Many trade economists and policy makers have tended to draw conclusions or form hypothesis about international trade by drawing parallels with domestic trade. They tend to see international and domestic trade in the same analytical framework, with the same rules of the game.
Recently Tyler Cowen, in an article defending globalization, had argued that while acceptance of domestic trade is built into the system, trade with foreigners evokes, often passionate, opposition.
Now, what is so different between domestic and international trade, that they evoke such contrasting feelings? Dani Rodrik thinks it has to do with the "embeddedness" of markets. He feels that "domestic trade takes place within thoroughly embedded markets; there are clear rules and they apply to all transactions equally. International trade, on the other hand, is conducted in only weakly embedded markets; the rules either do not exist or apply unevenly."
The concept of emebeddedness arises from his contention that "markets need to be embedded in a larger set of man-made rules and governance structures. Markets need regulation, stabilization, and legitimation because they are not self-regulating, self-stabilizing, or self-legitimizing. The success of modern capitalism is due as much to the institutions that govern markets - political democracy above all - as it is to the power of markets themselves."
This lack or deficiency of institutions that govern markets, or embedded markets, means that international trade is often driven by regulatory arbitrage opportunities - variations in quality, labour, environment, patent, and other standards.
Dani's analysis is from the perspective of the developed economies, whereas let me speculate on the view from the side of the developing economies.
1. The operative condition is not so much the quality of embedded institutions, as the issue of uniformity or homogenity in the "rules of the game". In many developing markets too, opposition to international trade arises from the absence of a "level playing field" - larger and well supported MNCs swamping domestic manufacturers, heavily subsidized farm products driving out local farmers, competition and government procurement policies that weigh in favour of larger firms, unregulated financial markets that spawn dubious practices etc. Yes, these are also perceived as "regulatory arbitrage" - depends on which side of the fence you are in!
2. The logical next step in this analysis would appear to be that we need to harmonize the rules of the game, so as to increase the domestic acceptability of globalization and international trade. While this may increase the acceptability in the developed countries (though I suspect, it will not, given the previous point), it will only increase the suspicion and resistance in the developing economies. We have seen this story enacted before!
It is impossible to bridge these contrasting views easily or soon. Till then, international trade and globalization will have to be driven by more uniform sharing of trade benefits, both between and within countries, and by having adequate enough social safety nets that can cushion those hardest hit by trade and globalization. In the meantime, we can progressively strive towards increasing the "embeddedness".
Wednesday, June 11, 2008
Tuesday, June 10, 2008
Trade and inequality debates
It has long been argued that international trade is a Pareto improvement and benefits both partners. The Ricardian theory of comparative advantage states that the most efficient and mutually beneficial arrangement for each country is to produce those goods in which they have a comparative advantage and then trade in those with other countries. While it may indeed be true that trade benefits both partners in the long-run and as a whole, it may have adverse distributional effects within any country.
There is an intense debate raging on in the United States over the sharply widening inequality and the role of trade in promoting this. It has been argued that trade has intensified wage inequality in the US. One of the foremost trade theorists, Paul Krugman, suddenly changed track from his long-held position that trade has very limited influence on inequality, and now claims that trade may be a much larger influence on inequality in developed countries. He based this claim on two factors - the rise of China, and the growing fragmentation of production.
The steep rise in share of imports from China led developing world, 6% of GDP for US, where wages are only a fraction of the developed world, 3% of US wages in China, has put sharp downward pressure on American wages. This has been exacerbated by the proliferation of a new category of labour-intensive industries through the fragmentation of production process and outsourcing of services, facilitated and encouraged by globalization, advances in communications technology and the increasing trade between nations.
Paul Krugman also feels that, "it's hard to avoid the conclusion that growing U.S. trade with third world countries (that pay their workers low wages) reduces the real wages of many and perhaps most workers in this country".
He argues that unlike trade between high-income countries, which produces broadly shared gains in productivity and wages, "trade between countries at very different levels of economic development tends to create large classes of losers as well as winners". He writes, "Workers with less formal education either see their jobs shipped overseas or find their wages driven down by the ripple effect as other workers with similar qualifications crowd into their industries and look for employment to replace the jobs they lost to foreign competition. And lower prices at Wal-Mart aren’t sufficient compensation."
James Surowiecki waded into this debate by suggesting that the "benefits of free trade with China, at least when it comes to shopping, are concentrated overwhelmingly among average Americans". While conceding that job losses and wage declines have affected middle and low income Americans badly, he argued that the same category, as consumers, were the biggest beneficiaries of the cheap Chinese import of manufactured goods.
Given that these imports consist mainly of products commonly consumed by lower and middle-income Americans and make up a large share of their consumption budgets, trade with China benefits them disproportionately more than the richer consumers. He quotes a study by University of Chicago economists Christian Broda and John Romalis which indicates that between 1999 and 2005, the inflation rate for lower-income Americans was almost seven points lower than it was for the wealthiest Americans, due mainly to trade with China.
Mark Thoma however takes a different view and feels that given the stagnant wages, rise in inequality, loss of health care and retirement benefits, and decreased job security, low and middle-income Americans may not feel that the benefits of globalization has not been proportionately shared.
He writes, "We need to find a way to distribute the gains (and the pains) of globalization so they are shared more equally, to increase opportunity so that everyone has the chance to reach their full potential, and we need to reverse the declines in economic security, retirement benefits, and health care coverage that have occurred for middle and lower income households over recent decades."
Some others have cited the Stolper-Samuelson theorem to explain the rising wage inequality in the US and other developed countries. This theorem states that "a rise in the relative price of a good will lead to a rise in the return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the return to the other factor". Alternatively, trade lowers the real wage of the scarce factor of production, while protection from trade raises it.
Therefore, an increase in the relative price of American exports to cheaper Asian imports, will lead to higher returns for capital (which is more intensively deployed in US exports) and lower returns for the other factor, labour. To quote Wikipedia, "Unskilled workers producing traded goods in a high-skill country will be worse off as international trade increases, because, relative to the world market in the good they produce, an unskilled first world production-line worker is a less abundant factor of production than capital."
It is therefore claimed that if the removal of barriers to trade causes the price of exported goods to increase (relative to imports), and if the exported goods use skilled labor intensively, then the price of skilled labor (the wage) will go up, and that of unskilled labor will go down.
But this may only be part of the story, since the other side of Stolper-Samuelson theorem reveals that in the Asian economies, the opposite effect dominates when export prices rise. Since their exports are more labour intensive, the returns to labour rises while the returns for capital falls.
The whole debate ultimately boils down to identifying which of the two effects - work migration and downward wage pressure on American workers, and cheaper produce for American consumers - pre-dominate. While Surowiecki argues in favor of the later, Mark Thoma and Krugman feels that the former pre-dominates.
As Tim Worstall points out, the importance of trade lies in the undeniable fact that while relative poverty is increasing in the rich countries, it is at the same time abolishing absolute poverty in the poor ones.
There are also convincing studies to indicate that changing economic environment and technology may play critical roles in determining wage inequality. Dani Rodrik calls attention to the work of Robert Feenstra and Gordon Hanson, who show that global "production sharing" has the same effect as skill-based technological change in shifting demand away from low-skilled activities, while raising the relative demand and wages of the higher skilled. Lawrence Katz and Claudia Godin have made out a brilliant case that the rising inequality in the US can be accounted for by rising educational wage differential.
There is an intense debate raging on in the United States over the sharply widening inequality and the role of trade in promoting this. It has been argued that trade has intensified wage inequality in the US. One of the foremost trade theorists, Paul Krugman, suddenly changed track from his long-held position that trade has very limited influence on inequality, and now claims that trade may be a much larger influence on inequality in developed countries. He based this claim on two factors - the rise of China, and the growing fragmentation of production.
The steep rise in share of imports from China led developing world, 6% of GDP for US, where wages are only a fraction of the developed world, 3% of US wages in China, has put sharp downward pressure on American wages. This has been exacerbated by the proliferation of a new category of labour-intensive industries through the fragmentation of production process and outsourcing of services, facilitated and encouraged by globalization, advances in communications technology and the increasing trade between nations.
Paul Krugman also feels that, "it's hard to avoid the conclusion that growing U.S. trade with third world countries (that pay their workers low wages) reduces the real wages of many and perhaps most workers in this country".
He argues that unlike trade between high-income countries, which produces broadly shared gains in productivity and wages, "trade between countries at very different levels of economic development tends to create large classes of losers as well as winners". He writes, "Workers with less formal education either see their jobs shipped overseas or find their wages driven down by the ripple effect as other workers with similar qualifications crowd into their industries and look for employment to replace the jobs they lost to foreign competition. And lower prices at Wal-Mart aren’t sufficient compensation."
James Surowiecki waded into this debate by suggesting that the "benefits of free trade with China, at least when it comes to shopping, are concentrated overwhelmingly among average Americans". While conceding that job losses and wage declines have affected middle and low income Americans badly, he argued that the same category, as consumers, were the biggest beneficiaries of the cheap Chinese import of manufactured goods.
Given that these imports consist mainly of products commonly consumed by lower and middle-income Americans and make up a large share of their consumption budgets, trade with China benefits them disproportionately more than the richer consumers. He quotes a study by University of Chicago economists Christian Broda and John Romalis which indicates that between 1999 and 2005, the inflation rate for lower-income Americans was almost seven points lower than it was for the wealthiest Americans, due mainly to trade with China.
Mark Thoma however takes a different view and feels that given the stagnant wages, rise in inequality, loss of health care and retirement benefits, and decreased job security, low and middle-income Americans may not feel that the benefits of globalization has not been proportionately shared.
He writes, "We need to find a way to distribute the gains (and the pains) of globalization so they are shared more equally, to increase opportunity so that everyone has the chance to reach their full potential, and we need to reverse the declines in economic security, retirement benefits, and health care coverage that have occurred for middle and lower income households over recent decades."
Some others have cited the Stolper-Samuelson theorem to explain the rising wage inequality in the US and other developed countries. This theorem states that "a rise in the relative price of a good will lead to a rise in the return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the return to the other factor". Alternatively, trade lowers the real wage of the scarce factor of production, while protection from trade raises it.
Therefore, an increase in the relative price of American exports to cheaper Asian imports, will lead to higher returns for capital (which is more intensively deployed in US exports) and lower returns for the other factor, labour. To quote Wikipedia, "Unskilled workers producing traded goods in a high-skill country will be worse off as international trade increases, because, relative to the world market in the good they produce, an unskilled first world production-line worker is a less abundant factor of production than capital."
It is therefore claimed that if the removal of barriers to trade causes the price of exported goods to increase (relative to imports), and if the exported goods use skilled labor intensively, then the price of skilled labor (the wage) will go up, and that of unskilled labor will go down.
But this may only be part of the story, since the other side of Stolper-Samuelson theorem reveals that in the Asian economies, the opposite effect dominates when export prices rise. Since their exports are more labour intensive, the returns to labour rises while the returns for capital falls.
The whole debate ultimately boils down to identifying which of the two effects - work migration and downward wage pressure on American workers, and cheaper produce for American consumers - pre-dominate. While Surowiecki argues in favor of the later, Mark Thoma and Krugman feels that the former pre-dominates.
As Tim Worstall points out, the importance of trade lies in the undeniable fact that while relative poverty is increasing in the rich countries, it is at the same time abolishing absolute poverty in the poor ones.
There are also convincing studies to indicate that changing economic environment and technology may play critical roles in determining wage inequality. Dani Rodrik calls attention to the work of Robert Feenstra and Gordon Hanson, who show that global "production sharing" has the same effect as skill-based technological change in shifting demand away from low-skilled activities, while raising the relative demand and wages of the higher skilled. Lawrence Katz and Claudia Godin have made out a brilliant case that the rising inequality in the US can be accounted for by rising educational wage differential.
Sunday, June 8, 2008
Carbon footprint in food
Ezra Klein draws attention to a study by Christopher Weber and Scott Matthews of the Carnegie Mellon University, which breaks down the carbon footprint contribution to a typical American food basket. Some interesting findings of the study are
1. 83 percent of emissions came from the growth and production of the food itself. Only 11 percent came from transportation, and even then, only 4 percent came from the transportation between grower and seller (which is the part that eating local helps cut). This means that the food shipped from far off may be better for the environment than food transported within the country -- ocean travel is much more efficient than trucking.
2. The average American household burns through about 8.1 metric tons of greenhouse gases as a result of food consumption. By contrast, if your house has a car that gets 25 mpg and you drive 12,000 miles a year (US average), that produces 4.4 metric tons of greenhouse gases. Therefore, switching to a totally local diet is equivalent to driving about 1000 miles less per year.
3. Red meat and dairy are responsible for nearly half of all greenhouse gas emissions from food for an average U.S. household. Replacing red meat and dairy with chicken, fish, or eggs for one day per week reduces emissions equal to 760 miles per year of driving. And switching to vegetables one day per week cuts the equivalent of driving 1160 miles per year.
1. 83 percent of emissions came from the growth and production of the food itself. Only 11 percent came from transportation, and even then, only 4 percent came from the transportation between grower and seller (which is the part that eating local helps cut). This means that the food shipped from far off may be better for the environment than food transported within the country -- ocean travel is much more efficient than trucking.
2. The average American household burns through about 8.1 metric tons of greenhouse gases as a result of food consumption. By contrast, if your house has a car that gets 25 mpg and you drive 12,000 miles a year (US average), that produces 4.4 metric tons of greenhouse gases. Therefore, switching to a totally local diet is equivalent to driving about 1000 miles less per year.
3. Red meat and dairy are responsible for nearly half of all greenhouse gas emissions from food for an average U.S. household. Replacing red meat and dairy with chicken, fish, or eggs for one day per week reduces emissions equal to 760 miles per year of driving. And switching to vegetables one day per week cuts the equivalent of driving 1160 miles per year.
Matching beneficiaries with benefits
Some time back, I had written a Mint op-ed about how the NGO world could benefit from the services of institutions like credit rating agencies, which can help funnel the massive amounts of philanthropic contributions, especially from the smaller contributors, to the most deserving causes. As a corollary to this, it is another major challenge to match deserving beneficiaries to the available philanthropic assistance.
Now Georgia Levenson Keohane, draws attention through a Slate column, about the role of SingleStop USA, a poverty fighting startup, which seeks to "connect the working poor in New York with government funds and services intended for them". After connecting beneficiaries to specific eligible assitance, SingleStop also helps them through the entire application process, helps them obtain the benefits and even give guidance on how to optimally use the assitance.
It has been estimated that nationally more than $65 bn in social welfare assistance goes unclaimed for, that 25 percent of the working poor receive no benefits at all, despite their eligibility, and that only 7 percent of these families access all four of the major supports (tax credits, Medicaid, food stamps, and child care subsidies). It gets support from philanthropists and some well known foundations.
Keohane describes SingleStop's operating model thus, "With a Turbo Tax-like software and legal and financial counseling, it helps people tap into public benefits (tax credits, food stamps, child care subsidies, and health insurance) that they're eligible for but aren't using." After matching them with the eligible assistance, SingleStop also after clients determine what they're eligible for, counselors walk them through the application process, help obtain the benefits, and then provide specific guidance about them.
Keohane goes on, "In 15 minutes, the organization's software tools calculate a family's eligibility for a host of benefits—public assistance (TANF and other welfare-to-work initiatives), food stamps, Medicaid, housing and child care subsidies, health care, school lunch programs, heating assistance, Social Security disability, and tax credits. SingleStop counselors then provide families with tailored legal and financial advice—how to stave off eviction with new rent money or vouchers, how to consolidate debt and begin to pay it off, how to open a savings or IDA account."
Since 2001, a New York City pilot version of the program has connected 70,000 low-income residents to hundreds of millions of government dollars. According to a McKinsey & Co. study of the New York pilot, the average family in a SingleStop program recouped $1,800 in tax credits and $5,000 in benefits that they weren't previously receiving.
It is no different in India where the large numbers of State and Central Government welfare programs - especially in health care, education, skill development, and rural credit - are inaccessible to the most deserving, both due to lack of awareness and also the complexity involved in the application procedure. The SingleStop model is an excellent example of how the huge challenge of rectifying the gaps and inefficiencies in the welfare assitance delivery channels can be addressed. It can be emulated to match beneficiaries with both Government welfare and philanthropic assistance.
Now Georgia Levenson Keohane, draws attention through a Slate column, about the role of SingleStop USA, a poverty fighting startup, which seeks to "connect the working poor in New York with government funds and services intended for them". After connecting beneficiaries to specific eligible assitance, SingleStop also helps them through the entire application process, helps them obtain the benefits and even give guidance on how to optimally use the assitance.
It has been estimated that nationally more than $65 bn in social welfare assistance goes unclaimed for, that 25 percent of the working poor receive no benefits at all, despite their eligibility, and that only 7 percent of these families access all four of the major supports (tax credits, Medicaid, food stamps, and child care subsidies). It gets support from philanthropists and some well known foundations.
Keohane describes SingleStop's operating model thus, "With a Turbo Tax-like software and legal and financial counseling, it helps people tap into public benefits (tax credits, food stamps, child care subsidies, and health insurance) that they're eligible for but aren't using." After matching them with the eligible assistance, SingleStop also after clients determine what they're eligible for, counselors walk them through the application process, help obtain the benefits, and then provide specific guidance about them.
Keohane goes on, "In 15 minutes, the organization's software tools calculate a family's eligibility for a host of benefits—public assistance (TANF and other welfare-to-work initiatives), food stamps, Medicaid, housing and child care subsidies, health care, school lunch programs, heating assistance, Social Security disability, and tax credits. SingleStop counselors then provide families with tailored legal and financial advice—how to stave off eviction with new rent money or vouchers, how to consolidate debt and begin to pay it off, how to open a savings or IDA account."
Since 2001, a New York City pilot version of the program has connected 70,000 low-income residents to hundreds of millions of government dollars. According to a McKinsey & Co. study of the New York pilot, the average family in a SingleStop program recouped $1,800 in tax credits and $5,000 in benefits that they weren't previously receiving.
It is no different in India where the large numbers of State and Central Government welfare programs - especially in health care, education, skill development, and rural credit - are inaccessible to the most deserving, both due to lack of awareness and also the complexity involved in the application procedure. The SingleStop model is an excellent example of how the huge challenge of rectifying the gaps and inefficiencies in the welfare assitance delivery channels can be addressed. It can be emulated to match beneficiaries with both Government welfare and philanthropic assistance.
It is not "embedded inflation"
This blog has consistently argued here and here that the RBI has a limited role to play in the current inflation scenario. The global rise in commodity prices and the resultant cost-push nature of inflation means that monetary policy levers become irrelevant.
Yes, oil is kicking on to $140 and maybe beyond, but RBI can do little to either lower oil price or to keep people from consuming oil. The major driver of inflation has been commodity and foodgrain prices, which are not sticky and adjust quickly to supply side signals. In contrast, the cost of final goods like consumer durables, services, and wages have not shown any alarming rises.
In this context, this blogpost by Paul Krugman makes interesting reading. He makes the distinction between those products and services whose prices fluctuate in response to market signals and those which are stickier and whose prices are set at fairly longer intervals. He defines inflation arising form the later as embedded inflation, since there is the possibility of a competitive price setting spiral among producers, that causes inflationary expectations to get embedded into the system. Such inflations can be addressed with Central Bank intervention.
But in case of the former, as we have in India today, the only option for Government is to mitigate the hardships faced by the poorest by strengthening the social safety nets. Such times are a strong reminder of the continuing need for a vibrant and strong food security and targetted social security policy. And direct cash tranfers are an excellent way to efficiently target the beneficiaries.
Update 1
Pauyl Krugman has this explanation of the importance of core inflation - in measuring "inflation inertia".
Yes, oil is kicking on to $140 and maybe beyond, but RBI can do little to either lower oil price or to keep people from consuming oil. The major driver of inflation has been commodity and foodgrain prices, which are not sticky and adjust quickly to supply side signals. In contrast, the cost of final goods like consumer durables, services, and wages have not shown any alarming rises.
In this context, this blogpost by Paul Krugman makes interesting reading. He makes the distinction between those products and services whose prices fluctuate in response to market signals and those which are stickier and whose prices are set at fairly longer intervals. He defines inflation arising form the later as embedded inflation, since there is the possibility of a competitive price setting spiral among producers, that causes inflationary expectations to get embedded into the system. Such inflations can be addressed with Central Bank intervention.
But in case of the former, as we have in India today, the only option for Government is to mitigate the hardships faced by the poorest by strengthening the social safety nets. Such times are a strong reminder of the continuing need for a vibrant and strong food security and targetted social security policy. And direct cash tranfers are an excellent way to efficiently target the beneficiaries.
Update 1
Pauyl Krugman has this explanation of the importance of core inflation - in measuring "inflation inertia".
Friday, June 6, 2008
"First mover disadvantage" in infrastructure finance
One of the biggest challenges facing the infrastructure debt market in India (and many developing countries) is the problem of the "first mover disadvantage" faced by the borrower. This refers to the high risk that in an emerging market, the initial borrowers will be saddled with a deal (cost of capital) that would look unfavorable or even bad, a few years henceforth when the market would have matured fully. I will briefly elaborate the problem below.
In an essentially virgin debt financing market in a particular sector, the lender is faced with numerous risks, many which are not fully understood. There is a huge information asymmetry problem and lenders are apprehensive of adverse selection. This gets exacerbated when government agencies, with their reputation for inefficiency and legacy costs, are involved. There are risks associated with the sector, company, and the project being financed. The fact that very few agencies in the sector have been credit rated, only compounds the problem.
Given the risks inherent in the sector, the credit rating agencies too tend play safe and discount for the general sectoral risks while rating the borrower or the project. The credit rating is therefore never a true reflection of the financial and organizational strength of the specific borrower or the particular project. The lenders hedge for all the risks and pass them on to the borrower as higher capital cost.
With the markets not appreciating the inherent strengths of the company and its projects, even a very credit worthy borrower faces a difficult situation. The onus is on him in effectively signaling to the market his credit worthiness and inherent financial strength, and thereby differentiating himself from the others in the sector. In other words, the borrower needs to differentiate himself from the numerous 'lemons'.
Further, the borrower has exposure to local banks who are willing to lend at much lower rates, albeit for a shorter tenor. The local banks tend to have good working relationships with such borrowers, and have a much better understanding of the borrowing organization. By lending at the lowest possible rates, these commercial banks "crowd out" other more long-term and structured sources of debt and thereby delays the development of alternative debt markets.
But the borrower's biggest concern arises from a fear that he may be left holding a debt, which while reasonable now, may look like a very bad deal after a few years when the sectoral debt market has matured. It is natural that when the sectoral risks have been fully understood, some debt financed projects are successfully implemented and regular repayment is established, and credit rating is a more accurate reflection of the strengths of the organization, the cost of capital will fall significantly.
This coupled with the long-term trend towards lower rates (given the high base rates in many emerging economies), it is inevitable that the cost of capital for the first few projects may look very expensive a few years down the line. In a Government organizational context, such apprehensions makes managers and officials wary of taking innovative financing decisions.
This is the dilemma facing many borrowers in urban infrastructure and power distribution and transmission sector financing markets in India. A recent study of the 63 JNNURM cities by the Water and Sanitation Program (WSP) found that the major demand for debt is coming from those ULBs that are strapped for finances and have weak balance sheets. In contrast, the stronger and richer ULBs are trying to fund their investments from internal revenues, reluctant as they are to venture into the debt market. The major deterrents for these stronger ULBs being the higher cost of capital relative to the cheaper local financing options available and the tortuous process of accessing the debt market.
Similarly, the power transmission and distribution companies have access to assured and easily available loans from traditional financiers like Rural Electrification Corporation (REC) and the Power Finance Corporation (PFC), apart from local commercial banks with which they have their regular banking relationships. Despite the fact that these loans come at very high rates, the ease of accessing them endears such sources to these borrowers. These readily accessible sources have had the effect of "crowding out" the formal long term debt market. The result is that there are no Government sector transmission or distribution companies that have accessed the debt market. In fact, I could not come across even a single distribution company which had got itself credit rated, with a fully disclosed rating.
Let me sum up the story. The lenders are wary of the risks associated with these emerging sectors, and hence charge higher returns on these investments, which forces up the cost of capital. Credit rating agencies refuse to rate borrowers on a stand-alone basis and circumscribe the borrowers within the sectoral risk matrix, thereby making lenders warier still. The borrowers, exposed as they are to inefficient, but readily accessible, alternative sources, balk at the higher cost of capital and refuse to venture into the debt market! We therefore have a classic chicken-and-egg situation!
I have dwelt earlier here and here about how the urban infrastructure financing market was stuck in a stalemated debate between credit rating agencies, financial markets/institutions and the Urban Local Bodies (ULBs). The same is happening in the downstream of power sector too, and the economically inefficient loans from REC and PFC crowds out the emergence of any structured long term debt market.
How do we get out of this chicken and egg riddle? For a start, financial institutions will need to exhibit enterprise by assuming more risks and finance a few credit worthy organizations and projects. Such delayed gratification will invariably benefit the lenders in the long run, as it opens up the way for tapping the massive market in infrastructure finance. The enterprising lenders also benefit from the first mover advantage in these emerging markets.
The Government should consider providing risk mitigation support by way of credit enhancement facilities or even gap funding for these initial borrowers. The borrowers can be reassured of the "first mover disadvantage" by structuring the facility of swapping and/or a floating rate provision for the original debt. All these steps would reassure borrowers and encourage them to actively explore the debt markets.
Once we have runs on the board, with a few project successes to show for, it becomes easier for others to enter the market. As the uncertainties and apprehensions become cleared, and risks more clearly understood, the cost of capital will come down, especially for the more credit worthy projects and organizations. Only then will the risk arising from "first mover disadvantage" will be mitigated.
In an essentially virgin debt financing market in a particular sector, the lender is faced with numerous risks, many which are not fully understood. There is a huge information asymmetry problem and lenders are apprehensive of adverse selection. This gets exacerbated when government agencies, with their reputation for inefficiency and legacy costs, are involved. There are risks associated with the sector, company, and the project being financed. The fact that very few agencies in the sector have been credit rated, only compounds the problem.
Given the risks inherent in the sector, the credit rating agencies too tend play safe and discount for the general sectoral risks while rating the borrower or the project. The credit rating is therefore never a true reflection of the financial and organizational strength of the specific borrower or the particular project. The lenders hedge for all the risks and pass them on to the borrower as higher capital cost.
With the markets not appreciating the inherent strengths of the company and its projects, even a very credit worthy borrower faces a difficult situation. The onus is on him in effectively signaling to the market his credit worthiness and inherent financial strength, and thereby differentiating himself from the others in the sector. In other words, the borrower needs to differentiate himself from the numerous 'lemons'.
Further, the borrower has exposure to local banks who are willing to lend at much lower rates, albeit for a shorter tenor. The local banks tend to have good working relationships with such borrowers, and have a much better understanding of the borrowing organization. By lending at the lowest possible rates, these commercial banks "crowd out" other more long-term and structured sources of debt and thereby delays the development of alternative debt markets.
But the borrower's biggest concern arises from a fear that he may be left holding a debt, which while reasonable now, may look like a very bad deal after a few years when the sectoral debt market has matured. It is natural that when the sectoral risks have been fully understood, some debt financed projects are successfully implemented and regular repayment is established, and credit rating is a more accurate reflection of the strengths of the organization, the cost of capital will fall significantly.
This coupled with the long-term trend towards lower rates (given the high base rates in many emerging economies), it is inevitable that the cost of capital for the first few projects may look very expensive a few years down the line. In a Government organizational context, such apprehensions makes managers and officials wary of taking innovative financing decisions.
This is the dilemma facing many borrowers in urban infrastructure and power distribution and transmission sector financing markets in India. A recent study of the 63 JNNURM cities by the Water and Sanitation Program (WSP) found that the major demand for debt is coming from those ULBs that are strapped for finances and have weak balance sheets. In contrast, the stronger and richer ULBs are trying to fund their investments from internal revenues, reluctant as they are to venture into the debt market. The major deterrents for these stronger ULBs being the higher cost of capital relative to the cheaper local financing options available and the tortuous process of accessing the debt market.
Similarly, the power transmission and distribution companies have access to assured and easily available loans from traditional financiers like Rural Electrification Corporation (REC) and the Power Finance Corporation (PFC), apart from local commercial banks with which they have their regular banking relationships. Despite the fact that these loans come at very high rates, the ease of accessing them endears such sources to these borrowers. These readily accessible sources have had the effect of "crowding out" the formal long term debt market. The result is that there are no Government sector transmission or distribution companies that have accessed the debt market. In fact, I could not come across even a single distribution company which had got itself credit rated, with a fully disclosed rating.
Let me sum up the story. The lenders are wary of the risks associated with these emerging sectors, and hence charge higher returns on these investments, which forces up the cost of capital. Credit rating agencies refuse to rate borrowers on a stand-alone basis and circumscribe the borrowers within the sectoral risk matrix, thereby making lenders warier still. The borrowers, exposed as they are to inefficient, but readily accessible, alternative sources, balk at the higher cost of capital and refuse to venture into the debt market! We therefore have a classic chicken-and-egg situation!
I have dwelt earlier here and here about how the urban infrastructure financing market was stuck in a stalemated debate between credit rating agencies, financial markets/institutions and the Urban Local Bodies (ULBs). The same is happening in the downstream of power sector too, and the economically inefficient loans from REC and PFC crowds out the emergence of any structured long term debt market.
How do we get out of this chicken and egg riddle? For a start, financial institutions will need to exhibit enterprise by assuming more risks and finance a few credit worthy organizations and projects. Such delayed gratification will invariably benefit the lenders in the long run, as it opens up the way for tapping the massive market in infrastructure finance. The enterprising lenders also benefit from the first mover advantage in these emerging markets.
The Government should consider providing risk mitigation support by way of credit enhancement facilities or even gap funding for these initial borrowers. The borrowers can be reassured of the "first mover disadvantage" by structuring the facility of swapping and/or a floating rate provision for the original debt. All these steps would reassure borrowers and encourage them to actively explore the debt markets.
Once we have runs on the board, with a few project successes to show for, it becomes easier for others to enter the market. As the uncertainties and apprehensions become cleared, and risks more clearly understood, the cost of capital will come down, especially for the more credit worthy projects and organizations. Only then will the risk arising from "first mover disadvantage" will be mitigated.
Wednesday, June 4, 2008
Role of NGOs in the development process
It has been some time since the Non Government Organizations (NGOs) have joined the public and private sectors as partners in the development process. More than a million NGOs operate in India, covering all the development sectors. But unfortunately, their impact, measured in terms of final outcomes, have been marginal and disproportionately lower than expectations. Only a handful of NGOs, and that too in a few sectors, have made an impact and significantly influenced the course of development process.
Unlike a few years back, when there was an acute scarcity of development funds, today we have an abundance of resources. But the problem remains one of spending the available resources, and spending them effectively and within the designated time. Getting the biggest bang for the development buck is the challenge! This is where Government institutions and systems fail miserably, and where the non-profit sector is uniquely positioned to assist.
The reasons for the government failings are numerous and is not the concern of this post. I will try to identify a few ways in which NGOs can increase their influence on the development process. So here is a laundry list of prescriptions for how NGOs can improve their performance. (some of them are inter-related)
1. Too many NGOs, especially the smaller ones, are involved in themselves running small schools, clinics, anganwadi centers, watershed projects, Self Help Groups (SHGs), child labour schools etc. Many of these NGOs are in turn funded by large aid agencies and foundations. While most of these institutions are undoubtedly run well, they are a small drop in the vast ocean of such activities. It is common place to find 20 to 30 good primary (even secondary and high) schools run by NGOs in each district, as against a few thousands of Government run schools.
In most of these cases, they are well run because of the immense personal effort and attention put in by a few dedicated individuals, and not the result of any radical systemic or institutional innovation. Given all the aforementioned are scarce commodities, it therefore becomes difficult to replicate and scale up. In fact, it would be more appropriate and efficient if these valuable human personnel are utilized on a larger canvas, rather than being confined to a few schools. In other words, we have an inefficient utilization of scarce, committed human resources.
Apart from being examples of well run development institutions, they have limited utility. Of course there are significant learnings from these examples, and many Government programs and policies have indeed drawn important lessons from them. But such examples are too many in number to draw any more meaningful inferences, but are too small to make any significant dent on the problem at a macro level.
2. NGOs need to complement and supplement the efforts of the Government in all their activities. But too many NGOs start running operations parallel to the Government and in competition with it, most often even without the knowledge of the local district administration. The perception that Government machinery is corrupt and inefficient may be the predominant reason for NGOs hesitating to associate with the local administration. But this fails to acknowledge the reality that there are severe limitations to their independent role, and the reality of Government role cannot be wished away.
NGOs need to be partners in assisting the local administration in achieving development goals. Instead of remaining stuck with pilots and small demonstration examples, NGOs need to be actively involved in the implementation of on going Government welfare programs. The local administration can leverage the strengths of these NGOs in effectively implementing major programs like the SSA, NREG, SHGs etc.
3. NGOs are more likely to have the expertise and knowledge to conceptualize school curriculums; affordable and appropriate construction designs for housing; rural transport systems; low-cost irrigation structures; identifying and adopting indigenous technologies after appropriate modifications and so on. NGOs can become an invaluable location for Government departments and agencies to source such expertise. NGOs can specialize in a specific sector, and become best practices resource banks for that sector. Such best practices need not be confined to technologies or materials, and should involve processes and work practices.
4. One of the biggest problems facing our field level development administration is the virtual absence of any comprehensive program for training functionaries working at the cutting edge. NGOs can play a vital role in preparing training material. They can also directly assist in the training of teachers, ANMs, community health workers, anganwadi workers, agriculture assistants, veternary assistants, community activists helping SHGs etc.
If one major NGO or corporate group can fully adopt the training requirements of primary school teachers in a district (say), that can make more meaningful difference than running a hundred schools. And all this will cost much less.
5. Government agencies are severely handicapped by the absence of adequate systematic process support. This deficiency manifests in the poor progress and quality of implementation of works and programs. NGOs and corporate groups can give a qualitative filip to the implementation of Government programs by helping put in place independent third party quality controls, independent program monitoring systems (software etc), carrying out impact evaluation studies.
Therefore it would be invaluable if NGOs assist local administration in such process support for programs like NREGS, SSA, PMGSY, NRHM/NUHM, welfare pensions and the numerous state government welfare programs.
6. NGOs and corporate groups can help Government agencies implement internal process improvements. For example, Urban Local Bodies (ULBs) in India are grossly inefficient and do not have any established and standardized accounting systems. NGOs and corporate groups can assist in the development and implementation of financial accounting softwares for double-entry accounting or revenue collection in ULBs.
In fact, this is an ideal example of how corporate welfare and development objectives can be reconciled. While the corporate group can make its money out of selling such software, albeit at a lower profit, the ULBs benefit by way of having access to a single stop software solution to their problems. Similar internal software support useful for Government offices include work-flow automation, file management systems, bill management/tracking systems, citizen grievance redressal softwares etc. While there have been too many local experiments in such systems, most of them have been unprofessional and have suffered from lack of standardization. Such software support increases the efficiency of government services and helps in containing corruption.
7. Another area where NGOs can be of great value is in helping adopt low cost solutions and technologies to many development problems. In recent years, construction technolgies and processes have undergone a massive revolution and we are constructing hundred storey buildings and grand civil engineering marvels. But on the other side, we are yet to have reliable, low-cost, pre-cast housing technolgies or models that can be replicated in a mass scale.
The Government of Andhra Pradesh is building 2.5 million houses for rural poor in three years and the Government of India is proposing to build another 10 million housing units to providing housing for poor. These are massively ambitious construction challenges and cannot be implemented along the conventional lines, and will require substantial pre-cast inputs so as to ensure their completion in time and with good quality.
Low cost irrigation solutions, electrification of remote and interior villages are examples of areas where non-profit sector can contribute in making a meaningful difference.
8. One of the most fertile areas for non-profit sector intervention is in awareness creation or Information Edication Campaigns (IEC). It has been well documented through numerous studies that one of the most important reasons for the poor implementation of various government programs is lack of adequate awareness among the stakeholders. Development also involves bringing about changes in the attitudes behaviour and perceptions of the stakeholders on many social issues.
Regular government programs and agencies do not attach much importance to this critical dimension, that is vital towards sustaining the change. Non-profit sector and NGOs have greater expertise in conceptualizing, preparing campaign materials and even running such IECs. In fact, effectively communicating social and other public interest messages would require borrowing techniques and processes from corporate communication strategies. Further, professsional communication strategies are important for effectively communicating critical reform issues to stakeholders.
9. Finally, Public Private Partnerships (PPP) are a more sustainable and mutually beneficial strategy for NGOs and private charitable foundations to become involved as active partners in the development process. There is enormous potential for mutually beneficial PPPs in agriculture (extension services, storage, and marketing facilities), micro-finance, vocational skill trainings, health care, education, sanitation and public health etc.
The PPPs, when suffused with a reasonable public service dimension, can deliver basic services of good quality at affordable cost to the poor. It is surely the way of the future and is also the most effective way to bring in the private sector into being active partners in the development process.
Unlike a few years back, when there was an acute scarcity of development funds, today we have an abundance of resources. But the problem remains one of spending the available resources, and spending them effectively and within the designated time. Getting the biggest bang for the development buck is the challenge! This is where Government institutions and systems fail miserably, and where the non-profit sector is uniquely positioned to assist.
The reasons for the government failings are numerous and is not the concern of this post. I will try to identify a few ways in which NGOs can increase their influence on the development process. So here is a laundry list of prescriptions for how NGOs can improve their performance. (some of them are inter-related)
1. Too many NGOs, especially the smaller ones, are involved in themselves running small schools, clinics, anganwadi centers, watershed projects, Self Help Groups (SHGs), child labour schools etc. Many of these NGOs are in turn funded by large aid agencies and foundations. While most of these institutions are undoubtedly run well, they are a small drop in the vast ocean of such activities. It is common place to find 20 to 30 good primary (even secondary and high) schools run by NGOs in each district, as against a few thousands of Government run schools.
In most of these cases, they are well run because of the immense personal effort and attention put in by a few dedicated individuals, and not the result of any radical systemic or institutional innovation. Given all the aforementioned are scarce commodities, it therefore becomes difficult to replicate and scale up. In fact, it would be more appropriate and efficient if these valuable human personnel are utilized on a larger canvas, rather than being confined to a few schools. In other words, we have an inefficient utilization of scarce, committed human resources.
Apart from being examples of well run development institutions, they have limited utility. Of course there are significant learnings from these examples, and many Government programs and policies have indeed drawn important lessons from them. But such examples are too many in number to draw any more meaningful inferences, but are too small to make any significant dent on the problem at a macro level.
2. NGOs need to complement and supplement the efforts of the Government in all their activities. But too many NGOs start running operations parallel to the Government and in competition with it, most often even without the knowledge of the local district administration. The perception that Government machinery is corrupt and inefficient may be the predominant reason for NGOs hesitating to associate with the local administration. But this fails to acknowledge the reality that there are severe limitations to their independent role, and the reality of Government role cannot be wished away.
NGOs need to be partners in assisting the local administration in achieving development goals. Instead of remaining stuck with pilots and small demonstration examples, NGOs need to be actively involved in the implementation of on going Government welfare programs. The local administration can leverage the strengths of these NGOs in effectively implementing major programs like the SSA, NREG, SHGs etc.
3. NGOs are more likely to have the expertise and knowledge to conceptualize school curriculums; affordable and appropriate construction designs for housing; rural transport systems; low-cost irrigation structures; identifying and adopting indigenous technologies after appropriate modifications and so on. NGOs can become an invaluable location for Government departments and agencies to source such expertise. NGOs can specialize in a specific sector, and become best practices resource banks for that sector. Such best practices need not be confined to technologies or materials, and should involve processes and work practices.
4. One of the biggest problems facing our field level development administration is the virtual absence of any comprehensive program for training functionaries working at the cutting edge. NGOs can play a vital role in preparing training material. They can also directly assist in the training of teachers, ANMs, community health workers, anganwadi workers, agriculture assistants, veternary assistants, community activists helping SHGs etc.
If one major NGO or corporate group can fully adopt the training requirements of primary school teachers in a district (say), that can make more meaningful difference than running a hundred schools. And all this will cost much less.
5. Government agencies are severely handicapped by the absence of adequate systematic process support. This deficiency manifests in the poor progress and quality of implementation of works and programs. NGOs and corporate groups can give a qualitative filip to the implementation of Government programs by helping put in place independent third party quality controls, independent program monitoring systems (software etc), carrying out impact evaluation studies.
Therefore it would be invaluable if NGOs assist local administration in such process support for programs like NREGS, SSA, PMGSY, NRHM/NUHM, welfare pensions and the numerous state government welfare programs.
6. NGOs and corporate groups can help Government agencies implement internal process improvements. For example, Urban Local Bodies (ULBs) in India are grossly inefficient and do not have any established and standardized accounting systems. NGOs and corporate groups can assist in the development and implementation of financial accounting softwares for double-entry accounting or revenue collection in ULBs.
In fact, this is an ideal example of how corporate welfare and development objectives can be reconciled. While the corporate group can make its money out of selling such software, albeit at a lower profit, the ULBs benefit by way of having access to a single stop software solution to their problems. Similar internal software support useful for Government offices include work-flow automation, file management systems, bill management/tracking systems, citizen grievance redressal softwares etc. While there have been too many local experiments in such systems, most of them have been unprofessional and have suffered from lack of standardization. Such software support increases the efficiency of government services and helps in containing corruption.
7. Another area where NGOs can be of great value is in helping adopt low cost solutions and technologies to many development problems. In recent years, construction technolgies and processes have undergone a massive revolution and we are constructing hundred storey buildings and grand civil engineering marvels. But on the other side, we are yet to have reliable, low-cost, pre-cast housing technolgies or models that can be replicated in a mass scale.
The Government of Andhra Pradesh is building 2.5 million houses for rural poor in three years and the Government of India is proposing to build another 10 million housing units to providing housing for poor. These are massively ambitious construction challenges and cannot be implemented along the conventional lines, and will require substantial pre-cast inputs so as to ensure their completion in time and with good quality.
Low cost irrigation solutions, electrification of remote and interior villages are examples of areas where non-profit sector can contribute in making a meaningful difference.
8. One of the most fertile areas for non-profit sector intervention is in awareness creation or Information Edication Campaigns (IEC). It has been well documented through numerous studies that one of the most important reasons for the poor implementation of various government programs is lack of adequate awareness among the stakeholders. Development also involves bringing about changes in the attitudes behaviour and perceptions of the stakeholders on many social issues.
Regular government programs and agencies do not attach much importance to this critical dimension, that is vital towards sustaining the change. Non-profit sector and NGOs have greater expertise in conceptualizing, preparing campaign materials and even running such IECs. In fact, effectively communicating social and other public interest messages would require borrowing techniques and processes from corporate communication strategies. Further, professsional communication strategies are important for effectively communicating critical reform issues to stakeholders.
9. Finally, Public Private Partnerships (PPP) are a more sustainable and mutually beneficial strategy for NGOs and private charitable foundations to become involved as active partners in the development process. There is enormous potential for mutually beneficial PPPs in agriculture (extension services, storage, and marketing facilities), micro-finance, vocational skill trainings, health care, education, sanitation and public health etc.
The PPPs, when suffused with a reasonable public service dimension, can deliver basic services of good quality at affordable cost to the poor. It is surely the way of the future and is also the most effective way to bring in the private sector into being active partners in the development process.
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