Weekend reading links

1. Is the stock market boom peaking? It may be so if insider share sales are any indication.

Many of the biggest sales this quarter have come from technology executives. Thiel, co-founder of data analytics group Palantir, sold $175mn this month, according to regulatory disclosures, his biggest sale since offloading $504.8mn of the company’s stock in February 2021. Amazon founder Bezos sold 50mn shares worth $8.5bn in the ecommerce group in February. Andy Jassy, Amazon’s chief executive, sold $21.1mn of stock this year, compared to $23.6mn in 2023 and 2022 combined. Zuckerberg, Meta’s chief executive, has sold millions of dollars of the company’s shares for years. But he has increased selling this year as its stock hit all-time highs. In early February, he sold 291,000 shares for $135mn, his first sale of that size since November 2021. He still has 13.5 per cent of the company’s outstanding shares, which makes him its largest shareholder.

2.  Tamal Bandopadhyay has an excellent article that puts into perspective the RBI's recent regulatory push.

The RBI doesn’t want to see a house on fire and call the fire brigade; instead, it wants to ensure that no fire breaks out. The recent actions against some of the regulated entities point to this... The RBI’s new-found enthusiasm for punishing the naughty boys needs to be seen in the right context. This is the time to do so since the resilience of the financial sector is at its peak. The level of non-performing assets on banks’ books, as a percentage of overall loan assets, is at a historic low. Besides, their provision coverage ratio (the amount of money set aside to take care of bad assets) has been on the rise. Also, the banks are well capitalised. When did we last see such a healthy Indian banking system? Smart regulators take tough calls when the going is good.

3. Merlin Entertainment, the owner of Legoland, Sea Life, and Madam Tussauds announced the introduction of dynamic/surge pricing at its top 20 global attractions by the end of 2024. This comes as a trend emerges where the entertainment industry adopts dynamic pricing by following in the footsteps of the airline and hotel industries. The US restaurant chain, Wendy's had announced dynamic pricing for burgers during peak demand from early 2025. 

4. The global unlisted infrastructure market stands at an AUM of $1.3 trillion as on June 2023, with $150 bn aimed at Asia-Pacific. Led by names like Macquarie, Brookfield, Global Infrastructure Partners (GIP), iSquared Capital (seeded and spun off from Morgan Stanley), Stonepeak, Antin Infrastructure (seeded and spun off from BNP Paribas), infrastructure has arrived as a major unlisted asset class. 

From a tiny sliver of the private investment market, infrastructure has surged since the global financial crisis. Its scope too has expanded to cover areas like gas export facilities, mobile phone towers, data centres etc., apart from the traditional infrastructure assets. The long period of ultra-low interest rates have been a major driver of this growth. 

During the 1980s and 1990s, Macquarie underwrote a wave of privatisations across Australia, Europe and Canada, countries where governments were looking to sell state monopolies such as utilities, airports and toll roads. It then began investing directly in the businesses that were being privatised. But translating that strategy to the US was initially challenging. Federal and state governments were less likely to sell assets, fearing a political backlash. The existence of large municipal debt markets, which carried tax advantages for domestic investors and generated funding for public bodies, meant there was less financial incentive to privatise...

A small number of deals sparked investors’ interest. In 1999, the provincial government of Ontario sold a lease on 407 ETR, a toll road around Toronto, for about $3bn — a price that in Dorrell’s eyes wildly undervalued the highway. Macquarie quickly became a large investor and by 2019, 407 ETR was valued at around $30bn. “It is arguably the most successful infrastructure asset ever,” says Dorrell. Canadian pension funds and those in Europe and Australia began pouring money into infrastructure and US municipalities started to sell assets such as the Chicago Skyway Bridge, acquired by Macquarie and Cintra for $1.8bn in 2004. Before long, large investment banks including Goldman Sachs, Credit Suisse, Citigroup, Morgan Stanley and Deutsche Bank were building their own dedicated investment teams. But the 2007-08 financial crisis brought the boom to an abrupt end and left many institutions nursing big losses.  

But the inflows into the sector is mostly bound for North America and Europe, with even Asia-Pacific getting just $7.8 bn out of around $175 bn in 2022, and just $3.1 bn out of $89 bn in 2023. 

5. Times has an article on the problems facing Boeing which has been struggling on the face of two fatal recent crashes of its Max 8 planes that killed 350 people. 

Some of the crucial layers of redundancies that are supposed to ensure that Boeing’s planes are safe appear to be strained, the people said. The experience level of Boeing’s work force has dropped since the start of the pandemic. The inspection process intended to provide a vital check on work done by its mechanics has been weakened over the years. And some suppliers have struggled to adhere to quality standards while producing parts at the pace Boeing wanted them... Several said employees often faced intense pressure to meet production deadlines, sometimes leading to questionable practices that they feared could compromise quality and safety... “For years, we prioritized the movement of the airplane through the factory over getting it done right, and that’s got to change,” Brian West, the company’s chief financial officer, said at an investor conference last week... 

One quality manager in Washington State who left Boeing last year said workers assembling planes would sometimes try to install parts that had not been logged or inspected, an attempt to save time by circumventing quality procedures intended to weed out defective or substandard components. In one case, the employee said, a worker sent parts from a receiving area straight to the factory floor before a required inspection... Employees would also sometimes go “inspector shopping” to find someone who would approve work, the worker said... Several current and former employees in South Carolina and in Washington State said mechanics building planes were allowed in some instances to sign off on their own work. Such “self-verification” removes a crucial layer of quality control... Another factor at play in recent years has been that Boeing’s workers have less experience than they did before the pandemic. When the pandemic took hold in early 2020, air travel plummeted, and many aviation executives believed it would take years for passengers to return in large numbers. Boeing began to cut jobs and encouraged workers to take buyouts or retire early. It ultimately lost about 19,000 employees companywide — including some with decades of experience... the company did not always provide new employees with sufficient training, sometimes leaving them to learn crucial skills from more experienced colleagues... District 751 of the International Association of Machinists and Aerospace Workers union, which represents more than 30,000 Boeing employees, said the... proportion of its members who have less than six years of experience has roughly doubled to 50 percent from 25 percent before the pandemic.

This is another example of how businesses trade off efficiency and profits, against resilience. 

6. Good explainer on the troubles associated with GDP estimation in India, specifically the deflator. Rajeswari Sengupta points to two problems.

First, the National Statistics Office (NSO) does not use the international standard measure of output prices — the producer price index — to deflate GDP. This is because India does not have a PPI. The NSO proxies the PPI with the wholesale price index (WPI). However, the WPI does not track producer prices very well. It is, in fact, heavily skewed towards commodities such as oil and steel which are essential inputs in commodity importing countries like India. Also, the WPI does not measure the price of services, and services constitute two-thirds of the economy. This skew in the composition of WPI means that whenever commodity prices fall steeply, the WPI will decline, even if producer prices are still rising. This has been a major issue recently. Since September 2022, consumer price index (CPI) inflation has been above 5 per cent, as producers kept increasing prices, but WPI inflation has steadily declined, because global commodity prices have fallen. During April-December, 2023, WPI inflation averaged -1.0 per cent. This persistent fall in WPI inflation artificially inflated real GDP during 2023-24.

Second, most G20 countries calculate real gross value added (GVA) in the manufacturing sector using a methodology known as double deflation. In this method, nominal outputs are deflated using an output deflator, while inputs are deflated using a separate input deflator. Then the real inputs are subtracted from real outputs to derive real GVA. India, by contrast, deflates nominal numbers using a single deflator. It matters because if input prices diverge from output prices, single deflation can misstate growth by a big margin. Consider what has been happening recently. When the price of inputs falls and price of output increases, profits increase and nominal value added goes up (it helps to think of GVA as profits, which go up when input prices fall). Since real GDP is supposed to be measured at “constant prices”, this increase needs to be deflated away. Double deflation will do this easily. But single deflation using an input price index like WPI will amplify the nominal increase. So, if the nominal increase in GVA is 10 per cent as the result of rising profits, while WPI falls by 1 per cent, the real increase will be calculated as 11 per cent, even if real output has not changed at all.

7. Capital expenditure has risen across state governments too

On capital expenditure, the Centre has succeeded in raising it from a level equivalent to 2.5 per cent of gross domestic product (GDP) in 2021-22 to 3.2 per cent in 2023-24. Something similar, and indeed better, has happened with the states. At the aggregate level, these 20 states have raised their capex as a percentage of their gross state domestic product (GSDP) from a lower level of 2.09 per cent to 3.36 per cent in the same period.

8. For all talk of rebalancing, the Chinese economy continues to be excessively reliant on capital investment. 

The only rebalancing that's happening is the shifting of credit from property and infrastructure into the three emerging areas of electric vehicles, Lithium-ion batteries, and solar photovoltaic cells manufacturing. The exports of the latter three rose 30% to $147 billion in 2023. This has naturally raised criticism of state-support offered by Beijing. 

Beyond China’s shores, many experts and government officials view the prospect of Beijing’s increased reliance on manufacturing for growth as an emerging threat. Comparisons of industrial policy are notoriously difficult. But the Center for Strategic and International Studies describes Chinese state support as “uniquely high”, estimating it at $406bn, or 1.73 per cent of GDP, in 2019. That compares to 0.39 per cent of GDP in the US and 0.5 per cent in Japan. In the US and Europe, politicians fear that such heavy spending will result in a wave of low-cost high-tech exports from China that could displace domestic industries and pose risks around national security... In private conversations with their Chinese counterparts, American economic officials have warned Beijing that the US and its allies will take action if China tries to ease its industrial overcapacity problem by dumping goods on international markets.

Mea culpa by Angus Deaton

In a revealing mea culpa published in the IMF’s F&D Blog, Angus Deaton has set the cat amongst the pigeons by questioning several settled wisdom in economics. 

He has sought to revise his views on labour unions, trade, and immigration.

Like most of my age cohort, I long regarded unions as a nuisance that interfered with economic (and often personal) efficiency and welcomed their slow demise. But today large corporations have too much power over working conditions, wages, and decisions in Washington, where unions currently have little say compared with corporate lobbyists. Unions once raised wages for members and nonmembers, they were an important part of social capital in many places, and they brought political power to working people in the workplace and in local, state, and federal governments. Their decline is contributing to the falling wage share, to the widening gap between executives and workers, to community destruction, and to rising populism. Daron Acemoglu and Simon Johnson have recently argued that the direction of technical change has always depended on who has the power to decide; unions need to be at the table for decisions about artificial intelligence. Economists’ enthusiasm for technical change as the instrument of universal enrichment is no longer tenable (if it ever was). 

I am much more skeptical of the benefits of free trade to American workers and am even skeptical of the claim, which I and others have made in the past, that globalization was responsible for the vast reduction in global poverty over the past 30 years. I also no longer defend the idea that the harm done to working Americans by globalization was a reasonable price to pay for global poverty reduction because workers in America are so much better off than the global poor. I believe that the reduction in poverty in India had little to do with world trade. And poverty reduction in China could have happened with less damage to workers in rich countries if Chinese policies caused it to save less of its national income, allowing more of its manufacturing growth to be absorbed at home. I had also seriously underthought my ethical judgments about trade-offs between domestic and foreign workers. We certainly have a duty to aid those in distress, but we have additional obligations to our fellow citizens that we do not have to others.

I used to subscribe to the near consensus among economists that immigration to the US was a good thing, with great benefits to the migrants and little or no cost to domestic low-skilled workers. I no longer think so. Economists’ beliefs are not unanimous on this but are shaped by econometric designs that may be credible but often rest on short-term outcomes. Longer-term analysis over the past century and a half tells a different story. Inequality was high when America was open, was much lower when the borders were closed, and rose again post Hart-Celler (the Immigration and Nationality Act of 1965) as the fraction of foreign-born people rose back to its levels in the Gilded Age. It has also been plausibly argued that the Great Migration of millions of African Americans from the rural South to the factories in the North would not have happened if factory owners had been able to hire the European migrants they preferred.

His humility and a long life have made Angus Deaton a wiser man!

Some observations:

1. Deaton describes his mea culpa as part of “questioning one’s view as circumstances evolve”. I believe that a more appropriate description would be “questioning one’s view as perceptions and understanding evolve”. 

I’m not sure that the circumstances on these have changed so dramatically as to merit such a paradigm shift in thinking. Instead, I’ll argue that Deaton’s understanding of the way the real world works has improved. This reinforces the point about academic economists being largely armchair commentators. Even those who claim to do field experiments are at best sanitised commentators. The disconnect with the real world is stark. To his credit, Deaton has shown the humility to revise his views, a sorely deficient feature of the field. 

In this context, I’m reminded of Lant Pritchett saying that for over three decades while Dani Rodrik stood the ground with his views on issues like free trade, financial liberalisation, globalisation, and immigration, the global norms on each swung from one side to the other. So Rodrik came to be described as right or centre or left based on these shifts, even as his views broadly remained still. 

2. I can think of four major blindspots with orthodox economics. One, it believes that markets are competitive and self-correcting, or efficient, which they are not in practice. It then follows that governments have no constructive role but should merely be confined to the limited area of correcting a theoretically defined set of market failures. Second, it elevates efficiency (and attendant profits and incomes) maximisation over all other considerations and has no place for ethics and human welfare. Third, it overlooks that the dynamic of exclusive efficiency maximisation invariably begets a Mathew Effect - the rich get richer, the big get bigger, the strong get stronger, and so on. Fourth, it ignores that this Mathew Effect leads to extreme concentration of power, such power in turn leads to political capture, which in turn distorts economic decisions (including the direction of technological changes). 

3. These blindspots mean that there’s a fundamental disconnect between theoretical and practical economics. It is reflected in the frameworks, techniques, and tools used generally by economists in the academia with those working in practical areas like government policy units, financial markets, corporates, journalism etc. 

This dissonance is natural given that academic economists have limited exposure to the experiential and immersive insights that emerge from long periods of being embedded in systems that apply economic research. As I have blogged earlier, such insights cannot be learnt from scholarship and sanitised visits. They only know who actually does things! This dissonance is brought out nicely in a recent blog by Ken Opalo in the context of examining Africa’s development issues. 

This means that there’s a strong case that academic economists should confine themselves to the work of building bodies of research knowledge, and allow practising economists (and others) to figure out how to use such knowledge. Unfortunately, we have created a situation where academic economists with limited experiential knowledge (and most often based outside these developing countries) are allowed to set the agenda on development debates.

Some thoughts on the CBAM debate

The European Union’s Carbon Border Adjustment Mechanism (CBAM) seeks to put a fair price on carbon emissions during the production of carbon-intensive goods entering the EU, to encourage green manufacturing in non-EU countries. 

By confirming that a price has been paid for the embedded carbon emissions generated in the production of certain goods imported into the EU, the CBAM will ensure the carbon price of imports is equivalent to the carbon price of domestic production, and that the EU's climate objectives are not undermined… CBAM will apply in its definitive regime from 2026, while the current transitional phase lasts between 2023 and 2026… On 1 October 2023, the CBAM entered into application in its transitional phase, with the first reporting period for importers ending 31 January 2024… The CBAM will initially apply to imports of certain goods and selected precursors whose production is carbon intensive and at most significant risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. With this enlarged scope, CBAM will eventually – when fully phased in – capture more than 50% of the emissions in ETS covered sectors. The objective of the transitional period is to serve as a pilot and learning period for all stakeholders (importers, producers and authorities) and to collect useful information on embedded emissions to refine the methodology for the definitive period.

During this period, importers of goods in the scope of the new rules will only have to report greenhouse gas emissions (GHG) embedded in their imports (direct and indirect emissions), without the need to buy and surrender certificates… The Implementing Regulation on reporting requirements and methodology provides for some flexibility when it comes to the values used to calculate embedded emissions on imports during the transitional phase. Until the end of 2024, companies will have the choice of reporting in three ways: (a) full reporting according to the new methodology (EU method); (b) reporting based on an equivalent method (three options); and (c) reporting based on default reference values (only until July 2024). As of 1 January 2025, only the EU method will be accepted and estimates (including default values) can only be used for complex goods if these estimations represent less than 20% of the total embedded emissions… The Commission has also developed dedicated IT tools to help importers perform and report these calculations, as well as in-depth guidance, training materials and tutorials to support businesses in this transitional phase.

And the CBAM is only likely to expand downstream in the coming years.

CBAM is itself a spur to innovative production. In its current form, it will secure an EU market for low-carbon steel and aluminium, cement, fertiliser, hydrogen and electricity. The efforts EU companies are making in green steel, for example, could become competitive with domestic “dirty” steel given the EU’s high domestic carbon tax, but would be undercut by carbon-intensive imports in the absence of an emissions-linked border levy. But by creating a market for low-carbon products in these sectors, CBAM also undermines the market for EU products that use those materials as inputs, such as cars. While CBAM protects the level playing field for Europe’s green steel and aluminium producers, downstream manufacturers receive no such protection from imports made with carbon-intensive raw materials or power. What a downstream industry like carmaking should push for, therefore, is to widen the scope of CBAM to cars. This economic logic means CBAM is politically unsustainable in its current form. Once its effects are felt, politicians will face enormous and legitimate pressure to undo the competitive damage experienced by downstream manufacturers such as carmakers. At that point, expanding CBAM to more sectors will be a better policy than reversing it.

The CBAM has generated an intense debate. The Europeans see it as an instrument to expedite the green transition by providing its manufacturers the protection (and level playing field) to undertake innovative low-carbon production. Without such protection, its manufacturers would be uncompetitive against the lower-cost imports from developing countries. 

And there are only too many examples of how industry after industry in advanced countries has been laid low by cheap Chinese imports, riding on the back of lax environmental standards. It’s therefore fair to argue that the CBAM is another negative externality imposed on other developing countries due to China’s heavily subsidised and aggressive export policies. 

But the developing countries view this differently. They see CBAM as a form of protectionism, a non-tariff barrier to discriminate against imports and protect the domestic industry. And they are right in so far as it’s an explicit tax, but to level the playing field for the European manufacturers. And who can fault the European Union for encouraging green production technologies?

It’s well-known that the embedded carbon levels will be higher in the manufacturing imports from developing countries. After all, like low labour costs, less rigorous environmental standards are part and parcel of the competitiveness of developing countries. The CABM is now striking at the heart of this competitiveness. One bloc’s innovation policy becomes discriminatory to another. 

There are no easy ways to resolve this impasse. 

Collectively, the countries of the world are committed to certain shared goals - limiting carbon emissions and expediting green transition, poverty reduction, eradicating child labour and human rights violations, preventing money laundering, eliminating terrorism etc. It’s clear that none of these goals are achievable without global cooperation - all of them suffer from the problem of the tragedy of the commons. 

So how should the comity of nation states prioritise and co-ordinate on these areas of collective action failures? 

The foundational basis of the CBAM is to expedite the green transition. For sure, the EU has every right to define its policy priorities. However the EU’s CBAM policy conflicts with economic growth, productive job creation, and poverty reduction in developing countries. Does the global community want to collectively prioritise green transition over poverty reduction? The discourse must be framed to make the EU and other developed countries confront this dilemma. 

How do we ensure that this (green transition and poverty reduction) is not an either-or choice? Instead, how can it be made mutually inclusive?

One approach would be to work the CBAM policy to permit those kinds of manufacturing techniques that are labour-intensive. Manufacturing techniques in any industry with labour content and domestic value addition (in the exporting developing country) greater than a certain percentage can be permitted with a lower baseline of environmental regulation (or higher carbon emission). While measuring and documenting these are difficult, it’s no more than that required to measure and document embedded carbon in imports. 

Another approach would be to link the CBAM to an emission trading scheme. For example, the EU could allocate carbon credits to developing countries based on some reasonable measure of people living in poverty. Companies from those countries could in turn compete (based on some measure that achieves poverty reduction) to avail their respective country’s carbon credit allocations. This competition can be tailored to enhance firm competitiveness while also achieving poverty reduction. This could be linked to the EU’s commitment to support developing countries reduce their carbon emissions under various global agreements. 

In any case, from the perspective of developing countries, such bargaining with a proposal on the table may be a more effective response than outright rejection of the CBAM policy. The CBAM in some form or another is here to stay and we have to live with it.

Weekend reading links

1. Animal spirits contribute to inflation

One recent academic paper argued that animal spirits or bubbles in markets can themselves be responsible for as much as an additional 0.8 percentage points on US inflation rates. 

2. Apple joins the list of Google, Amazon, and Meta which are currently under various stages of anti-trust actions by US competition regulators. Apple with a net income in 2023 of $97 bn, more than the GDP of over 100 countries, and with a services revenue of $85 billion, has been accused of using its market power in the smartphone market to quash competition and limit consumer choice. The lawsuit has been brought by a bipartisan group of 16 state and district attorneys and accuses the company of imposing contractual limitations on developers and making it difficult for users to switch developers. 

The DoJ’s antitrust chief Jonathan Kanter described Apple’s response to competition over the years as “a series of ‘Whac-A-Mole’ contractual rules and restrictions” that had allowed it to crush competition. The complaint accuses the company of abusing its market power in a variety of ways: to squash the growth of innovative apps and messaging services, reduce the appeal of rival smartwatches, keep rival tap-and-pay apps from its devices and block the development of game streaming apps.

The lawsuit is centred on Apple's services business, which the company sees as its next frontier as its iPhone sales have plateaued. 

The US has portrayed the alleged scheme as stretching all the way back to Steve Jobs, the company’s iconic founder who died in 2011. It was Jobs’ vision to maintain an oppressive monopoly, identifying at an early stage the power the iPhone could wield over the online economy — and going so far as to direct executives to “force” developers to use only its own payment system to keep them locked into its ecosystem, the US alleged. The core of the claim is that Apple uses its market-leading device to draw a growing share of services revenue from users, excluding competitors from access. Services revenue — which includes its App Store, Apple Pay, and TV and music streaming — has been a continuing success story and an increasingly important source of growth for the company as its hardware sales face challenges.

3. Highlighting the lengths companies can go to avoid regulatory oversight, Microsoft has found a creative way to avoid sharing information on its acquisitions. Instead of buying a startup firm wholesale, it has decided to hire the co-founders and staff of the startup, in an acqui-hire model!

Microsoft’s decision to hire co-founders and staff of artificial intelligence start-up Inflection is not an acquisition, according to the companies... On the surface, the plan appears to skirt the Hart-Scott-Rodino Antitrust Improvements Act that requires companies to report pre-merger notifications for acquisitions. In addition to hiring staff, Microsoft is reported to be paying to license Inflection AI software but the deal is not exclusive. Inflection will remain an independent business, albeit a hollowed-out one. It can keep licensing its technology and can even be acquired. The curious set-up is still likely to attract regulator interest. If agencies are concerned that it will reduce competition in a potentially transformative area of technology, they can investigate.

4. Exactly a hundred years after their launch, mutual funds are facing rising competition from ETFs and others.

Mutual funds manage nearly $20tn in US assets and about $63tn worldwide, including everything from stakes in fledgling tech start-ups to government bonds. More than half of all American households and 116mn of the country’s 333mn residents hold shares in at least one mutual fund... US mutual funds suffered more than $1tn in net outflows from January 2021 to December 2023. While they gathered about $13bn in net inflows in February, it was the first time they had a positive month in two years, according to Morningstar, a data group. The active stockpicking funds that have been the industry’s bread and butter have suffered the biggest decline as a newer option, exchange traded funds, amassed more than $2tn in inflows in the US since January 2021, including more than $575bn last year alone... the alternatives to mutual funds have fundamentally reshaped the investment marketplace, as customers opt not just for ETFs but also separately managed accounts and collective investment trusts. 

For investors, ETFs are like mutual funds on speed. Instead of pricing the pooled assets once a day, as mutual funds do, ETFs trade continuously on exchanges as stocks do. They can keep up this frenetic pace because shares are sold through online trading platforms, and financial firms create and redeem shares with in-kind baskets of securities, rather than having to buy and sell the underlying assets. That structure attracts frequent traders who want to bet on market movements or the price of specific assets such as gold or bitcoin and also gives ETFs distinct advantages in the competition for long-term investors. ETF sponsors do not have to invest in the same level of back office customer service, so their costs can be lower than traditional mutual funds. And due to a quirk of the US code, ETFs avoid the annual capital gain tax charges that buy-and-hold mutual fund investors incur when they invest outside a retirement plan...

Between 2014 and today, US ETF assets quadrupled from $2tn to $8tn, according to the Investment Company Institute. While that total is still well shy of the $19.6tn in mutual funds, ETFs are closing the gap... There are also secondary challenges brewing from other pooled accounts that cater to very wealthy people and institutional investors. Separately managed accounts grew from about $856bn at the end of 2014 to $1.7tn by 2022, while collective investment trusts nearly doubled from almost $2.4tn to more than $4.6tn in that time, according to Cerulli data... Nearly 2,000 ETFs launched in the US between 2019 and 2023, nearly double the 1,100 new mutual funds, according to Morningstar.

5. After 17 years, the Bank of Japan increased interest rates in response to rising inflation in the country.

With this, the country also exited the negative interest rate regime, the last major economy to do so.

6. The Basel III rules on banking regulation that have been announced in recent months have generated strong pushback from large US banks. The rules are proposed for implementation in EU and UK from January 2025 and in US from July 2025.

The roots of the current battle stretch back to an agreement reached by the committee in 2017 in response to concerns that Basel III, the package of reforms implemented in the aftermath of the 2007-08 financial crisis, had failed to close all potential loopholes in the rules designed to safeguard the banking system. In particular, they wanted to revisit risk-weighted assets, or RWA. These are calculated by applying a risk weighting to banks’ businesses, including loans they have made to their customers. They are the denominator in the capital ratios that show how well positioned banks are to withstand losses; lower RWAs make banks look healthier. A set of rules dating back to 2004 allowed banks to use their own models to calculate RWA rather than standard measures of risk laid down by supervisors — and a string of studies had shown vast discrepancies in the ways that banks did that...

The committee argues that a “wide range of stakeholders lost faith in banks’ reported risk-weighted capital ratios” and that its proposed revisions, which greatly restrict the use of in-house models, “will help restore credibility in the calculation of RWA”... US regulators issued rules that would increase system-wide capital requirements by 16 per cent. In a nod to last year’s regional banking crisis, the package also proposed that banks with $100bn to $250bn of assets would have to follow most of the Basel rules for the first time. That brought the number of banks covered by the measures to 99, but still left the vast majority of US banks unaffected by the new rules...

There are several reasons why the impact of the package has been greater in the US. But the main one is that regulators there chose to exceed the global standards, particularly in “operational risk” — such as cyber crime — where the US has gone for a more conservative approach that means banks with lower historical losses cannot use that to reduce their current capital requirement. Banks say the changes to RWA calculations will lead to significant hikes in capital requirements for mortgages, corporate loans and loans to other financial institutions. More capital will also be needed for the less risky sectors such as wealth management that banks were encouraged to pivot towards in the aftermath of the crash. JPMorgan said it was facing a 25 per cent jump in capital requirements, while analysts at Autonomous predicted American Express might need 40 per cent more capital... Bank executives argue that the rules are not needed because banks are already financially strong. According to the Financial Services Forum, which lobbies for the eight largest US banks, its members had $940bn of capital at the end of 2023, up from just under $297bn in 2009... They also say higher capital requirements for trading businesses will have real-world consequences — threatening activities such as hedging contracts for airlines’ fuel bills or retailers’ foreign-exchange exposure — while rules on credit risk threaten lending to ordinary Americans and small businesses.

The opposition by banks is also a reflection of their fight to protect their margins.

Michael Hsu, the current Comptroller of the Currency, points out that if lending becomes more expensive, banks could spend less of their multi-billion-dollar profits on dividends and stock repurchases, rather than rationing loans. “There’s a choice to be made with capital,” he told the FT in January. The regulators’ proposals note that based on end-2021 calculations, five large banks were short between 16 and 105 basis points of capital to meet the new requirements. But they also state that “the largest US bank holding companies annually earned an average of 180 basis points of capital ratio between 2015 and 2022” — implying they should have no difficulty covering any shortfall.

Getting the proportionality of the capital ratio increase right is clearly a difficult problem to solve and involves reconciling conflicting objectives. The challenge is to ensure that the risk weights are not increased beyond what's required. But getting this requirement right is the problem. It's important to ensure that the rules don't end up significantly increasing the cost of capital for the real economy. It's also important to ensure that banks don't end up palming off the increases to their borrowers while retaining their current margins. 

See also this.

7. Excellent graphical feature in FT on the semiconductor chip making process.

A diminishing number of companies have been able to keep pace in the race to build the most advanced smartphone chips in recent years. The design and manufacturing processes have become extremely long, complex and costly, requiring ever more specialist equipment and knowledge. Advances take years of experimentation and require staggering levels of R&D spending. Working at nanoscale is also full of jeopardy. Precision, repeatability and cleanliness are some of the biggest challenges, says Sell, explaining that any particle, even those smaller than a bacterium, could “kill” a chip on contact. Inside chip fabrication plants, more than a thousand precisely controlled steps create each integrated circuit, layer by layer. Every time a new generation of chips is developed, these stages all need to be reviewed... A new chip generation also requires new tools and processes, says TSMC’s Cao. The transistor advances in the next 2nm chips mean some elements need to be built laterally, rather than vertically, bringing extra challenges, he adds...

Creating the tiny components for a chip’s circuits requires cutting-edge equipment: machines that can transfer microscopic patterns on to each wafer using a process called photolithography. For the smallest chips, multi-million-dollar machines made by a single Dutch company, ASML, use extreme ultraviolet light to create these fine stencils. The machines are the size of a bus, but so accurate they could direct a laser to hit a golf ball as far away as the Moon... While leading manufacturers are hoping the 2nm chip will solve many of the 3nm generation’s problems, the limits of scaling mean engineers are already developing alternative ways of getting more power and efficiency out of the same space. Building on current 3D designs, engineers plan to stack transistors on top of each other, rather than cramming them in side-by-side... 

Packaging developments have paved the way for another shift in semiconductor architecture: “chiplets”. Engineers are moving away from building an entire microprocessor on a single piece of silicon — the monolithic “system on a chip” — and towards multi-chip modules (MCMs). These MCMs see groups of chips with different functions built on separate pieces of silicon and then bundled together to work like a single electronic brain... Many believe chiplet manufacturing is the only way to keep Moore’s Law alive in the longer term. Intel, AMD and Apple have already launched products, while others, like Nvidia, have indicated they have them in development. AMD’s latest MI300 employs modular architecture. The companies investing in MCMs say one of their key advantages is flexibility — they can be adapted for different customers because makers can swap in chiplets depending on requirements. They also offer manufacturers the option of mixing older and newer designs and upgrading elements incrementally, rather than overhauling a chip’s entire system at once.

This graphic captures the increasing cost associated with smaller chip manufacturing.

8. Marginal Revolution points to this far-reaching set of urban planning reforms in Wellington, New Zealand. 

The first is the inner-city character areas, which have been reduced from 306 hectares to 85 hectares. This is huge. This is the most desirable, most density-friendly land in the city. The reason these suburbs have “character” is because they are old. They’re old because they’re the closest places to the city, so they were the first places anyone built houses. The character protections effectively prevented any development whatsoever from occurring in these suburbs. Thanks to Thursday’s votes, this land will be able to become apartments for thousands of new residents (which will also mean huge value uplift for current homeowners, whose land has suddenly become more developer-friendly). 

The second huge win is for the northern suburbs. By defining the Johnsonville rail line as “rapid transit”, the council has enabled thousands of new homes to be built along the train line. Anything within a walking catchment of a rapid transit station must automatically be zoned for six-storey apartments. A successful amendment by Nīkau Wi Neera took it even further, expanding the rapid transit walking catchment from five minutes to 10 minutes. Multiplied across nine train stations on the Johnsonville and Kāpiti lines, this adds up to enormous potential for new housing.

There are countless smaller wins. The Gordon Wilson flats will no longer be a heritage-protected blight, staring over The Terrace menacingly like a diseased predator. Finally, (finally!), Victoria University of Wellington will be free to demolish the building and do something better with that land... Rebecca Matthews successfully passed an amendment to remove front and side yard setbacks. This goes much further than the National Policy Statement on Urban Development, or the Medium Density Residential Standards. Put simply, it means people building new townhouses or apartments don’t have to leave a gap between the house and the front or side of a section (as is common with UK-style terraced housing). That means more of the land can be used for housing. In many cases, it actually means larger backyards, because you don’t have to leave an ugly, weird dark alleyway along the side of the flat. It’s a small difference on every individual property, but it will add up enormously across the scale of the city. It will mean larger townhouses, or more townhouses per section, both of which are a win for density.

As can be seen, there are a lot of details here. It means that cities must have the capability to figure out which areas need to be applied with which set of urban planning instruments.

9. For every convincing argument, there's an even more convincing counter-argument. From David Andolfato. 

You could also add globalisation, the emergence of China, technological advances etc to the mix of factors that has contributed to the stabilisation of the economy. 

10. Finally, we worry needlessly about what has not happened in a thousand years. Hyperinflation edition.

The chronicle of an industrial decline - US shipbuilding industry

Econ 101 teaches us that the combination of comparative advantage and free market would result in efficient and mutually beneficial outcomes. The problem is that this is correct, but only in theory. The reality, while always different, is made far worse by the domineering presence of China with its capture-global-markets industrial policy. 

Across industries, the Chinese have established global market dominance through its combination of economy-wide (cheap land, labour, and capital) and industry-specific (cheap inputs, credit, and other incentives) subsidies, and tariff and non-tariff barriers on foreign competition. In this journey, the state-owned entities have been complemented with privately owned but strictly government-guided entities to pursue broad national economic, industrial, and strategic goals. 

The strategy is now clear and has been repeated across industries. It goes something like below:

1. Declare certain industries as national strategic priorities, and provide them long-term industrial policy support. Such support would include both economy-wide and industry-specific incentives and subsidies. 

2. Encourage local firms to iterate and test products and technologies and deploy them in the domestic market where foreign competition is walled off. Alternatively, establish favourable partnerships and joint ventures with foreign companies underpinned by strict technology transfer requirements. 

3. Incentivise export competition so that only the most competitive succeed and the weak fail. 

4. Leverage the economies of scale (from both domestic consumption and exports) to drive mega-scale manufacturing. 

5. Use foreign policy to creatively and egregiously strike deals with national governments to funnel minerals and other inputs required for the industry. 

6. Establish firm political control over all companies, including foreign-owned ones, through the Communist Party membership on their Boards. 

This means that the playing field in each industry becomes heavily skewed in favour of Chinese firms and also against foreign firms. It becomes difficult, almost impossible, for foreign firms to be competitive with Chinese firms. In most industries, the losers are firms from other developing countries which are competing in the same markets with Chinese firms. 

The results are damaging in the long run for the importers. Their domestic industry is destroyed by cheap Chinese imports. The domestic firms are made uncompetitive. The tightly politically controlled nature of Chinese enterprises, public and private, means that there’s limited technology transfer and other beneficial spill-overs in the host countries. Even when these companies establish local factories, they fly in Chinese workers and managers to manage all critical activities. Then there’s the deeply problematic risk to national security from the likelihood of Beijing weaponising its dominance to suit its national interests. 

In the nineties and noughties, this playbook was adopted in textiles, footwear, furniture, and consumer electronics. Since then it was expanded to cover thermal, solar and wind power generation, metro railways, construction equipment, shipbuilding etc. In recent times, the strategy has been embraced in lithium batteries, electric vehicles and automobiles in general. The country is now pushing hard on semiconductor chips, though with limited success till date. 

Rana Faroohar in FT has an excellent long read that chronicles the decline of the US shipbuilding industry. She points to the national security and economic concerns that it raises, and the trade tensions that Chinese dominance engenders. 

The industry has come to the fore as the US labour unions have filed a Section 301 petition to the US Government accusing China of distorting global markets in the maritime, logistics, and shipbuilding sectors through "unreasonable and discriminatory acts, policies, and practices". 

The petition, which the US government now has 45 days to respond to, seeks a variety of penalties and remedies to level the global playing field in shipbuilding and stimulate demand for commercial vessels built in the US. These include port fees on Chinese-built ships docking at US ports, and the creation of a Shipbuilding Revitalisation Fund to help the domestic industry and its workers. A case that might appear focused on one industry in fact has dramatic global implications. Not only does it have the potential to reignite the US-China trade conflict, but it will also increase the focus on China’s growing military might and the massive commercial shipping industry that underpins it. At the same time, it raises questions about America’s ability and even willingness to reindustrialise in strategic sectors... Finally, it’s a window into whether the US has the ability to continue to play its traditional post-second world war security role, which includes policing global shipping lanes and securing the South China Seas for commercial transport, at a time when it no longer has the industrial capacity and workforce to build its own ships. 

The trajectory of the Chinese shipbuilding industry has followed other industries which were Beijing’s national priorities.

In 2006, it became one of the seven strategic industries over which state-owned enterprises should maintain control. In 2015, as part of the Made in China 2025 plan, Beijing identified shipbuilding as one of the ten priority sectors in which China would seek to dominate global commerce by 2025. Since then, the Chinese shipbuilding industry has enjoyed policy loans from state-owned banks, equity infusions and debt-for-equity swaps, below market rate steel inputs, tax preferences and grants from export agencies, as well as protection from foreign ownership.

The decline of American shipbuilding industry has been dramatic and mirrors trends elsewhere in manufacturing.

In 1975, the US shipbuilding industry was ranked number one in terms of global capacity, with more than 70 commercial ships on order for production domestically. Nearly 50 years later, the US now produces less than 1 per cent of the world’s commercial vessels, falling to 19th place globally. China meanwhile has tripled its production relative to the US over the past two decades, producing over 1,000 ocean-going vessels last year, versus America’s 10.

This trajectory of decline of the US shipbuilding industry is emblematic of others where the Chinese have now established dominance,

The shrinkage in the US shipbuilding industry is a result of several factors, say US shipbuilding experts, starting in the 1980s, when most government subsidies for shipbuilding were pulled, given that they were antithetical to the free market economics embraced by the Reagan administration... Much of the raw materials and components needed to produce new ships are no longer available in the US, thanks to the shrinking and outsourcing of the American manufacturing base, according to defence officials and unions. That’s a problem common in many industries, not just shipbuilding. Meanwhile, as a “just in time” production approach was employed over the past few decades, US contractors were discouraged from having excess capacity that might be needed in the event of a supply chain disruption, natural disaster, or security emergency. This, along with consolidation in the industry and the rise of cheaper ships produced in Japan, South Korea and most recently China, has led to lowered investment in things like technology, factory equipment and training for US workers. The result has been an overall decline in competitiveness and capacity in US shipbuilding yards, according to navy and union officials, as well as some labour economists.

The article makes an important point about the incentive mismatch between the businesses and their executives, and the employees and the local communities. 

USW president David McCall, who represents workers making everything from steel and engines to paints, cables and other products used in ships, notes that US steel mills are running at about 70 per cent capacity around the country… Indeed, it’s telling that the steelworkers’ union actually negotiates things like capital investment into the factories that support industries like shipbuilding as part of their own collective bargaining efforts. In a globalised market, the workers have more incentive to seek investment in their industries than large public corporations that can place jobs or investments anywhere, according to McCall. “The CEOs that run these companies may leave after a few years, with golden parachutes, but we work in our communities for decades. We have to think about long-term security for workers,” says McCall. 

This is a complaint that many on the labour left, and increasingly some on the political right too in the US, have made, particularly as it relates to industries in crucial or strategic sectors. With the breakdown of the US-led system of free market policies and institutions known as the Washington consensus, the supply chain vulnerabilities exposed by Covid-19 and wars in Ukraine and the Middle East, and the increase in economic and political tensions between China and the West, business as usual is increasingly challenged… Rebuilding a workforce and factories from scratch takes time, and achieving the scale and high-speed iteration crucial to the cost-effectiveness and productivity of operations can take further years or decades of investment… a viable commercial shipping industry and national security aren’t discrete problems, but are intricately connected.

The rise of Chinese shipbuilding and port operating companies poses serious strategic concerns and national security risks 

More than 90 per cent of military equipment, supplies and fuel travels by sea, according to the 301 complaint, the vast majority on contracted commercial cargo vessels. All of these are made overseas, including some in China... The complaint says, “Chinese companies — primarily state-owned companies — have become leaders in financing, building, operating and owning port terminals around the world.” According to research by Isaac B Kardon, an assistant professor at the China Maritime Studies Institute at the US Naval War College, and Wendy Leutert, an assistant professor at Indiana University, Chinese firms own or operate one or more terminals at 96 foreign ports, 36 of which are among the world’s top one hundred by container throughput.“Another 25 of these top 100 are on the Chinese mainland, establishing a PRC nexus for some 61 per cent of the world’s leading container ports,” they wrote in a 2022 article in International Security. China also makes much of the equipment used in the industry. A Chinese state-owned company, ZPMC, provides 70 per cent of the world’s cargo cranes. This level of control over global logistics and supply chains offers clear economic and security advantages, and reflect decades of policy decisions taken by both the US and China... As the secretary of the navy, Carlos del Toro, put it in a speech at the Harvard Kennedy School last September, “History proves that, in the long run, there has never been a great naval power that wasn’t also a maritime power — a commercial shipbuilding and global shipping power.”

The article points to other serious security concerns from Chinese actions in the shipbuilding industry.

China has, over the past several years, rolled out the pre-eminent global logistical supply chain platform, Logink, which it is giving for free to various ports around the world. The worry on the part of the US administration, as well as many in the labour and defence communities, is that this could give Beijing a window into global supply chains — both commercial and military — that would be both a competitive issue and a national security concern. As a recent Department of Transportation Maritime Administration warning put it, “Logink is a single-window logistics management platform that aggregates logistics data from various sources, including domestic and foreign ports, foreign logistics networks, shippers, shipping companies, other public databases, and hundreds of thousands of users in the PRC.” The warning further states that “the PRC government is promoting logistics data standards that support Logink’s widespread use, and Logink’s installation and utilisation in critical port infrastructure very likely provides the PRC access to and/or collection of sensitive logistics data”.

Faroohar’s conclusion is apt

The case calls into question the role of industrial policy in fair and secure market crafting, as well as the need for a new global trading paradigm — one that accounts for state-run systems, and acknowledges the challenges that free market economies and public corporations governed by short-term, shareholder concerns have competing with them.

Keith Bradsher in The NYT has another article on how China established global dominance in solar energy.

China unleashed the full might of its solar energy industry last year. It installed more solar panels than the United States has in its history. It cut the wholesale price of panels it sells by nearly half. And its exports of fully assembled solar panels climbed 38 percent while its exports of key components almost doubled… With China’s economy stumbling, the ramped-up spending on renewable energy, mainly solar, is a cornerstone of a big bet on emerging technologies. China’s leaders say that a “new trio” of industries — solar panels, electric cars and lithium batteries — has replaced an “old trio” of clothing, furniture and appliances… China produces practically all of the world’s equipment for making solar panels, and almost all of the supply of every component of solar panels, from wafers to special glass. 

The market destroying dynamics of cheap Chinese imports.

The alarm in Europe is particularly great. Officials are bitter that a dozen years ago, China subsidized its factories to make solar panels while European governments offered subsidies to buy panels made anywhere. That led to an explosion of consumer purchases from China that hurt Europe’s solar industry. A wave of bankruptcies swept the European industry, leaving the continent largely dependent on Chinese products…

China’s cost advantage is formidable. A research unit of the European Commission calculated in a report in January that Chinese companies could make solar panels for 16 to 18.9 cents per watt of generating capacity. By contrast, it cost European companies 24.3 to 30 cents per watt, and American companies about 28 cents. The difference partly reflects lower wages in China. Chinese cities have also provided land for solar panel factories at a fraction of market prices. State-owned banks have lent heavily at low interest rates even though solar companies have lost money and some went bankrupt. And Chinese companies have figured out how to build and equip factories inexpensively. Low electricity prices in China make a big difference. Manufacturing the main raw material for solar panels, polysilicon, requires huge amounts of energy. Solar panels typically must generate electricity for at least seven months to recoup the electricity that was needed to make them.

The trajectory of the evolution of the Chinese industrial base in solar sounds familiar.

As recently as 2010, Chinese producers of solar panels relied mainly on imported equipment, and faced long and costly delays if anything broke down… In 2010, Applied Materials, a Silicon Valley company, built two extensive labs in Xi’an, the city in western China famous for terra-cotta warriors. Each lab was the size of two football fields. They were intended to do final testing for assembly lines with robots that could churn out solar panels with practically no human labor. But within several years, Chinese companies had figured out how to do it themselves. Applied Materials considerably cut back its production of solar panel tooling and focused on making similar equipment that makes semiconductors.

The shipbuilding and solar industries are a sobering reminder if one were needed after so many such examples globally, that the so-called free markets are (in addition to several other factors) deeply distorted by domestic policies (especially in China). Large countries therefore need to have domestic industrial bases in all the major sectors, especially those with strong national security interests. Foregoing the benefits from trading with trade distorters like China may just be the cost of maintaining economic stability and national security. It’s more than a fair price to pay.

Some reforms to GST administration

The mainstream public commentary on GST revolves around the tax rates for various goods and services. This post will look at three other aspects of GST that do not get the attention it deserves. They cover the areas of GST administration (for both tax officials and taxpayers), investigations, and enforcement. 

The GST system consists of four taxpayer-side processes - registrations, returns filings, e-way bills (EWB) generation, and refunds - and its administration by tax officials. These processes generate three distinct databases - GST registrations, GST returns filings, and e-way bills (EWB) generation. Once electronic invoicing picks up, the returns filings database becomes a trove of very granular business transactions. The administration consists of registration of taxpayers, scrutiny of returns, investigations to detect revenue loss and its adjudication (audit, inspection, and vehicle interception), and refunds. 

On the administrative side, the GST Network (GSTN) operates a Back Office portal (BOWEB) that's accessed by tax officials for all administrative activities and taxpayers for all their transactions. This BOWEB provides a standardised process for all GST business processes. The GSTN also provides an MIS of the BOWEB processes and analytics of the transactions in the Business Intelligence and Fraud Analytics (BIFA) portal. 

In the years since its adoption, the GST system has become more automated and access to data has increased. In the last couple of years, the fidelity and reliability of business processes like returns filings have improved with several workflows becoming fully automated. The returns filing and EWB generation processes are moving towards the ideal of a single source of truth. This will only be hastened with the advent of electronic invoicing.

Here are a few thoughts on the next stage of reforms to the GST systems. 

1. Arguably the biggest institutional problem with any tax system is its revenue bias. This manifests in the form of excessive and unreasonable tax demands. This cannot be controlled without strong institutional restraints on such demands. Apart from the formal appellate processes, there should be institutionalised scrutiny and review mechanisms to validate demands before they are raised, especially those above a certain threshold. In a world gripped by the fear of oversight agencies like CBI and CVC, high-pitched demands can be restricted only by directly engaging with the problem. 

I have blogged here about the issue and offered some suggestions to address it.

2. The statutory business processes of the GST system, on both the taxpayer's and the tax administrator's sides, are standardised and run on a single IT system, the BOWEB. This is an essential requirement for a national taxation system. However, this workflow standardisation should be viewed distinctly from value-added aspects like business intelligence generation and decision-support MIS reports. 

In a large country with widely varying contexts and capabilities, there cannot be a one-size-fits-all BI or MIS. It's only natural that each tax unit figures out its unique BI and MIS. The GSTN could of course come up with some default version of data analytics and MIS that tax units could use as a starting point. However, the main objective should be to facilitate innovation in these areas by state units. This requires enabling access to data through web-APIs. 

In this context, it's important to highlight two points. One, it should become part of the policy (in fact data transfer policy itself) to restrict all data access only through APIs and disallow downloads and sharing of information through the likes of file transfers. Only APIs-based access allows for the automation of data processing. Two, it's misplaced to believe that it's sufficient to enable access to loads of tax data that can be downloaded and analysed to generate actionable information. Instead, given weak capabilities and low motivation levels, data analytics must be workflow-automated so that they make available directly actionable information. 

3. Given the extensive workflow automation and digitisation of tax processes, tax administration today is largely a knowledge-based activity. It's about identifying taxpayers whose transactions exhibit a high likelihood of evasion and then undertaking clinical investigations and enforcement of those cases. An essential requirement for this is the quality of data analytics and its interpretation as business intelligence. The objective is to identify taxpayers with a high likelihood of high-value evasion, while also minimising false positives (which can result in the harassment of genuine taxpayers).

This requires developing predictive models of various kinds of evasions that use multiple independent variables. Such models can be developed using the different GST databases, especially that of returns filings. These models will have to be periodically iterated to improve their accuracy in response to adaptive behaviours by taxpayers. 

4. High-quality data analytics require access to data on taxpayer transactions as well as third-party data sources. However, state tax units currently have limited access to the transactional data of taxpayers of other states. Even if they can access case-by-case data on request, there's no way to conduct meaningful automated data analytics. 

For example, a fake outward ITC claim (made on the GST revenue of a sale from another state) cannot be investigated without accessing the transactional data of the other state taxpayer. In such cases, while the purchaser's state loses revenue and has an incentive to investigate, it does not have access to the data required to do so. In contrast, the seller's state, which has the data, has no incentive to investigate. 

For example, the investigations of fake ITC claims most of which involve crisscrossing inter-state transactions are hampered by the data access restrictions. Accessing third-party data sources like NHAI toll gates, Income Tax filings, PAN numbers, corporate registrations and filings (MCA21) etc even in a request mode is difficult, and is impossible in API-mode. 

5. The GST system is currently administered by the tax units of the central and state governments. The taxpayers are more or less equally distributed between the state and central tax units, which exercise considerable concurrent jurisdiction over the taxpayers. This division creates a fundamental incentive mismatch problem that's at the heart of many of the challenges with GST systems reforms. 

For one, with their very limited field presence (compared to the state units), the CBIC units have limited capabilities and incentives to focus systematically on tax evasion and revenue loss. Second, unlike the state tax units which are strongly incentivised to maximise revenues, the internal structure and geographical spread of CBIC units incentivise them to prioritise investigations and enforcement. All this means that the CBIC units tend to be focused on process compliance and raising demands, irrespective of whether they end up realising revenues or not. This also amplifies their revenue bias and results in unreasonable demands. 

6. One of the biggest challenges in GST administration is the presence of fake and non-genuine taxpayers, who exist only to evade taxes through ITC claims. Instead of detecting shell companies after they have been registered through periodic one-off campaigns, the GST administration should shift to detecting likely shell companies at the time of registration application and also constant surveillance of new registrants for unusual activities (disproportionately high ITC claims, EWB generation, low cash-liability ratio etc.). 

In this context, it's useful to keep in mind the trade-off between ease of doing business and economic inefficiencies. An excess of ease of doing business prioritisation, especially given the Indian context, can paradoxically end up lowering the ease of doing business. The pervasiveness of shell companies leads to GST administrators focusing on enforcement actions that also snare the honest taxpayers. 

7. The GSTN provides an unmatched platform for mass flourishing and ecosystem development in two important ways. One, the GSTN's BOWEB can become a platform on which third-party applications can plug in through secure Application Programme Interfaces (APIs). These applications include those developed by state tax units to improve administrative efficiencies - automation of processes like scrutiny and refunds, screening and surveillance of registrations, faceless administration of registration and refunds etc - or by the National Informatics Centre's mobile App used for capturing vehicle interceptions. Or they could also include applications by fintech companies or the RBI's Trade Receivables Discounting System (TREDS) to enable lending to small and medium businesses, and e-commerce platforms to conduct their businesses. This has the potential to catalyse markets, improve economic productivity, and generate large economic multipliers. 

8. The GSTN BOWEB is a source of some of the richest data on economic transactions. This data has immense value in granular macroeconomic surveillance and forecasting sources using trends of high-frequency indicators of consumption across even states and cities. It could plug a big gap in good economic data and spawn a vibrant research ecosystem. On the commercial side, the data could be used by businesses to assess creditworthiness, consumption trends, investment decisions etc. The data sharing can be made secure and with sufficient private protections. 

One of the biggest obstacles to the use of GST data for macroeconomic data is the poor quality of HSN and SAC codes. For a variety of reasons ranging from the multiplicity of goods and services offered by any firm to tax evasion incentives, and the reluctance of the GST administration to be more firm with self-coding by the taxpayer, these codes are not a reliable unique identifier to categorise businesses. This must change if we are to make greater use of the GST data. 

Weekend reading links

1. Graphic on India's semiconductor chips manufacturing ambitions

On Thursday, the Union Cabinet app­ro­ved Rs 1.26 trillion worth of investments in three semiconductor plants, including one by the Tata group to build India’s first major chip fabrication facility at Dholera in Gujarat. The Cabinet also cleared a separate Tata proposal for a chip assembly and testing plant in Morigaon, Assam, and another by CG Po­wer in Sanand, also in Gujarat. Work on all three is expected to begin within 100 days. The Tata group’s Dholera plant entails an investment of Rs 91,000 crore and will churn out 28-nanometre and above chips — known for high performance and low power consumption — beginning with 50,000 wafter starts per month. It has tied up with the third- largest Taiwanese chip maker, PSMC, for the crucial technology. PSMC might take equity. Tata’s Assam project, for which Rs 27,000 crore is earmarked, will do semiconductor assembly, testing, marking, and packaging (ATMP). Deploying indigenous technology, it will process the wafers manufactured in Dholera, as well as wafers made by other companies, into “make in India” chips. 

This is the global landscape of chip manufacturing

After the slowdown of 2023, says SEMI, 82 fab plants, including new ones and capacity expansion, will be operational during 2022-24 — the majority in 28 nanomet­res. In 2024 alone, 42 fab plants will join the fray, raising concerns about a possible oversupply. Companies including TSMC, Intel, Mic­ron, and Samsung are investing over $500 billion by the year-end in building fabs in their home countries as well as in the US and Europe, where the supply chain is establis­h­ed, instead of looking at newer countries. India’s investment in fab and ATMP tog­ether would account for a mere 3.6 per cent of what the big guns are investing. The country’s subsidy incentive scheme is only 18 per cent of what the US offers ($52 billion). Also, the US and China are locking horns. About 40 per cent of the new plants are being built in the US, of which six will be operatio­nal in 2024. But China is moving faster, with 18 new plants slated to go on stream this year.

2. Office space demand in major Indian cities to top 50 million sq ft. 

Gross leasing of office space stood at 58.2 million square feet across six major cities namely Bengaluru, Chennai, Delhi-NCR, Hyderabad, Mumbai and Pune... In a realistic scenario, the gross leasing of Grade-A office space is estimated at 50-55 million square feet this year across these six cities.

3. Elon Musk and the art of tax evasion in the name of philanthropy.

Since 2020, he has seeded his charity with tax-deductible donations of stock worth more than $7 billion at the time, making it one of the largest in the country. The foundation that houses the money has failed in recent years to give away the bare minimum required by law to justify the tax break, exposing it to the risk of having to pay the government a substantial financial penalty. Mr. Musk has not hired any staff for his foundation, tax filings show. Its billions are handled by a board that consists of himself and two volunteers, one of whom reports putting in so little time that it averages out to six minutes per week. In 2022, the last year for which records are available, they gave away $160 million, which was $234 million less than the law required — the fourth-largest shortfall of any foundation in the country...

A New York Times analysis found that, of the Musk Foundation’s giving in 2021 and 2022 — the latest years for which full data is available — about half of the donations had some link to Mr. Musk, one of his employees or one of his businesses. Among the donations the Musk Foundation has made, there was $55 million to help a major SpaceX customer meet a charitable pledge. There were the millions that went to Cameron County, Texas, after the rocket blew up. And there were donations to two schools closely tied to his businesses: one walled off inside a SpaceX compound, the other located next to a new subdivision for Musk’s employees.

4. China is circumventing sanctions against it by shipping more to Mexico. 

Chinese companies are seeking to circumvent US and EU tariffs in a number of different ways. One of these ways is transshipment, a method that is fully on display in Mexico, which as a member of North American Free Trade Agreement (Nafta) can export goods to the US market at much lower tariffs than China can access. An FT analysis of trade data shows a sharp rise in 20ft containers shipped from China to Mexico in the first three quarters of 2023 compared with the same period a year earlier. The rise came as Mexico overtook China as the biggest exporter of goods to the US last year, and as truck shipments across the border into the US have continued to increase quickly.

Sample this

Figures from Container Trades Statistics, analysed by Xeneta, show the number of 20ft containers shipped from China to Mexico hit 881,000 in the first three quarters of 2023, the most recent period for which data is available, up from 689,000 in the same period of 2022. The rise came as Mexico overtook China as the biggest exporter of goods to the US last year, and as truck shipments across the border into the US have continued to increase quickly.

5. As the WTO stalls and countries are pursuing bilateral deals, this is a good status report on India's bilateral FTA negotiations.

6. Some interesting facts about the dominance of the Magnificient Seven in the US equity markets and the general concentration of market capitalisation.

Today, the top decile of stocks in the US account for more than 75 per cent of total market capitalisation. The only other time we have seen this level of concentration was at the bubble peaks of 2000 and 1929. Worryingly, in both the prior periods, this ratio eventually mean-reverted to 60 per cent. Since 1926, the median ratio of concentration for the US has been 63 per cent. If we look at the top five stocks, at 25 per cent of the S&P 500, this ratio is back to the peak of the Nifty 50 era of the late 1960s. Even the top 10 stocks, constituting 34 per cent of the S&P 500, have never been a bigger part of the market than today. Driven by the Mag Seven, concentration, whichever way you cut it, has never been higher...

Taken together, the Mag Seven stocks, with a market capitalisation of $13 trillion, would be on their own the second-largest stock market in the world, larger than China and more than double the third-largest market, Japan. The single largest stock, Microsoft, at a market capitalisation of over $3 trillion, would on its own be the fifth-largest market in the world (just after India). Today, Microsoft and Apple individually have market capitalisation greater than the UK stock market... Even on the basis of profits, we are in a different world. Taking trailing 12 months profits, the Mag Seven have a total net profit of $361 billion—almost equal to the total profits of corporate Japan and half the profits of all the companies listed in China. Their profits on an absolute basis are more than double the profits of all the companies listed in India ($151 billion: Source DB). Apple alone over the last 12 months, delivered a net profit of $101 billion, 70 per cent of the profitability of all listed Indian corporations (source: DB). Combined, Apple and Microsoft deliver 20 per cent more profit than all the listed companies in India. I don’t think we have ever seen a phenomenon of companies with market capitalisation and profitability equal to large countries before... The US has had an incredible 15 years of both absolute and relative performance, and currently represents 62 per cent of global market capitalisation. It was higher than this in the mid-1960s, when there was no China and emerging markets. This relative performance dominance will reverse at some stage. The US cannot outperform forever...

All other global markets are far more concentrated. Most have a ratio of top 10 stocks over 50 per cent, and many have single stocks at over 25 per cent, compared to 8 per cent for the US. The size and profitability of these platform companies is also due to their network effects, global penetration and the inability of regulators until recently to rein them in. How do you compete against a company spending more than $30 billion a year each in terms of capex and research and design (R&D), as all the global platform stocks do? And how does one compete against Nvidia, which has the software/hardware integration, head start in graphics processing units (GPUs), and has locked much of TSMC’s leading edge Fab capacity?

7. A feature of today's capitalism is the extreme concentration of wealth and therefore power in the hands of a few. This threatens to destroy the social contract. There's a good FT interview of Peter Turchin where he makes this point.

In the modern period, elites have sometimes staved off the worst outcomes. Britain, Turchin argues, suffered decades of instability from the 1830s to the 1860s, but avoided revolution by abolishing food tariffs, widening the suffrage and allowing labour unions. For Turchin, these helped to address the root cause of instability: the fact that real wages had fallen between 1750 and 1800. Wealthy Americans checked their own power between the 1930s and 1960s, accepting income tax rates of more than 90 per cent. But today’s elites — by which Turchin means the richest 10 per cent — are unwilling to follow suit. “We are back to very similar attitudes that were prevalent during the Gilded Age.”

Saving capitalism from capitalists! 

8. Two striking graphics on China. The first is the steep fall in economic data disclosures as the economy worsens.

The second is the surge in Chinese manufacturing surplus during the pandemic that contradicts the conventional wisdom on global decoupling. 

9. FT long read on perhaps the biggest beneficiary yet of the Chip wars, Malaysia. Penang, a state in Northern Malaysia, has become the epicentre of the country's flood of semiconductor chip investments. 

The state attracted RM60.1bn ($12.8bn) in foreign direct investment in 2023, more than the total it received from 2013 to 2020 combined... Malaysia has a 50-year history in the “back end” of the semiconductor manufacturing supply chain: packaging, assembling and testing chips. But it has ambitions to move up to the front end of a $520bn global industry that powers everything from televisions to smartphones and electric vehicles. That includes higher value activities such as wafer fabrication and integrated circuit design.

The region and the country has a history in the industry is well placed to benefit from the diversification away from China,

In 1972, a muddy paddy field in Penang became the first production facility outside the US for Intel. Lured by a new free trade zone and a busy shipping port in the Malacca Strait, Intel, alongside AMD, Renesas (formerly Hitachi), Keysight Technologies (formerly Hewlett-Packard) and several other tech multinationals were the pioneers of what used to be called the “Silicon Valley of the East”. Malaysia became a well-oiled machine in the packaging assembly and testing of chips, until recently considered a fairly low-end, labour intensive but necessary part of the semiconductor manufacturing supply chain. It is already the world’s sixth largest semiconductor exporter and holds 13 per cent of the global semiconductor packaging, assembly and testing market. It is the origin for 20 per cent of US semiconductor imports annually, more than Taiwan, Japan or South Korea. But there hadn’t been much of a catalyst for it to move up the value chain in semiconductors — until now.

Demand for ever more high-powered chips in sectors such as electric vehicles and artificial intelligence means so-called advanced packaging — which connects chips to their circuitboards and protects them from contamination — is regarded as key to improving performance. A previously labour-intensive process now often takes place in highly automated factories. Intel, the world’s largest chipmaker by revenue, is spending $7bn on new facilities in Malaysia, including a “3D” advanced packaging site due to be finished later this year. The cutting-edge technology stacks chips on top of each other to improve performance. It is also building another chip assembly and testing factory in Kulim, which borders Penang... Micron and Germany’s Infineon are also in expansion mode. US-based Micron last year launched its second facility for assembly and testing in Penang, while Infineon, a former subsidiary of German engineering conglomerate Siemens, said it would spend up to $5.4bn to expand over the next five years. It is building the world’s largest production site for the silicon carbide chips widely used by makers of electric vehicles.

The sudden spurt in activities in Penang has come with all the problems:

Prices of industrial land have gone from about RM50 per square foot in 2022 to as much as RM85 per square foot... Across south-east Asia, Penang’s residential property price growth in the first half of 2023 was second only to the expensive city-state of Singapore... Traffic jams have become a regular feature... The country’s engineering staff shortage has also become more acute. Zafrul, the trade minister, says the electrical and electronics sector alone requires 50,000 engineers, but only 5,000 engineering students graduate each year — and many of them slip across the causeway to Singapore, where they are paid much more. Engineering salaries, especially for starting graduates, are still below most other professional sectors in Malaysia and experts say there is a lack of specialised expertise crucial for moving up to the front end of the supply chain... Malaysia does not have a national champion in semiconductors like Taiwan’s TSMC.

The US crackdown on China has been the trigger for Malaysia,

Since the US began imposing trade restrictions on Chinese technology under the Trump administration, and especially since they were tightened by current US President Joe Biden, Penang started to see a flood of interest from mainland groups like Fengshi, according to InvestPenang’s Loo. Many of these are companies with global suppliers or western customers hedging against further US restrictions, she says. InvestPenang estimates there are now 55 mainland companies in Penang operating in manufacturing, mostly in semiconductors. That compares to just 16 before the American crackdown began. US restrictions do not currently apply to advanced chip packaging services, but Chinese businesses fear potential future curbs, says one Hong Kong-based analyst for a Chinese company, who asked to remain anonymous. Some are de-risking by partnering with Malaysian firms to assemble a portion of their high-end chips, they added.

The most interesting thing is that the wave of chip investments in Malaysia has come without too many incentives and active pursuit by the government. In other words, there has been not too much industrial policy contribution to these investments. 

10. Sajjid Chinoy urges caution on reducing interest rates in India pointing to several conflicts trends and patterns in the economy.

Credit growth has been running at almost 16 per cent for the last year, almost twice as strong as nominal gross domestic product (GDP) growth of 9 per cent -- a multiple last seen in 2007... Uncertainty about neutral rates with the prospect they have increased, negative output gaps, but also forecasted inflation still above target... India’s policymakers are currently confronting several cross currents. Growth has surprised to the upside even as the economy remains below its pre-pandemic path. Core inflation is at multi-year lows, but credit growth is at multi-year highs. Private investment is yet to broaden out but public investment has been strong. GDP growth is strong but GVA growth has slowed.

11. Interesting graphic about the historical trend of GDP.

12. This year's meeting of the Chinese National People's Congress, the country's parliament, and the Chinese People's Political Consultative Conference, the top advisory body, (collectively called the "Two Sessions") set growth rate at an ambitious 5% and resolved to fight the country's high local government debt, property crisis, and persistent disinflation. 

The ballooning local government debt has been a rising source of major concern. 

Chinese local government debt, including off-balance sheet financing vehicles and shadow credit, was probably equivalent to between 75 and 91 per cent of national GDP in 2022, according to a paper last year by Victor Shih and Jonathan Elkobi of the University of California San Diego. Twelve province-level governments had outstanding bonds alone equivalent to more than 50 per cent of their GDP, they wrote. China says its total central and local government debt is less than 51 per cent of GDP.

The biggest worry is the pace at which indebtedness has grown. 

The deeply indebted province of Guizhou is a totemic example of the problems with debt-based infrastructure development.

Fixed-asset investment was expected to fall this year by 60 per cent for the western province of Guizhou... Guizhou, one of China’s poorest provinces, is now home to nearly half of the world’s 100 highest bridges, including four of the top 10. Yuekai Securities estimates the province’s infrastructure building spree has left it with total debt, including off-balance sheet liabilities, at 137 per cent of its gross domestic product.

13. Finally, an article on the increasing mothballing of conventional car factories as they give way to electric vehicles highlights both the risks of foreign investment in China and more importantly how China is bearing the costs of the green transitions. 

In 2017, Hyundai invested $1.15bn in a new factory in Chongqing, southwestern China, with the goal of reaching an annual output of 300,000 internal combustion engine cars. But six years later, the rapid switch by Chinese consumers to electric vehicles has stalled sales, forcing the carmaker to sell the factory in December for less than a quarter of the investment value... That plant is one of the hundreds of zombie factories that analysts are predicting over the next decade in the Chinese car market, the world’s biggest across sales, production and, since last year, exports. In 2023, China produced 17.7mn internal combustion engine cars, a 37 per cent fall from its prior peak in 2017, according to data from Automobility, a Shanghai consultancy. Bill Russo, the former head of Chrysler in China and founder of Automobility, said the “precipitous decline” of internal combustion engine car sales meant as much as half of the industry’s installed capacity — about 25mn out of 50mn units’ annual capacity — was not being used. While some older factories will be repurposed for plug-in hybrids or pure battery electric vehicles, others will never produce another car, posing a problem for both foreign and Chinese companies.

This has increased the pressure on foreign car makers in China who are now using China as a base for their exports, thereby undercutting their factories elsewhere. 

Until recently, foreign carmakers could only enter the Chinese market as a joint venture with a local partner. Of 16 joint ventures between Chinese and foreign groups, only five had a capacity utilisation rate higher than 50 per cent while eight were below 30 per cent, according to a report by Chinese media outlet Yicai Global. In response to the worsening domestic market situation, Chinese companies have been ramping up exports of cheap petrol-powered cars to Russia, a market that many international carmakers have quit in the wake of that country’s full-scale invasion of Ukraine. Yet analysts question whether those sales deliver meaningful profits to the Chinese groups, for how long they can continue, or if other developing markets can help soak up Chinese non-EV exports. Foreign brands, too, are increasingly trying to export more from their Chinese factories. But, experts say, in doing this companies risk undercutting their own factories in other markets.