Weekend reading links

1. Amidst all the negative news that surrounds Europe, we overlook the real successes. Spain's recovery from the binge growth of the last decade is outstanding. Even more impressive has been its resolve to push ahead with reforms to labour market, banking systems, and corporate bankruptcies. The wage restraint and flexibility given to companies under the 2012 labor market reforms have ensured that the country's unit labour costs have fallen by 14 per cent since 2010, thereby enhancing the country's external competitiveness.

But the chronicle of the  construction boom that built up the excesses is worth remembering,

That boom coincided with the arrival of millions of migrants from Latin America, eastern Europe and north Africa, fuelling demand for homes that eventually reached fantastical proportions. In 2007, Spain accounted for more housing starts than Germany, France, Britain and Italy combined and 2.7m Spanish workers were active in the construction sector — equivalent to 13 per cent of the national workforce.

In Valencia, the boom was even more pronounced, helped by two factors that had nothing to do with central bankers in Frankfurt. One was the decision by the regional and local government to sink billions of euros into one-off events and pharaonic architectural designs. The other was the proximity between political leaders and the cajas, or regional savings banks, under their control. Poorly run and poorly supervised, the cajas provided the rocket fuel for Spain’s housing boom, dutifully funding one unviable project after another... Local politicians had little incentive to urge restraint, if only because so many of them stood to benefit personally from the boom... But the combination of mismanagement, hubris and greed, coupled with a banking system that lent according to political not financial criteria, proved disastrous. As the bubble continued to inflate, it touched on the lives of more and more people: teenagers left school without any qualifications to work on building sites. Orange farmers pulled up their groves to build apartment blocks. Owners of family companies abandoned them to sell real estate. A region that once prided itself on its manufacturing industry succumbed to the dream of dinero fácil or easy money.

Construction booms, especially those fed by real estate prices, should count as the most pernicious forms of resource misallocation. This story plays itself out with surprisingly high frequency, including in developing countries.

And its banking sector clean up was instructive,

“Spain did a textbook bank rescue,” says Angel Ubide, a managing director at Goldman Sachs and until recently a senior fellow at the Peterson Institute for International Economics. “It shut down the banks that couldn’t survive and recapitalised the ones that could. And then it moved all the bad assets into a bad bank.” The overhaul killed off the cajas, which were either folded into larger private banks or forced to become normal lenders, free from political influence. But it also meant that markets regained trust in the broader banking system relatively quickly. Balance sheets were cleaned up, bad loan ratios fell and loan loss provisions started to decline.

Unlike the misallocation problem, I don't think the banking sector clean up is relevant to India.

2. Martin Wolf explains the massive deleveraging and rebalancing challenge facing China.

Annual gross savings in the Chinese economy amount to 75 per cent of the sum of US and EU savings, at over $5tn last year. China’s gross investment, at 43 per cent of gross domestic product in 2015, was still above its share in 2008, even though the economy’s rate of growth had fallen by at least a third. To sustain such high investment, the ratio of credit to GDP soared from 141 per cent of GDP at the end of 2008 to 260 per cent at the end of last year... China saves more than it can profitably invest at home. In 2015, gross national savings were 48 per cent of GDP. World Bank data show that households contributed only a half of this. The rest came from corporate profits and government savings. International comparisons suggest that economic growth of 6 per cent warrants investment of little more than a third of GDP. This indicates that China’s surplus savings — surplus, that is, to domestic requirements — may be as much as 15 per cent of GDP.

3. India has one of the highest trade tariff barriers among all major economies,

4. On Uber's driver acquisition strategy,

UberEats launched in London in June, promising “the food you want, from the London restaurants you love, delivered at Uber speed”. In a bid to recruit self-employed couriers to ferry food from restaurants to customers, UberEats initially offered to pay £20 an hour. But as customer demand increased, the company began to reduce pay. By August, the couriers were on a piece rate with a fiddly formula: £3.30 a delivery plus £1 a mile, minus a 25 per cent “Uber service fee”, plus a £5 “trip reward”. Then, one day, the couriers woke up to find the app had been updated again. The “trip reward” had been cut to £4 for weekday lunch and weekend dinner times, and to £3 for weekday dinner and weekend lunch times. Outside those periods, it had been cut altogether.

Not only does e-commerce firms benefit from regulatory arbitrage, they also have the flexibility of changing the rules of the game at their choice.

5. Fascinating graphic in the Times that captures the scale and speed of urbanisation in China's Pearl River Delta. Guangzhou, Shenzhen, and Dongguan have become bustling economic centres in Guangdong province over the last 35 years from being small backwater townships. The rapid growth has encroached into the wetlands, reclaimed water courses, and destroyed mangrove forests, making the region vulnerable to recurrent floods and sea water ingress. So much so that Guangzhou has been classified as the city most under risk from climate change.

6. Incidentally Economist has a feature on the Pearl River Delta (PRD), comprising nine cities of Guangdong province and Hong Kong and Macau. Its significance,

The World Bank recently declared the PRD the world’s biggest megacity, surpassing Tokyo. With over 66m residents, it is more populous than Italy or, just, Britain... Its GDP, at more than $1.2trn, is bigger than that of Indonesia, which has four times as many people. It has been growing at an average of 12% a year for the past decade. As a global trading power the region is outranked only by America and Germany. For China itself, the PRD is crucial. Though it accounts for less than 1% of the country’s territory and 5% of its population, it generates more than a tenth of its GDP and a quarter of its exports. It soaks up a fifth of China’s total foreign direct investment and has attracted over a trillion dollars-worth of FDI since 1980... Most remarkably, a region once known for copycat products is emerging as a world-class cluster for innovation. 

7. City Lab has this nice video of how existing road patterns can be rationalised to squeeze in bike lanes and parking, without reducing vehicle volumes and carrying capacity and while increasing safety. 

Not sure of its relevance to developing countries like India where lane driving comes at a premium and bike usage unlikely to take-off for practical reasons. 

8. The latest version of inequality analysis by Piketty-Saez-Zucman is out. 

For the 117 million US adults in the bottom half of the income distribution, growth has been non-existent for a generation, while at the top of the ladder it has been extraordinarily strong... From 1980 to 2014, for example, none of the growth in per-adult national income went to the bottom 50%, while 32% went to the middle class (defined as adults between the median and the 90th percentile), 68% to the top 10%, and 36% to the top 1%...

Because the pre-tax incomes of the bottom 50% stagnated while average national income per adult grew, the share of national income earned by the bottom 50% collapsed from 20% in 1980 to 12.5% in 2014. Over the same period, the share of incomes going to the top 1% surged from 10.7% in 1980 to 20.2% in 2014... these two income groups basically switched their income shares, with about 8 points of national income transferred from the bottom 50% to the top 1%. The gains made by the 1% would be large enough to fully compensate for the loss of the bottom 50%, a group 50 times larger. To understand how unequal the US is today, consider the following fact. In 1980, adults in the top 1% earned on average 27 times more than bottom 50% of adults. Today they earn 81 times more.

9. A new paper points to the sustained and much faster economic expansion since the dawn of the 20th century to "less shrinking in recessions",

Stephen Broadberry of Oxford University and John Wallis of the University of Maryland have taken data for 18 countries in Europe and the New World, some from as far back as the 13th century. To their surprise, they found that growth during years of economic expansion has fallen in the recent era—from 3.88% between 1820 and 1870 to 3.06% since 1950—even though average growth across all years in those two periods increased from 1.4% to 2.55%. Instead, shorter and shallower slumps led to rising long-term growth. Output fell in a third of years between 1820 and 1870 but in only 12% of those since 1950. The rate of decline per recession year has fallen too, from 3% to 1.2%.

10. Finally, the best read comes from a fantastic article in the Economist about how parking norms influence the urban form and growth 

In 2004 London abolished minimum parking requirements. Research by Zhan Guo of New York University shows that the amount of parking in new residential blocks promptly plunged, from an average of 1.1 spaces per flat to 0.6 spaces. The parking minimum had boosted supply far beyond what the market demanded.

The cost of parking mandates invariably gets passed on across the economy,

Donald Shoup, an authority on parking economics, estimates that creating the minimum number of spaces adds 67% to the cost of a new shopping centre in Los Angeles if the car park is above ground and 93% if it is underground. Parking requirements can also make redevelopment impossible. Converting an old office building into flats generally means providing the parking spaces required for a new block of flats, which is likely to be difficult. The biggest cost of parking minimums may be the economic activity they prevent.

Free parking is not, of course, really free. The costs of building the car parks, as well as cleaning, lighting, repairing and securing them, are passed on to the people who use the buildings to which they are attached. Restaurant meals and cinema tickets are more pricey; flats are more expensive; office workers are presumably paid less. Everybody pays, whether or not they drive. And that has an unfortunate distributional effect, because young people drive a little less than the middle-aged and the poor drive less than the rich. In America, 17% of blacks and 12% of Hispanics who lived in big cities usually took public transport to work in 2013, whereas 7% of whites did. Free parking represents a subsidy for older people that is paid disproportionately by the young and a subsidy for the wealthy that is paid by the poor.

Natural gas market update

Excellent article that summarizes the global gas market which is likely to see a production glut and low prices for the foreseeable future, especially so with Qatar's decision to lift the production moratorium on the world's biggest natural gas field, the North Field. 

Four countries are vying to be the world’s biggest exporter: Qatar, the current leader, with 78 million tons per year capacity (10.3 billion cubic feet of gas per day), is likely to be overtaken by Australia this year. The U.S., awash with cheap shale gas, is building five projects totaling 74 million tons per year, and expansions could boost this further. On Thursday, Russian President Vladimir Putin said his country would become the top exporter, though that seems a distant aspiration... New supplies are also set to come from big fields off Mozambique and Tanzania. Gas is easy to find around the world; the tough part is getting it to market at a competitive price.

All these aspirants now realize the giant of the LNG world is back in the game. With its prolific reservoir, existing infrastructure and large scale, new Qatari LNG should again be the world’s cheapest to produce. Developing more at home will be lower-cost and less risky than searching for gas in Morocco and Cyprus, which QP recently entered. Qatargas may even be able to inexpensively de-bottleneck existing "trains" (LNG-producing units), rather than having to construct new ones at a cost of some $14 billion. So, this move is partly about deterring new LNG projects, with the threat of new ultra-competitive Qatari gas arriving around 2022, just when many observers expect the market to be tightening again.

A few lessons for India

1. All this coupled with the construction of terminals on US Gulf Coast means that fragmentation and index pricing in global gas market is soon likely to be a thing of the past. India's gas companies should therefore be cautious about long-term external contracts with index pricing

2. In an environment of low gas prices, the Government of India would do well to forget chasing foreign companies for gas exploration in/off India.

3. Instead, this is an opportunity to lock-in long-term purchase contracts, especially leveraging the LNG infrastructure of Qatar that is likely to come on line.

4. More of the existing model for producing fertilisers - cheaper to produce fertiliser in Qatar and bring them here rather than bring gas here and then produce fertilisers here.

5. I am not sure about this, but the economics of some of our RLNG terminals/FSRUs under construction will come under strain if gas stays low for too long.

Putting poverty in perspective

Manas Chakravarthy has this to say about India's wealth inequality problem,

The average value of assets held by a household in decile 10 in urban India, or the richest 10%, is Rs1.5 crore. That is 50,034 times the average value of assets held by an urban household in the lowest decile. It’s 18.7 times the average value of assets held by a household in the 6th decile. And it’s 4.1 times the average value of assets held by a household in the ninth decile, one rung lower than the top 10%... If we count the assets of the poor, we find the poor do not count... The household in the poorest decile — decile 1—will then have Rs291, the one in decile 2 assets worth Rs9,565 and so on. The richest household will then have assets worth Rs1.5 crore. But if we add up the total value of assets held by all the rest, that is the other nine households, that amounts to Rs82,90,418. In other words, the richest household’s assets are worth much more than that of all the others combined. 

To put this in perspective, with Rs 35,13,327, the average wealth of those in the 9th decile, it would not be possible to buy a two bed room house in any large city! Forget house, a family in the sixth decile would just be able to afford a decent car, and that too only if they mobilise all their assets!

This tallies with the findings of every survey, public and private. Poverty is far deeper and pervasive than we all believe. And the vast majority of those we consider above the notional poverty line are not much better off than their below poverty line counterparts. They are maybe one shock away from slipping back to poverty. 

It is for this reason that I am not a big fan of the current outsized focus on screening subsidy leakages. Yes, pilferage should be arrested. But inclusion errors are not exactly as bad as we think. And we haven't even got to this, this and this. 

Is this the worst of kritarchy?

If you thought that only politicians indulged in farm loan waivers, wait. The Hindu reports,

The Madras High Court... while allowing a petition by the National South Indian River Interlinking Agriculturists' Association... directed the Tamil Nadu government to waive loans of all drought-hit farmers and restrained cooperative societies and banks from recovering their dues. It noted that the state’s financial situation was grim and it was single handedly shouldering the debt burden in a drought year in which farmers were committing suicide and suggested that the Centre come forward to extend financial help to Tamil Nadu during this difficult situation... It directed the cooperation, food and consumer protection department and registrar of cooperative societies to extend the crop loan waiver scheme under two Government Orders of 2016, to all farmers, including those whose landholding was more than five acres.

I just can't see even one reason for a judicial intervention on this. It clearly is an exercise of a political judgement by a judicial institution. Such judgements seriously call into question the competence and intentions of those administering them. 

It puts both the state and central governments in a great fix. Neither can the state government appeal against the order nor can the central government refuse at least some assistance without risking being dubbed anti-farmer. 

And unlike farm waivers which are now baked into electoral cycles, the Court has set a precedent by wading into loan waivers during droughts. Even if the Supreme Court overturns this, the damage has been done. The Chief Justice of India needs to save the country's judicial system from his own irresponsible and trigger happy brethren!

Postscript

It gets even worse! A friend sends me links to the campaign launched by the Madurai Bench of the High Court to remove prosopis juliflora from all public and private lands in the state. Principal District Judges were directed to inspect the lands and report the progress of removal to the Court. 

It was apparently for the public good. These trees absorb all the moisture in the atmosphere and prevents rains. It also causes several other harmful things. The Court even started a parallel executive administration of advocate commissioners to implement the order, directed the legislature to pass law,  and finally has set up an independent treasury to fund the project.

The problem with urbanisation in developing countries

Excellent new paper by Edward Glaeser and Wentao Xiong that summarizes the case for urbanisation for developing countries. 

The authors examine the reasons for the wide income and productivity differentials observed between cities and rural areas, as well as within industries in the same city. They examine whether the income gaps are due to productivity differentials or due to other factors like labour regulations, high housing costs and disamenities in cities, or unobserved worker human capital. Their findings are summarised here. This post though critically looks at the deeper forces driving urbanisation. 

The story about beneficial agglomeration effects goes like this. Firms and workers prefer to concentrate geographically. For firms, the economies of scale and network effects increases the likelihoods of access to suppliers, service providers, partnerships, skilled workers, distribution and marketing, and consumers. For workers, the same effects increase the likelihood of more opportunities, ideas sharing, partnerships, social amenities, similar friendship networks and so on. These locations then become attractive entry points for external technologies and ideas. Finally, there is the positive feedback loop associated with such locational equilibriums - the Mathew effect of agglomeration. 

But are these agglomeration effects real? Or they are because of the confounding effects of unobservable migrant and firm characteristics - the more skilled and enterprising workers and the more dynamic and productive firms (and industries) self-select themselves and locate in cities? Or is the concentration driven by the spatial attributes of the geography - ports, geographic proximities, special zones etc? This is a big research challenge. And it would be a very high value endeavour. 

If it is the latter two, then the agglomeration benefits may only be secondary and the real benefits accrue from having higher quality self-selected workers and firms moving into cities or specific locational advantages of the area. In that case, we may actually be ending up with something more closer to a zero-sum game, or one where the more skilled or competent vote with their feet to certain geographies (urban areas here). This potentially leaves the remaining areas, especially villages, less likely to be able to benefit from exactly the same set of dynamics (enterprising workers and productive firms) that drive the growth of the cities.

The most extreme and disturbing form of this dynamic is the one happening within cities, in the form of gentrification. See this, this, and this. If the current trends play themselves out, it is not unlikely that in the general equilibrium, the city cores will become affordable only for those above the upper middle-class. We would then have massive doughnut sprawls, with deficient infrastructure and poor quality of living even within the urban agglomeration. And, as is happening, if political power gets captured by the rich and (therefore) those who reside in the core, these trends will be accentuated and then urbanisation itself start hitting its limits.

It is for this reason that I am increasingly inclined to the view that housing and transportation are going to be the two most important determinants of the future of urbanisation, and, therefore, national economic growth itself. A time may have come to view gentrification (as we perceive it, a blighted area becoming upmarket) as a negative externality. We may no longer be able to afford leaving this to the dynamics of markets. Public policy may have to play an increasingly important role in moderating the gentrification effects, even with the risk of potential excesses.

How to promote entrepreneurship?

One of the buzzwords in international development is entrepreneurship promotion. Governments in countries like India have hitched their growth wagons behind the energy and spirit of entrepreneurship. 

Public policies have been formulated to support entrepreneurs. Entrepreneurship training programs abound. Start-up incubators and accelerators are being established by governments across cities with policies to encourage their establishment. And the major driver of improving the ease of doing business may be unlocking of entrepreneurial energies. 

But what is the evidence that such policies promote entrepreneurship? Edward Glaeser and Wengtao Xiong's excellent summary on urbanisation and agglomeration in developing countries has this to say regarding public policy on entrepreneurship,

The public role in generating entrepreneurship is less clear. It seems quite reasonable to believe that local regulations can stymie entrepreneurship, although there has been little research using U.S. data documenting such a relationship. While local governments do occasionally try to increase entrepreneurship by supporting specific “innovation clusters,” we know little about whether such clusters are really effective or whether other local policies, like entrepreneurship training programs, will bear fruit....

The U.S. literature does indicate that local entrepreneurship has been important for local economic growth. There is not yet any comparable literature for developing-world cities, and there is little hard evidence – in either the U.S. or elsewhere – on how public policy can potentially encourage local entrepreneurship. There are at least three public policy strategies aimed at increasing local entrepreneurship: training, clusters and deregulation. Business schools have tried to train entrepreneurs for decades, yet there is little rigorous evidence that such training works. There are cheaper programs that try to provide disadvantaged youths, such as “The Possible Project” in Cambridge, Massachusetts, but they have not yet been evaluated with randomized control trials. It consequently remains an open question whether cities can actually teach entrepreneurship.

A second approach focuses on the generation of entrepreneurial clusters, which presumably allow entrepreneurs to learn from each other. Boston’s Innovation District is one such public initiative. Private initiatives, such as co-working spaces for small start-ups, also provide scope for sharing entrepreneurial knowledge. In a sense, markets filled with small, individual merchants in the developing world, either with or without explicit public support, represent yet a third form of entrepreneurial cluster. Again, we have little firm empirical evidence on whether the formation of such clusters materially increases the overall level of entrepreneurship within a city.

A third approach starts with the view that at least some entrepreneurs are deterred by various regulations. Many U.S. cities, for example, forbid food trucks to provide meals on city streets, which appears to deter at least one form of urban entrepreneurship. In the developing world, really small-scale entrepreneurs typically ignore labor- and product-market regulations, so deregulation seems unlikely to increase the number of really tiny firms. However, it seems more likely that these regulations prevent the growth of such firms, especially when they reach the point to employ non-family members. Such regulations may explain the dominance of small firms in the firm-size distribution in the many developing countries. Small firms can’t grow into larger firms because they would then have to follow the rules.

In India's case, the concern should not be about whether the country needs more entrepreneurs or not, but that it may be having too many. So the concern should be about promoting the right kind of entrepreneurs. An even bigger challenge!   

Amazon fact of the day

The Economist has some staggering numbers about Amazon, 

Since the beginning of 2015 its share price has jumped by 173%, seven times quicker than in the two previous years (and 12 times faster than the S&P 500 index). With a market capitalisation of some $400bn, it is the fifth-most-valuable firm in the world. Never before has a company been worth so much for so long while making so little money: 92% of its value is due to profits expected after 2020. That is because investors anticipate both an extraordinary rise in revenue, from sales of $136bn last year to half a trillion over the next decade, and a jump in profits. The hopes invested in it imply that it will probably become more profitable than any other firm in America. Ground for scepticism does not come much more fertile than this: Amazon will have to grow faster than almost any big company in modern history to justify its valuation.

To meet this valuation, Amazon's task is extraordinary and unprecedented, 

Morgan Stanley, a bank, expects Amazon’s sales to rise by a compound average of 16% each year from 2016 through to 2025: that is higher than its estimates for Google or Facebook. That is a slower pace than Amazon managed over the past decade; but the bigger a company is, the harder it is to keep growing. Amazon’s annual sales of $136bn are almost 50% more than those of Alphabet, Google’s parent, and over four times Facebook’s. Credit Suisse, another bank, calculates that only ten firms with sales of more than $50bn have managed to grow by an average of 15% or more for ten years straight since 1950; no company with sales of more than $100bn has done so. If Amazon were to pull it off, it would be the most aggressive expansion of a giant company in the history of modern business.