More market failures in Munis

America's $2.7 trillion municipal bond market is infamously opaque and has witnessed several failures and defaults. But even by its standards, as Gillian Tett writes, the case of Poway Unified, one San Diego educational district, in issuing so called "capital appreciation" bonds, is scandalous,

Last year, it issued some $105m worth of "capital appreciation" bonds to finance previously planned investment projects. These are similar to zero-coupon bonds, meaning the district does not need to start repaying interest or capital until 2033.As a result, Poway’s local authority has been able to promise to keep local taxes unchanged while completing previously promised investments (building projects, computers and so on). But, there is a big catch: to compensate for this payment deferral, these bonds are paying double-digit interest rates and cannot be redeemed early. When the bond is repaid in 2051, the total bill will be more than 10 times the initial loan.

This is no exception among California's school districts. Other San Diego school authorities have indulged themselves similarly - Oceanside Unified (borrowed $30m but will need to repay $280m), Escondido Union (borrowed $27m, faces $247m repayments) and San Diego Unified (borrowed $164m, will repay $1.2bn). In fact, while California may be an extreme case, the situation is not thought to be much better elsewhere.

These are classic regulatory failures. None of these bonds are backed by any credible repayment revenue streams. The issuers gambled on capital appreciation to finance repayments. The credit rating agencies who rated these bonds failed to signal the glaring deficiencies in the bonds issue. Regulatory gatekeepers who were supposed to ensure that issuers adhere to certain basic principles of prudent financial management looked the other way.

It is yet another reminder to those who claim that financial markets regulate themselves that financial markets cannot function effectively without strong regulation.

India Labour Fact of the Day

At the Maruti factory, even staff workers earn less than $2 an hour; their counterparts in Japan take home nearly $40 an hour for the same work.

(HT: Latitude NYT)

The HLEG report examined

Livemint reports that the Planning Commission, drawing on the recommendations of the Prime Minister's High Level Experts Group (HLEG), is contemplating a radical overhaul of India health care system in its Twelfth Plan (2012-17). The Commission divides health interventions into two categories - public health issues such as immunizations, births and HIV testing to be financed and delivered by the government, and the delivery of clinical services through the managed network system of public and private providers. It quotes the Chairman of the Commission, Mr Montek Ahluwalia,

Universal healthcare is perhaps best delivered if we move away from the present system, in which public healthcare providers are funded by the budget, to operating a network of primary, secondary and tertiary providers, where the network is paid on a per-capita basis depending on the number of people registered with it. The network could consist of pure public sector providers, or it could include some private providers on suitable terms. This certainly incentivizes the network to minimize costs and to emphasize preventive care since the total payment is fixed... Whoever manages the network will have to divide the total receipts between levels. Remuneration to doctors may have to be linked to patients actually seen. People will not be able to go straight to higher levels of the network, but will have to go through on a referral basis.  

The report also quotes the HLEG chairman, Dr Srinath Reddy's summary of its recommendations,

The HLEG had suggested a package of essential health services, which includes preventive, promotive, curative and rehabilitative services. The provision of these services has to be free of cost, and public sector facilities should be the main provider... Where necessary, private providers may be contracted-in on clearly defined terms. This should be done directly by the public sector without recourse to an insurance intermediary. For universal healthcare to succeed, with respect to public health and clinical services, it is essential that the public healthcare delivery system is strengthened all the way from the sub-centre to the district hospital.

Taken together, these statements do not bode well for health care reforms. Interestingly, both stand at the two extremes of how health care should be delivered. Both have all the hallmarks of classically misguided policy suggestions masquerading as informed prescriptions.

1. I am not aware of the HLEG's mandate, but its two prescriptions - what constitutes universal health care and the details of its standards, and how it should be delivered - are two entirely different issues, requiring very different competencies. While the HLEG's constitution does make it eminently well placed to address the first issue, I am not sure about its competency to address the second.

2. The HLEG's elimination of the use of an insurance intermediary, even to deliver tertiary care services, is surprising. The report too does not contain any valid justification for such a sweeping advocacy, especially when insurers are an important actor in any universal health care system where the presence of private operators is significant.

3. Managing the proposed public-private healthcare providers network in a country like India, where private providers increasingly dominate the market in secondary and tertiary care, even in rural areas, is no mean task. In fact, very large and experienced insurers, even in developed markets, have not been able to successfully manage the incentive distortions that are inevitable in health care markets. All the talk of contracting private providers on "suitable terms" or "clearly defined terms" betrays an understanding of the complexity of managing such contracts.

For example, the just released Annual Health Survey reports of grossly excessive C-section deliveries in private hospitals. Compounding problems is the near complete absence of health care service delivery standards for private sector. In view of all this, to imagine that the government will be able to effectively manage the regulation of contracted service delivery in a vast and diverse country like India, even if segmented regionally, appears to be a stretch. In fact, it is an invitation to crony capitalism in health care.

In simple terms, Mr Ahluwalia equates health care delivery to any other market where services can be bought and sold efficiently if incentives are aligned. Dr Reddy effectively advocates throwing more money on public institutions in the hope that more beds, specialists, and equipments will deliver universal healthcare. Both misdiagnose the issue and their prescriptions are bound to fail. As I blogged earlier, the immediate need is to have somebody in India's health care policy making establishment to "kill off bad ideas".

Income mobility for its own sake is good?

Tyler Cowen's defence of the case against income mobility has some very interesting arguments. He writes,

For a given level of income, if some are moving up others are moving down. Do you take theories of wage rigidity seriously? If so, you might favor less relative mobility, other things remaining equal. More upward — and thus downward — relative mobility probably means less aggregate happiness, due to habit formation and frame of reference effects.

Paul Krugman takes umbrage at this and accuses Tyler of promoting a form of class society. However, from behavioural economics point og view, Tyler is right. Researchers have shown that people generally suffer from loss-aversion bias - they are more motivated by avoiding a loss than acquiring a similarly sized gain.

Analyzing income mobility from this framework, it therefore follows that there is a net decrease in happiness with any changes in income levels. Those losing their income status suffer from a much greater loss than those benefiting from similar gains in income status. The economist would therefore argue that any income distribution is a Pareto optimum and any change in this would involve lowering aggregate happiness.

Tyler's central point is that at any particular income level, "there was no gain per se from having a higher rate of mobility churn, if not accompanied by higher standards of living". He also argues that the best way to ensure upward mobility is "to have a high rate of economic growth and spread across many income classes". In fact, he writes that if the general standard of living is rising, mobility takes care of itself over time. I have two issues here

1. Given the prevailing extremes in income distribution, even assuming stagnant incomes, there is a compelling in favor of higher mobility churn by itself. In the circumstances, a decrease in incomes at the top of the ladder (due to say, increase in taxation) generates limited marginal discontent. The magnitude of the loss aversion bias at the highest income levels is small, whereas the happiness from similarly sized gains at the bottom of the ladder are much higher.

2. Recent trends are ample proof of the fact that if the general standard of living rises, income mobility does not automatically take care of itself. Over the past quarter century, though standard of living has improved dramatically, income increases have been captured by those at the top of the income ladder.

Alex Tabbarok's defense of Tyler is not convincing. He picks up an simplified illustration which takes away from the complexity of income mobility in modern societies.

To repeat, given the high level of concentration of wealth at the top of the income ladder, any income mobility by way of shifts in the distribution of income, even at the same standard of living, generates beneficial effects.

Private participation in municipal water sector

Marginal Revolution has an interesting post in response to this article which discusses the effectiveness of municipal water privatization in the US. The article writes,

Across the nation cash-strapped municipalities are considering the sale of their public-utility systems. These moves are intended to raise cash and rid the municipalities of expensive liabilities such as debt service and pension obligations. But officials considering this approach might do well to look to France and other nations that are rapidly moving in the opposite direction with a “remunicipalization” of their utility systems. In 2010, Paris, in the best known case of remunicipalization, ended contracts with the world’s two biggest water service companies, Suez and Veolia, bringing an end to their 100-year private duopoly. The reversal of a century-old practice in Paris was an acceleration of an international movement away from private control.

Tyler Cowen argues that water privatization may fail in well developed markets as the private contractors acquire skills to manipulate the political and regulatory process. Similarly, the absence of adequate purchasing power and the difficulty in collecting bills, makes privatization difficult to implement in very poor countries. However, he claims significant cost and quality benefits from water privatization in middle income countries, in terms of ease of mobilization of capital, expansion of water coverage, increase in quality of supply, and reduction in unaccounted for water.

I will disagree with Tyler on this. My argument is that instead of wholesale, end-to-end privatization, a more nuanced approach of privatizing specific services in the sector, depending on the specific local conditions, may be a more effective approach to encouraging private participation in the sector. Political considerations arising from the need to maintain distributional fairness in pricing and allocation is a major imepdiment to any privatization efforts. Further, the inherent difficulty of establishing baseline standards and monitoring quality of outcomes defined in a contract too makes private contracting difficult to manage successfully.

Services like billing, database management, and contracting employees are the simplest to outsource. Likewise, maintenance of upstream assets like treatment facilities too are amenable to private participation. Efficiency improvement services like supervisory control and data acquisition (SCADA) can be both installed and maintained by private agencies. However, maintenance of distribution network is difficult to regulate and monitor. At best, the maintenance of 24 hours supply distribution networks in certain distinct metering areas, where distributional concerns are not an issue, can be outsourced.

For more on these, see this, this, this, and this.

India's electricity mess

The massive power blackout in 20 states of North, East, and the Northeast of India, for several hours, affecting 670 million people should serve as a rude wake up call on arguably India's biggest infrastructure bottleneck - electricity generation and transmission.

Amidst all the search for explanations, it cannot be denied that the the immediate cause for the blackout is a simple and shocking grid management failure at multiple levels. The load management centers at the utility, state, and regional levels are supposed to monitor the grid drawls and the frequency of transmission. If the drawl exceeds the utility/state's allocation or if the transmission frequency falls below 49.5 Hz, the load managers at each level are supposed to activate circuit breakers and cut off certain outgoing feeders that provide load relief.

There is a system of cascading accountability. If the utility continues to overdraw, the state level managers are supposed to disconnect supply to certain incoming 132 KV feeders to the utility, thereby forcing load reliefs. Similarly, for the state as a whole, if its load managers fail to respond with required load reliefs, the load managers of the Power Grid Corporation of India are supposed to cut off the state's incoming 220KV or 400 KV feeders so as to offset the excess drawl. Instructions to provide load relief gets transmitted down to the utility and state, and if this fails to elicit the desired response, the feeders are forcibly tripped off.  

In simple terms, Blackout Tuesday was triggered off by simultaneous failures in monitoring at three levels. Given the commonplace nature of this monitoring and the widespread instances of forced load reliefs, it strains credulity that it was a case of simple monitoring failure. The NYT quoted a  previous regulator who captured this failure appropriately,

He attributed this week’s problems to the bureaucrats who control the system, saying that civil servants are beholden to elected state leaders who demand that more power be diverted to their regions — even if doing so threatens the stability of the national grid.

This failure should not be glossed over. The simple management failure should not be confused with the larger policy failings. Without getting into the reasons for overdrawls nor that for inadequate generation, those responsible for this failure should be held accountable in the interest of ensuring future grid discipline. The over-drawing states of UP, Rajasthan, Haryana, and Punjab should be suitably penalized so as to deter others from persistent overdrawls. India's wildly overstretched electricity sector - hobbled with problems in generation, transmission, and distribution - will collapse if basic grid discipline breaks down.

All talk about the need to have excess capacity of stand-by peaking power plants to meet such contingencies of excess drawls is largely superfluous. Leave alone adequate level of generation and transmission redundancies, we are some way off from even having adequate off-peak time capacity. In the circumstances, the least that can be done to prevent things worsening further is to do everything possible to maintain grid discipline.

More on the psychology of poverty

One of the most enduring and deeply controversial debates on poverty is about what causes poverty. Conservatives lay the blame for poverty on the poor themselves, specifically their apparent laziness. They point to the stereotyped image of poor people idling away, shirking work and indulging in self-destructive behaviour to validate their claim. However, this argument fails to resolve the causation-correlation problem - whether they are the cause or symptoms of poverty?

Bryan Kaplan writes,

If people are poor because they're behaving irresponsibly, they should be far down our queue of people to help - if they belong on the queue at all... I also happen to think that reducing the generosity of the welfare state and making assistance conditional on good behavior will (eventually) reduce bad behavior... the fact that poor people are often the authors of their own destitution is morally significant and sadly neglected.

I am not very convinced with this reasoning. In fact, I am inclined to agree with recent findings from behavioural sciences research that point to causal links running from poverty to bad behaviours. In particular, they highlight the self-control and commitment challenges imposed on people who are constantly exposed to an environment of scarcity in time and money. In fact, the "bone-headedly simple", "very very bad" choice trade-offs on "drinking" or "smoking" or "single-motherhood", are not as simple as it appears. Consider this parable that may resonate with many of us.

Mr Meritocrat is deeply satisfied man, completely at peace with himself, his world, and his work. He gets up in the morning, attends to his natural calls, drinks the hot coffee served by his servant, reads newspaper and browses the internet from the comfort of his air-conditioned room, switches on the morning television to do yoga, takes bath, has his breakfast, gets driven to office, and has his personal assistant arrange the daily schedule. He then dives deep into his hugely rewarding and enriching work, for which he pockets a fortune each month. And I could go on.
Now consider this counterfactual. He wakes up to find that there is no water in the toilet, no servant to boil tea, and no electricity to read newspaper or browse the internet or do yoga. Worse still, his cook has taken leave, forcing him to prepare his breakfast. After he gets ready, he finds that his vehicle has broken down and he needs to wait till a taxi is hired. Thanks to the delays, he arrives late for the morning meeting. There he finds that a critical functionary has taken leave for the day, rendering the meeting largely superfluous. The cascade of events leds to a build up stress that takes it toll on Mr Meritocrat, whose productivity declines precipitously for the day. The downsward spiral will take many forms and could go a long distance down.
Mr Meritocrats' travails, amplified many times over and in a qualitatively more depressing form, echoes with the plight of a poor slum resident of any Indian city. He wakes up every morning to a day of struggles. A daily routine characterized by a seemingly endless succession of such struggles, drains him/her emotionally and congnitively, and manifests in less than desirable behaviours.

This reasoning considerably complicates the search for explanations for poverty. In any country, even in tightly controlled command economies or despotic autocracies, merit and effort does get rewarded, though the extent varies. However, to draw the simplified linear inference that, therefore, all those not successful do not have the requisite merits is simply misleading. Those apparently "irrepsonsible lifestyles" on "bone-headedly simple" issues are therefore not necessarily a matter of choice.

A more nuanced search for explanations, one that accounts for the serious incentive and behavioural distortions caused by poverty itself, necessary for us to make any meaningful and sustainable dent in addressing the scourge of poverty.