Scaling up Aadhaar-based solutions

Business Standard chronicles the challenges with scaling up biometric validated distribution of rations from the Public Distribution System (PDS) in Andhra Pradesh. A few observations,

1. A transition to a digitally circumscribed validation-cum-distribution mechanism is a paradigm shift, likely to adversely affect several stakeholders. It needs to be done carefully, in a phased manner, slowly onboarding a critical mass of stakeholders. The success of scalability of an idea depends more on its social and political acceptability and internalization that its technological superiority. 

As an example, ten years back third party audits of engineering works were vilified for signaling a lack of trust in public engineering departments. Today, they have become business as usual, with even third party school testing becoming widespread. Ideas take some time to mature. Leadership and public policy can expedite this.  

2. Another reason for phased scale-up is that the supply side, especially in such emerging services, also needs time to develop. It is not just about procuring a few devices, recruiting people and running them. Building operational and managerial capacity is not easy and takes time. A district, leave aside a state, is a very large unit, especially when it involves covering the vast majority of the population. Poorly executed scale-up runs the risk of failures (exclusion errors, harassment of beneficiaries by having to come and go repeatedly etc) which could potentially provide grist to opponents to discredit the intervention.  

3. Public systems are entrapped in low-level equilibriums due to multiple forces interacting in mutually reinforcing and interlocking webs. For example, it is well-known that dealers have accommodated woefully inadequate commissions that make Fair Price Shops (FPS) commercially unviable only because of the ample opportunities for attractive rent-seeking by diverting stocks. This allowed fiscally squeezed governments, led by the respective Finance Ministries, skimp on commissions and condone rent-seeking. Any technological solution that unsettles this equilibrium will generate demands for adequate commissions, which run into budgetary constraints. There are no free lunches!

4. If we did not know it already, it would be useful to keep in mind that technology can only get you so far in addressing state capability problems. As the article itself highlights, several loose ends will still remain. Technology can identify duplicate and fictitious beneficiaries, but may not be able to screen based on eligibility. 

Shopkeepers can put weights in packets of rice and evade detection. They also use pre-packaged rice bags to generate bills, but later use manual weighing machines to deliver the goods to the beneficiaries... Many BPL beneficiaries claim their quota of rice for Rs 1 a kg, but sell it to middlemen for Rs 10 a kg.

5. Finally, for all the undoubted savings from these interventions, some of the numbers on savings being claimed by officials need more forensic analysis. For more, see this. 

The challenge of gentrification

Richard Florida (study here) adds clustering of talent based on the level of occupational creativity (knowledge-based Vs routine) with Michael Porter's theory of tradeable and locally-oriented industrial clusters (to create four distinct industrial-occupational categories), for over 260 metro areas making up three-quarters of US population, and comes up with very interesting findings,

Creative-in-traded employment is a key driver of both innovation and economic growth, according to our analysis. It is positively associated with higher levels of innovation (with a correlation of .61), higher levels of economic output per capita (.53), and higher wages (.6). (As usual, we note that correlation does not equal causation, but simply points to associations between variables). That said, creative occupations are more closely associated with innovation and economic growth (with correlations of .52 to economic output, .52 to patents, and .66 to wages) than traded industries (with correlations of .38 to economic output, .35 to patents, and .25 to wages). Furthermore, creative-in-local jobs are modestly associated with wages (.34) and economic output (.17), but not with innovation. On the other hand, both routine-in-traded and routine-in-local jobs are negatively correlated to wages and innovation, while only routine-in-local jobs are negatively associated with economic output per capita.

Further, creative occupations, tradeable and local, make up just 39% of the workforce, while routine-local occupations make up nearly 45%. The average salary in creative-traded occupations is 31% more than those of creative-local workers, 117% more than toutine-traded workers, and 182% more than routine-local workers. And these trends have been widening over the years.

Pointing to gentrification effects, it finds higher concentration of creative-traded occupations associated with greater inequality, and the same being magnified by housing costs, 

The share of creative-in-traded jobs is positively associated with income inequality (.31)... The share of routine-in-traded jobs (largely in manufacturing), for instance, is negatively associated with inequality (-.20). This divide is magnified by housing costs, which are higher in more knowledge-based metros... All four categories of workers have higher wages in more creative-in-traded metros. But, when we take housing costs into account, we find distinct winners and losers in these more advanced, knowledge-based metros. On the one hand, the two groups of creative workers end up being better off after paying for housing, with positive correlations for both creative-in-traded (.33) and creative-in-local (.36) workers. For both categories, their wages rise enough on average to more than cover the increased costs of housing in these more expensive metros. On the other hand... our analysis found a statistically insignificant correlation for routine workers in traded clusters, and routine workers in local industries are significantly worse off (with a negative correlation of -.43).

And its consequences are stark,

Higher wages in metros with larger creative-in-traded employment create greater incentives for more skilled and advantaged workers to migrate to these metros. As housing costs rise, routine workers—especially those in routine-in-local jobs—are shunted off to less expensive metros which, by definition, have smaller concentrations of higher-paying creative-in-traded jobs. This creates a vicious cycle in which the advantaged become more advantaged over time, while the disadvantaged sink further into poverty.

This challenge is most unlikely to be resolved anytime in the foreseeable future and the problem will keep getting worse. Cities in developing countries like India are witnessing such trends playing out on a much faster scale. Housing within a reasonable distance of the city center in large cities is out of reach for all but those at the top 1% of the income ladder. Government officials, with their quarters, and the small sliver of senior level private employees belong to this category. The booming suburban clusters and towns, into where private economic activity, especially in knowledge-based services, has been displaced, too are soon likely to experience similar gentrification effects, and so on. 

Standard public policy approaches, including those aimed at education and skilling, are unlikely to make any dent on the problem. Robust social safety nets (eg access to quality healthcare), massive affordable housing programs, re-skilling programs for dis-employed workers especially those engaged in routine-traded sectors, and equal access to inter-generational mobility opportunities (eg. top-quality higher education) have to be essential components of any public policy intervention to mitigate the consequences of this trend. It has to be complemented with far higher levels of taxation at the top of the income ladder to generate the additional resources required to support such policy interventions.

Weekend reading links

1. An ADB study tries to estimate the impact of a slowdown in China on global commodity prices. The impact varies across commodities and there is apprently more to the decline in commodity prices than China.

2. The major argument supporting the wide pay disparity across occupations revolves around a "skill premium" in sectors like finance and law. A Brookings paper by Jonathan Rothwell points to a paper by John Abowd and four others which examined administrative records of millions of Americans from the 1990-2011 period and finds high levels of "rents" or "gratuitous pay" - pay in excess of skills - in these sectors. They find that people working in finance and law earn 26% and 23% more, regardless of skill, whereas those in eating and drinking establishments earn 40% below their skill level. 

What's more, Rothwell finds that the rents have increased dramatically in certain industries in the 1980-2013 period, with that for workers in securities and investment industry rising from 41% to 60%, legal services from 27% to 37%, and hospitals from 21% to 39%, while those in eating and drinking establishments stayed stagnant at about minus 20%.

Rothwell finds that income from financial market investments like hedge funds and large entry barriers (pervasive among lawyers, doctors, and dentists, the three highest represented occupation groups among the top 1 per cent) are far bigger contributors to widening inequality than increasing share of capital income, technology, and superior skills.

3. Illuminating Citi report on the pension fund financing deficit facing the world economy. It estimates that "the total value of unfunded or underfunded government pension liabilities for 20 OECD countries is a staggering $78 trillion, or almost double the $44 trillion publicshed national debt number". The demographic shifts expected across the world are immense.

And the recommendations,

4. Fascinating graphic that captures the dominant revealed preferences of the counties that provide the biggest support base for Donald Trump.

5. The denser the area, less happy people are. But people still prefer to live in denser areas!

It is called the "urban-rural happiness gradient".

6. City Lab points to a fascinating study that captures the sounds (yes!) of localities in a very innovative and stunning visualization. A team of map, social science, data science, and acoustic researchers used public Flickr photos, their geo-location, tagged the photos with sound-related words, categorized the words into six categories (transport, nature, human, music, mechanical, and indoor sounds), and finally mapped the correlation between each category and the emotion it evokes! The maps are available for 12 cities across the world. 

India "missing" middle class fact of the day

This blog holds the view that contrary to perception, the Indian middle class may be far smaller than originally thought, thereby raising doubts about the assumptions held by businesses when they enter the country's market. The latest to hit the growth ceiling are the global fast food majors,

India’s once seemingly insatiable appetite for fast food has hit a wall at McDonald’s, Pizza Hut, KFC and other established global brands, deflating optimism that untapped demand in the 1.2 billion-person market will offset slumping consumption in the West and China. While the overall market for eating out is projected to expand, growth is slowing and less of it is happening at the international chains that were the trailblazers in India... The biggest global fast-food brands had been rolling out outlets at an ever-accelerating rate in Asia’s third-largest economy. Nearly half of Domino’s 1,000 stores in India, for example, were built in the past five years. But the anticipated take off in customers has been weaker than expected.

The tapering off was to be expected and the only uncertainty was how soon. That it has started binding at the initial stages itself is a matter of concern and lends further credence to the argument about the very narrow consumer base.

Update 1 (07.07.2016)

Livemint points to similar trends in e-commerce market,

After pumping more than $9 billion into Indian start-ups since the beginning of 2014, investors started pulling back late last year. For the first time in years, online retail sales in April were at a lower level than December of the preceding year, according to executives at top e-commerce firms... Experts said it is a worrying sign that customers seem to cut back the moment discounts are pulled.

“All of us had hoped that once we create the habit of buying online among consumers, they will keep buying even if discounts are reduced. Factors like a wide product range and convenience of getting products delivered at your doorstep would prove to be compelling, we had thought,” said a Flipkart investor, requesting anonymity, as he isn’t authorized to speak on this topic. “And this is happening with some consumers, but the fact is that a majority of them don’t buy unless you offer steep discounts. It’s true that e-commerce companies are yet to find new ways of growing the market quickly without the help of discounts,” he added.

Picking up the pieces from the latest oil bubble - history repeats itself!

Haven't we seen this before,

From 2004 to 2013, annual capital spending by 18 of the world’s largest oil companies almost quadrupled, from $90bn to $356bn, according to Bloomberg data. The assumptions used to justify that borrowing were fuelled by a textbook example of disruptive technological innovation: the advances in hydraulic fracturing and horizontal drilling that made it possible to produce oil and gas from previously unyielding shales. The success of those techniques added more than 4m barrels a day to US crude production between 2010 and 2015, creating a glut in world markets that has sent prices down 65 per cent since the summer of 2014. The expectations of sustained high prices have vanished: crude for 2020 delivery is $52 a barrel. Oil is now back to where it was in 2004, but most of the debt that was taken on in the boom years is still there.

The extraordinary monetary accommodation by central banks pushed investors in search for yields into oil and gas companies. Now, the signatures of the wreck caused by the boom and bust are seen across the market, 

From 2006 to 2014, the global oil and gas industry’s debts almost tripled, from about $1.1tn to $3tn, according to the Bank for International Settlements. The smaller and midsized companies that led the US shale boom and large state-controlled groups in emerging economies were particularly enthusiastic about taking on additional debt... Since the decline in oil prices began in mid-2014, activity in the Eagle Ford, one of the heartlands of the shale revolution, has slowed sharply. The number of rigs drilling for oil has dropped from a peak of 214 to 37... Since crude prices began to fall in the summer of 2014, investors in oil and gas companies have lost more than $150bn in the value of their bonds, and more than $2tn in the value of their equities, according to FT calculations... The decline in the industry’s cash flows has prompted huge cuts in investment, with about $380bn worth of projects delayed or cancelled according to Wood Mackenzie, the consultancy. 

Three observations

1. All rapid sectoral growth episodes will, more likely than not, end up in tears. Industry analysts, especially the cheerleaders of US shale boom, who gloated over the spectacular technological breakthroughs generally suffer from cognitive biases which nudged them into overlooking historical evidence and flashing warning signals. Who will hold up the mirror to infuse a dose of realism among all stakeholders during such booms?

2. No matter how rigorous regulatory restrictions are, euphoric times will always be accompanied by over-optimistic investments and reckless lending, and are almost always backed by governments. Financial markets simply lose their disciplining powers as the "irrational exuberance" takes hold. Someone has to "take away the punchbowl when the party gets going".

3. Commodity exploration lenders should eschew mark-to-market valuation of the borrowers commodity reserves, and resultant borrowing limits. In good times, when prices balloon, it encourages excessive lending, whereas during troughs, it engenders liquidity squeezes and insolvencies. A more prudent strategy may be to value them at a ten-year rolling average or a long-term trend price.  

The great Chinese "cash out"?

The Governor of the People's Bank of China (PBoC) has expressed concern about the rising Chinese corporate indebtedness, now at 160% of GDP. Corporate weakness has been rising alarmingly in recent months,

Data from the 1,627 domestically listed companies, or 58 per cent of the total, that have reported their 2015 earnings show a clear deterioration in fortunes. Average operating revenues per share fell to their lowest level so far this decade, sliding to Rmb5.4 from Rmb6.55 in 2014... In addition, just over one-fifth of listed Chinese companies reported negative cash flows during 2015 and about one-third owed at least three times as much in debts as they owned in assets.

The Governor's statement follows a week after the little known and reclusive Chinese private insurer with deep political connections, Anbang Insurance, made audacious $13 bn and $6.5 bn all-cash offers to purchase Starwood Hotels & Resorts and Strategic Hotels & Resorts. This takes the total volume of Anbang's foreign purchases to $32 bn in the last 18 months. 

Such aggressive deal-making, most often through all-cash transactions, have taken overseas spending by Chinese investors to $102 bn, just shy of the $106 bn record for all of last year. Data from the 54 overseas deals last year show that may of these transactions are "highly leveraged". This has also stretched Chinese banks, whose NPAs have risen to 1.3 trillion renminbi, itself most likely a heavy underestimate. 

Anbang's rise is symptomatic of rising corporate indebtedness and foreign deal making. For a firm which has never published an audited financial statement, does not divulge its owners or even executives, and does not disclose the business cases for its various investments, Anbang has been wildly successful in raising cash for such transactions. The all-cash offers are a way around the disclosure requirements and may reflect either lack of desirable level of assets or reluctance to disclose asset ownership. It also allows these firms to move at amazing speed in taking decisions and closing deals. 

The FT has this story which argues that the foreign deal making is motivated by a desire by the country's high net worth individuals to move away from renminbi-based assets and diversify their income sources into foreign currency denominated cash flows, 

A broader concern about China Inc’s acquisition spree stems from questions about why it is happening. Is it being driven by strength, or is it a reflection of the waning vigour of heavily indebted corporations in a slowing domestic market? To a significant degree, analysts say, the exodus of Chinese investment capital is in fact a “quest for cash flow”... the ample cheap credit available under Beijing’s loose monetary policies allows companies with good banking relationships to spend heavily overseas as a way to diversify away from their dwindling earnings at home.

But hedging against a slump in renminbi may not be the full story. Such purchases are also motivated by the emergence of the global Chinese consumer and strategic thinking,

Many of their investments are linked to the emergence of the global Chinese consumer. In residential real estate, Shanghai-based Greenland Group bought a majority stake in the Atlantic Yards development in Brooklyn, promising to help sell units to wealthy Chinese immigrants and investors. Part of the project has been renamed Pacific Park. Dalian Wanda, owned by China’s richest man, Wang Jianlin, has similar plans for its projects in Madrid, Australia’s Gold Coast, Chicago and Beverly Hills in Los Angeles.

In other cases, the motivation is to acquire foreign technology. China’s leaders have long said that they want national champions to move up the value chain, especially in basic commodity industries suffering from overcapacity, which has cut profit margins to the bone. Many of these deals are too small to grab headlines. In 2014, state-owned China National Building Materials acquired Avancis, a German manufacturer of advanced materials used in solar panels. This year’s $43bn bid by ChemChina, a large state-owned enterprise, for Syngenta, the Swiss agribusiness, was driven mainly by the Swiss company’s biotechnology and agrochemcial prowess.

Fund management fact of the day

More confirmation of the case against stock-picking from a global S&P Dow Jones study which analyzed the after-fee performance of 25000 active funds and,

... found that 100 per cent of actively managed equity funds sold in the Netherlands have failed to beat their benchmark over the past five years. Ninety-five per cent of funds sold in Switzerland and 88 per cent of those on offer in Denmark also underperformed... Overall in Europe, four out of five active equity funds failed to beat their benchmark over the past five years, rising to 86 per cent over the past decade... Within that sample, 98.9 per cent of US equity funds underperformed over the past 10 years, 97 per cent of emerging market funds and 97.8 per cent of global equity funds... On a one-year basis it is still possible to outperform, but it is very difficult on a consistent basis over the long run.

The overwhelming lesson for long-term retail investors in equity markets is to choose the low-cost index-tracking funds which have grown six-fold over the past decade to $2.9 trillion,

The average equity fund manager is unable to deliver outperformance from stock selection or market timing. This means a typical investor would be almost 1.44 per cent better off per annum by switching to a UK equity tracker. A small group of star fund managers are able to generate superior performance, but they extract the whole of this outperformance for themselves via fees, leaving nothing for investors. All but the most sophisticated investors should invest in index funds.

Amen!