, given the potential for A.I. to do great harm to jobs, privacy and cybersecurity. Arms races without restrictions generally do not end well. History has repeatedly demonstrated that control over information is central to who has power and what they can do with it... 

This technology is in the hands of two companies that are philosophically rooted in the notion of “machine intelligence,” which emphasizes the ability of computers to outperform humans in specific activities... This philosophy was naturally amplified by a recent (bad) economic idea that the singular objective of corporations should be to maximize short-term shareholder wealth. Combined together, these ideas are cementing the notion that the most productive applications of A.I. replace humankind. Doing away with grocery store clerks in favor of self-checkout kiosks does very little for the productivity of those who remain employed, for example, while also annoying many customers. But it makes it possible to fire workers and tilt the balance of power further in favor of management. We believe the A.I. revolution could even usher in the dark prophecies envisioned by Karl Marx over a century ago... Our future should not be left in the hands of two powerful companies that build ever larger global empires based on using our collective data without scruple and without compensation.

They have three proposals to control these data monopolies and future of civilisation

Congress needs to assert individual ownership rights over underlying data that is relied on to build A.I. systems. If Big A.I. wants to use our data, we want something in return to address problems that communities define and to raise the true productivity of workers. Rather than machine intelligence, what we need is “machine usefulness,” which emphasizes the ability of computers to augment human capabilities. This would be a much more fruitful direction for increasing productivity. By empowering workers and reinforcing human decision making in the production process, it also would strengthen social forces that can stand up to big tech companies. It would also require a greater diversity of approaches to new technology, thus making another dent in the monopoly of Big A.I.

We also need regulation that protects privacy and pushes back against surveillance capitalism, or the pervasive use of technology to monitor what we do — including whether we are in compliance with “acceptable” behavior, as defined by employers and how the police interpret the law, and which can now be assessed in real time by A.I. There is a real danger that A.I. will be used to manipulate our choices and distort lives.

Finally, we need a graduated system for corporate taxes, so that tax rates are higher for companies when they make more profit in dollar terms. Such a tax system would put shareholder pressure on tech titans to break themselves up, thus lowering their effective tax rate. More competition would help by creating a diversity of ideas and more opportunities to develop a pro-human direction for digital technologies. If these companies prefer to remain in one piece, the elevated tax on their profits can finance public goods, particularly education, that will help people cope with new technology and support a more pro-human direction for technology, work and democracy.

7. On a related note, another article points to a recent strike by over 11000 film and TV writers in the Writers Guild of America Union which went, calling for among other things, studios to guarantee them weeks of work at a time instead of hiring by the day.

This protest yet again highlights the biggest problem with the gig economy. Labour is an important cost in any industry, but especially so in the services sectors. But services sectors also allow for flexibility to employers in the management of their workforce. This flexibility gets enabled by technology. For workers, the same flexibility also proved the attraction, though it has now soured with instability and low wages.

8. Byju's, the eponymous Edtech firm, is hurtling towards what should be its inevitable denouement. First,  it missed a $40 million repayment due on June 5 and cheekily sued its lenders over alleged harassment in the loan recovery. The lenders have accused Byju's of moving $500 million out of Byju's Alpha, the US borrower. The company's $1.2 billion debt is trading at 64 cents. Second, its auditor since 2016 and re-appointed for another five years in 2020, Deloitte, has quit with immediate effect citing "long-delayed" financial statements. The auditor also said there was a "significant impact" on its ability to perform the audit according to standards and that it has "not received any communication on the resolution of the audit report modifications for 2020-21. The auditor's statement is a damning indictment,

The financial statements of the company for the year ended March 31, 2022 are long delayed. In accordance with the Companies Act, 2013, the audited financial statements for the year ended March 31, 2022 were due to be laid before shareholders in the Annual General Meeting by September 30, 2022.

We have also not received any communication on the resolution of the audit report modifications in respect of the year ended March 31, 2021, status of the audit readiness of the financial statements and the underlying books and records for the year ended March 31, 2022 and we have not been able to commence the audit as on date.

As a result, there will be significant impact on our ability to plan, design, perform and complete the audit in accordance with the applicable auditing standards. In view of the aforesaid, we are tendering our resignation as statutory auditors of the company with immediate effect.

Third, its three largest investors, Sequoia, Naspers, and Chan Zuckerberg Initiative, have quit the company's Board, leaving it with only family members - husband, wide, and brother. The resignation came just after Byju's firmly denied any resignations, thereby clearly pointing to problems with all its investors. 

Byju's should count alongside the likes of WeWork in having acutely deficient corporate governance  standards, promoters with questionable integrity, and defrauding investors. I'm inclined to believe that the only reason the Government is not actively pursuing the various investigations, including by the Serious Fraud Investigations Office (SFIO), is that it does not want the unravelling to rock the Indian start-up ecosystem. In other words Byju's is too big to fail, and therefore its end game has to be a gradual phase down. 

On Edtech, Andy Mukherjee is spot on in his assessment of the market potential

As it has always been, the real money is in coaching 16-year-old Indians from big cities and small towns, helping them get into a top engineering, medical or management program. Most will fail because of the sheer demand-supply gap, but all will pay to try. For this segment, online resources like question banks are valuable, but only as a supplement. They are no substitute for talented teachers whose reputations fill stadium-sized classes.

9. A bribes for jobs scandal has erupted in TCS, India's largest software firm. It has been uncovered, following a whistleblower complaint, that a few senior personnel at the company were accepting bribes from staffing firms for giving jobs to their candidates, for years. The company's internal investigations appear to have confirmed the practices and the global head of recruitment has been sacked and debarred from coming to the office. It's estimated that the officials may have earned atleast Rs 100 Cr through commissions in the last three years when the company hired 300,000 people. 

This does not involve any loss of public money, so does not attract indignation in the media. But I'm strongly. inclined to believe that such practices are not uncommon in almost all the major Indian companies in procurements and recruitments. After all the social norms, which allow such corrupt practices, are the same whether in the public or private sectors. 

10. Donald Shoup proposes replacing the free street parking slots in New York City with paid parking. His idea is to recover parking charges and use it to pay for benefits in the area.  

Several US cities have established parking benefit districts that charge demand-based prices for curb parking within a selected area and use the resulting revenue to pay for public services on the metered blocks. The purpose of a parking benefit district is to convince stakeholders they want to charge for their curb parking, by connecting those fees to visible neighborhood amenities. If stakeholders see substantial local benefits from the meter revenue, a new golden rule of parking prices may emerge: Charge others what they would charge you.

Revenue generated by the meters can be used to pay for public services, such as repairing sidewalks, planting street trees or providing other improvements. Few will pay for curb parking but all will benefit from public services. For example, Boulder, Colorado, uses its downtown meter revenue to buy transit passes for all downtown workers. Drivers who park on the street subsidize commuters who ride the bus. If the meter revenue pays for public services that residents and area business owners want and will get only if the city charges for curb parking in their neighborhood, market prices begin to make political sense.

He estimates this to generate $237 million a year in revenues if implemented in New York's Upper West Side district's 12300 free curb spaces.  

Suppose the city spends this revenue to buy an MTA transit pass ($33 a week) for each of the Upper West Side’s 111,000 households. The total cost would be $189 million a year. The remaining revenue could be used to clean and maintain the Upper West Side’s 14 subway stations. Curb parkers would improve life for many more transit riders. Parking revenue would pay the transit fares, and the fare-free transit for residents would boost MTA ridership.

The FT has an article which describes US cities as one big parking lot. This is striking

“At the centre of our biggest cities, some of the most valuable public land on earth has been exclusively reserved for the free storage of private cars,” writes Henry Grabar, author of Paved Paradise: How Parking Explains the World. There are more square feet of housing in the US for each car, he notes, than there are for each human... The authors of A Pattern Language, the classic 1977 study of livability and urban design, note that cars require a thicket of infrastructure useless to carless humans — driveways, garages, asphalt. When there are too many cars, residents feel "that the outdoors is not meant for them, that they should stay indoors, that they should stay in their own buildings, that social communion is no longer permitted or encouraged". The authors suspected that 9 per cent of an area's land devoted to parking was the threshold. Yet fully 30 per cent of central Detroit is devoted to parking. So is 28 per cent of Louisville, 24 per cent of Dallas and 21 per cent of Phoenix. Swaths of city centres across the country exist solely to house cars. Some 20 per cent of all studied city centres were parking lots.

This is a stunning map of downtown Detroit 

And this of downtown Dallas

11. China may be set to reglobalise, as the share of its manufacturing output set for exports is expected to grow.

12. As Nvidia goes past one trillion dollar market capitalisation, Brad Setser points to the fact that the company pays negligible federal income tax in the US! Its effective tax rate was 1.9%, 1.7% and 5.9% in 2022, 2021, and 2020 respectively. 

Directed Improvisation - the growth of venture capital in China

Yuen Yuen Ang has described China's growth model as one of "directed improvisation", which combines top-down direction with bottom-up improvisation. Instead of dictating precise plans, the central government guides and incentivize adaptive responses within the system. This included flexible policy signals, concrete definition of success, high-powered incentives at all levels, promotion of regional niches etc. The local officials figure out local solutions to local problems. 

She builds a three-step framework to explain development that followed from "directed improvisation". 

Harness weak/wrong/backward institutions to build markets > emerging markets stimulate strong institutions > strong institutions preserve markets. This three-step sequence of development presents a fundamental corrective to the conventional wisdom, which traditionally has insisted that it is either “good” institutions (such as rule of law and formal property rights) that led to economic growth, or the other way around. China’s experience demonstrates that the first step of development, paradoxically, is to re-purpose “weak/wrong/backward” institutions to create new markets. Taking this first step, however, requires directed improvisation as an organizational prerequisite.

Sebastian Mallaby's book on the rise of venture capital, The Power Law: Venture Capital and the Art of Disruption, has an excellent description of this approach at play in the development of China's venture capital financing and startup ecosystem

The Chinese government forbade foreign ownership of a broad swath of Chinese businesses, including ones that ran websites. This meant that U.S. venture investments into companies like Alibaba were on their face illegal, as was the listing of Chinese internet stocks on America’s Nasdaq market... To breathe life into China tech, the U.S. VCs and their lawyers came up with a series of workarounds. To begin with, the Chinese internet companies they backed were incorporated in the Cayman Islands. Cayman law allowed for every variety of stock: common shares for the startup founders, share options for employees, preferred shares for the investors. Further, a Cayman outfit could accept investment capital from a non-Chinese VC: Goldman Sachs was forbidden to invest in an internet startup in Hangzhou, but it could buy shares in its Cayman parent. Finally, the Cayman shell could easily be listed on a non-Chinese stock exchange such as the Nasdaq, providing a way around the blockage of China’s primitive markets. 

Once the Cayman company had been established, the next task was to use its venture dollars to build a business in China. To get around the prohibition on foreigners owning equity in a Chinese internet venture, the Cayman dollars were pumped into a parallel Chinese-owned operating company in the form of a loan. Then, to give foreign investors the sorts of rights that they expected from venture deals, Silicon Valley’s lawyers invented what amounted to synthetic equity. They executed a series of side contracts between a China-based subsidiary of the Cayman company and the Chinese-owned internet operator. The Chinese internet company granted control rights to its foreign creditors, simulating the influence that comes with an equity stake. The Chinese company also agreed to pay interest on its foreign loan in amounts that varied according to the success of the business: in effect if not in law, the foreigners received dividends. Finally, to cap off these arrangements, all parties agreed that disputes would be resolved under New York law. Chinese officials refused to bless this Silicon Valley confection. But, to be fair, they tolerated it.

The improvisation at the local level and the officials turning a blind-eye to the legality of these structures is instructive. This structuring was permitted to happen in a de-facto regulatory sandbox. Once it got refined, it got adopted as the mainstream mode for foreign investment in China through the so-called "variable interest entities (VIEs)". 

This example also illustrates the problems with the conventional wisdom that countries can attract foreign investments only if their regulatory environment is enabling and welcoming. China has consistently disproved this ostensibly sacrosanct principle in attracting foreign investment. There are several accounts that show that its domestic policy and operating environment, and that too not in recent years but even in its development phase, have been deeply uncertain. Investors have sought to overlook this and invest in the country.

The American influence was deep

China’s technology boom was forged to a remarkable extent by American investors, and the Chinese VCs who emerged alongside them were themselves quasi-American—in their education, professional formation, and approach to venture capital. They had studied at top U.S. colleges, worked at U.S. companies, and carefully absorbed the U.S. venture playbook: equity-only funds, stage-by-stage financing, sleeves-rolled-up involvement, and stock options for startup employees... In short, U.S. capital, legal structures, and talent were central to the development of China’s digital economy. Without this American input, companies like Alibaba could not have gotten off the ground, and today’s Chinese dominance of technologies such as mobile payments would not have been likely either.

The challenges of scaling and firm capability

The issue of state capability has been a recurrent theme in this blog. Governments in developing countries struggle to implement programs with fidelity thereby weakening their impact. This is especially so with what is human engagement intensive and non-quantifiable (quality-based), or thick, activities, compared to logistics-heavy and quantifiable, or thin, activities. 

I'm inclined to argue that even private companies are not immune from this problem. Firms in the business of producing goods and services that primarily involve thick activities will struggle with execution fidelity as they expand in size. Whether done in the public or private sector, scaling thick activities is very hard, one of the hardest of human endeavours. 

In general, there are at least three differences between the activities of the public and private sectors. One, many of the basic public sector activities are inherently thick activities where the quality of human engagement is critical and is also the difference between success and failure. Two, the transactional nature of private sector activities, where one side pays to buy a good or service, is a powerful incentivising force to keep the system disciplined. Three, public sector activities are embedded in a social and political context and interact constantly with these contextual factors. In contrast, private sector activities are performed in a near sanitised or controlled environment. 

But I'll argue that even with these differences, businesses run into the problems of size-related vulnerabilities as they scale. The thin nature of private sector activities, the disciplining force of the market, and technology cannot mask the scaling challenges. 

The Times has an article that tries to capture Amazon's emerging vulnerabilities, especially in terms of labour unrest, as it grows in size and expands the scope of its business activities. As Amazon grows, so do the perils of bigness. 

Amazon’s recent growth helped create the choke points that workers have sought to exploit. During its first two decades, the company stayed out of the delivery business and simply handed off your cat toys and razor blades to the likes of UPS, FedEx and the Postal Service. Amazon began transporting many of its own packages after the 2013 holiday season, when a surge of orders backed up UPS and other carriers. Later, during the pandemic, Amazon significantly increased its transportation footprint to handle a boom in orders while seeking to drive down delivery times... 

The problem is that shipping networks are fragile. If workers walk off the job at one of Amazon’s traditional warehouses, the fulfillment center, the business impact is likely to be minimal because the sheer number of warehouses means orders can be easily redirected to another one. But a shipping network has far less redundancy. If one site goes down, typically either the packages don’t arrive on time or the site must be bypassed, often at considerable expense. All the more so if the site handles a huge volume of packages... And as Amazon’s chief executive, Andy Jassy, seeks to drive down shipping times further, the disruptive potential of this kind of organizing may be growing...

According to data from MWPVL International, the consulting firm, a small portion of Amazon fulfillment centers ship an extremely high volume of goods — more than one million items a day during last year’s peak period... If a union strikes and shuts down one of those buildings, “there will be penalties to pay” for Amazon even with its redundant capacity... More precarious is the company’s delivery infrastructure, where such extensive redundancy is impractical. For example, Amazon also operates dozens of so-called sort centers, where often more than 100,000 packages a day are grouped by geographic area. Many metro areas the size of Albuquerque or St. Louis have only one or two such centers, and a metro area as large as Chicago has only four. If one went down... Amazon could be forced to reroute packages to sort centers in other cities, raising costs... To get a sense of what this could cost, consider that FedEx spent hundreds of millions of dollars on such rerouting in 2021.

The Times did an earlier investigation into human resource problems that bedevil Amazon. 

For at least a year and a half — including during periods of record profit — Amazon had been shortchanging new parents, patients dealing with medical crises and other vulnerable workers on leave, according to a confidential report on the findings. Some of the pay calculations at her facility had been wrong since it opened its doors over a year before. As many as 179 of the company’s other warehouses had potentially been affected, too... That error is only one strand in a longstanding knot of problems with Amazon’s system for handling paid and unpaid leaves, according to dozens of interviews and hundreds of pages of internal documents obtained by The New York Times. Together, the records and interviews reveal that the issues have been more widespread — affecting the company’s blue-collar and white-collar workers — and more harmful than previously known, amounting to what several company insiders described as one of its gravest human resources problems.

Workers across the country facing medical problems and other life crises have been fired when the attendance software mistakenly marked them as no-shows, according to former and current human resources staff members, some of whom would speak only anonymously for fear of retribution. Doctors’ notes vanished into black holes in Amazon’s databases. Employees struggled to even reach their case managers, wading through automated phone trees that routed their calls to overwhelmed back-office staff in Costa Rica, India and Las Vegas. And the whole leave system was run on a patchwork of programs that often didn’t speak to one another. Some workers who were ready to return found that the system was too backed up to process them, resulting in weeks or months of lost income. Higher-paid corporate employees, who had to navigate the same systems, found that arranging a routine leave could turn into a morass. In internal correspondence, company administrators warned of “inadequate service levels,” “deficient processes” and systems that are “prone to delay and error.”

This is the longer detailed investigation. It shows how Amazon's spectacularly successful rapid scale-up of operations in the aftermath of the Covid 19 pandemic (it hired 350,000 new workers between July and October 2020, through computer screening and with little conversation or vetting) relied on efficiency maximising business process automation which carried within itself the seeds of its failures. 

Amazon and its founder, Jeff Bezos, had pioneered new ways of mass-managing people through technology, relying on a maze of systems that minimized human contact to grow unconstrained. But the company was faltering in ways outsiders could not see... In contrast to its precise, sophisticated processing of packages, Amazon’s model for managing people — heavily reliant on metrics, apps and chatbots — was uneven and strained even before the coronavirus arrived, with employees often having to act as their own caseworkers, interviews and records show. Amid the pandemic, Amazon’s system burned through workers, resulted in inadvertent firings and stalled benefits, and impeded communication, casting a shadow over a business success story for the ages.

The mass layoffs in Amazon in recent months are a social cost inflicted by the company's efficiency and profits maximising and resilience neglecting its business model. It's the classic private appropriation of all profits and socialisation of costs. It's therefore important to have regulations that force the likes of Amazon to internalise these social costs. Do R&D investments that promote such efficiency maximisation deserve its current generous tax concessions?

In fact, super-scaling of any activity, even the thin kinds, creates its own vulnerabilities. The numbers of people, functional units, and the multiplicity of processes become too big to be supervised and managed effectively through centralised systems, much less ones that are mostly automated. Such organisations require some form of delegation of powers, and discretion and exercise of judgment at appropriate levels. This, in turn, generates risks and vulnerabilities. It's for this reason that all large corporations experience recurrent episodes of management failures. The threshold at which an activity becomes scale or super-scale enough to reach peak-automation varies widely across activities. 

It's appealing to overcome this challenge by going further down the work-flow automation pathway. Amazon's leave management system is a good example. This is teachable.

As the country’s second largest private employer, Amazon offers a wide array of leaves — paid or unpaid, medical or personal, legally mandated or not. While Amazon used to outsource the management of its leave programs, it brought the effort in-house when providers couldn’t keep up with its growth. It is now one of the largest leave administrators in the country. Employees apply for leaves online, on an internal app, or wade through automated phone trees. The technology that Amazon uses to manage leaves is a patchwork of software from a variety of companies — including Salesforce, Oracle and Kronos — that do not connect seamlessly. That complexity forces human resource employees to input many approved leaves, an effort that last fall alone required 67 full-time employees, an internal document shows... 

Current and former employees involved in administering leaves say that the company’s answer has often been to push them so hard that some required leaves themselves... Amazon’s own teams have not always been well-versed in the system, internal documents show. An external assessment last fall found that the back-office staff members who talk with employees “do not understand” the process for taking leaves and regularly gave incorrect information to workers. In one audited call, which dragged on for 29 minutes, the phone agent told a worker that he was too new to be eligible for short-term disability leave, when in fact workers are eligible from their first day...

In some cases, Amazon has been accused of violating the law. In 2017, Leslie Tullis, who managed a subscription product for children, faced a mounting domestic violence crisis and requested an unpaid leave that employers must offer under Washington State law to protect victims. Once approved, Ms. Tullis would be allowed to work intermittently; she could be absent from work as much as necessary, and with little notice; and she would be protected against retaliation. Amazon granted the leave, but the company didn’t seem to understand what it had said yes to. It had no policy that corresponded to the law of the company’s home state, court documents show. Ms. Tullis said she spent as many as eight hours a week dealing with the company to manage her leave.

In its search for efficiency maximisation, cost minimisation, and limiting discretion Amazon transformed the simplest and most commonest administrative task, approval of leaves, into a logistics-only process. Through workflow automation, it has not left any activity to the slightest discretion of managers, even high enough ones. Applying the accountability framework, one could state that Amazon has taken accounting-based accountability to its logical extremes in an effort to avoid the hard task of building account-based accountability even among its middle and senior managers. Sample this.

David Niekerk, a former Amazon vice president who built the warehouse human resources operations and who retired in 2016 after nearly 17 years at the company, said that some problems stemmed from ideas the company had developed when it was much smaller. Mr. Bezos did not want an entrenched work force, calling it “a march to mediocrity,” Mr. Niekerk recalled, and saw low-skilled jobs as relatively short-term. As Amazon rapidly grew, Mr. Niekerk said, its policies were harder to implement with fairness and care. “It is just a numbers game in many ways,” he said. “The culture gets lost.”...

Amazon intentionally limited upward mobility for hourly workers, said Mr. Niekerk... Instead... wanted to double down on hiring “wicked smart” frontline managers straight out of college... Amazon’s founder didn’t want hourly workers to stick around for long, viewing “a large, disgruntled” work force as a threat, Mr. Niekerk recalled. Company data showed that most employees became less eager over time, he said, and Mr. Bezos believed that people were inherently lazy. “What he would say is that our nature as humans is to expend as little energy as possible to get what we want or need.” That conviction was embedded throughout the business, from the ease of instant ordering to the pervasive use of data to get the most out of employees. So guaranteed wage increases stopped after three years, and Amazon provided incentives for low-skilled employees to leave...

He and the other newcomers had been hired after only a quick online screening. Internally, some describe the company’s automated employment process as “lights-out hiring,” with algorithms making decisions, and limited sense on Amazon’s part of whom it is bringing in. Mr. Niekerk said Mr. Bezos drove the push to remove humans from the hiring process, saying Amazon’s need for workers would be so great, the applications had to be “a check-the-box screen.” Mr. Bezos also saw automated assessments as a consistent, unbiased way to find motivated workers, Mr. Niekerk said.

While many routine activities are automated in governments too, the system still allows managers significant discretion to step in and relies on them to address emergent problems as per the relevant rules. By and large, despite the complex nature of their tasks and their context, they do a reasonably good job. It's then surprising that massively endowed behemoths like Amazon prefer complete automation for even routine tasks.

Over-engineered solutions, like that of Amazon, will always struggle to anticipate all possible contingencies and not be able to stay up to speed in a dynamic environment. Amazon's leave automation system is an example that illustrates the limit to work-flow automation of business processes. 

For this reason, I would rate the functioning of governments in many developed countries, the conduct of census and elections in India etc as being the most impressive organisational performances of our times, much superior to anything in the private sector. 

Amazon is a classic example of a logistics-heavy business. It manufactures/procures goods, aggregates suppliers, connects buyers, lightly curates the sale, manages the storage and transportation logistics, manages the payments and accounting, and delivers the item to the customer's doorstep. The important processes and outputs associated with each of these activities are inherently clearly definable, quantifiable, and amenable to accounting-based accountability. Besides, there's the disciplining force of the seller's accountability to the buyer. 

But even here, as one goes beyond a certain size, vulnerabilities emerge at the margin across several dimensions. These vulnerabilities are a direct cost of the company's efficiency and profits maximising business models across people, logistics, cost of inputs, and pricing. These models tend to skimp on the numbers of people, their wages, their capacity building, storage space, transportation logistics, and time, thereby leaving insufficient slack when vulnerabilities materialise. 

Employees face the force of efficiency maximisation in four dimensions - just enough people are employed to do the business at the least cost, employees are stretched out to the margins of their breakdown limits (through intense monitoring, for even how much time a worker pauses between tasks), are trained just enough for them to do their basic tasks, and are paid just enough to retain them for only just enough time (its hourly associates turnover was 150% a year, twice that in the retail and logistics industries). 

Sample this.

Two measurements dominated most hourly employees’ shifts. Rate gauged how fast they worked, a constantly fluctuating number displayed at their station. Time off task, or T.O.T., tracked every moment they strayed from their assignment — whether trekking to the bathroom, troubleshooting broken machinery or talking to a co-worker... In newer, robotics-driven warehouses like JFK8, those metrics were at the center of Amazon’s operation. A single frontline manager could keep track of 50, 75, even 100 workers by checking a laptop. Auto-generated reports signaled when someone was struggling. A worker whose rate was too slow, or whose time off task climbed too high, risked being disciplined or fired. If a worker was off task, the system assumed the worker was to blame. Managers were told to ask workers what happened, and manually code in what they deemed legitimate excuses, like broken machinery, to override the default

Storage spaces and transportation fleets are just enough to maximise their utilisation, the margin of safety on delivery times is squeezed enough to leave limited room to manoeuvre for even the average failures, and commissions are maximised to just about retain suppliers. The power of data analytics and automation is harnessed to reach an exalted efficiency maximisation plane. It's easy enough to imagine how the likelihood of things going wrong increases when the size increases. 

The conclusion from the Times article on Amazon's HR problems is apt

The extent of the problem puts in stark relief how Amazon’s workers routinely took a back seat to customers during the company’s meteoric rise to retail dominance. Amazon built cutting-edge package processing facilities to cater to shoppers’ appetite for fast delivery, far outpacing competitors. But the business did not devote enough resources and attention to how it served employees, according to many longtime workers.

The administrative tools available with a business like Amazon are heavily skewed in the direction of efficiency maximisation and at the cost of resilience. For a start, efficiency maximisation is at the core of management theories and what's taught in business schools. It permeates everything the company does. Reflecting on the business model choices, the resources (time and man-hours) spent modelling resilience will be negligible compared to what's expended on efficiency and profit maximisation. In fact, all models will heavily under-weight resilience and over-weight efficiency (and profits) maximisation. Sample this.

“Amazon can solve pretty much any problem it puts its mind behind,” Paul Stroup, who until recently led corporate teams understanding warehouse workers said in an interview. The human resources division, though, had nowhere near the focus, rigor and investment of Amazon’s logistical operations, where he had previously worked. “It felt like I was in a different company,” he said.

In some sense, it's a choice companies make in terms of their willingness to pay the cost of doing business. On each of these dimensions, the standard efficiency and profits maximisation approach invariably trades-off against resilience. And as size increases, the risks too increase.