Tax and subsidy way to healthy eating?

Mark Bittman bites the bullet and advocates taxing unhealthy food like soda, French fries, doughnuts and hyperprocessed snacks, and subsidizing fruits and vegetables.

He suggests that sweetened drinks could be taxed at 2 cents per ounce, so a six-pack of Pepsi would cost $1.44 more than it does now. An equivalent tax on fries might be 50 cents per serving; a quarter extra for a doughnut. He argues that "taxes would reduce consumption of unhealthful foods and generate billions of dollars annually. That money could be used to subsidize the purchase of staple foods like seasonal greens, vegetables, whole grains, dried legumes and fruit."



Such taxes are justifiable despite arguments that it will unfairly target poor people who pay a higher percentage of their income for food. Such critics overlook the long-term health effects of these foods and the much higher medical and other costs imposed on low-income people. Such criticism can be mitigated by subsidies on high-quality, fresh and healthy foods.

Though no American city today has taxes that are explicitly aimed at reducing consumption, many have proposals to tax soda or all sugar-sweetened beverages. Research by the Rudd Center for Food Policy and Obesity at Yale have found that such soda taxes become significant at the equivalent of about a penny an ounce. Further, it is also suggested that these taxes should be in the form of excise taxes on inputs, so that the taxes will be incorporated into the shelf price of the drink, thereby nudging consumers on their purchasing decisions.

There is also an excellent graphic that points to how economic incentives, signalled through prices of cigarettes, have contributed to a dramatic drop in smoking among Americans since the eighties.



Remarkably, more than half of all Americans who once smoked have quit and smoking rates are about half of what they were in the 1960s.

Greece's selective default

After prolonged foot-dragging, the inevitable has happened. The Eurozone leaders approved the second bailout of Greece, one that bears clear signatures of a partial default. The €109 bn ($157 bn) bail-out of Greece will force private bondholders to take losses on their bonds through debt swaps, roll-overs and buy-backs. In return, the Eurozone economies collectively guarantee the repayment of Greece's debt principal.

Instead of significant "haircuts", bond holders will now have to accept smaller losses and agree for maturity extensions at lower interest rates. Private bondholders will be required over the next three years to swap or roll over debts for new 15-30 year bonds. Whatever its form, this will ensure that Greece becomes the first western developed world country to default in more than 60 years.

This bailout deal comes after consistent opposition among the main economies, especially Germany, against any form of selective or partial debt default by any Eurozone economy. In the circumstances, the preferred policy was to continuously keep rescheduling Greek debts by swapping it with longer-term bonds in the hope that austerity measures would restore growth and ease the debt burden. It was also argued that this would prevent a run on Greek debt and ensure that Greece and other PIIGS economies were not elbowed out of the nobd markets. However, these measures had failed to reassure the bond markets, especially in light of recent fears of a similar crisis in Italy.

In an attempt to limit contagion effects, the debt deal also contained provisions to enable the European rescue fund, the €440 bn European Financial Stability Facility (EFSF), to assist countries like Spain and Italy that have so far not received any assistance. All three bail-out countries – Ireland, Portugal and Greece – will see rates cut to about 3.5%, or about 100-200 basis points, and will not have to repay the loans for up to 30 years. The EFSF will now be able to buy government bonds (or alternatively lend to these economies) on the secondary market (presumably at a discount rate, compared to the high rates that each of the peripheral economies would have to pay) and to help recapitalize banks, moves long resisted by Germany.

Further, holders of short-term obligations would be able to swap their notes for debt with longer maturities and backed by high-rated bonds. It is expected that 90% of all Greek bonds will be exchanged. The terms of the aid package from Europe to Greece would be eased, with maturities lengthened to 15 years from 7.5 years, at very low 3.5% interest rate. Most encouragingly, the deal also includes a commitment from Europe’s leaders to support Greece until it is able to return to the financial markets – a potentially unlimited guarantee that could see European taxpayers fund Greece for years.

As the FT reports, bondholders will be given four options – three forms of debt exchange and one rollover plan – with different durations and interest rates. The first exchange plan and the rollover would flip existing paper into new 30-year bonds at par value and with interest rates beginning at 4% and rising in 0.5 percentage point increments during the first 10 years to 5.5%.

The other two exchange plans – one for 15 years and the other for 30 – would pay higher coupons of 5.9-6.8% as compensation for taking an upfront 20% "haircut" on the value of the bond. All plans would be backed by an obligation on Greece to reinvest a portion of receipts from the rolled-over or exchanged financing in European AAA bonds, which would act as collateral against default. These bondholder programmes, limited to Greece only, amount to a 21% reduction in the net present value of their current bondholdings, and amount to a selective default.

Though voluntary, it is estimated that upto 90% bond holders will participate. Most major investors and financial institutions have welcomed the plan. Accordingly, private bondholders are expected to contribute €54 bn from mid-2011 to mid-2014 and a total of €135 bn during the period to 2020. On top of all this, an additional €12.6 bn is expected to come in commitments from bond owners to sell their holdings at a reduced price as part of a bond buy-back programme.

The financial institutions that own Greek bonds would effectively contribute 54 billion euros through 2014, largely by accepting reduced interest payments, and will stretch their maturities to as long as 30 years. The plan does not immediately reduce the total Greek debt is 350 billion euros ($496 billion) which form nearly 150% of GDP by much. Greece will benefit by way of reduced interest burden, extended loan maturities, discounted rates for Greek bond repurchases by EFSF, and even some haircuts on debt principals. The benefits are conservatively estimated to shave off atleast €26 bn off the country’s €350 bn debt pile by 2014. Further, the maturity profile of Greek debts will increase from six to eleven years.

The selective default is also an admission of the failure of the fiscal austerity policies. Over the 12 months ending in March, the Greek economy shrank by 5.5%, while unemployment, at 12.2% when the country was first bailed out, rose to 15%. More importantly, it is the first step in acknowledging that the solution to Eurozone problems lies in a fiscal union. The bailout virtually involves fiscal transfers from the better off economies to the beleaguered ones. Further, the EFSF, with its explicit financial stabilization mandate, becomes an effective European Monetary Fund.

Catch-up growth and global convergence

Citigroup economists Willem H. Buiter and Ebrahim Rahbari, who earlier identified 11 global growth generating (3G) economies for the first half of this century, have another paper investigating the likely future sources of global economic growth between 2010 and 2050.

They use 40 year economic forecasts by Citi economists, historical GDP data for the most recent 10-year period, and available economic research on the drivers of long-term growth, to examine national-level global growth generators. They assume United States as the technology frontier country and draw the distinction between growth at the technology frontier (productivity growth at the frontier) and catch-up or convergence growth (mainly through adoption and importation of best-practice technology and know-how from the frontier countries). Naturally, they foresee most of the global growth to come from the latter source.

Their earlier 3G index aggregates some key growth drivers - gross fixed domestic capital formation; gross domestic saving; a measure of human capital (which aggregates demographic, health and educational achievement indices); a measure of institutional quality; a measure of trade openness; and the initial level of per capita income. Their final analysis and prescription about how a country grows fast

"1. Start poor
2. Start young
3. Open up to trade in goods and services and to foreign direct investment
4. Achieve reasonable political stability (the absence of significant external and internal conflict)
5. Create some semblance of a functioning market economy
6. Boost the domestic saving and investment rates
7. Invest in human capital (educate and train both boys and girls, focusing on pre-school, primary and secondary education and on vocational training)
8. Invest in infrastructure
9. Don’t be unlucky. Avoid war-like neighbours and natural disasters
10. Don’t blow it. Avoid internal conflict and populist assaults on the incentives to work, save and invest; avoid macroeconomic mismanagement, premature capital account
liberalisation and financial regulatory disasters.

Catch-up and convergence will do the rest."

If we examine the Indian economy with respect to these ten attributes/tenets, the picture is indeed encouraging, especially if point 9 is taken care of. Points 1, 2, 4, and 5 are inherent and historical advantages. Points 3 and 6 are true reform achievements. Even point 7 is being addressed. This leaves us with the real concerns - points 8 and 10.

All our immediate (inflation) and long term (growth prospects and convergence growth pace) macroeconomic challenges are closely linked with infrastructure. This is all the more so since infrastructure forms the basic platform that underpins the growth of the modern economy. We need to plan, design, raise resources and execute massively in all infrastructure sectors. And even if we mobilize the resources and show the requisite commitment to conceptualize and create infrastructure, the greater challenge is to ensure that we do not blow it up.

Here I am not worried about macroeconomic mismanagement nor financial market problems nor even corruption or internal conflicts. All these dangers always lurk around the corner and will even explode once a while, but when seen in historic perspective and when analyzing growth prospects over half-century, they are all surmountable, especially for a continental economy like India. A real worry will be with picking up the pieces from the "populist assaults on the incentives to work, save and invest". I will come back and post on this in the days ahead.

The impossibility of regulating street vendors

The Times reports that many American cities are grappling with the issues raised by an increase in food trucks vending relatively inexpensive and convenient food in its streets.

Opponents of food trucks argue that such food trucks clog streets, eat into scarce parking spaces, pollute the area, annoy neighbours, and cannibalize the earnings of existing restuarants. Therefore, several US cities - Seattle, Chicago, and Raleigh - have sought to regulate food trucks with more restrictions - notifying areas where they could park, types of food they could sell, distance from restuarants etc. Such restrictions are expected to regulate the food truck business without causing much harm to existing business, raising opposition from neighbours, and by minimizing negative civic externalities.

This example is an excellent illustration of the difference between societies like India and the US in using regulations to control such types of activities in our cities. The city councils in the US obviously take for granted that these restrictions are enforceable and the minority of deviants could be forced to toe the line by strict enforcement. In contrast, in Indian cities, practical considerations, as discussed here, makes enforcement a near impossibility.

For a start, most city spaces and corners are already occupied either by squatting hawkers or cart-based vendors. Despite grappling with the problem for several years now and having passed numerous legislations, no Indian city has even remotely succeeded in addressing the problem of regulating street vendors. In simple terms, the challenge is in choosing between depriving tens of thousands (as in the case of any decently large city) off their livelihoods and in the process bringing order and discipline into urban life or leaving cities as stages for vibrant small-scale entrepreneurial activity with all its attendant disorderliness problems.

There are two issues here. Is there enough space to accommodate the demand? And assuming there is enough space, is enforcement of regulations possible? The first question is easily answered. No! The rapid pace of urbanization in recent years has ensured that there is no corner of any city which has been left free from being encroached. The informal market (controlled by local musclemen) in accessing such spaces and the magnitude of its rents is a reflection of their huge demand.

Any rationing would perforce leave massive numbers of people without their livelihoods. This is apart from sucking the government into a highly corrupt and inefficient allotment process, which the informal second-best market is currently administering with reasonable fairness and efficiency. The possible incentive distortions with such an arrangement are unimaginable and hugely counterproductive.

About the second issue of enforcement, as already discussed, it is a non-starter. When deviations and violations are the norm than the exception, enforcement becomes simply impossible. Enforcement works when deviations are at the margins. Strong enforcement signals can get the recalcitrant few at the margins to fall in line. It fails when the majority are deviants or violators.

Given the scarcity and demand for space, actual enforcement would involve uprooting large numbers of street vendors from each area in order to limit, regulate and discipline the hawking activity. Apart from the political impossibility of getting such policies through municipal councils, there is the practical issue of finding out alternative livelihoods for them.

This argument should not be seen as one supporting street hawkers. It is merely outlining the challenges that need to be overcome if we are to regulate street vendors in developing countries. Unfortunately, it is a challenge which does not appear to have been satisfactory addressed anywhere.

The solar power convergence

One of the most talked about points in power sector is when the cost of solar power converges with conventional carbon power. At current pricing levels, solar photo-voltaic generators still cannot compete with thermal and other traditional generators. However, the dramatic reduction in solar panel prices in recent years has ensured that the convergence is not far away.

The graphic below shows that PV panel manufacturing costs have come down, from $60 a watt in the mid-1970's to $1.50 today, declining about 18% for every doubling of production. People often point to a "Moore's Law" in solar - meaning that for every cumulative doubling of manufacturing capacity, costs fall 20%.



A staggering ramp-up in installations around the world have driven an even greater increase in solar manufacturing. Underlining the speed with which solar panels can be manufactured and installed, in 2010, 17 GW of capacity was manufactured, shipped and installed, the equivalent of 17 nuclear plants in one year! GTM Research predicts we'll have 50 gigawatts of module global production capacity by end-2011.



The commercial convergence is more likely to happen earlier with distributed solar generation in rural and remote areas for lighting, agriculture pump sets etc. Even in cities, technologies other than flat-panel PVs, like concentrating parabolic troughs and multiple reflecting mirrors offer great potential to both generate electricity and heat for boiling water in large single-point installations like hotels, hospitals, airports etc.

Stephen Lacey has excellent pricing curves of solar with respect to peaking natural gas, nuclear, and thermal. He shows that solar PV panels will become competitive against even new coal plants in the next 6-8 years.

Moral Hazard in Power Sector

I have blogged earlier here and here about how the possibility of contract renegotiations on competitively bid tender conditions has generated a moral hazard among infrastructure developers. Secure in the belief that the re-negotiation window is always open, they bid aggressively to win the bid.

The latest evidence of this moral hazard comes from Reliance's Coastal Andhra Power Ltd. (CAPL) stopping work at its Krishnapatnam Ultra Mega Power Project due to increase in the cost of its Indonesian coal. The developer claims that the new Indonesian Coal Price Regulation would push up the coal price and therefore cost of generation, imperil its cash flow and its ability to repay lenders.

As the Businessline writes, this development is surprising since the UMPP PPAs exclude fuel from the force majeure provisions, being specifically mentioned under Clause (a) of Article 12.4 of the PPA that lists out the 'Force Majeure Exclusions'. Further, even the 'Non-natural Force Majeure events' specified in the PPA does not include actions by a foreign government.

In other words, when the tender was called and agreement negotiated, it was clearly known to all parties that the fuel risk was solely vested with the developer. CAPL had bid aggressively in the tariff-based competitive bidding process, quoting a levelised tariff of Rs 2.33 per unit. Reliance Power has won three UMPPs so far. It is therefore, on every measure of reasonableness and contractual obligations, unacceptable for CAPL to stop work citing fuel price risks. Given precedents elsewhere by the same firm and others, this is the predictable path towards a request for re-negotiations on the terms of the contract.

It reflects a lack of professionalism, even questionable intent, on the part of the developer to have entered into the PPA without having hedged for fuel price risks. In the circumstances, the government should issue notice and get the developer to comply with its contractual commitments failing which the PPA should be terminated and the firm black-listed. It is the least that can be done to mitigate the moral hazard that has been unlreashed by frequent requests for re-negotiations.

Most importantly, the final outcome from the CAPL example could well determine the fate of tariff-based competitive bidding in India. The critical parameter in all the Case I bids are the tariffs discovered in the competitive bidding process. All bidders offer their quotes based on clearly known assumptions, of which fuel price risk being borne by bidder is the most fundamental. It is outright dishonest for any successful bidder to backtrack from the project citing fuel price increases.

Therefore, if the CERC buckles on this, it will inevitably open the floodgates for similar requests and destroy the market for tariff-based competitive bidding in the country.

Update 1 (28/7/2011)

Another example of contract renegotiations is the decision by Reliance Power Transmission's Talcher-II Transmission Company to issue the force majeure notice to electricity distribution utilities in Andhra Pradesh, Karnataka, Kerala, Tamil Nadu and Orissa. The Businessline reports that the company has cited unforeseen delays in clearances for a key transmission link being executed by it as one of the reasons for serving the notice. It has not started work on the Talcher-II transmission system that was to evacuate electricity from generation stations in the eastern region to mainly the southern States. The link was to be up by October 2012.

The counterfactual problem in public policy

Heads I win, tails you lose! This aphorism could well describe the debate on many intractable public policy issues, those where conclusive answers are difficult to come by. Supporters claim that it would have been worse without the intervention. Critics denounce the intervention as a failure since the problem persists. The challenge with all such issues is the difficulty of establishing the counterfactual. Let me illustrate this dilemma with three examples.

The most famous counterfactual problem of our times is the debate on the impact of expansionary policies implemented in the US in the aftermath of the Great Recession. Conservatives point to the persistent high unemployment rates and weak economic conditions, despite the extraordinary fiscal (more than $ 1 trillion) and monetary expansion (zero bound rates and $2.3 trillion QE), as conclusive proof of the failure of expansionary policies.

They reinforce their argument by pointing to the failure of the now infamous recovery projection, estimating future unemployment rates with and without a stimulus plan, made in January 2009 by Christina Romer and Jared Bernstein, then part of President Barack Obama's team. Their way-off-the-mark estimates suggested that unemployment would approach 9% without a stimulus, but would never exceed 8% with the plan.



In May 2011, using the latest figures available from the BLS, the unemployment rate reached 9.1%. In contrast to the Romer and Bernstein projections which estimated that the unemployment rate would be around 8.1% for May without a recovery plan, or 6.8% with a stimulus plan, the actual rate was 9.1%. The actual unemployment rate has been consistently above Romer and Bernstein’s worse case scenario for the economy – and by a considerable margin. Critics of the stimulus invoke this as proof of its complete failure. After all, though a massive and unprecedented monetary and stimulus was enacted, it appears to have had no impact in terms of improving the economic conditions.

Supporters of the stimulus in turn point to other statistics to put forward their claims about how the stimulus created employment, supported the poorest, propped up aggregate demand, and helped local governments. They argue that in the absence of the stimulus measures, the counterfactual, the economy would have plunged into a full-blown depression.

Further, economists like Paul Krugman have consistently held that the actually enacted stimulus policies have been severely deficient and have been advocating much larger doses of expansion to mitigate the high unemployment rate. In the absence of the required magnitude of expansion, they claim, it is unfair and incorrect to blame the expansionary policies for the economy languishing.

Such counterfactual problems are pervasive in economic policy making. This is especially so given the impossibility of localizing and quantifying the impact of specific policy interventions. In the circumstances, if the intervention fails to yield the desired result, critics will denounce it as a failure. Supporters will find that establishing the counterfactual, the scenario in the absence of the stimulus, is fraught with insurmountable difficulties.

Another example of such analysis is the debate about the benefits of metro-rail in New Delhi. Critics argue that despite the massive investments in the Metro, the Delhi traffic remains as bad as ever, even worse. This argument is made on the assumption that the Delhi Metro was set up with the objective of lowering traffic congestion in the city. Now that the final outcome shows no signs of traffic improvement, they argue, the Metro project has failed.

Supporters naturally point that without the Metro Delhi would been uninhabitable. They argue that the Metro has taken 1.7 million people out of the roads, and thereby ensuring that those many people stay out of city roads. They argue that the success of the Metro is a function of how many people it is able to attract and how fast its network expands. The persistent congestion is only a reflection of the fact that the Delhi traffic has been growing at a pace faster than even the growth in the Delhi Metro traffic.

Such criticisms are commonplace with infrastructure investments. They most often fail to produce tangible and immediate impact, and leaves all stakeholders unsatisfied. When the power deficit is a few gigawatts, the commissioning of a few hundred megawatts of power generation capacity has limited impact on the load-shedding situation. Similar situation arises with even major new water and sewerage treatment capacity expansion, since the requirements are massive. The problem is most acute with transportation, since traffic always appears to worsen. In the absence of any salient impact, municipal councils have no incentive to sanction scarce resources in such sectors.

Finally, the left-wing critics of economic liberalization in India point to the persisting high poverty rates and social deprivation and blame it on the neo-liberal policies of the past two decades. They argue that these policies have exacerbated social tensions, widened economic inequality, dismantled social and economic protections and therefore weakened the nation economically.

This too is a classic counterfactual problem. There are two issues here. One, serious commentators question the nature and extent of liberalization undertaken by successive governments, claiming that they have been too little and limited in scope and piecemeal and stop-start. In the absence of, leave alone the full breadth and scope, atleast even some reasonably acceptable level of liberalization, they argue, how can we blame liberalization for the current state of affairs?

Second, they argue that in the absence of this limited economic liberalization, the economy would have been in doldrums. They point to the undoubted macroeconomic gains of recent years as proof of this. How do we know what would have the state of affairs in the absence of the liberalization policies? See Ananth's excellent take on the critics of economic liberalization, including on other dimensions.

In all three cases - stimulus measures in the US, Metro railways in New Delhi, and economic liberalization in India - there is a classic cognitive bias at work, availability bias. People observe salient outcomes - the poor state of the economy, despite the stimulus spending; poor state of Delhi traffic, despite the Metro; and the persistent high poverty levels, despite economic liberalization - and conclude that these interventions failed to achieve the outcome. However, the reality clearly (albeit less so clearly in case of stimulus) points to all having had considerable effect in mitigating the respective problems, though the exact magnitude of their impacts is difficult to quantify.

Then there is another issue here. In all three cases, the opponents frame the debate by equating the particular intervention with the text-book case of the underlying concept. Accordingly, for example, they define the stimulus as was implemented in the US was the classic Keynesian stimulus, and therefore its apparent failure to get the economy out of the recession is conclusive evidence of the failing of the underlying Keynesian concept itself.

Similarly, critics' definition of the success of metro rail as measured by the resultant reduction in congestion rate, means that an actual increase in congestion is taken as proof of its failure. For neo-liberal critics, Manmohanomics is the embodiment of economic liberalization and since it did not "eliminate poverty", as promised, it has failed!