Sub-national jurisdictions as engines of development

From a very good op-ed in NYT about how well functioning cities (in this case Lagos) could show the way for failing states,

Nigeria, of all places, may be pointing the way to a strategy by which fragile states might begin to succeed: Devolve more power to cities from their corrupt and overcentralized national governments. At least in democracies, the cities have promise because their elected politicians face pressure to deliver specific services to their constituents. In the central governments, which are more remote, there is too much power and wealth to be grabbed by dysfunctional politicians and their cronies, and too little direct accountability...

The turnaround in Lagos can be traced to 1999, when Nigeria returned to democracy and the city began holding regular elections. For the first time since independence, Lagos was able to re-elect its own leaders, or turn them out of office. And while national elections became a mud fight between elites to control the state’s enormous oil wealth, local contests forced candidates to show pragmatism and competence. Citizens in densely populated cities find it easier to organize themselves. And in an ethnically and religiously diverse metropolis like Lagos, politicians could not afford to pit ethnic and religious groups against one another, a problem that has long bedeviled Nigeria. Simple geography also helped the city administration. The powerful and wealthy classes are more likely to insist on better governance when their own neighborhoods are affected.

And unlike national politicians, local leaders know that the better they perform, the more money their city nets. The better its roads, schools and business environment, the more likely companies will pay taxes, and individuals will buy goods and services, which also contribute to the tax base. At the national level, by contrast, the great majority of the central government’s income has little to do with government’s performance, since about 75 percent of the national budget comes from the $50 billion a year that Nigeria collects in oil revenue.

Whether Lagos is a model or not, the central point about encouraging cities as the locus of development is hard to disagree. For many strife-torn African countries, where the capacity of the central government is very weak, smaller sub-national governments are far more likely to be effective. Among sub-national governments, city governments are best positioned to push the boundaries on economic growth. Therefore, devolution of power to city governments should be top of the agenda in political reforms for these countries. In large countries like India too, the major source of dynamism is already from well governed states rather than the central government.

The challenge is to get national governments to devolve power to these local governments. Multi-lateral agencies and international diplomacy should spend as much capital pushing for such reforms as they do with democratization and the like. That will be good politics as well as sound economics.

Asset markets in 2013

Barry Ritholtz draws attention to this graphic from Economist.

Both charts are good manifestations of the changed economic order. The rapid growth of last ten years has been on the back of spectacular performance by the emerging markets, which in turn drove commodity prices to record levels. 

Notice the absence of any prominent emerging market in the list of equity market toppers. However, the performance of the first four countries - Argentina, Greece, Ireland, and Pakistan - is clearly at a remove from their economic fundamentals. Further, the strong performance of many developed economy equity markets, despite their persistent economic weakness, is more a reflection of the uncertainty facing the world economy coupled with the liquidity glut than their own economic fundamentals. The second graphic shows that commodities have been the worst performing asset class, along with emerging market equities.  

Is the market-registration price wedge a good second-best policy?

It is widely believed that the difference between market value and (government notified) registration rates (basic or guidance value) in India are a major contributor to the creation of black money and its amplification. Across the country, sales transactions are generally recorded at the registration rates, which are much lower than the actual transaction rates. A lower officially recorded transaction price helps buyers and sellers minimize their outflow on stamp duty and capital gains tax.  

But on the positive side, it is also believed that the wedge works to the advantage of mortgage lenders since it leaves them with an asset whose actual valuation is much higher than its declared collateral value. Given the impressive growth of mortgage market in the country, it will be interesting to explore the contribution of the price-wedge to the development of this market. 

In line with "second-best" models approach, it would appear that the price-wedge, despite all its distortions, may have had important unintended consequences. It may have provided property lenders the additional collateral cushion required to expand their lending activity. In other words, the premium may have incentivized financiers to readily lend against properties. It may also have served as a buffer against declines in property prices, thereby acting as a form of default-risk insurance, for the entire financial system.   

The "assault on Incentives" in Delhi

I have blogged earlier (here, here, and here) that the most retrograde and debilitating policies are those that dramatically distort incentives. These "assault on incentives" are more pernicious than common manifestations of governance failures like corruption, wasteful subsidies, and poor quality service delivery.

The policies on free water, power, and so on being implemented or under consideration in Delhi are good examples of "assault on incentives". Nobody needs any reminder about the political challenge with reforming free farm power and raising electricity tariffs. Given the resonance between such policies and the entrenched culture of political populism, it was only a matter of time before such things generated a cascade of demand from elsewhere for free and lower priced utility services. See this, this, and this.

Now, I am not against providing free water. Appropriately structured free supply can be both good politics and economic efficiency enhancing, especially in systems with intermittent supply. For example, in South Africa, Durban municipality initiated a program in 1998 to provide a basic minimum water supply, amounting to 40 lpcd (litres per capita per day) for a family of five (or 6 kilolitres per month per family). This was subsequently implemented in many other municipalities across the country.

But the Delhi experiment has atleast two important differences. One, instead of an assured universal minimum free of cost, consumers who use more than the free quota of 20 kl have to pay a (higher) full price (based on an increasing block tariff pricing model) for the entire consumption. Two, whereas the South African model assures a basic minimum supply free of cost, the Delhi model assures the global standard of supply free.

The former will certainly distort incentives by making 20 kl a high-stakes target, and there encourage manipulated clustering of consumption around that target. The later ensures that the scheme will benefit the non-poor much more than the poor. In fact, even though there are benchmarks of 140-170 lpcd, the median Indian city resident can rarely access this quantity of water.

While the aggregate supply (upstream treatment) may be high, the actual supply (downstream distribution) is far less, due to atleast three factors. One, the distribution loss by way of leakages etc is atleast 30-50% of the supply in most Indian cities, including Delhi. Two, the consumption pattern is heavily skewed towards the large consumers for a variety of factors. Three, the typical slum resident, who has supply for 1-2 hours, at very low pressures (a head of 3-5 m), can collect much less than half the aggregate supply. In the circumstances, the full benefit of the 700 litres free supply accrues only to the not-so-poor.

Personnel deployment and procurement reforms

My latest Governance Agenda column on reforming transfers of officials and public procurement, the two biggest contributors to governance failures, is available here. 

Re-negotiations and the "bid premium"

Aggressive bidding by developers has been one of the features of private participation in India's infrastructure projects in recent years. All but a few of these projects end up in re-negotiations. Such re-negotiations, which post-facto accounts the unhedged risks in the original bid, invariably lead to much favorable terms for the developer, most often at the cost of the tax payer or user. Further, the inherently non-transparent manner of re-negotiations, engenders a culture of crony capitalism that favors politically connected firms and vitiates the contract environment. Most worryingly, all this generates a moral hazard that erodes the sanctity of the tender process and makes developers bid aggressively safe in the assurance that they can change the rules of the game during the re-negotiations.

So how do we curb aggressive bids? How about a "bid premium" for each bid that would normalize each bid? This "bid premium", unique for each developer, could be calculated based on the  developer's prior history of re-negotiations. The difference between the original and re-negotiated bids is a measure of the mis-pricing of risks (a sector premium) and the degree of aggression in the bid (a bid premium).

The former can be adjusted by discounting for the same difference for all the projects that have been bid out in the sector. The excess difference, that remains after subtracting the sector premium, belongs to the firm and is a measure of the firm's aggressive bidding. Each project would have a bid premium. Some weighted average of the bid premiums of all projects undertaken by the same promoter in that sector can be used to calculate his project bid premium. This bid premium can then be added to his present bid so as to discount his current bid for any aggressive practice when evaluating the bids. 

Happy New Year!