Substack

Monday, May 8, 2017

Do interest rates matter?

Central bank rate cycles have become the pivot around which economic discussions converge. But is this perceived central role reflected in the actions of economic agents? In other words, do businesses respond to rate cuts with increased investments and vice-versa? Do their hurdle rates change in response to rate changes? The historical evidence on the inverse relationship between interest rate and investment changes have been mixed.

A 2014 Federal Reserve of Washington paper that did a cross-sectional analysis of the findings of the Global Business Outlook Survey conducted in the second quarter of 2012 found that,
Most firms did not see themselves as likely to increase investment if interest rates decreased. Firms expected to be somewhat more sensitive to interest rate increases than decreases, but for the most part the interest rate increases required to elicit adjustments to investment plans are generally quite large. The investment plans of firms that do not expect to borrow over the coming year or for firms that do not report that working capital management as one of their top business concerns tend to be less sensitive to interest rate changes than the average sample firm. More surprisingly, we find that firms that expect stronger growth in revenue— presumably firms with brighter investment opportunities—also tend to be less sensitive to interest rates. We interpret this finding as suggesting that faster growing firms face marginal investment returns that substantially exceed the cost of borrowing. Separately, we provide evidence from other business surveys conducted over the past few decades which indicates that, in contrast to steeply declining interest rates, average hurdle rates have remained elevated and quite steady over that period. This seems to corroborate our main finding that investment plans tend to be quite insensitive to interest rates.
A Reserve Bank of Australia paper too comes to the same conclusion,
Firms typically evaluate investment opportunities by calculating expected rates of return and the payback period (the time taken to recoup the capital outlay). Liaison and survey evidence indicate that Australian firms tend to require expected returns on capital expenditure to exceed high ‘hurdle rates’ of return that are often well above the cost of capital and do not change very often. In addition, many firms require the investment outlay to be recouped within a few years, requiring even greater implied rates of return. As a consequence, the capital expenditure decisions of many Australian firms are not directly sensitive to changes in interest rates. Furthermore, although both the hurdle rate of return and the payback period offer an objective decision rule on which to base expenditure decisions, the overall decision process is often highly subjective, so that ‘animal spirits’ can play a significant role. 
The last point about 'animal spirits' highlights an important distinction. 

Interest rate transmission has two channels. One, a direct response, whereby a cut in rates lowers the cost of borrowing and therefore increases the attraction of investing. In a world where rate changes in a cycle nowadays, at least in the major economies, are likely to be no more than 2-3 percentage points, often lowered in small increments of 25 basis points that further diffuses their impact, it is not surprising that the direct channel is weak.

The second is an indirect response channel where rate cuts, when combined with other trends perceived as favourable, boost 'animal spirits', which again increases the attraction of investing. However, 'animal spirits' are not a function of just interest rate cuts, especially when the rate cuts are small. They require a confluence of other, most often much more proximate and structural, factors perceived as favourable to economic growth. Small rate changes are more likely to be marginal contributors to the generation of 'animal spirits'. 

So we have two weak channels for monetary policy influence on investment decisions. This raises more questions about the appropriateness of the current out-sized importance of central banking in these economies. This assumes even greater significance given the now well acknowledged (the work of BIS economists in particular) role of monetary policy actions in engendering market distortions and widening inequality. 

Saturday, May 6, 2017

Weekend reading links

1. In an excellent article Praveen Chakravarthy highlights the resource misallocation happening in India's capital markets with disproportionate flows into the tertiary derivatives markets, at the cost of primary and secondary markets. He examined SEBI data on capital raising in these markets for the 2005-15 period and found that the apparent success of India's capital markets can be traced back to speculative derivatives trading,
The value of derivatives trading has risen 30 times in this period while the amount of resources raised by corporates from the capital markets has remained flat in this period... In the capital markets, resources to corporates are not growing but are volatile and at best, have stayed flat for a decade. Yet, the Sensex is at an all-time high and foreign investors are flooding in. In other words, all that money that flowed into the stock markets did not necessarily go into funding Indian industry but instead fuelled trading in derivatives... In 2015, Indian corporates raised only one-tenth (as US) – $21 billion from BSE and NSE. India’s exchanges traded twice as much in equity derivatives volumes as the United States in 2015...
The classic example of India’s penchant with derivatives can be found in the currency derivatives markets which was introduced in India only in 2008. Typically, currency derivatives are intended as a hedging tool for exporters and importers that have exposure to foreign currency. Hedging foreign capital flows is the other major reason for currency derivatives. India’s share of world trade is 2.3 percent but its share of exchange-traded currency derivatives is nearly 50 percent. India traded 6 times more currency derivatives than the United States in 2015, whose share of world trade is 12 percent!

This is instructive and draws attention to the limited reach of capital markets in India's financial intermediation,
Indian households save about $400 billion a year on average. Indian mutual funds received just $100 billion in net inflows in an entire decade.
2. Is Crossrail an example of a best practice for constructing large infrastructure projects?
Crossrail, as the £14.8bn ($19bn) infrastructure project is known, is on track to deliver other small miracles. With 85% of the work completed, the project is on-budget and on-time, in spite of its size and complexity. The programme required ten new stations, some with passenger tunnels linking them to existing Tube lines... When service begins in December 2018, it will increase rail capacity in central London by 10%, thanks to the longer trains.
Or, have I asked this question too early?

3. Fascinating article about the problems faced by antiquated signalling systems in New York Metro. The Metro, started in the 1930s, touched a record 6 million commuters on weekdays, has initiated a $29.5 bn five year modernisation plan. for a network that spans 472 stations,
Most of New York’s subway system still relies on antiquated technology, known as block signaling, to coordinate the movement of trains. A modern system, known as communications-based train control, or C.B.T.C., is more dependable and exact, making it possible to reduce the amount of space between trains. A computerized signal system like C.B.T.C. is also safer because trains can be stopped automatically. New York’s quest to install the new system began in 1991... More than 25 years later, the authority has little to show for its effort to install modern signals. The L line began using computerized signals in 2009 after about a decade of work. A second line, the No. 7, should have received new signals last year, but the project was delayed until the end of this year.
The process is complicated. It requires installing transponders every 500 feet on the tracks, along with radios and zone controllers, and buying new trains or upgrading them with onboard computers, radios and speed sensors. The authority also had to develop a design and software that was tailored to New York’s subway. Over the years, the authority has kept pushing back the timeline for replacing signals. In 1997, officials said that every line would be computerized by this year. By 2005, they had pushed the deadline to 2045, and now even that target seems unrealistic. Upgrading the signals is expensive, but an even bigger challenge is scheduling work on such a vast system where ridership is always high, even on weekends... (In London) The rollout of modern signals on four lines has significantly reduced delays, making travel across this huge city of nearly nine million people more efficient. This month, the Victoria line will reach a peak of 36 trains per hour — compared with 27 trains per hour a decade ago, and among the highest rates in Europe. In New York, the Lexington Avenue line, the nation’s most crowded subway route, runs a peak of 29 trains per hour.
In contrast, London, whose metro started in 1863, has installed computerised signal network on four of its 10 main subway lines, and work is underway on four more. Modern signalling helps increase train frequency by lowering the distance between two successive trains.

4. Puerto Rico has filed for bankruptcy relief before a federal court, the first ever occasion by a American state or territory. The territory's debt at $123 bn ($74 bn in bond debt and $49 bn in unfunded pension liabilities) dwarfs Detroit city's $18 bn obligations when it filed for bankruptcy in 2013. This would lead to pension cuts, pruning down public services, and lead to the more qualified Puerto Ricans leaving for the mainland.

The region has been in recession since 2006 and has been borrowing heavily in recent years to finance operating expenses. The decision to file for bankruptcy was expedited by the several suits filed by creditors. The bankruptcy now gives Puerto Rico leverage in negotiations to impose haircuts on creditors. The court proceedings will not technically be called bankruptcy since territories (unlike cities and counties) are not covered by Chapter 9 of the Bankruptcy Law, but by the Title III of the Promesa law which contains certain Chapter 9 bankruptcy provisions.

Does this mean that the first step in ushering in the possibility of sovereign defaults in the US has been taken? Will States be next, especially with the overhang of pension liabilities?

5. After tur dal and onion farmers in Maharashtra comes the turn of red chilli farmers in Andhra Pradesh to face the harsh realities of the market. Consider this,
Last year, as prices of dry chilli hit Rs 12,000 per quintal, lakhs of farmers in Telangana and Andhra Pradesh sowed the crop hoping for good returns this year. Production increased by 14% in Telangana and 25% in Andhra Pradesh. In Telangana, against an average of 2 lakh metric tonnes every year, nearly 7 lakh MT of chilli has been produced in 2016-17. In Andhra, production increased from 7.93 lakh MT last year to 9.22 lakh MT this year. As bags of chilli began to cause a massive glut in market yards in the first week of April, prices crashed by 50%. With prices still between Rs 5,000 and Rs 6,000 per quintal around April 25, frustrated farmers who had been holding on in the hope of getting Rs 10,000-12,000 per quintal, also started to sell. Last Friday, as the Khammam Market Yard opened after 2 consecutive local holidays, stock that is usually around 60,000 bags, had swollen to nearly 2 lakh bags. As the auction began, there were no takers at even Rs 5,000 per quintal — the chairman and secretary then fixed prices at between Rs 3,000 and Rs 4,000 per quintal, depending on the variety of the chilli. Infuriated chilli farmers went on the rampage, vandalising the offices of the chairman and secretary, and setting furniture on fire. They accused officials of being hand-in-glove with commission agents to keep prices low.
Four lakh farmers in the two state are affected. The Centre has announced that it would procure 1.22 lakh tonnes under the Market Intervention Scheme, and both states have also announced price support for upto a certain quantity from each farmer.

One can spin any number of stories arguing that distortionary policies by governments are responsible for such cycles and price volatility. But even without such distortionary interventions, there is enough evidence from across the world to show that agricultural market will remain vulnerable to such volatility.

6. City Lab points to gentrification in New York
While businesses increased citywide... New York City has gone in the wrong direction on black-owned businesses—a steep 31.4 percent decline from 2007 to 2012, compared to the national average of 2.4 percent increase, as indicated in the table below.
7. The latest Pew study on public attitudes towards government finds that just a fifth of Americans trust the federal government to do what it right just about always or most of the time, an all time low. 
8. Economic Times reports that India's banking sector is facing up to the reality of job losses arising from automation (ATMs) and digitisation. A Citi report estimates that nearly 30% of global banking sector jobs will be lost in the 2015-25 period.
This is a good example of our industrial promotion policy priorities. ATMs and digital technologies benefit from capital investment subsidies whereas hiring labour face the full brunt of taxes. A country with an abundance of labour ends up taxing the use of this cheap resource and subsidising expensive technologies that end up displacing labour!

But even if the industrial promotion policies were reversed, would that be enough to leave aside reverse even stem the labour displacement tide. More importantly in a global market place, with more deregulation likely in the banking sector would the Indian banks be able to stand up against foreign competitors without embracing these productivity improving technologies. Would these banks be able to withstand the digital onslaught? We are caught in a remorseless global treadmill that throws people off a fast moving platform at a rapidly increasing pace.

9. Livemint has nice summary graphics on India's banking sector bad assets status. As on September 2016, the gross NPAs stood at Rs 6.7 trillion of 9.55%. Further 40% of the debt lies with companies having interest coverage ratio of less than one. But this graphic is striking. It shows that while large borrowers formed 56.5% of the gross advances of scheduled commercial banks, they formed 88.4% of the gross NPA.
Banks face a perilous situation. On the assets side, as the NPAs continue to rise, it forces greater provisioning requirements, leading to six continuous quarters of losses. This in turn necessitates capital erosion or recapitalisation by the government.

10. Finally, staying with banks, Ananth has everything that you need to know about the latest government step on banking sector NPA resolution. The Government of India promulgated an ordinance to amend the Banking Regulation Act 1949 by introducing explicit enabling provisions to allow the Reserve Bank of India to issue specific directions to banks to resolve their stressed assets. 

I am broadly in agreement with Ananth here. Though there could have been specific circumstances which necessitated the amendment, I fail to see why there was a need to issue this given the broad sweep of supervisory powers already available under Section 35A. For example, the provision in the new Section 35AB(2) can be interpreted as a subset of possibilities under Section 35A. In fact, over the last three years, the RBI has issued several different policy directions under the existing Section 35A to resolve bad assets, which conveys its broad sweep. And the actions of the Committees to be established under Section 35AB(2) are advisory in nature, leaving decision making power still with the individual banks. 

I am inclined to believe that the ordinance has been promulgated more as a layer of comfort for RBI to pursue a more active asset disposal agenda. This is a classic example of how, when faced with the decision paralysis problem, bureaucracies (and this is true of public and private, in fact any human being) tend to prefer the status quo and be reluctant to take high-stakes decisions that involve exercise of judgement. Unfortunately, even with this comfort, nothing changes substantively as regards the overhanging cloud of potential CIC-CBI-CVO-Court interpretations and actions. 

More important issues remain about the actual implementation of asset disposal - narrow supply side, actual taking over of the stressed company, limited appetite for banks to offer significant haircuts, resources to recapitalise if extensive haircuts are offered, and decision-making itself on haircuts. The Insolvency and Bankruptcy Code 2016 is just getting operational and will take years before it can meaningfully contribute to addressing a massive problem like this. Yes, the amendments to Prevention of Corruption Act, especially Section 13(1)(d)(iii) can be a great psychological cover to bite the bullet on taking losses. But the amendment itself will take time and clearing the psychological scars from the legacy even more time.

The only difference from pre-amendment days is that now the world will see the ball as squarely being in the RBI's court. 

Automation update

As concerns about automation and its impact on the labour market increase, Times points to a new paper by Daron Acemoglu and Pascual Restrepo which is apparently the first to quantify large, direct, negative effects using real-world data of industrial robot usage in 19 industries in the US on labour markets in the 1990-2007 period. They write,
On average, the arrival of one new industrial robot in a local labor market coincides with an employment drop of 5.6 workers... Using a model in which robots compete against human labor in the production of different tasks, we show that robots may reduce employment and wages... we estimate large and robust negative effects of robots on employment and wages across commuting zones... The impact of robots is distinct from the impact of imports from China and Mexico, the decline of routine jobs, offshoring, other types of IT capital, and the total capital stock (in fact, exposure to robots is only weakly correlated with these other variables). According to our estimates, one more robot per thousand workers reduces the employment to population ratio by about 0.18-0.34 percentage points and wages by 0.25-0.5 percent.

Free Exchange puts this in perspective, 
Messrs Acemoglu and Restrepo reckon that one additional industrial robot per thousand workers reduces wages across the economy by 0.5%... between 1990 and 2007, each industrial robot added per thousand workers reduced employment in America by nearly six workers.
In other words, the negative displacement effect of automation appears to trump the positive productivity effect. But the last word on this is far from said.

Update 1 (14.05.2017)

From the Economist on the automation challenge (by way of e-commerce) in retailing in the US which employs 15.9 million people or one in nine US jobs,
At its current pace, by July 2018 retailing will have shed three times as many jobs as Amazon is due to create... Yet the skills required for retailing’s new jobs differ from those needed for old ones. Burning Glass found that 78% of e-commerce postings want applicants with a university degree, compared with just 12% in traditional retailing. Even warehouse positions demand more training: 53% of jobs in automated warehouses also require a degree. Couriers need less training to ferry goods to customers’ doors. Their ranks have grown to 655,000 workers last year. But that is a tiny sliver of the total retailing workforce. Retailing workers might switch to the companies that are taking over empty stores, including restaurants, beauty salons and health clinics. But it is as improbable that such firms will replace all of America’s boarded-up shops as that they will offer jobs to every former shop worker, particularly those without training...


Two-thirds of books, music and films are now purchased online, as well as over two-fifths of office supplies and toys, according to Cowen and Company, a financial-services firm... For every percentage-point increase in their share of e-commerce sales, a retailer’s margins shrink by about half a point, according to estimates by Morgan Stanley, a bank.
To put this in perspective, across the world there are 192 million retailing jobs which are apparently threatened by automation.

Thursday, May 4, 2017

The backlash - French edition

Ananth draws attention to Chris Caldwell's excellent review of Christophe Guilluy's new book which explore the causes of social divisions in French society.
At the heart of Guilluy’s inquiry is globalization. Internationalizing the division of labor has brought significant economic efficiencies. But it has also brought inequalities unseen for a century, demographic upheaval, and cultural disruption... A process that Guilluy calls métropolisation has cut French society in two. In 16 dynamic urban areas (Paris, Lyon, Marseille, Aix-en-Provence, Toulouse, Lille, Bordeaux, Nice, Nantes, Strasbourg, Grenoble, Rennes, Rouen, Toulon, Douai-Lens, and Montpellier), the world’s resources have proved a profitable complement to those found in France. These urban areas are home to all the country’s educational and financial institutions, as well as almost all its corporations and the many well-paying jobs that go with them. Here, too, are the individuals—the entrepreneurs and engineers and CEOs, the fashion designers and models, the film directors and chefs and other “symbolic analysts,” as Robert Reich once called them—who shape the country’s tastes, form its opinions, and renew its prestige. Cheap labor, tariff-free consumer goods, and new markets of billions of people have made globalization a windfall for such prosperous places. But globalization has had no such galvanizing effect on the rest of France. Cities that were lively for hundreds of years—Tarbes, Agen, Albi, Béziers—are now, to use Guilluy’s word, “desertified,” haunted by the empty storefronts and blighted downtowns that Rust Belt Americans know well.
And this cleavage has generated its social dynamics which in turn has been amplified by migration,
The laid-off, the less educated, the mistrained—all must rebuild their lives in what Guilluy calls (in the title of his second book) La France périphérique. This is the key term in Guilluy’s sociological vocabulary, and much misunderstood in France, so it is worth clarifying: it is neither a synonym for the boondocks nor a measure of distance from the city center. (Most of France’s small cities, in fact, are in la France périphérique.) Rather, the term measures distance from the functioning parts of the global economy. France’s best-performing urban nodes have arguably never been richer or better-stocked with cultural and retail amenities. But too few such places exist to carry a national economy. When France’s was a national economy, its median workers were well compensated and well protected from illness, age, and other vicissitudes. In a knowledge economy, these workers have largely been exiled from the places where the economy still functions. They have been replaced by immigrants.
After the mid-twentieth century, the French state built a vast stock—about 5 million units—of public housing, which now accounts for a sixth of the country’s households. Much of it is hideous-looking, but it’s all more or less affordable. Its purpose has changed, however. It is now used primarily for billeting not native French workers, as once was the case, but immigrants and their descendants, millions of whom arrived from North Africa starting in the 1960s, with yet another wave of newcomers from sub-Saharan Africa and the Middle East arriving today... While rich Parisians may not miss the presence of the middle class, they do need people to bus tables, trim shrubbery, watch babies, and change bedpans. Immigrants—not native French workers—do most of these jobs... a huge supply of menial labor from the developing world has created its own demand.
To the extent that urban centres are areas where narratives get spun and are also at the vanguard of emergent social cleavages, gentrification may turn out to be one of the most important trends to watch for in the years ahead. On the corrosive effects of gentrification in French context,
No equivalent exists any more of Madame Vauquer’s boardinghouse in Balzac’s Père Goriot, where the upwardly mobile Rastignac had to rub shoulders with those who had few prospects of advancement. In most parts of Paris, working-class Frenchmen are just gone, priced out of even the soccer stadiums that were a bastion of French proledom until the country’s World Cup victory in 1998. The national culture has changed. So has French politics. Since the age of social democracy, we have assumed that contentious political issues inevitably pit “the rich” against “the poor” and that the fortunes of one group must be wrested from the other. But the metropolitan bourgeoisie no longer lives cheek-by-jowl with native French people of lesser means and different values. In Paris and other cities of Guilluy’s fortunate France, one often encounters an appearance of civility, even consensus, where once there was class conflict. But this is an illusion: one side has been driven from the field... Most often, Parisians mean what Guilluy calls la gauche hashtag, or what we might call the “glass-ceiling Left,” preoccupied with redistribution among, not from, elites: we may have done nothing for the poor, but we did appoint the first disabled lesbian parking commissioner... Those outside the city gates in la France périphérique are invisible, their wishes incomprehensible. It’s as if they don’t exist. But they do.
The social and political disempowering effects of these trends are very disturbing,
Three years after finishing their studies, three-quarters of French university graduates are living on their own; by contrast, three-quarters of their contemporaries without university degrees still live with their parents. And they’re dying early. In January 2016, the national statistical institute Insée announced that life expectancy had fallen for both sexes in France for the first time since World War II, and it’s the native French working class that is likely driving the decline. In fact, the French outsiders are looking a lot like the poor Americans Charles Murray described in Coming Apart, failing not just in income and longevity but also in family formation, mental health, and education. Their political alienation is striking. Fewer than 2 percent of legislators in France’s National Assembly today come from the working class, as opposed to 20 percent just after World War II.
The political schism is striking and is as much applicable to US and elsewhere, as to France,
The two traditional French parties—the Republicans, who once followed a conservative program elaborated by Charles de Gaulle; and the Socialists, who once followed socialism—still compete for votes, but along an ever-narrowing spectrum of issues. The real divide is no longer between the “Right” and the “Left” but between the metropoles and the peripheries. The traditional parties thrive in the former. The National Front (FN) is the party of the outside.
And the reaction of the establishment has been one of denial and pushback, 
French elites have a thesaurus full of colorful vocabulary for those who resist the open society: repli (“reaction”), crispation identitaire (“ethnic tension”), and populisme (an accusation equivalent to fascism, which somehow does not require an equivalent level of proof). One need not say anything racist or hateful to be denounced as a member of “white, xenophobic France,” or even as a “fascist.” To express mere discontent with the political system is dangerous enough. It is to faire le jeu de (“play the game of”) the National Front... the rhetoric of an “open society” is “a smokescreen meant to hide the emergence of a closed society, walled off for the benefit of the upper classes.”
This is excellent stuff and is explanatory of social dynamics elsewhere in the West. My only grouse is that this too represents only a part of the problem. For example, the dynamics of modern economy, with its labour displacing technologies, skill-biased technical change, and disempowered labour, have all played an important role in the emergence of the La France périphérique. There may even be a case for reining in the excessive focus on individual rights often at the cost of social responsibilities. The narrative cannot be complete without documenting and exploring these forces too. To the extent that they are ignored, this too becomes a convenient fig-leaf for the anti-globalists to work their fury on globalisation. 

Unfortunate as it is, the reality is that trade, migration, excessive technology (read automation), globalisation, deregulation, gentrification etc impose significant economic costs and, especially when taken together, is associated with an inexorable dynamic of widening inequality. Most often the losers are the poor and those in rural areas. The winners are the rich and the liberal middle class living in cities. Redistribution and retraining etc is practically difficult. Some of the losses are irreversible. And social safety nets are being pruned down. 

Worse still a hegemony has been established that all these are progressive ideals. In the establishment as well as among liberals, these forces are seen as part the logical progress of human civilisation. In fact, even commonplace traits like decency have been yoked to these trends. To reverse or even qualify them is seen as retrograde. So, questioning them runs the risk of being branded populist, Luddite, Marxist and so on.

Wednesday, May 3, 2017

The need to combine iteration with a basic production function

I blogged earlier expressing my frustration at the excessive hold of the evidencariat on development thinking.

One variant of evidence fanaticism takes scepticism about what works to its extremes and disowns all priors. There is just no credible enough production function for the problem. Replication of any best practice is isomorphic mimicry. But this leaves them without anything to say about what can be done about the problem.

In this backdrop, the iterative adaptation model of tackling public policy challenges that Lant Pritchett and Co have formulated, Problem Driven Iterative Adaptation (PDIA), comes handy. So their proposition - we can tell you how to go about trying to solve the problem, but we cannot tell you what to do. But, as any practitioner worth his salt would say, this won't suffice if the objective is scaled up implementation or if the challenge is to design a program or policy to address a complex development problem. The practitioner needs to start with something baked up enough. Let me explain.

I am a strong believer in the model of Pritchett et al, especially in the implementation of programs. At some level, even without knowing it, many successful practitioners deeply internalise this approach when they try out new initiatives. They consciously iterate based on a minimum viable product (MVP) (generally arrived at combining knowledge on what has worked with contextual adaptations) as the initiative gets rolled out. The need for an MVP necessitates delving into some form of the production function.

And when we are talking of scale in a system with very weak capacity and poor median leadership, the ability to carry out such iterative adaptation starts looking questionable. So the MVP has to be far more prescriptive than is desirable.

The challenge with policy making or program formulation is even greater. The implementer, by being close to the cutting-edge, has the luxury of being able to string short and closely monitored feedback loops and iterate on multiple strands of the implementation model. However, the policy maker's flexibility in this regard is far limited. He is distant, his span encompasses several contexts, his monitoring and guidance bandwidth limited, and his own institutional capacity weak. He just cannot stand back and let the policy or program elements largely evolve iteratively.

One option then is to delegate or devolve finances and functions to provincial or state government levels. Let them figure out policies and formulate programs to address learning outcomes, poor primary health care, and poor nutrition levels. But two problems with this.

One, they too suffer from the similar span, bandwidth, and institutional capacity problems. Two, given the reality of weak capacity at provincial levels and the limited likely ability to iterate adaptively, such delegation could easily become counter-productive.

At a fundamental level, the binding constraint is clear. It is very weak state capacity. And approaches like PDIA, by their very nature, require strong states.

So, we need a PDIA plus to meaningfully engage with practitioners. The next step in the evolution of iterative adaptation literature should be the incorporation of the MVP. Ironically, the iterative adaptation model should include a basic version of the production function. Fortunately, there is a lever already available. Iterative adaptation literature talks about positive deviances. The learnings from these positive deviances should help construct an MVP. 

An illustration with respect to education is available here

Monday, May 1, 2017

Informality cannot be taxed away

Niranjan raises several policy challenges associated with the persistence informality in Indian economy. I have three observations

1. One point I have been struggling with for a long time is the demand-side of informality. Can an economy with this really tiny middle class, be able to support a large formal sector? After all, any formality adds layers to the cost of production which is transmitted into prices, thereby raising questions of affordability or market availability. Productivity improvements in non-tradeables, especially services, takes long time to materialise. Even in a tradeable sector like agriculture, despite the low baseline, we have witnessed very slow productivity improvements. 

2. Post-demonetisation, there has been an increase in debates about causes of informality and policies to increase the share of formal sector. But much of the discussion have revolved around capturing informal firms in the tax net and the role of supply-side reforms like financial inclusion, digital transactions, and the impending Goods and Services Tax (GST) in achieving this objective. 

India's 58.5 million enterprises eco-system is a very deceptive one. Of these, just 0.8 million are formally registered as a firm under the Companies Act. One can safely say that we have maybe about 2-3 million enterprises which can even be remotely called as enterprises. The rest are just subsistence activities. 

So the lens of subsidy and tax may actually be counter-productive. If you try to tax them, then there are both demand and supply-side dimensions which make them unviable economic activities. In fact, the implicit subsidy may actually be what keeps them going, with whatever disguised unemployment that it entails. In other words, the tax and subsidy may be two sides of the same coin, cancelling themselves out. Informality cannot just be taxed away!

3. I am not sure how much of the resource misallocation literature like that of Diego Restuccia and Richard Rogerson applies to the analysis of India's informal sector. Consider this. Just as formal enterprises raise capital through the formal institutions of financial intermediation, informal ones are likely to remain predominantly reliant on own capital or informal intermediaries, and any significant share of the latter form of capital is unlikely to find its way into formal intermediation for a long time to come. Any regulation is likely to have no influence on the informal firms, which by their very nature are outside the regulatory eco-system. If we accept that a very small proportion of the 58.5 million enterprises are ever likely to turn formal, the argument that financial resource misallocation and regulatory arbitrage is squeezing out formality loses its sting. 

I am strongly inclined to the work of Andrei Shleifer and Rafael La Porta who find that it is unrealistic to expect informal firms to transition to formal status and that the transition to formality is best left to the dynamics of economic growth. In fact, the most likely dynamic is that as the economy expands, the share of informality shrinks without, perhaps, shrinking in absolute terms.

Sunday, April 30, 2017

India Middle Class fact of the day

This blog has persistently hammered away at the possibility that India's much discussed middle class may after all be far smaller than estimated. One more data point is from this assessment from the India Human Development Survey conducted by the National Council of Applied Economic Research (NCAER) in 2011-12. 
Just 3% of Indians, or about 7-8 million households, own all the five things generally associated with middle-class status! In fact, nearly 65% of Indians own either none or just one (most likely a television) of the things, and 80% just two. As Livemint writes, the scale of transformation required is simply staggering. And the vast majority of discussion just don't realise this. 

Update 1 (16.05.2020)

According to the Azim Premji University’s state of working India report of 2018, about 85% of India’s workforce earns less than Rs 10,000 a month. About 50% earns less than Rs 5,000 a month, or less than Rs 166 a day.