Dani Rodrik is right in claiming that in developing economies entrepreneurial activity, whose social value is much more than private costs, comes up against the issue of "first mover disadvantage" arising from uncertainty about the underlying cost structure - what can and cannot be produced profitably.
He writes about such entrepreneurs, "If they succeed, much of the gains are socialized through entry and emulation, whereas if they fail, they bear the full costs... One must presume that there are many more (discovery efforts or entrepreneurial activities) that could be taking place, but which are not, because it is difficult for pioneers to capture a large enough part of the social surplus they generate, even with the subsidy programs in place."
So how do we enable the pioneers to internalize a greater share of the social surplus? We cannot provide exclusive rights, like patents, because many of these are not patentable. Governments cannot assume the role of a venture capitalist of last resort. How can governments distinguish between "good" and "bad" ideas and entrepreneurs, and support the "good" ones? Can Governments avoid the moral hazard associated with picking winners, especially given the numerous examples of subsidies ostensibly given to support entrepreneurship, but plainly doled out to cronies and favorites? Nor can we expect the markets to step in and single-handedly perform the role of supporting entrepreneurship and picking winners.
There are those, like William Baumol and Co, who will say that Governments can play an in-direct role in enabling the development of entrepreneurial culture - lowering entry and exit barriers (start-up registration, flexible labour markets, accessing finance); institutional framework that rewards entrepreneurial activity (property and contract rights); discourage destructive entrepreneurship that divides the pie than increase its size( corruption, crime, excessive taxation, subsidies etc); and winners should be incentivized to continue their innovation and not stagnate (anti-trust laws, and openness to trade). But these are the necessary, but not sufficient, conditions for entrepreneurial activity and economic development.
Scanning the economic landscape of the past few decades, it is difficult to come across examples of such market driven rise of entrepreneurship in the developing economies. On the contrary, one can cite numerous examples of "guided bureaucratic" entrepreneurial activity - East Asia, China, India, the flower industry in Ethiopia etc. Even the economic history of Japan, US and Europe bears this out.
Take the example of the first flush of flower exporting entrepreneurs in Ethiopia. There was no way they could have emerged endogenously, through the dynamics of the market forces, given the inherent economic, commercial and technical uncertainties (not even "risks" - remember the "known unknowns and unknown unknowns"). An exogenous intervention, by way of subsidy through cheap land and tax holidays, was necessary to discover the underlying cost structure and break open the market. As Dani says and as the theory about positive externalities affirms, private sector will always be reluctant to step in where social benefits exceed private costs.
Given the crucial role of the Government in picking winners, the importance of a committed bureaucracy and enlightened political administrators assumes significance. This institutional framework, probably the most critical determinant, is rarely a consideration in standard economic principles of policy making for promoting entrepreneurship. Wherever acknowledged, it gets grudgingly marginalized into a corner, clubbed as part of the now fashionable "good governance".
I had blogged earlier on the similar chicken and egg problem facing the market for infrastructure financing and government sector software applications in India. Both remain trapped in a stalemate, and will continue to be so in the absence of active external (read government) intervention to break the dead-lock.
Thursday, December 25, 2008
Wednesday, December 24, 2008
Mother of all moral hazards!
Hyman Minsky brilliantly captures the world view in this age of 'irrational exuberance',
To the list we can also add stock analysts, fund managers, investors, home buyers, and most of the others who participated in the market orgy. This is the "mother of all moral hazards"!!
(HT: Martin Wolf)
"A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him."
To the list we can also add stock analysts, fund managers, investors, home buyers, and most of the others who participated in the market orgy. This is the "mother of all moral hazards"!!
(HT: Martin Wolf)
War and fiscal stimulus
Martin Feldstein proposes a temporary rise in defense spending on supplies, equipment and manpower, as part of any fiscal stimulus package. Military procurement is a classic fiscal stimulus measure, the most famous example being the role of World War II spending in decisively pushing the American economy into a high growth trajectory.
This has resonance for India too, especially through investments in an one-time catch up for the resource-strapped defense forces. It is also likely to bring political points, especially in light of the Mumbai attacks and the sabre-rattling with Pakistan. By logical extension of this argument, a war with Pakistan has the potential to be the ideal fiscal stimulus! Wonder why the Pakistani Government is not using this to buttress their claims of Indian war mongering!!
This has resonance for India too, especially through investments in an one-time catch up for the resource-strapped defense forces. It is also likely to bring political points, especially in light of the Mumbai attacks and the sabre-rattling with Pakistan. By logical extension of this argument, a war with Pakistan has the potential to be the ideal fiscal stimulus! Wonder why the Pakistani Government is not using this to buttress their claims of Indian war mongering!!
Markets and negative externalities
A generous description of any commonplace urban public marketplace in India (or for any developing country) would be that of disorder and melee. Such public grocery, vegetable, fish and meat markets attract large numbers of hawkers selling a whole variety of regular consumption items. Exacerbating the disorder and confusion created by the hawkers are the riotously parked bicycles, motorcycles, and cars belonging to the customers. Most often the area becomes a traffic nightmare and inconveniences everybody. Unfortunately, we see this problem as a regulatory failure and continue to set up such markets across our cities on this assumption.
These markets draw in predominantly poor, lower-middle and middle class consumers, whose general propensity is to make their purchases of basic kitchen and other household necessities during their market shopping trips. Further, they make their purchases of these items typically from small hawkers and roadside stores. This incentivizes hawkers peddling these regular consumption items to set up shop around the public market. Besides, these markets and its immediate surroundings also provide a focal point for those traders who have missed out getting a stall or shop allotted in the public market. In fact, a significant proportion of the hawkers around such markets belong to the aforementioned category.
Thus it is inevitable that vegetable markets get swamped with still more vegetable vendors and fruit hawkers. Policy makers and planners fail to recognise the reality that these public markets become market organisms whose utility and importance goes much beyond the mere supply of the designated specific commodities. They become the pivot around which an entire set of unorganized commercial activity gets developed, which can neither be prohibited or disincentivized. This is much like the village shandy, which hosts the entire spectrum of small commercial activity, covering all the basic household goods. And I am inclined to believe that it is desirable that these public market places develop like the shandies, encouraging small traders and entrepreneurs, while meeting consumer demand for a one-stop shopping convenience for middle class households.
Urban planners need to be receptive to the fact that any urban public market place comes as a package - hawkers, mobile vendors, parking etc. In many respects these elements form a negative externality imposed by the market. It is important that we factor in this reality in planning our market places. This implies that we locate our public market places in areas where there exists enough space for parking and the other informal commercial activity, besides being away from major traffic areas. Even if this means inconveniencing the customers by their having to travel farther, instead of the convenient walk down to the next street!
These markets draw in predominantly poor, lower-middle and middle class consumers, whose general propensity is to make their purchases of basic kitchen and other household necessities during their market shopping trips. Further, they make their purchases of these items typically from small hawkers and roadside stores. This incentivizes hawkers peddling these regular consumption items to set up shop around the public market. Besides, these markets and its immediate surroundings also provide a focal point for those traders who have missed out getting a stall or shop allotted in the public market. In fact, a significant proportion of the hawkers around such markets belong to the aforementioned category.
Thus it is inevitable that vegetable markets get swamped with still more vegetable vendors and fruit hawkers. Policy makers and planners fail to recognise the reality that these public markets become market organisms whose utility and importance goes much beyond the mere supply of the designated specific commodities. They become the pivot around which an entire set of unorganized commercial activity gets developed, which can neither be prohibited or disincentivized. This is much like the village shandy, which hosts the entire spectrum of small commercial activity, covering all the basic household goods. And I am inclined to believe that it is desirable that these public market places develop like the shandies, encouraging small traders and entrepreneurs, while meeting consumer demand for a one-stop shopping convenience for middle class households.
Urban planners need to be receptive to the fact that any urban public market place comes as a package - hawkers, mobile vendors, parking etc. In many respects these elements form a negative externality imposed by the market. It is important that we factor in this reality in planning our market places. This implies that we locate our public market places in areas where there exists enough space for parking and the other informal commercial activity, besides being away from major traffic areas. Even if this means inconveniencing the customers by their having to travel farther, instead of the convenient walk down to the next street!
Tuesday, December 23, 2008
Design of financial systems
Robert C. Merton and Zvi Bodie have an interesting article that proposes a functional approach to designing and managing the financial systems of countries, regions, firms, households, and other entities, by a synthesis of the neoclassical, neo-institutional, and behavioral perspectives.
Their Functional and Structural Finance (FSF) theory seeks to combine the traditional neo-classical theories on frictionless markets, rational agents, and efficient outcomes with two additional attributes - an institutional approach (see here) that focus on the structural aspects of the financial system that introduce friction and may lead to non-efficient outcomes; and a behavioural approach (here, here, here, and here) that focuses on the ways in which and the conditions under which economic actors are not rational.
This approach recognizes the fact that neo-classical models cannot satsifactory predict or explain the institutional structure of financial systems, or how specific types of financial intermediaries, markets, and regulatory bodies will or should evolve in response to underlying changes in technology, politics, demographics, and cultural norms.
(HT: Baseline Scenario)
Their Functional and Structural Finance (FSF) theory seeks to combine the traditional neo-classical theories on frictionless markets, rational agents, and efficient outcomes with two additional attributes - an institutional approach (see here) that focus on the structural aspects of the financial system that introduce friction and may lead to non-efficient outcomes; and a behavioural approach (here, here, here, and here) that focuses on the ways in which and the conditions under which economic actors are not rational.
This approach recognizes the fact that neo-classical models cannot satsifactory predict or explain the institutional structure of financial systems, or how specific types of financial intermediaries, markets, and regulatory bodies will or should evolve in response to underlying changes in technology, politics, demographics, and cultural norms.
(HT: Baseline Scenario)
Monday, December 22, 2008
The economic crisis in plain English
Oportunidades and the role of CCTs
Tina Rosenberg has this excellent article in the NYT about the hugely successful anti-poverty program of the Mexican governments, Oportunidades (earlier Progressa). Oportunidades has now become the de facto welfare system in Mexico.
The program gives the poor cash, but unlike traditional welfare programs, it conditions the receipt of that cash on activities designed to break the culture of poverty and keep the poor from transmitting that culture to their children. Its success has catapulted Conditional Cash Transfer (CCT) schemes to the forefront of poverty fighting strategies throughout the world.
Oportunidades focuses on providing cash grant to parents for sending children to school (and maintaining good attendance); basic food grant if children and ante-natal women attend regular health checkups, take nutrition supplements, besides attending a monthly workshop on a health topic, like purifying drinking water. The cash payments are made to the women, and surveys show that 70% of Oportunidades’ payment is spent on food — mostly fruit, vegetables and meat - and much of the rest goes to kids’ shoes and clothing and home improvements.
Beneficiaries are selected using the census data to find the poorest rural areas and urban blocks, and within those areas, by giving out questionnaires about people’s income and possessions. The families must be re-certified every six years. The criteria apply nationally — the program allows for no local discretion. Local political leaders have no influence and so cannot use the payments to extort political support. Oportunidades staff members do not handle money — local banks hand out the envelopes of cash, and recipients are encouraged to open bank accounts to receive direct transfers. It has limited infrastructure and bureaucracy, and is relatively cheap, costing Mexico only about $3.8 billion annually, of which an estimated 97% of the budget goes directly to the target group.
The criticisms are mostly about the programs design, about how the conditions should be structured. It is argued that the conditions should be made more stringent - that student achievement, not just attendance, should be rewarded. But these are part of the process of evolution of any welfare program. Another criticism is that the payments are too small to make any significant dent in poverty.
As Rosenberg says, the CCT model is an attempt to reconcile the traditional stalemate between conservatives and liberals (right and left), who attributed poverty to the poor themselves (with its attendant implication that they are impervious to external support) and capitalism (with its low wages, institutionalized discrimination, and widening inequality), respectively. It forces the poor to imbibe many of the structural and behavioural traits that the middle class takes for granted. It seeks to offer the "new paternalism" of the State in the form of "tough love", instead of unconditional love of the old nanny state. It enforces outcomes and dispenses off with targets and impersonal subsidies.
CCT offers an excellent model for delivering individual welfare benefits in India. It can be neatly fitted into the paradigm of competitive populism driven proliferation of individual beenfit schemes in India. Even if the Governments want to provide specific benefits, instead of cash, the benefits can be made conditional to fulfilling certain desirable social goals. Thus, the Rs 2 kg rice can be linked to say, school attendance of the children of the household.
The free television and other individual benefits given to poor families can be moneized and the cash transferred directly, ideally in instalments, conditional to their achieving certain desired social goals. This would considerably reduce the cost of the program, by eliminating the transaction costs and pilferage inherent in the procurement and distribution process. As the success of cash payments for NREGS and old age pensions, through bank and post office savings accounts have shown, the logistics of these cash transfers can be easily managed. Further, the strong roots established by the women Self Help Group (SHG) movement in many states, enables easy integration of CCT programs into the rural society. Besides, by bringing the poor into the ambit of the formal banking and credit mechanisms, it would also achieve the objective of Total Financial Inclusion (TFI).
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Fifty years back Mexican anthropologist Oscar Lewis published a book called "Five Families: Mexican Case Studies in the Culture of Poverty", detailing a single day in these families’ lives, where he singled out elements of a culture that, he argued, keep those socialized in it mired in poverty - machismo, authoritarianism, marginalization from organized civic life, high rates of abandonment of illegitimate children, alcoholism, disdain for education, fatalism, passivity, inability to defer gratification and a time orientation fixed firmly on the present.
The program gives the poor cash, but unlike traditional welfare programs, it conditions the receipt of that cash on activities designed to break the culture of poverty and keep the poor from transmitting that culture to their children. Its success has catapulted Conditional Cash Transfer (CCT) schemes to the forefront of poverty fighting strategies throughout the world.
Oportunidades focuses on providing cash grant to parents for sending children to school (and maintaining good attendance); basic food grant if children and ante-natal women attend regular health checkups, take nutrition supplements, besides attending a monthly workshop on a health topic, like purifying drinking water. The cash payments are made to the women, and surveys show that 70% of Oportunidades’ payment is spent on food — mostly fruit, vegetables and meat - and much of the rest goes to kids’ shoes and clothing and home improvements.
Beneficiaries are selected using the census data to find the poorest rural areas and urban blocks, and within those areas, by giving out questionnaires about people’s income and possessions. The families must be re-certified every six years. The criteria apply nationally — the program allows for no local discretion. Local political leaders have no influence and so cannot use the payments to extort political support. Oportunidades staff members do not handle money — local banks hand out the envelopes of cash, and recipients are encouraged to open bank accounts to receive direct transfers. It has limited infrastructure and bureaucracy, and is relatively cheap, costing Mexico only about $3.8 billion annually, of which an estimated 97% of the budget goes directly to the target group.
The criticisms are mostly about the programs design, about how the conditions should be structured. It is argued that the conditions should be made more stringent - that student achievement, not just attendance, should be rewarded. But these are part of the process of evolution of any welfare program. Another criticism is that the payments are too small to make any significant dent in poverty.
As Rosenberg says, the CCT model is an attempt to reconcile the traditional stalemate between conservatives and liberals (right and left), who attributed poverty to the poor themselves (with its attendant implication that they are impervious to external support) and capitalism (with its low wages, institutionalized discrimination, and widening inequality), respectively. It forces the poor to imbibe many of the structural and behavioural traits that the middle class takes for granted. It seeks to offer the "new paternalism" of the State in the form of "tough love", instead of unconditional love of the old nanny state. It enforces outcomes and dispenses off with targets and impersonal subsidies.
CCT offers an excellent model for delivering individual welfare benefits in India. It can be neatly fitted into the paradigm of competitive populism driven proliferation of individual beenfit schemes in India. Even if the Governments want to provide specific benefits, instead of cash, the benefits can be made conditional to fulfilling certain desirable social goals. Thus, the Rs 2 kg rice can be linked to say, school attendance of the children of the household.
The free television and other individual benefits given to poor families can be moneized and the cash transferred directly, ideally in instalments, conditional to their achieving certain desired social goals. This would considerably reduce the cost of the program, by eliminating the transaction costs and pilferage inherent in the procurement and distribution process. As the success of cash payments for NREGS and old age pensions, through bank and post office savings accounts have shown, the logistics of these cash transfers can be easily managed. Further, the strong roots established by the women Self Help Group (SHG) movement in many states, enables easy integration of CCT programs into the rural society. Besides, by bringing the poor into the ambit of the formal banking and credit mechanisms, it would also achieve the objective of Total Financial Inclusion (TFI).
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Fifty years back Mexican anthropologist Oscar Lewis published a book called "Five Families: Mexican Case Studies in the Culture of Poverty", detailing a single day in these families’ lives, where he singled out elements of a culture that, he argued, keep those socialized in it mired in poverty - machismo, authoritarianism, marginalization from organized civic life, high rates of abandonment of illegitimate children, alcoholism, disdain for education, fatalism, passivity, inability to defer gratification and a time orientation fixed firmly on the present.
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