Thomas Schelling insight of the day

From this obituary by Henry Farrel,

The U.S. stationed a small garrison in Berlin, which was embedded deep in East German territory, and indefensible against any serious attack. As Schelling described it, these soldiers’ job was not to defend the city but to die if it were attacked. This would then trigger a large scale U.S. response, since no U.S. president could tolerate the USSR killing American soldiers and not retaliate. Hence, by the logic of credible threats, the USSR would not attack Berlin, since it knew that the U.S. would have to punish it harshly, since it had effectively bound itself to deliver on the implied threat. Similarly, Schelling argued that the loss of thousands of American soldiers in the Korean War was a small price to pay if it preserved the U.S. reputation for resolve.

This explanation of Schelling's chessboard experiment, one of my favourite economic concepts, is brilliant.  A DIY version here. The exposition of such counter-intuition is a genius at work!

Why doesn't India have its Internet sensation?

Sample this about Tencent,

Tencent, a $225bn internet company whose social platforms have become a part of the very fabric of Chinese lives... It is, says one banker, “a social enterprise powerhouse”: under one roof, it has amassed China’s answer to Facebook, WhatsApp, Spotify, Kindle and ApplePay. Chi Tsang, internet analyst at HSBC, says Tencent has “the most killer apps in the world”. Weixin, along with the WeChat app outside China, has 846m active monthly subscribers.

Tencent also has a huge multibillion investment portfolio, ranging from stakes in Didi Chuxing, China’s biggest ride-sharing company, through to start-ups. It dabbles in artificial intelligence, electric cars and bike sharing. Its posse of champion hackers managed to gain remote control of Tesla’s Model S, forcing the US carmaker to roll out a security patch... The company employs 30,000 workers, more than half of whom are in research and development. While its home market is by far and away the largest, Tencent has an overseas presence in many sectors — its WeChat payments app can even be used at Caesars Palace in Las Vegas. “They are everywhere, the US, Europe — especially among Chinese speakers because if you want to contact business or family in China there is only one way to contact them, and that’s WeChat,” says Elinor Leung, a research analyst at CLSA...

And it has been more innovative, restrained, and principled, than their Silicon Valley peers,

"Tencent has a better corporate governance than Google or Facebook,” says Richard Windsor, founder of independent research company Radio Free Mobile, pointing to its spurning of the dual-class shareholding allowed in the US but banned in Hong Kong... Like Alibaba, Tencent “has gone well beyond copying [the west],” adds another banker. “They are inventing and reinventing what their businesses should be”. Tencent’s Moments feed on WeChat prefaced Facebook’s addition of Messenger and the $22bn acquisition of WhatsApp. Payments are another case in point. China’s online third-party smartphone payments market dwarfs that of the US: iResearch estimates it to be worth Rmb15.7tn in 2016 — 28 times the $62.5bn forecast by eMarketer for the US in 2017 — and Rmb28.5tn in 2018... 

Tencent favours a cautious approach to monetising its database of active monthly users. Rather than blitz Moments with ads and risk the sort of backlash dished out to Facebook, Tencent has restricted itself for now to a maximum of one ad per user each day. UBS estimates WeChat Moments’ ad load at about 1 per cent of non-advertising content, compared with 7-10 per cent for Facebook, leaving big scope for growth. In 2015, online advertising made up 17 per cent of revenues. China’s mobile ad market was worth Rmb90bn in 2015, according to iResearch, up 178 per cent year on year, and is forecast to grow at a compound annual rate of 54 per cent from 2015 to 2018. Yet monetising the subscribers — and its database — offers the real keys to the kingdom for China’s BAT contingent and their global peers.

The market valuation of Baidu, Alibaba, and Tencent (BAT) is more than a quarter of India's GDP. I just can't put my finger on why India struggles to produce even any local social enterprise (or any internet space) brands. And each one of its me-too e-commerce sites run the risk of being gobbled up their global competitors.

If I am to stick out my neck and make a prediction, then I will hazard one potential area where India can lead the global race and Indian companies emerge as global pioneers. The Unified Payments Interface (UPI) and the RuPay payment gateway has the potential to unlock India's internet champions. Specifically, if UPI moves ahead quickly to embrace third party payments (as it should), given the Aadhaar identify layer, it could disrupt the cards-based payments eco-system. And the identity layer opens up possibilities that go beyond that offered by online payment services like Paypal or Alipay. 

But this can happen only with a revision of the way India's government looks at catalysing markets. The Indian state has played an exceptional and far sighted role in developing public goods platforms like Aadhaar, RuPay gateway, and the UPI. It now needs to put in place a light-touch regulatory regime (with strong privacy and data security protocols) and step back to let the internet entrepreneurial eco-system play itself out with digital disruptions. Some of them, like Paytm, will surely make windfall gains, piggybacking on the public good platforms. 

But we need to have the political maturity and bureaucratic guidance to allow this market catalysis. And, given the relatively small middle-class, fragmented and largely informal market, entrepreneurs should have the vision and patience to build the platforms and play the long game. And, more importantly, they should eschew the temptation to play on things like regulatory arbitrage and crony capitalism, a characteristic feature of much of corporate governance in India.  

For a country that spares no effort to follow China, it is a great opportunity to emulate how the country created its own payment gateway, Union Pay, and let its internet champions emerge. 

IMF's prudent assessment of globalisation

IMF continues the post-crisis revisionism of some of the central tenets of economic orthodoxy in its latest edition of F&D magazine. 

Sebastian Mallaby makes the most prudent assessment of globalisation and free trade. He decomposes cross-border capital flows and shows that cross-border lending has declined dramatically since 2007. 

To some extent—indeed, probably to quite a large extent—the retreat from cross-border lending represents a healthy correction... there has been a reappraisal of the case for cross-border finance. For one thing, some of its theoretical advantages appear to be just that: theoretical. In principle, financial globalization allows savers in rich countries to reap high returns in fast-growing emerging market economies, thus easing the rich-country challenge of paying for retirement. Meanwhile, it supplies foreign capital to emerging market economies, allowing them to invest more and thereby catch up faster with the rich world. But in reality, many large emerging markets have grown by mobilizing domestic savings, exporting capital rather than importing it. The textbook case for financial globalization exists mostly in textbooks.

If the upside of financial globalization has been elusive in practice, the downsides have grown more obvious. First, global capital tends to rush into small open economies during good times, aggravating the risk of overinvestment and bubbles; it flees in bad times, exacerbating recession. That has led middle-income nations to experiment with capital controls. Second, cross-border banking involves large, complex, and hard-to-regulate lenders, which poses risks to society that became evident during the 2008 bust. Because of those risks, regulators in the rich world have discouraged banks from foreign adventures, which has added materially to deglobalization. Forbes, Reinhardt, and Wieladek (2016) show that, in the case of Britain, regulatory discouragement of foreign lending can be remarkably powerful, accounting for about 30 percent of the attrition in cross-border lending by U.K. banks during 2012–13.

Although there is no denying that finance is less international than it used to be, it is debatable whether this retrenchment is best described as “deglobalization,” with its connotations of retreat, or as something more positive—“sounder global management.” After all, the new regulatory restrictions are at least partly a response to the risks of cross-border financing, which suggests a desirable level of flows considerably lower than the 9.9 percent of global output during 2002–04. If the optimal ratio were, say, around 5 percent, today’s degree of financial globalization might be just about right.

He argues that the apparent slowdown in global trade since 2008 may be due to statistical illusion (lower dollar price of commodities like oil), shifts in supply chains (China makes more intermediate goods itself instead of importing them), increased consumption of services as against manufactures as economies develop, and shrinking current account balances. To that extent, he finds that the decrease may not be something to be alarmed about. 

Maurice Obstfeld makes a long delayed case for having policies that redistribute the gains from trade to cushion those adversely affected. However, the focus on safety nets seems to be confined to developed countries, whereas one would argue that developing countries need them more. He also makes the distinction between safety nets (which protect those subject to job loss) and trampoline (which offer a springboard to new jobs, through trainings etc), and favours the former. 

But Paul Krugman is disappointing in his assessment. Two examples. The first is a benign assessment of international trade till eighties,

And for a long time—from the 1940s into the 1980s—trade liberalization proceeded remarkably smoothly. The losers from growing trade didn’t seem that obvious or numerous, largely because much of that growth took the form of intra-industry flows between similar countries, which had minimal effects on distribution.

I think the fundamental reason why there is a backlash against trade liberalization now is because the shoe (in terms of being at the receiving end of terms of trade) is on the feet of the developed economies. When unfettered free trade was critiqued in the eighties and nineties by those in developing countries as being detrimental to their economies and societies, the very same people used to mock the critics as marxists and socialists!

On the more prudent response to anti-globalisation sentiments, he writes,

The best attitude might well be to treat globalization as a more or less finished project, and turn down the volume on the whole subject.

Really! What about the third wave of globalisation, in terms of migration? 

Weekend reading links

1. Who is the best-selling music artist of the year?

Wolfgang Amadeus Mozart beat Drake, Beyoncé and Adele to become the year’s biggest-selling artist, according to Billboard, shifting 1.25m CDs in five weeks.T

This, thanks to Universal’s recent 200-CD compendium Mozart 225, released to mark the anniversary of his death at 35 in December 1791. 

2. Who is the most successful business leader of our times? In the real world, the choice would be a struggle between the likes of Lee Iaccoca, Jack Welch, Bill Gates, Steve Jobs, Jaime Dimon, and Mark Zuckerberg. In an ideal world, the choice is simpler. Arguably, Amancio Ortega, the founder of Inditex, the owner of Zara, and with a personal worth of nearly $80 bn! 

He defies all the conventional moulds of successful business leaders and went against the grain of outsourcing and off-shoring, and Inditex has been the standout performer among its competitors for many years now. I had blogged earlier about the firm's strategy of iterative adaptation. Surprising that management gurus who swoon over Jack Welch's ruthlessness or Steve Jobs' disruptiveness gloss over the profound wisdom of iterative adaptation. 

3. Talking about management theories, Economist does a brilliant take down. It shows that the four basic ideas that underpin management theories - business is more competitive than ever, we live in an age of entrepreneurialism, business is getting faster, and globalisation is both inevitable and irreversible - stand on clay foundations.

4. The recapture of Aleppo from rebel hands after four years of very violent fighting should count as a seminal moment in global geo-politics. Even as the US was busy grappling with Donald Trump, Russia, Iran, and Turkey have proceeded to carve out a historic diplomatic achievement, and entrenched themselves as important arbiters in the region for the foreseeable future. It may be the beginning of a truly multi-polar global order. 

It is estimated that the five year civil war has displaced more than half the country's 21 million population, nearly 5 million as refugees, and left over 450,000 dead. 

It is all too easy and tempting to denounce President Obama for not intervening decisively to bomb Bashar Al-Assad's forces even when they crossed the red-line and deployed chemical weapons against the rebel held areas. If the US had intervened more forcefully, it would only have played into the ISIS hands, strengthening them and hastening their progress. Apart from mutilating Syria and Iraq, it would also have left President Obama with no choice but to embrace the politically suicidal option of having boots on the ground to prevent an even more toxic brand of barbarism. 

When all possibilities are equally bad, it is not a bad idea to stand aside. It may be slightly easier, when, on relative barbarism at least, Assad comes out better, if only slightly. The brilliant Robert Fisk has this excellent article that highlights the duplicity associated with the mis-concieved angst at the recapture of Aleppo.

5. India's export engine is in reverse gear. Ajay Shah points to this,

From Q4/2013 onwards, the compound average growth rate of exports (of non-finance non-oil listed companies) has been minus 17.5% per year.

The FTP with the target of doubling trade to $900 by 2019, clearly unrealistic ab-initio, is in shambles. 

The new PISA report

The Economist has a summary of the sixth round of PISA rankings of 15 year olds from 2015 here. Singapore tops in all the three subjects - Math, Reading, and Science - and Qatar, Argentina, and Israel have seen the biggest rise since 2006.

Interestingly, beyond a certain level, possibly necessary to assure minimum facilities, additional spending does not lead to any increase in outcomes. To this extent, Russia, Poland, and Estonia have the most efficient school systems. 

Finally, at a time when non-profits like Pratham are promoting Teaching at Right Level (TaRL) by grouping children by ability within schools, PISA results, atleast in Science, appear to indicate that this is associated with decrease in scores. Granted the different dynamics associated with such grouping in better school systems compared to the very poor ones, it is still worth keeping in mind while we pursue TaRL. Interestingly, in contrast, the use of adaptive instruction is associated with a significant increase in learning outcomes, equivalent to an additional one-third of a year of instruction. 

The results find that while public school children fare worse than private school kids in science, this difference disappears once their economic and social backgrounds are accounted for. 

And for countries like India which are intensely promoting vocational education, a note of caution comes from the finding that it is associated with a widening of the gap between the learning outcomes of rich and poorer children. Another note of caution should be on the efforts to restore the practice of detentions - school systems that follow such policy are associated with a decrease in score by 50, equivalent to more than one-and-half years of schooling.

This year, the PISA authorities have generated a model that explains 85% of the variations in scores across countries. The Times has this summary of the model,

Generally speaking, the smartest countries tend to be those that have acted to make teaching more prestigious and selective; directed more resources to their neediest children; enrolled most children in high-quality preschools; helped schools establish cultures of constant improvement; and applied rigorous, consistent standards across all classrooms.

Book Review and Extract on state capacity

Karthik has a review of our book here in his excellent blog. And I agree with most of his observations and critiques. 

Swarajya has an extract from our book on policy prescriptions to improve state capacity. This is a pet theme for me and I am convinced that it significantly diminishes the effectiveness of every other reform. Governance or reform in a weak state setting is almost like running a sprint while carrying a very heavy backpack. Heck, even Swachh Bharat requires state capacity!

The crisis in healthcare quality

The mirror to the learning outcomes deficiency in India is the medical treatment quality crisis. In a just released paper highlighted in Marginal Revolution, Jishnu Das and Co draws attention in an empirically rigorous manner on something which is not very salient in mainstream debates,

We sent standardized (fake) patients to rural primary care providers in the Indian state of Madhya Pradesh, and recorded the quality of care provided and prices charged in each interaction. We report three main findings. First, most private providers lacked formal medical training, but they spent more time with patients and completed more essential checklist items than public providers and were equally likely to provide a correct treatment. Second, we compare the performance of qualified public doctors across their public and private practices and find that the same doctors exerted higher effort and were more likely to provide a correct treatment in their private practices. Third, in the private sector, we find that prices charged are positively correlated with provider effort and correct treatment, but also with unnecessary treatments. In the public sector, we find no correlation between provider salaries and any measure of quality. We develop a simple theoretical framework to interpret our results and show that in settings with low levels of effort in the public sector, the benefits of higher diagnostic effort in the private sector may outweigh the costs of market incentives to over treat. These differences in provider effort may partly explain the dominant market share of fee-charging private providers even in the presence of a system of free public healthcare.

They write,

Private providers spent 1.5 minutes more with patients (62 percent more) and completed 7.4 percentage point more items on a checklist of essential history and examination items (47 percent more) than public providers. They were equally likely to pronounce a correct diagnosis (only 4 percent of public providers do so), to offer a correct treatment (27 percent of public providers do so), and to offer clinically unnecessary treatments (provided by 70 percent of public providers)... The rate of correct treatment is 42 percent higher (16 percentage points on a base of 37 percent), the rate of providing a clinically non-indicated palliative treatment is 20 percent lower (12.7 percentage points on a base of 64 percent), and the rate of antibiotic provision is 28 percent lower (13.9 percentage points on a base of 49 percent) in the private practice relative to the public practice of the same doctor.

As can be seen, reflecting the higher quality of public sector doctors, they perform the best with checklist completion. But I am not sure whether I agree with the tone (and possible headline takeaways) from this,

Under the status quo, considerable attention has been focused on improving access and spending for publicly-provided healthcare. Our results suggest that enthusiasm for the public sector as the primary source of primary care services in resource poor settings has to be tempered by the extent to which administrative accountability is enforced in the system and that poor incentives for effort may be a binding constraint to quality in the public system of healthcare delivery.

It would be a shame if instead of spotlighting attention on the very poor quality of primary medical care, the main lesson drawn from this paper is that private production is the way forward, as Alex Tabbarok's suggestion is likely to be interpreted. This is all the more significant given that the policy takeaway from the context of the paper concerns primary health care and not general medical care. This "bottom line" from Tabbarok is not encouraging,

The bottom line is that the private market for health care is much bigger and less expensive than the public health regime in rural India and once we control for knowledge it’s of higher quality. These results have important implications for reform. In particular, much more effort should go into improving the knowledge of the private sector.

You cannot draw a simple public policy take away that the superior outcomes associated with private provision and their ubiquitousness implies relying on markets to deliver primary care. If we do so then we are merely revisiting the long settled debate on who should deliver primary health care. As the very rich historical experience of every major country shows, an affordable and sustainable primary health care can be delivered only through a strong public system, though private providers can be important complements.

The challenge with improving the effectiveness of primary care in India requires work in two directions. Strengthen a very weak public system with resources and appropriate incentives, and mainstream and leverage the services of a huge, mostly unqualified, and completely unregulated private market.