The challenge facing the Gulf oil economies

If ever there was an example of digging one's grave, Saudi Arabia's decision to open wide its oil taps could count as one. The stream of actions over the last few years - intensification of engagement in Yemen, upping the ante with Iran, blockade of Qatar, murder of Jamal Kashoggi, recurrent internal crackdowns including within the royal family itself, vanity projects like NEOM and ill-thought out economic diversification attempts, and now this even as the world grapples a coronavirus - cannot but not raise questions about the maturity of leadership in the most important Arab country. 

David Fickling points to the challenge faced by the Gulf economies from the low oil prices. On a purely commercial terms, the cost of recovery of Gulf oil, especially Saudi, is so low as to support very low oil prices. 

No one can produce oil as cheaply as Saudi Arabia: It takes just $2.80 to get a barrel out of an existing Saudi Arabian Oil Co. field, compared with about $16 for Exxon Mobil Corp. and more than $20 for Rosneft PJSC.

But that calculation does not take into account the fact that oil surpluses finance their budgets too, and it requires high oil prices. This graphic captures the overall breakeven cost for different countries.

Sample this about the likely impact on the large horde of financial resources accumulated by them,

Take the net financial assets held by Saudi Arabia’s government — central bank reserves, plus sovereign wealth fund assets, minus government debt. These declined to just 0.1% of gross domestic product from 50% over the four years through 2018 as crude plunged from levels of around $100 a barrel at the end of 2014. The kingdom is now likely to be a net debtor for the foreseeable future, even if prices rise back above $80. Over the same four years, net financial assets held by the six Gulf monarchies fell by around half a trillion dollars, to around $2 trillion, according to a study last month by the International Monetary Fund. Even if peak oil demand doesn’t hit until 2040, that remaining sum could be depleted by 2034, according to the Fund. Oil at $20 a barrel would run it down even faster, emptying the coffers as soon as 2027. With oil prices in the range of $50 to $55 a barrel, Saudi Arabia’s international reserves would fall to about five months of import coverage as soon as 2024, according to an IMF report last year. That should be a deeply alarming prospect, bringing the kingdom within months of an unthinkable balance-of-payments crisis and the abandonment of the dollar peg, which has underpinned the global oil trade for a generation. Yet the prices we’re now seeing make this look almost like an optimistic scenario. 

The fiscal positions, represented by the average non-oil primary balance of the GCC countries, stood at a deficit of 44 per cent in 2018, highlighting the magnitude of reliance on oil.

This is the projections about financial wealth of different GCC countries under the benchmark assumption of $55 per barrel (the average price between 1967 and 2018).

In the aftermath of the 2014 oil price shock, many Gulf countries introduced excise and value added taxes and made their first serious attempts at fiscal consolidation. This will have to be deepened and also broadened to include direct taxes. It is no longer a matter of choice, but of timing and that too in the foreseeable future.

Weekend reading links

1. More corona updates.

Some nifty graphics on the value of early quarantine, infection and mortality rates in US modelled for corona compared to other diseases, modelling in WaPo of the spread of corona under various conditions of quarantine or social distancing, another model in NYT of the spread of the virus under different conditions of response. This models Covid 19 based on the classical infectious disease model.

This and this by Thomas Pueyo are very informative reads.

This Q&A with Bill Gates clarifies on several ongoing studies, including this now famous one by the Imperial College which made the UK Government reverse on herd immunity. Nicholas Kristof has this best case and worse case assessments. This is a good article about India's relatively successful efforts till date. This raises questions on the seasonality or temperature based arguments on Covid 19 - it feels the effects would be modest.

On the disease itself, President Trump's characterisation of it as a Chinese virus has drawn a lot of flak among the liberals. But as this article in the Nikkei Asian Review informs, the Chinese were certainly culpable of not only originating the virus but also spreading it outside, 

The Chinese government locked down Wuhan on Jan. 23, halting all public transportation going in and out of the city. The following day an order was issued suspending group travel within China. But in a blunder that would have far reaching consequences, China did not issue an order suspending group travel to foreign countries until three days later, on Jan. 27. In retrospect, it was a painful mistake.

This is what happened in those critical three days: The weeklong Lunar New Year string of holidays began on Jan. 24, with the outbound traffic peak lasting through Jan. 27. The Chinese government let the massive exodus of group travelers continue despite the public health crisis. No explanation has been given. Furthermore, while suspending group travel, China did nothing to limit individuals traveling overseas.

Groups account for less than half of all Chinese tourists heading abroad. Chinese travelers journeyed to Japan, South Korea, Italy, Spain, France, the U.K., Australia, North America and South America, one planeload after another. This was happening while many restaurants in China were unable to open for business due to the outbreak. It is said that once abroad, many Chinese prolonged their vacations as much as possible to avoid having to return home... 

After the first wave hit China, the outbreak went on a second wave across the world, especially in Europe. The number of deaths from the coronavirus in Italy, home to many Chinese residents, has topped 2,100. The delay in the Chinese government's ban on group travel to foreign countries may have helped to double or possibly triple the number of people infected. In the days before Wuhan was locked down on Jan. 23, as many as 5 million of its 11 million citizens had already left the city, as the mayor and others have testified.

See also this on the Chinese role.

In terms of fiscal policy, Germany seems to have gone the most far,

Mr Olaf Scholz (Finance Minister) said the government would provide unlimited liquidity assistance to German companies hit by the pandemic, which has played havoc with supply chains and led to a spate of production stoppages across the country. The package unveiled on Friday envisages a massive expansion of loans provided by KfW, the state development bank. Companies will also be allowed to defer billions of euros in tax payments. “This is the bazooka, and we will use it to do whatever it takes,” Mr Scholz told reporters in Berlin. He said there was “no upper limit on the amount of loans KfW can issue”. Peter Altmaier, economy minister, said the measures were “unprecedented in Germany’s postwar history”, calling them the “most comprehensive and effective assistance and guarantees there have ever been in a crisis”... The terms of KfW loans would be changed so that the federal government assumes more risk, he said, while loan application procedures would be simplified and speeded up. Access to credit guarantees would also be expanded. “We are making an unlimited pledge, to the smallest businesses, from taxi-drivers, to the creative industries, to really big firms with tens of thousands of workers,” said Mr Altmaier... On Friday the Bundestag also rushed through a law expanding the Kurzarbeit or short-time work scheme, under which companies that put their workers on reduced hours can receive state support.

Neil Irwin puts the coronavirus induced economic damage in the US in perspective,

The Bureau of Economic Analysis tables of personal consumption expenditures include three categories likely to see very sharp declines in the weeks ahead. Americans spent $478 billion on transportation services in 2019 (which includes things like airfare and train fare but not the purchase of personal automobiles). They spent $586 billion on recreation services (think tickets to sports events or gambling losses in a casino). And they spent $1.02 trillion on food services and accommodation (restaurant meals and hotel stays, but not grocery store food brought home). That adds up to $2.1 trillion a year, 14 percent of total consumption spending — which appears likely to dry up for at least a few weeks and maybe longer. We don’t know how much those consumption numbers will drop, and for how long, just that it will be by a lot...

The five sectors experiencing the most direct and immediate collapse in demand or facing government-mandated shutdowns because of coronavirus are air transportation; performing arts and sports; gambling and recreation; hotels and other lodging; and restaurants and bars. Together, they accounted for $574 billion in total employee compensation in 2018, about 10 percent of the total. It was spread among 13.8 million full-time equivalent employees. Those numbers represent the share of the economy at most direct risk. These are the industries and workers where revenue is likely to plummet; they will simply not have enough revenue to fulfill their usual obligations. In danger is the $11 billion a week they normally pay their employees, not to mention all those payments for rent, debt service and property taxes.

As to public policy responses in the US, Greg Mankiw writes,

Fiscal policymakers should focus not on aggregate demand but on social insurance. Financial planners tell people to have six months of living expenses in an emergency fund. Sadly, many people do not. Considering the difficulty of identifying the truly needy and the problems inherent in trying to do so, sending every American a $1000 check asap would be a good start. A payroll tax cut makes little sense in this circumstance, because it does nothing for those who can't work. There are times to worry about the growing government debt. This is not one of them. Externalities abound. Helping people over their current economic difficulties may keep more people at home, reducing the spread of the virus. In other words, there are efficiency as well as equity arguments for social insurance. Monetary policy should focus on maintaining liquidity. The Fed's role in setting interest rates is less important than its role as the lender of last resort. If the Fed thinks that its hands are excessively tied in this regard by Dodd-Frank rules, Congress should untie them quickly.

The Economist has a good article on the social and economic costs of schools closures, now being implemented in over hundred countries, and the challenges with administering online classes. 

This is a very good article by three doctors (HT: Ananth) striking a cautionary note on going overboard with social distancing. Ananth makes an excellent summary,

With elites in India and talking heads making social distancing, isolation, etc., as priorities – borrowed from the West – one is reminded of the upper deck and lower deck in the Titanic. Here, the only difference is that some of the upper deck folks might not be escaping a sinking Titanic but their wanting to escape might sink the Titanic (read ‘the economy’) for the rest to sink with it as they try to escape. This Titanic might, otherwise, be floating.

Good article in FT chronicling how different Asian countries have responded to the virus outbreak.

2. As economic distress mounts, one of the market segments which may be looking forward with anticipation may be distressed asset buyout funds. They are sitting on a record level of dry powder.

However, these PE firms also face the reality of struggling assets.

The most welcome development for the PE firms would be the drops in valuations due to the recession as well as the distress buyout opportunities. However, as this report points out, it may also benefit only the larger and reputed PE firms, thereby widening the divide at the top of the PE charts.

3. Barrons has a good interview of the financial market economist David Rosenberg who warns of recession and deflation. This about the stock market is very apt,

What has made this cycle unique is that the correlation between GDP growth and the direction of the S&P 500 index has been only 7%. Historically it has been 30% to 70%. The stock market is telling you nothing about the economy anymore. Economic fundamentals have never mattered as little for the stock market as has been the case during this 11-year bull market. The stock market is behaving more like a commodity than anything else, in that it's trading on simple supply and demand... With the correlation between the economy and the stock market so low, you're probably better off talking about the stock market with your plumber, your electrician, or a taxi driver. An economist is not going to help you, because the stock market has not been operating on fundamentals...

We've had $4 trillion of quantitative easing perfectly matched with $4 trillion of corporate share buybacks, to the point where the share count of the S&P 500 is down to its lowest point in two decades... We've never before seen such a stock market performance in the face of what has been in the last 11 years the weakest economic expansion of all time. We haven't even had one year of 3% or better real GDP growth in the US since 2005.

4. Fascinating review of Augustine Sedgwick's new book of how coffee has come to dominate the world as the preferred drink drug. The account of how coffee came to dominate the agriculture landscape of El Salvador is fascinating,  

Because growing coffee requires a tremendous amount of labor—for planting, pruning, picking, and processing—a planter’s success depends on finding enough people in the countryside willing to work... Rural Salvadorans, most of whom were Indians called “mozos,” weren’t hungry. Many of them farmed small plots of communally owned land on the volcano, some of the most fertile in the country. This would have to change if El Salvador was to have an export crop. So at the behest of the coffee planters and in the name of “development,” the government launched a program of land privatization, forcing the Indians to either move to more marginal lands or find work on the new coffee plantations... Even the lands newly planted with coffee still offered plenty of free food for the picking. “Veins of nourishment”—in the form of cashews, guavas, papayas, jocotes, figs, dragon fruits, avocados, mangoes, plantains, tomatoes, and beans—“ran through the coffee monoculture, and wherever there was food, however scant, there was freedom, however fleeting, from work,” Sedgewick writes. The planters’ solution to this “problem”—the problem of nature’s bounty—was to eliminate from the landscape any plant that was not coffee, creating an ever more totalitarian monoculture in which nothing else was permitted to grow. When a chance avocado tree did manage to survive in some overlooked corner, the campesino caught tasting its fruit would be accused of theft and beaten if he was lucky, or shot if he was not. Thus was the concept of private property impressed upon the Indians.

5. As the governments fight the epidemic, with limited fiscal space, businesses in countries like India are losing no opportunity to bargain out self-serving and economically harmful concessions in the guise of economic bailout,

Mohandas Pai, former CEO and board member at Infosys, made a pitch for removing the tax on share buybacks. “Investors have lost Rs 35 trillion but bad tax policies are penalising open market buybacks of shares by companies," he said in a tweet... Companies such as Sun Pharma, Emami, Supreme Petrochem, Thomas Cook, and SP Apparels have announced or proposed buybacks recently. This is in the backdrop of a significant correction in stock prices over the past few days. The 20 per cent tax on buybacks introduced in the last year's Budget could dissuade more companies from announcing similar initiatives... The clamour for removing long-term capital gains (LTCG) tax arising on sale of listed equity shares is also back on the agenda of market players.

Ananth has a summary of the demands from western bankers.

MGI on trends in social contract in advanced economies

Some extracts from an MGI report on the changing social contract between individuals and institutions that covers trends from 22 advanced countries.

Work opportunities have increased everywhere, and to record levels in some countries, but work security and income growth have declined or expanded unevenly... The gains in employment were primarily driven by growth in alternative work arrangements. As consumers, individuals have benefited from improved access and lower prices for discretionary goods and services, such as communications, clothing, and recreation. However, rising housing prices, which account for 37 percent of general inflation, together with higher healthcare and education costs and spending, have absorbed between 54 and 107 percent of the gains in income for average households in Australia, France, the United Kingdom, and the United States since 2002... Household saving rates have fallen at a time when individuals have to save for longer retirement and assume greater responsibility for saving. Since 2000, pension levels guaranteed by the public sector or employers have declined by an average of 11 percentage points. Yet household saving rates fell in 11 of the 22 countries; in 2017, more than half of individuals did not save for old age...

Changes in individual outcomes across the three arenas have been propelled by the changing role of institutions, which are cushioning individuals to a lesser degree from the effects of the forces at work in the economy. For example, employment protections are now lower, a higher share of healthcare and education costs is private, and guaranteed pension levels have dropped... As a more individualized social contract evolves, different groups of individuals are affected differently. Outcomes have been favorable for about 115 million workers equipped for high‐skill jobs, individuals for whom discretionary consumption is relatively high compared with their spending on basics, and savers able to accumulate capital. However, more than 120 million middle‐skill workers in Europe and the United States experienced declining employment and stagnating wages at a time when the cost of basics rose faster than general inflation. Low‐income individuals experienced challenging outcomes in their roles as consumers and savers. Young people have less secure employment, spend more on meeting basic needs, and have just one‐third of the average adult wealth compared with two‐thirds a generation ago. Women in general, and minorities in some countries, have fared less well than others in incomes and savings. While individuals have achieved many gains that will need to be sustained and expanded, the bottom three quintiles of the population—about 500 million people—have experienced challenges.

We identify ten key questions to address if outcomes are to improve and be inclusive as the century progresses. These include: how to reduce job fragility and wage stagnation at a time of changing work arrangements; how to address rapidly rising costs of housing and, in some countries, healthcare and education; how to mitigate the risk of saving shortfalls for some; and how to address the challenges faced by particularly vulnerable groups, including the young and lower‐ income households.

Some more,

Employment in advanced economies is at historically high levels and has recovered after the financial crisis in most countries, largely due to rising part-time employment... Average real wages stagnated while relative poverty increased... The net pension replacement rate that an average worker can expect to receive from her or his mandatory pension... to replace preretirement earnings... have declined in 16 out of 22 countries by an average of 11 percentage points, and net pension wealth covers just ten years on average... Over half of individuals in advanced economies did not save for old age, a quarter did not save any money, and 20 percent do not have enough wealth to cover six months of basic costs... Household saving rates fell in 11 out of 22 countries by 1.4 percentage points on average, which appears to be driven primarily by low saving rates among lower wealth groups... Over half of individuals did not save for old age, and a quarter did not save any money... Lower wealth groups have lower rates of return on their assets... Mean individual wealth has returned to pre-crisis levels but median wealth has not, and growth rates of both are fairly flat... Twenty percent of individuals do not have enough wealth to cover six months of basic costs...

The report uses two indexes to understand the role of institutions in the social contract and how they have evolved over the past two decades

The first gauges the extent to which institutions are intervening in the marketplace to manage market outcomes for individuals. The second focuses on the extent to which government spending cushions individual economic outcomes. Putting the indicators for market intervention and public‐ sector spending together highlights movements in the social contract... Our results suggest that in 19 out of 22 countries, institutions are intervening less in the marketplace, while governments in 18 out of 22 countries have somewhat stepped up their spending. Some of the biggest changes in the extent of market intervention are a decline in employment protection for workers on temporary contracts, a substantial reduction in product‐market regulations, and a sharp fall in the net replacement rate for mandatory pensions... On average, market intervention by institutions declined by 13 points, while public‐sector spending increased by three percentage points of GDP. This shift to lower market intervention and increased public‐sector spending occurred in 15 out of 22 countries... Market intervention for workers, consumers, and savers declined by 13 points, although public-sector spending increased by three percentage points on average.

 Outcomes have been more negative for the younger populations,

Changes in housing prices explain 37 percent of general inflation in 20 countries between 2002 and 2018, and a significant share of rising incomes went into housing.

The major trends sharing the economies and the responsibilities between institutions and individuals in the social contract is as follows

The ten high priority challenges in advanced countries identified are as follows

The full report is here.

The economic history of the last decade in one graphic

The extraordinary monetary accommodation since the crisis is central to understanding the trends in the world economy. 

Ananth points to this excellent graphic from Albert Gallo at Algebris Investments.

This pretty much captures it all. Two small points. One could be to add "rigged capitalism" as an outcome along with populism. Two, on the supply side, there is a Mathew Effect or superstar effect  or TBTF that operates (which is more than just monopoly), which drives business concentration, rising entry barriers etc.

This time is different - zombie companies, corporate debt, and GFC 2.0

What is different this time is that unlike earlier times, the impending global financial crisis is not made in Wall Street or banking sector. Instead, it looks set to have its origins in the non-financial corporate board rooms. More specifically in the decisions take during the last decade of extraordinary monetary accommodation to gorge up on debt.

The dangers of rising corporate debt has been flagged several times in recent years, including this and this reports by MGI and BIS respectively.

The FT had this assessment about US corporations, citing this recent study by the US Federal Reserve Board,

The average ICR is a rather low 3.7 and the percentage of debt at risk (with ICR < 2) is a non-negligible 31.7 per cent.<2 31.7="" a="" b="" cent.="" is="" non-negligible="" per="">

The Economist writes,

The locus of concern is in the world’s ocean of corporate debt, worth $74trn. On Wall Street the credit spreads of risky bonds have blown out... The scare has four elements: a queasy long-term rise in borrowing; a looming cash crunch at firms as offices and factories are shut and quarantines imposed; the gumming-up of some credit markets; and doubts about the resilience of banks and debt funds that would bear any losses... Global corporate debt (excluding financial firms) has risen from 84% of GDP in 2009 to 92% in 2019, reckons the Institute of International Finance. The ratio has risen in 33 of the 52 countries it tracks. In America non-financial corporate debt has climbed to 47% of GDP from 43% a decade ago, according to the Federal Reserve. Underwriting standards have slipped. Two-thirds of non-financial corporate bonds in America are rated “junk” or “bbb”, the category just above junk. Outside America the figure is 39%... Naughty habits have crept in: for example, using flattering measures of profit to calculate firms’ leverage...

To get a sense of the potential damage in other countries The Economist has done a crude “cash-crunch stress-test” of 3,000-odd listed non-financial firms outside China. It assumes their sales slump by two-thirds and that they continue to pay running costs, such as interest and wages. Within three months 13% of firms, accounting for 16% of total debt, exhaust their cash at hand. They would be forced to borrow, retrench or default on some of their combined $2trn of debt. If the freeze extended to six months, almost a quarter of all firms would run out of cash at hand.

John Detrixhe in Quartz writes about zombie companies,

About 17% of the world’s 45,000 public companies covered by FactSet haven’t generated enough earnings before interest and taxes (EBIT) to cover interest costs for at least the past three years. Bank for International Settlements economists, using a similar but narrower definition, find that the world’s equity markets’ share of zombies has risen to more than 12%, up more than 8 percentage points since the mid 1990s... While unemployment in the US and parts of Europe are at multi-decade lows, a growing number of businesses may be held together by little more than cheap financing, instead of their ability to sell things and make a profit... Zombie companies have contributed to the glut of $3 trillion of risky borrowing around the world...

“You have delayed the normal lifecycle of companies with low interest rates,” said Alberto Gallo, a portfolio manager at Algebris Investments. “You keep alive business models that are unsustainable.”... John McClain, a money manager at Diamond Hill Capital Management... thinks a number of venture-capital funded companies with high valuations—privately funded “unicorns” with price tags of more than $1 billion—are effectively zombies as well...

There’s a close link between lower interest rates—central banks’ primary weapon for giving the economy a boost—and the stock market’s share of zombie companies, according to BIS economists Ryan Banerjee and Boris Hofmann. They found that these weaker companies are spreading because zombies aren’t dying. That is, they’re staying in a “zombie state” for longer instead of regaining their corporate health or reorganizing in a bankruptcy, and potentially weakening economic productivity...Instead of defaulting, companies can end up tying up resources—talented employees, and capital—that could be more useful somewhere else... Lower rates can beget more zombie companies, crowding out resources that could have been available for healthier enterprises. This in turn weakens the economy, causing lower interest rates and sustaining more companies with weaker finances.

Policy makers face a Hobson's choice in the circumstances,

Allowing interest rates to jump higher could set off a string of defaults, threatening livelihoods. But delaying the day of reckoning is showing few signs of bringing zombie companies back to life, and there are signs that current policies are starting to backfire. In the worst case, they may be setting up another debt crisis.

Rana Faroohar writes about its knock-on effects on the banking sector too,

It’s one thing for the aircraft manufacturer Boeing to draw down its entire $13.8bn credit line. It’s another for multiple big corporations to draw theirs at the same time. Still, as a recent Credit Suisse report pointed out, “we now have a global banking system where all major banks have to pre-fund 30-day outflows” with high-quality liquid asset portfolios. This is one important reason why these corporate funding stresses haven’t caused a real time banking crisis in the way that the 2008 subprime crisis did. Another reason is that the Fed is backstopping the banking system with its repo operations, as banks exchange Treasury bills for cash. All of this underscores a fundamental truth — regulators usually tend to fight the last war. The dollar deposits that corporations are currently drawing down are one of the highest-quality types of funding for banks, the same kind that the Basel III rules stipulate they should keep on hand. Nobody assumed that a pandemic would result in huge credit drawdowns by many companies all at once. Losing these deposits so quickly threatens the liquidity profile and regulatory compliance of banks themselves. And that is before we start to see the spike in corporate downgrades and defaults that will create even more funding pressure.

The fact is that the banking system has already been pulled into the corporate credit crisis that many people predicted would be the cause of the next big market downturn. It’s all too easy to see how the problems of individual companies — technology firms, retailers, airlines and insurance companies — could be passed to individual banks and then to countrywide banking systems. Ultimately, they could spread throughout the global financial system, leaving central bankers once again the lender of last resort, standing between us and another global financial crisis. That is pretty much what is already happening, and we haven’t even seen the next phase of falling dominoes — the meltdown of passive and algorithmic investing, the unwinding of exchange traded funds, and the sale of even the highest quality assets by people who are desperate to raise cash in the midst of a liquidity crisis. All this means that central bankers will have to keep the money taps on, and probably increase the variety of assets that they are buying or backstopping.

It is not just corporates, even countries are exposed to debt burdens which could turn unsustainable with a deep slowdown. FT writes,

This disease-induced shock to supply and demand could not have come at a worse time for a world economy awash in debt: $72.7tn (92.5 per cent of global gross domestic product) for sovereign borrowers and $69.3tn (88.3 per cent of GDP) for non-financial corporate borrowers, according to the Institute of International Finance. Many highly indebted sovereign and corporate borrowers will be in distress.

Lebanon has just defaulted. Zimbabwe, Zambia, Republic of Congo, Mozambique, and Angola are struggling at the margins of default. Italy, the worst affected European country, as the FT report writes, is the perennial "elephant in the room".

Update 1 (18.03.2020)

The global non-financial corporate debt has been on a rising trend since the last crisis.

Inequality debates and Piketty 2.0

Reviews of Thomas Piketty's latest book, Capital and Ideology.

Idrees Khaloon in the New Yorker writes,

In his retelling, the so-called Trente Glorieuses, the thirty years of relative equality between 1950 and 1980, were the result not of two world wars—which played “only a minor part in this collapse,” he has determined—but, rather, of political decisions made “to reduce the social influence of private property.” And the policies we adopt certainly do influence inequality. Steeply progressive income taxes and estate taxes shaped income distributions during those Trente Glorieuses... He argues that the “Brahmin left”—the most educated citizens and the greatest beneficiaries of the knowledge economy and the supposed meritocracy—has captured the left-wing parties in Western democracies, distracting those parties from their mission of improving the lives of working people. Conservative parties, meanwhile, are under the sway of the “merchant right.” Such polarization makes debate over redistribution impossible, and so the lower classes debate immigration and borders instead.

The review itself is representative of the views of the "brahmin left". Two points in particular. One, the big problem is not inequality per se, but the excessive levels of inequality and the extreme concentration of wealth in the hands of a few plutocrats. Two, the bigger problem with the prevailing levels of inequality is that of elite capture of rule making. The latter makes such levels of inequality bad in itself.

Raghuram Rajan in the FT writes,

Inequality is a real problem today, but it is the inequality of opportunity, of access to capabilities, of place, not just of incomes and wealth. Higher spending and thus taxes may be necessary, not to punish the rich but to help the left-behind find new opportunity.

I think this is somewhat digressive and platitudinous. The inequalities of opportunity etc are only second order manifestations of economic inequality. The real problem is with inequality of income and wealth. And here too, inequality by itself is not the problem, but excessive inequality is the problem.

Excessive inequality with income and wealth, as is the case now, inevitably leads to rigging the rules of the political system and its processes which affect the entire society in favour of a handful and against the overwhelming majority. If a few people become so rich compared to the rest, political capture is inevitable. This is just a fact of life.

Political choices then get made by and for the elites, often to the exclusion and detriment of the vast majority. It becomes a threat to the democratic system itself. So preventing such excessive accumulation of wealth, even if it means punishing the rich by way of taxation, cannot be avoided.

As to "scholarship without solutions", I am inclined to believe that widening inequality and its consequences, as the reviews indicate, are widely under-appreciated. So in some ways, the gravity of the problem itself is inadequately recognised. In the circumstances, articulation of the problem with evidence and historical comparisons is itself worthwhile. As Rajan himself writes,

So Piketty’s focus on documenting the true state of economic inequality, following which informed voters will push for change.

Unfortunately, this alone is very unlikely to do much in realising change, though it is essential to create the conditions.

Rajan is right with the challenges associated with redistribution. And also with the perils of excessive activism by governments. But irrespective of what is driving the widening of inequality, its corrosive effects and the need for corrective action cannot be denied. As to what those corrective actions should be, one can rightfully disagree with Piketty' suggestions.

As to solutions, the idea of "steeply progressive taxes on income, wealth..., and bequests" may sound fanciful today. But history tells us that once far-fetched thoughts can quickly get adopted as the norm, though one can never tell with certainty about the tipping point.

Ananth has a post on Rajan's review. 

Paul Krugman in Times perhaps gets it right by making the distinction between the presentation and substance of the material. He is disappointed at the breadth and scope of the narrative and feels that it detracts from the central point about what is driving recent inequality that Piketty is making. He calls it an "endless series of digressions rather than the cumulative construction of an argument" and feels that the arguments are scattered throughout the book and "gets lost in the dubiously related material". His summary,

To be fair, the book does advance at least the outline of a grand theory of inequality, which might be described as Marx on his head. In Marxian dogma, a society’s class structure is determined by underlying, impersonal forces, technology and the modes of production that technology dictates. Piketty, however, sees inequality as a social phenomenon, driven by human institutions. Institutional change, in turn, reflects the ideology that dominates society: “Inequality is neither economic nor technological; it is ideological and political.”... 

For Piketty, rising inequality is at root a political phenomenon. The social-democratic framework that made Western societies relatively equal for a couple of generations after World War II, he argues, was dismantled, not out of necessity, but because of the rise of a “neo-proprietarian” ideology. Indeed, this is a view shared by many, though not all, economists. These days, attributing inequality mainly to the ineluctable forces of technology and globalization is out of fashion, and there is much more emphasis on factors like the decline of unions, which has a lot to do with political decisions.

But why did policy take a hard-right turn? Piketty places much of the blame on center-left parties, which, as he notes, increasingly represent highly educated voters. These more and more elitist parties, he argues, lost interest in policies that helped the disadvantaged, and hence forfeited their support. And his clear implication is that social democracy can be revived by refocusing on populist economic policies, and winning back the working class. Piketty could be right about this, but as far as I can tell, most political scientists would disagree. In the United States, at least, they stress the importance of race and social issues in driving the white working class away from Democrats, and doubt that a renewed focus on equality would bring those voters back. After all, during the Obama years the Affordable Care Act extended health insurance to many disadvantaged voters, while tax rates on top incomes went up substantially. Yet the white working class went heavily for Trump, and stayed Republican in 2018.

Could it not be that the shifts in choices of centre-left parties and liberals (perhaps their co-option as ideologues) has had the effect of exacerbating the racial and social cleavages which for years had been alleviated through progressive policies?

Weekend reading links

1. The WSJ extrapolates from history of stock market crashes,

On March 10, 2000, the Nasdaq Composite Index hit an intraday high of 5132.52. We all know what happened next. By October 2002, the index had fallen 78.4%—to 1108.49. And that was only half the agony. The other half was the index’s anemic recovery from that low. It took until November 2014 for the index to battle back to its March 2000 level, even after taking dividends into account. If you adjust for inflation, the index didn’t recover until August 2017, more than 17 years later.

If the Dow Jones Industrial Average were to follow the same script, it would be trading at around 5400 in October 2022, and not make it back to its current level until November 2034 (or, on an inflation-adjusted basis, the summer of 2037). It is hard to overestimate how devastating such a scenario would be for retirees and soon-to-be-retirees.

2. Nidheesh MK writes about the problems facing Surat's diamond industry as it battles a crippling downturn,

According to a report in The Times of India (TOI) in September 2019, some 40,000 workers were laid off in the preceding year, and 20% of small diamond units were shut and salaries were trimmed across the sector... The city is the biggest processing hub for diamonds in the world. According to estimates, nine out of 10 diamonds sold anywhere in the world would have passed the hands of a worker in Surat. Of the 4.5 million residents in the city—it is among the world’s fastest-growing 30 cities as per recent United Nations data—more than 800,000 people work in the diamond industry, as cutters or diamantaires, workers, wholesalers, traders, brokers, retailers, jewellery fabricators, according to The Diamond Trailby Shantanu Guha Ray. But today, suicides and job losses reflect many trends of a slowdown— declining global sales; international trade wars which make imported diamonds from the US more expensive and less attractive in the biggest diamond market of Hong Kong; the impact of demonetization and the goods and services tax (GST); and more recently, the coronavirus outbreak.

3. A FT explainer on the latest oil war triggered by Saudi Arabia.

Saudi Arabia's decision to turn on the oil spigot loose even as Covid 19 was breaking out will be judged as a very reckless one. 

The biggest loser in the oil war may be Saudi Arabia itself. While for others, including US and Russia, the breakeven cost of oil is more relevant to their respective oil companies, in case of oil-dependent Saudi Arabia, it is of national economic relevance. 

The Economist writes,

Russia—the tactical target of Saudi Arabia’s price war—is different. Since 2014 it has run orderly monetary and fiscal policies. It has been a net provider of credit to the world, not a net borrower. And it has saved a lot of its surplus oil revenue for a rainy day, by basing its budget on an oil price of $40 a barrel. Middle Eastern and African producers (and never mind Venezuela) have not been as disciplined. Saudi Arabia itself needs $80 a barrel to balance the books. 

4. More on the World Bank's Pandemic Bonds which are yet to pay out.

The bonds did not pay out a cent during a severe attack of Ebola in the Democratic Republic of Congo last year and are yet to pay out to relieve effects of the coronavirus outbreak, which has led to at least 110,000 cases worldwide and more than 4000 deaths. Some analysts say the bonds’ terms are too stringent, preventing money from being funnelled to countries where the spread of the pandemic could be resisted.

Be that as may, the allure of financial engineering to solve complex problems will endure.

5. One of the most disturbing things about the aftermath of the global financial crisis has been the failure to convict any executives from the major financial institutions.

In a high-profile reversal, UK's Serious Fraud Office has failed in the first criminal trial to examine steps taken by senior bankers during the financial crisis. The jury exonerated three Barclays executives on allegations of lying to the market in the Bank's official documents on a deal with Qatar to mobilise capital at the height of the crisis. This acquittal follows that of the Bank's Chief Executive earlier.

This raises questions about UK's laws which make it difficult to establish corporate criminal liability.

Prosecutors in England and Wales must demonstrate that the “directing mind” of a company was involved in alleged criminality if they are to prove a company liable. “It is almost impossible to find a controlling mind and prove that controlling mind is complicit in any criminality,” says David Green, director of the SFO when it launched its investigation into Barclays, who argues that prosecutions are being hampered by this legal requirement. “The email chain tends to dry up at middle management level... The current law was developed in the industrial revolution when companies were beginning to be formed and consisted of one person or two or three people so it was very easy to identify who was a controlling mind.”

6. Good article about the changes happening in last mile distribution of groceries in India. The humble kirana shop is emerging as the last-mile warehouse for temporary storage by online grocers.

7. FT writes about the troubles mounting on the corporate debt market,

Companies have gorged on cheap debt for a decade, sending the global outstanding stock of non-financial corporate bonds to an all-time high of $13.5tn by the end of last year, according to the OECD, or double where it stood in December 2008 in real terms. Borrowing costs had tumbled after central banks lowered interest rates to jolt their economies following the 2008 financial crisis. Investors, starved of yield from safer government bonds, saw lending to riskier companies as a way to juice returns... Ruchir Sharma, Morgan Stanley’s chief global strategist, estimates that one in six US companies does not earn enough cash flow to cover interest payments on its debt. Such “zombie” borrowers could keep putting off the crunch as long as debt markets kept letting them refinance.

8. Softbank is apparently fast becoming a persona-non-grata in Silicon Valley. It is true that Softbank's practices have been corrosive and representative of the reckless financing trend in vogue. But it is hardly alone nor has it been the progenitor of this trend, though it has been critical in amplifying these practices. Softbank is merely taking a leaf out of Wall Street's own historical playbook that fuelled many an asset bubbles. The difference being private capital as against public markets.

The pushback in Wall Street to Softbank has more got to do with vested interests in the form of large incumbents like Sequoia being relegated into the margins by the new kid on the block. A touch of racism cannot also be denied.

9. A coronavirus primer with a lot of graphs. Also this. The main priority, at this point in time of the outbreak, may be slow down its spreading, thereby buying time for medical systems to cope with the flow. That may be possible only through isolation.

The Economist has a good technical briefing on SARS-CoV-2 virus which causes Covid 19.

And also a very informative Corona section.

Nice graphic of the progression, how it has tapered off in China.

The Chinese response has been striking in its success,

On February 4th China recorded 3,887 new cases. On March 4th the number was 139. The report that the who group published on February 28th put the good results down to the way that the state had used manpower and technology to implement quarantine meticulously on an unprecedented scale... All over the country cities closed down schools, public transport and almost all social and economic activity to stop people from moving around. In Wuhan, a city of 11m people, the population has been restricted to their homes for five weeks. The lockdown was enforced not just by the network of officials which covers every block of flats, street and alley but also, under the influence of those officials, by the property managers at residential compounds.

The corona mitigation immediate response strategy for the economy,

The first task is to get manpower and money to hospitals. China drafted in 40,000 health workers to Hubei province... Just as important is to slow the spread of the disease by getting patients to come forward for testing when outbreaks are small and possible to contain. They may be deterred in many countries, including much of America, where 28m people are without health coverage and many more have to pay for a large slug of their own treatment. People also need to isolate themselves if they have mild symptoms, as about 80% of them will. Here sick pay matters, because many people cannot afford to miss work. In America a quarter of employees have no access to paid sick leave and only scattered states and cities offer sickness benefits. Often the self-employed, a fifth of Italy’s workforce, do not qualify. One study found that, in epidemics, guaranteed sick pay cuts the spread of flu in America by 40%. Sick pay also helps soften the blow to demand which, along with a supply shock and a general panic, is hitting economies. These three factors, as China shows, can have a dramatic effect on output...

Better to support the economy directly, by helping affected people and firms pay bills and borrow money if they need it. For individuals, the priority should be paying for health care and providing paid sick leave... For companies the big challenge will be liquidity... Firms that lose revenues will still face tax, wage and interest bills. Easing that burden, for as long as the epidemic lasts, can avoid needless bankruptcies and lay-offs. Temporary relief on tax and wage costs can help. Employers can be encouraged to choose shorter hours for all their staff over lay-offs for some of them. Authorities could fund banks to lend to firms that are suffering, as they did during the financial crisis and as China is doing today. China is also ordering banks to go easy on delinquent borrowers. Western governments cannot do that, but it is in the interest of lenders everywhere to show forbearance towards borrowers facing a cash squeeze.

This about paid sick leaves,

A study of paid sick-leave mandates in America by Stefan Pichler and Nicholas Ziebarth, two economists, found that the policy reduced the spread of influenza by 5% in normal times and 40% during a wave.

National responses have been varied. Singapore perhaps did the best in early response to prevent the outbreak. China's actions after the initial bungling has been very impressive. Italy too has responded with great swiftness. S Korea has been very impressive with testing and isolating. Iran, perhaps has been the most shambolic. In terms of being lackadaisical, given the importance of isolation in the strategy, US and UK are perhaps the worst offenders.

In fact, in terms of turnarounds, China's has been very impressive - even as Apple closed down all its stores globally, it re-opened its Chinese stores!

Vikram Patel puts Covid 19 in perspective compared to TB.

An assessment of its impact across a variety of sectors in the US, and on the equity markets here.

10. The majority of Indian startups that attract VC funding are incorporated outside India,

An analysis by Tracxn shows that of 73 SaaS firms that have received at least $20m each in funding, 50 have headquarters outside India. Many flee to Singapore, where expatriate managers can catch a six-hour flight to Delhi or Mumbai, which plenty do on a weekly basis.

Some of the reasons,

To list on India’s main exchanges firms must demonstrate a few years of profits. Laws impede those whose management is based in India from floating overseas (the approach of many successful Israeli startups) without first going public at home. Complex and mutable levies on shares handed to investors and staff in effect give the government first dibs on a firm’s cash.

11. Anirudh Laskar in Livemint chronicles the flawed rise of Yes Bank to become India's fourth largest private bank,

When the going was good, Kapoor was known as the banker who would never say “No". Under Kapoor, Yes Bank was the go-to institution for companies seeking loans. The bank would even lend money to corporates who had been refused by other lenders... All business decisions at Yes Bank, even where the bank’s board was involved, ultimately hinged on Kapoor’s whims and fancies. Many senior employees who couldn’t get along with him ultimately ended up leaving... Yes Bank’s commercial banking modus operandi was to lend to subsidiaries of large corporate groups whose promoters were friends of Kapoor. “When all banks used to refuse to lend to a particular client, Yes Bank would step in. That’s because different kinds of collateral—land parcels, plant machinery, promoter’s guarantees in personal capacity—were taken by them," said an ex-official of the lender on condition of anonymity... Kapoor’s remedy to keep bad loan ratios low was to grow the loan book at a breakneck speed. In the three years leading to FY17, Yes Bank’s loan book had bloated by 76%, which kept bad loan ratios near low single-digits.

While the regulator should obviously take blame, what about Yes Bank's management as well as Board, including the likes of Ashok Chawla?

See also this by Ananth.

The Yes Bank story should lay to rest all the claims about superior corporate governance and performance of private sector banks, as if that evidence was ever required given the experience of the US. All of ICICI, Axis Bank, and RBL have been guilty of corporate governance issues.