Rent seeking in the US - Fed, judiciary, and revolving doors

I have blogged on several occasions about rent-seeking, including in the developed economies. This post points to three examples of institutionalised corruption from the United States. 

The first concerns the actions of leading officials within the US Federal Reserve system, as reported by the Wall Street Journal. It raises questions  about possible insider trading. The million-dollar stock market transactions of Presidents of Dallas and Boston Federal Reserve Banks Robert S Kaplan and Eric Rosengren came at a time when the Fed was undertaking emergency asset purchases to ensure liquidity and prop up the markets, thereby raising concerns about them benefiting financially from information they learn through their positions. Interestingly, these transactions were not prohibited under the Fed's decades old ethics rules. The Times writes,

Mr. Kaplan made nearly two dozen stock trades of $1 million or more last year... Those included transactions in companies whose stocks were affected by the pandemic — such as Johnson & Johnson and several oil and gas companies — and in firms whose bonds the Fed eventually bought in its broad-based program... Mr. Kaplan was buying and selling oil company shares just as the Fed was debating what role it should play in regulating climate-related finance. And everything the Fed did in 2020 — like slashing rates to near zero and buying trillions in government-backed debt — affected the stock market, sending equity prices higher... Mr. Kaplan’s financial activity included trading in a corporate bond exchange-traded fund, which is effectively a bundle of company debt that trades like a stock. The Fed bought shares in that type of fund last year... “People will ask, fairly or otherwise, about the extent to which his views about the balance sheet or interest rates are influenced by his personal investments in the stock market,” Ms. Binder said of Mr. Kaplan’s trades.

In fact, Kaplan also purchased shares of Apple while the Fed was buying the company's bonds. It's difficult to imagine that Fed officials with exposures to the stock market can take a dispassionate view on decisions that while necessary for the economy as a whole (like exiting quantitative easing) may adversely impact the financial markets (and thereby their personal financial interests). We are all human beings, captives of our own personal preferences. And when millions are at stake, how can we expect the typical human being to deviate from such high stakes personal interests?  

In a veiled admission of culpability, both officials have announced their resignation. It's also a reflection of the institutional maturity of the system that once such practices come out in the open, it becomes untenable for these officials to continue. But the same system also promotes a culture of self-censorship which generally prevents such cozy relationships from being exposed.  

Central banks have grown in enormous importance over the last 25 years, coming to occupy an exalted position of power over national economies but with little democratic accountability. Their actions have enormous distributional consequences, even involving future generations. These are essentially political choices made by unelected technocrats using objective functions which are often biased towards protecting the status quo and the welfare of powerful financial market interests. 

I have blogged here about the problems with such exercise of power and also pointed to several instances of questionable and even corrupt practices by central bankers. The Times article draws attention to one such matter of concern,

Janet L. Yellen, the former central bank chair, faced criticism when financial documents filed as part of her nomination for Treasury secretary showed that she had received more than $7 million in bank and corporate speaking fees in 2019 and 2020, after leaving her top central bank role.

It's difficult to believe that Ms Yellen would have received such fantastic sums if not for her previous Fed role. Even more disturbingly, after having received such generosity, it's questionable as to how tough she can humanly be with the same interests she's now entrusted to control. 

This is a good illustration of the complex legal and ideological props to entrench the status quo,

The Federal Reserve Act limits governors’ abilities to go straight to bank payrolls if they leave before their terms lapse, but speaking fees from the finance industry are permitted. Defenders of the status quo sometimes argue that the Fed would struggle to attract top talent if it curbed how much current and former officials can participate in markets and the financial industry. They could face big tax bills if they had to turn financial holdings into cash upon starting central bank jobs. Because Fed officials tend to have financial backgrounds, banning financial sector work after they leave government could limit their options.

Another WSJ investigation revealed that 131 federal judges (out of a total of 600 odd full time federal trial judges) broke law between 2010-18 by presiding over 685 cases involving companies in which they or their families also happened to be shareholders.

About two-thirds of federal district judges disclosed holdings of individual stocks, and nearly one of every five who did heard at least one case involving those stocks... When judges participated in such cases, about two-thirds of their rulings on motions that were contested came down in favor of their or their family’s financial interests... The Journal found 61 judges or their families not only holding stocks in companies that were plaintiffs or defendants in the judges’ courts but also trading the stocks during cases...

In New York, Judge Edgardo Ramos handled a suit between an Exxon Mobil Corp. unit and TIG Insurance Co. over a pollution claim while owning between $15,001 and $50,000 of Exxon stock, according to his financial disclosure form. He accepted an arbitration panel’s opinion that TIG should pay Exxon $25 million and added $8 million of interest to the tab. In Colorado, Judge Lewis Babcock oversaw a case involving a Comcast Corp. subsidiary, ruling in its favor, while he or his family held between $15,001 and $50,000 of Comcast stock. At an Ohio-based appeals court, Judge Julia Smith Gibbons wrote an opinion that favored Ford Motor Co. in a trademark dispute while her husband held stock in the auto maker. After she and the others on the three-judge appellate panel heard arguments but before they ruled, her husband’s financial adviser bought two chunks of Ford stock, each valued at up to $15,000, for his retirement account, according to her disclosure form... Timothy Batten Sr., chief judge of the U.S. District Court for the Northern District of Georgia and a member of the Committee on Codes of Conduct for the Judicial Conference of the U.S... himself owned shares of JPMorgan Chase & Co. while he heard 11 lawsuits involving the bank, most of which ended in the bank’s favor...

The ethics code for federal judges “requires recusal when a judge has a financial conflict, regardless of the substance of the judge’s actual involvement in the case,” the Judicial Conference’s Committee on Codes of Conduct wrote in a letter to a judge this month.

The third story concerns the institutionalised revolving door between private and public sectors. Consider this example,

For six years, Audrey Ellis and Adam Feuerstein worked together at PwC, the giant accounting firm, helping the world’s biggest companies avoid taxes. In mid-2018, one of Mr. Feuerstein’s clients, an influential association of real estate companies, was trying to persuade government officials that its members should qualify for a new federal tax break. Mr. Feuerstein knew just the person to turn to for help. Ms. Ellis had recently joined the Treasury Department, and she was drafting the rules for this very deduction. That summer, Ms. Ellis met with Mr. Feuerstein and his client’s lobbyists. The next week, the Treasury granted their wish — a decision potentially worth billions of dollars to PwC’s clients. About a year later, Ms. Ellis returned to PwC, where she was immediately promoted to partner. She and Mr. Feuerstein now work together advising large companies on how to exploit wrinkles in the tax regulations that Ms. Ellis helped write.

The NYT story concerns the practice in accounting industry,

The largest U.S. accounting firms have perfected a remarkably effective behind-the-scenes system to promote their interests in Washington. Their tax lawyers take senior jobs at the Treasury Department, where they write policies that are frequently favorable to their former corporate clients, often with the expectation that they will soon return to their old employers. The firms welcome them back with loftier titles and higher pay... From their government posts, many of the industry veterans approved loopholes long exploited by their former firms, gave tax breaks to former clients and rolled back efforts to rein in tax shelters — with enormous impact... some former industry veterans said they viewed the rapid back-and-forth arrangements as a big part of the reason that tax policy had become so skewed in favor of the wealthy, at the expense of just about everyone else...

In the last four presidential administrations, there were at least 35 instances of round trips from big accounting firms through Treasury’s tax policy office, along with the Internal Revenue Service and the Congressional Joint Committee on Taxation, and back to the same firm, according to public records and interviews with government and industry officials. In at least 16 of those cases, the officials were promoted to partner when they rejoined their old accounting firms. The firms often double the pay of employees upon their return from their government sojourns. Some partners end up earning more than $1 million a year... Going from an accounting firm into the Treasury means taking a big pay cut. But lawyers know they are likely to be rewarded with significantly higher pay when they rejoin their old firm... five of the last six people to run the Treasury tax office had returned to their previous accounting or law firms after stepping down from their government jobs.  

The article has several instances of how brazen the revolving door and cohabitation has become - officials working one day in private sector and the next week in public sector dealing with the same issues they were dealing in their parent firm and then back; officials formally drawing benefits from their private employers while working in important public positions etc.

For Indians smitten with the bug of lateral entry, this is a cautionary note.

Weekend reading links

1. The rise of dual class voting shares in the US, where owners have outsized voting power and others very limited.

2. India's disinvestment target and realisation over the years from Livemint.

3. Tamal Bandopadhay advocates RBI exiting the monetary accommodation,

Withdrawal of excess accommodation in the form of liquidity sugar rush is akin to taking away the training wheels from a kid’s bike. Yes, training wheels help kids maintain balance and stay upright on a bike and pedal at an early age but they don’t teach them how to ride a bike. The fiscal health of the government is improving with higher tax collections, and consumer demand has started picking up. As the path looks less treacherous now, it’s time to remove the training wheels.

4. Sivakasi produces 95% of India's fire crackers and employs 800,000 to a million people. PTI has a story on the poor state of work conditions of these workers,

For all the hard work, workers approximately get anywhere between Rs 290 to Rs 500-Rs 570 per day as wages and a bonus ranging between 20 and 27 per cent in addition to Provident Fund and Employees State Insurance Scheme cover. The pay structure is only indicative and applies to organised, licensed and properly run units and about 55 per cent of the workforce is women. Remuneration, in some big units as well, covers aspects like the "piece rate" concept and working hours (up to 4 and 8 hours) and pay varies depending on the kind of work done while hazardous processes like chemical filling are mostly assigned to men... Unlike well-defined and mandated practices to ensure safety in regulated, licenced units, workers in unlicensed and illegal firecracker manufacturing cottage industry are exposed to grave hazards and a chunk of accidents.

5. Jean Dreze on the risks with Aadhaar enabled bank payments through Banking Correspondents. Some useful suggestions to limit the risks,

There are ways of reducing the vulnerabilities of AePS. For instance, BCs could be required to make manual if not digital entries into printed customer passbooks. That would act as a permanent, verifiable receipt that cannot be denied to the customer so easily (a blank entry would be incriminating). Ensuring that BCs are clearly identified in transaction records would also help. So would SMS alerts, when the customer has a mobile number. Roaming BCs should perhaps be banned, at least in states with low literacy levels. And most importantly, better grievance redressal facilities must be made available to the victims of AePS fraud.

6. In the aftermath of the German elections, Gideon Rachman makes an interesting observation,

It is the US and the UK where politics seem increasingly prone to “angst, aggressiveness” and all those other unattractive, supposedly Teutonic, qualities. These days, it is German public life that is characterised by the virtues the British often attribute to themselves — calm, restraint, rationality and compromise. The recent German election and its aftermath underline the point. It was a close contest, but the losers accepted the results gracefully. Nobody tried to claim that the voting was rigged or that their opponents were “scum” — or represented a mortal danger to the country.The Social Democrats now look set to lead a German government for the first time since 2005. But a transition of power will not bring about an abrupt rupture in policies or an attempt by the political opposition to paralyse the government, as is happening in the US. The SPD’s Olaf Scholz, who may become chancellor, ran as a continuity candidate. As my FT colleagues reported, voters saw Scholz “with his quiet demeanour, long experience in government and pragmatic politics, as Merkel’s natural successor”. How very different from the leadership profiles of Donald Trump or Boris Johnson... One difference between Germany and other large western nations is that high levels of immigration have not radicalised the mainstream right.

7.  This on grade inflation in India's Board examinations is very disturbing,

CBSE Class X and XII boards have passed a record 99.04% and 99.37% students respectively, with those scoring above 95% jumping 38% and 81%. This extraordinary uptick is echoed across state boards. For example, Maharashtra HSC results have witnessed a gravity-defying 1,000% rise in the 90% category... grade inflation was an epidemic even before the pandemic. Before the 95% club more than doubled in the 2020 Class XII CBSE boards, it soared by 39% in 2019.

HT: The Ken 

8. I've not yet had the occasion to write about Byjus, the $18 bn valued Edtech startup making it the world's most valuable Edtech firm. But The Ken here points to some interesting aspects about Byjus. 

9. India laptop market fact of the day,

A report by EY and ICEA in 2019-20 had said India imported laptops with a value of $4.21 billion, which accounted for a staggering 86 per cent of the $4. 85 billion per annum laptop market. Out of this, 87 per cent was imported from China. Further, India’s laptop imports have increased by 42 per cent from $2.97 billion to $4.1 billion in five years. Only a handful of companies, including HP, Dell and Lenovo, manufacture laptops locally and in very limited numbers, either on their own or with third-party players. According to government estimates, the value addition in India is not more than 5-10 per cent.

In this context, the decision by Dixon Technologies to leverage the Production Linked Incentive (PLI) scheme to make upto 1 million Acer laptops in India and increase local value addition to 25%. 

10. Interesting data that once again points to India's missing middle class,

Residential property sales have been stagnant. In the eight major cities, sales have been stuck at around 3 lakh units a year since 2012 (last year it was about half that). India is second from bottom on the Knight Frank Global House Price Index. There has been no growth in the sales of passenger vehicles for 10 years — about 2.7 million units in 2012, 2.7 million in 2015, 2.7 million in 2019 and 2.7 million in 2020, according to the Society of Indian Automobile Manufacturers. The government says this is because of Uber and Ola, but ride-hailing apps have not stopped the growth of passenger vehicle sales in the United States, where they went from about 10 million in 2009, the year Uber was founded, to 17 million. In China, sales doubled from 12 million to 24 million in this same period. In India, the sales of two-wheelers have been stagnant for six years, with 16 million sold in 2015, then 17 million in 2019, and 15 million in 2020. Something that has not received attention outside of the business dailies is that sales of commercial vehicles have stopped growing, with 6 lakh sold in 2015, then 7 lakh in 2019 and 5 lakh in 2020.

This snippet on manufacturing is striking, 

Automobiles are about half of India’s manufacturing sector. Because auto sales have stagnated, manufacturing’s share of GDP fell from 16 per cent to 13 per cent after the launch of Make in India in September 2014. An analysis by the Centre for Economic Data and Analysis in May found that jobs in manufacturing halved from 51 million in 2016 to 28 million today. This aligns with the issue that is highlighted by automobile sales.

The numbers need to be checked, and if true they are disturbing.

11. Rwanda is another cow loving country, and that too with milk bars,

In 2006, President Paul Kagame introduced the “Girinka” program, which aims to give every poor family one cow. The program has so far distributed over 380,000 cows nationwide... The program (Girinka means “may you have a cow” in the local language) is one of the development projects that have garnered Mr. Kagame support nationwide... As milk production increased in this landlocked nation, so did the number of people who moved to urban areas for education and employment. And so were born the milk bars, which allowed farmers to sell their surplus milk and let customers drink copious amounts of it to be reminded of home. Most milk bars are in Kigali, the country’s most-populous city, with 1.2 million people.

Some lessons from Air India privatisation

The privatisation of Air India is a big moment. Given the tortuous two decade history of failed attempts, this is some achievement. Much will be analysed in the coming days. This post will instead confine to some observations that contradict the conventional wisdom on privatisation of public assets. 

Business Standard has the quick facts,

Some observations that upend conventional wisdom and draw attention to the complex nature of public policy making and implementation.

1. Conventional wisdom has it that privatisations are transparent and procedurally driven exercises to divest public shareholding. Frame procurement rules and set bidding terms, then bid out the asset, and market participants will compete to buy the asset. And anything involving backdoor negotiations is always vitiated and undesirable. 

The reality could not have been more different. This privatisation could not have happened without important backdoor negotiations and influencing and significant understanding on all sides. It's unlikely that the Tatas would have taken the plunge on purely commercial considerations and without its own deep legacy and existing ownership of Vistara and Air Asia. Even with the legacies, it would have required some significant prod. 

2. Conventional wisdom focuses on orthodox models of price discoveries like auctions, highest offer bids, least cost bids etc. It is a very simplified view. Instead, in reality there is a vast spectrum within which real-world privatisations happen. 

Take the example of national highways in India. It started at the turn of the millennium with the belief that governments could get private developers to build and maintain roads without incurring any public expenditure, by relying on tolls. But it slowly dawned that private investors could not assume the large construction risks. Policy then oscillated to BOT annuity models, which completely absolved private investors off any commercial risk. It took more than a decade and half to iterate and settle on hybrid models that allocated risk more fairly and efficiently. It involved a collective journey of realisation within the system and among all stakeholders.

On the same lines, the nineteen years of recurrent failed attempts were critical in convincing the decision-makers within Government of India that privatisation without assuming the vast majority of Air India's debts was impossible. The failures were a critical learning requirement for not only the decision-makers but also in shaping the public debates to accept the privatisation of the kind that has happened. This underlines the importance of path dependency in decision-making. 

3. This brings us to another conventional wisdom, one which has it that privatisations are done to unlock resources for the government. It is an article of faith that privatisation by selling public assets will always generate money for the government to spend elsewhere. 

But this one generates only a small amount in cash inflow and leaves the government with most of Air India's debt and guarantees. Instead, Air India is a great example of privatisation to cut losses. Sample this,

The government, which has invested Rs 54,584 crore since 2009-10 as cash support and Rs 55,692 crore as guarantee support for Air India, has not succeeded in turning around the company. An estimate by the government said it would cost the government Rs 620 crore per month to operate the airline, which is losing Rs 20 crore daily, said Department of Investment and Public Asset Management Secretary Tuhin Kanta Pandey.

Imagine the losses that could have been avoided with this realisation in 2009-10. But this expectation glosses over political economy realities and path dependency factors.

One can only hope that Air India creates a precedent of looking at privatisation as also a means to ring-fence and cut losses. 

4. The non-controversial nature (at least till now) of the privatisation underlines the importance of transparency and procedural credibility. Even the opposition criticism have been confined to the ideology of selling public asset, but has not been vitiated by questions of preferential treatment and corruption. 

5. Finally, as a guidance for others willing to embrace the idea of privatisation to cut losses, but avoiding going through the long-drawn path dependency of repeating tenders, a good strategy would be to undertake a reasonably long Expression of Interest (EoI) path. Issue the EoI, elicit market preferences through an objective and transparent process and then formulate and issue the Request for Proposal (RFP). Complement it with stakeholder consultations. The most critical requirement is transparency of the process and credibility of those undertaking it.

Industrial policy works - evidence from Korea

A friend points to a paper by Jaedo Choi and Andrei A. Levchenko which draws attention to the long run welfare enhancing effects of industrial policy. 

Using a natural experiment and unique historical data during the Heavy and Chemical Industry (HCI) Drive in South Korea, we find large and persistent effects of firm-level subsidies on firm size. Subsidized firms are larger than those never subsidized even 30 years after subsidies ended. Motivated by this empirical finding, we build a quantitative heterogeneous firm model that rationalizes these persistent effects through a combination of learning-by-doing (LBD) and financial frictions that hinder firms from internalizing LBD. The model is calibrated to firm-level micro data, and its key parameters are disciplined with the econometric estimates. Counterfactual analysis implies that the industrial policy generated larger benefits than costs. If the industrial policy had not been implemented, South Korea's welfare would have been 22-31% lower, depending on how long-lived are the productivity benefits of LBD... A firm receiving the average subsidy between 1973 and 1979 had a 919% larger sales growth between 1982 and 2009, amounting to a 8.6% higher annual growth rate over this period... Most of the total welfare effect (between one half and two-thirds) is due to the long-run impact of subsidies on productivity through LBD.

The HCI Drive was abruptly announced in 1972 and terminated in 1979 and had pronounced regional variations. This makes it amenable to study as a natural experiment. The policy instrument itself was the allocation of foreign credit. The Korean government strictly regulated access to foreign capital, and once firms got approval to borrow abroad the government guaranteed the loan thereby allowing them to borrow at cheaper rates than locally.

The problem with industrial policy is less the underlying theory and more the discipline of its implementation. As Joe Studwell has shown with the contrasting fortunes of North and South East Asian economies, the former succeeded with the same set of policies that the latter failed miserably. Like in South East Asia, history informs that it's very likely that any industrial policy can get captured by domestic vested interests and thereby become a fig leaf to perpetuate inefficient domestic manufacturers. This is the biggest threat to the production linked incentive scheme that government of India has initiated.

Institutions and Industrial Revolution

Pseudorasmus draws attention to an excellent essay by Davis Kedrosky on the consequences of the Glorious Revolution. Far from ushering in Industrial Revolution and an era of property rights, laissez-faire capitalism, and parliamentary democracy, as claimed by the institutionalists like Douglass North, it was a messier transition.

The institutionalist narrative was something like this - the Parliament introduced restraints on executive authority, protected property rights, encouraged entrepreneurship, promoted fiscal responsibility, created representative government, and thereby ignited the Industrial Revolution. But reality was different.

Consider this on the laissez-faire narrative,

The system of “private bills” (in the House of Commons) meant that politicians and local legal changes were essentially up for sale, and these acts composed an astonishing 70 percent of all legislation. In the early eighteenth century, special interests repeatedly won out. The Calico Acts of 1700 and 1721 restricted first the import and then the sale of printed cotton, a flagrant capitulation in favor of the wool and silk industries in the face of competitive innovations. Under an Act of 1729, beer brewers were forced to secure licensing from local magistrates, ending a once-open system for a century. Alcohol distributors continued to be favored with tariffs on French wines, while the Corn Laws were not repealed until 1846, and even included an export subsidy until 1815. After the passage of the Bubble Act of 1720, the formation of joint-stock companies was difficult and subject to strict Parliamentary approval. Oligopolies, enforced through licensing, mandatory inspections, and price controls, were often promoted for revenue-raising purposes, as their concentration eased the collection of the excise.

On representative government,

Landowners remained the paramount faction in national politics and, until the end of the nineteenth century, they were the economic winners of industrialization. Already buoyed by rising land values around coal and water power sites, they continued to extract significant rents from their legislative dominance. As tax receipts accelerated—five times faster than national product—during the eighteenth century, the land tax barely changed. The aristocracy passed on the costs of fighting Britain’s wars to the commercial middle class through the excise and customs, the extraction of which was aided by a quadrupling in the size of the fiscal bureaucracy. On finding that 179 of 189 millionaires dying between 1809 and 1859 were landed, Rubinstein (1981) remarked that “an observer entering a room full of Britain's 200 wealthiest men in 1825 might be forgiven for thinking that the Industrial Revolution had not occurred.”

On property rights, which were supposed to have lowered expropriation risks and transaction costs, and thereby encouraged investments, risk taking and entrepreneurship, 

Landownership... had been secure since the Middle Ages under the common law, and was enshrined in the Magna Carta agreed at Runnymede in 1215. Small farmers and great landowners alike regarded property rights as sacrosanct and fundamental to English freedom, and these rights could be held or transferred at will, thanks to a constellation of competing courts. By the mid-eighteenth century, agricultural expansion had been taking place for 200 years on that basis. But this security was not static; between 1750 and 1830, Parliament passed 5200 acts of enclosure, converting communal property over open fields, commons, and wastes (21 percent of the kingdom) to private forms regardless of opposition. This was not a restriction per se, but rather a transition from particularized—where assets can be used and transferred by a small set of people defined extra-economically—to generalized rights. Enclosure may have failed to generate significant short-term growth, but it did reduce feudal ownership patterns based on membership in certain social strata and created larger, contiguous blocs of land over which tenants had control over investment and cropping choices. Tellingly, enclosed farms were more likely than open to have introduced the new experimental crops of the late agricultural revolution—turnips, clover, and sainfoin. Parliament also intervened to remove land from “equitable estate,” which prohibited holders from mortgaging, leasing, or selling most of their plots.

This on the role of Parliamentary mandates in promoting infrastructure development, albeit by limiting certain property rights,

The Whigs generally represented urban financial interests and manufacturers, and in their thirty years of ascendancy, they promoted infrastructural developments—turnpikes, canals, river extensions—that tended to open up the domestic market. They were also recognized as more creditworthy by public bondholders, as reflected in interest rate movements... Acts established “statutory authorities” empowered to build, maintain, and operate public infrastructure and services and secure funding through taxes, debt, and tolls. These organizations replaced inadequate governmental entities lacking revenue-raising abilities and eminent domain, such as the sewer commissions that in the seventeenth century had to maintain river navigation without the ability to tax users or purchase land along the banks. Turnpike acts, for example, created trusts that could levy tolls on roads and mobilize labor (or the equivalent in taxes) from communities alongside them. These organizations could issue debt and equity secured by tolls, which could be claimed by bondholders if default occurred. Crucially, if landowners on the route attempted to obstruct construction by refusing to sell their plots, the trusts could appeal to commissions that forced a sale at a juridically-determined “fair price.” The mechanism eliminated the hold-up problem and was “legal origin for modern laws concerning eminent domain.” Similar solutions were devised for the construction of bridges and canals. The total number of estate, statutory authority, and enclosure acts increased from 30 per year during the 1600s to 400 by 1800. The novel characteristic of eighteenth-century landed property rights appears to have been flexibility, not rigid security.

Similarly, contrary to conventional wisdom, the role of patent protections may have been exaggerated, 

Before the system was reformed in 1852, taking out a patent in England alone cost £100 and over three times that for the United Kingdom as a whole. Moser (2007) showed that at the Crystal Palace exhibition of 1851, only 11 percent of British exhibits (and 16 percent of award winners) had successfully filed. Patents were frequently violated, a practice facilitated by judges who often deemed the holders monopolists. And in many cases, they were right to think so; Thomas Savery’s steam engine patent blocked Thomas Newcomen from getting one for his far more successful device, while James Watt used his own to delay the development of the high-pressure steam engine. “Caveats” allowed speculators to express the intention of filing a patent in an area, prohibiting future applications with actual content. Mokyr—following Nye (1991)—suggests that the importance of the system may have been that a few famous examples led inventors to innovate in the expectation of securing a patent, but which didn’t actually grant the hoped-for monopoly rights. Instead, the technical information could be freely disseminated and used. Once again, as with land use, the achievement of the British state appears to have been a fortunate flexibility, not rigid adherence to guarantees.

This summary of the distributional coalitions as described by Joel Mokyr and John Nye,

They argued that a “distributional coalition” emerged in English politics during the eighteenth century, uniting “Big Land” and “Big Commerce” in a “centralized government structure” dedicated to ripping up the feudal ancien regime and replacing it with a uniform national regulatory framework. Private acts solved hold-up problems in land use and—through infrastructural development—created a single national market, one in which inefficient local monopolies would be wiped out by firms operating with the latest technologies on a country-wide scale. Rent-seeking moved away from the regional to the Parliamentary level, preventing the installation of internal tariff barriers of the kind that plagued many Continental economies. Legislation ceased to be primarily redistributionary—exemplified by the repeal of the Calico Act in 1774—and pursued, if not the national interest, at least those of the critical wealth-holding factions represented in government. The Glorious Revolution’s establishment of Parliamentary supremacy made the body the uncontested rule-maker in the land, able to elastically supply the demand for economic reorganization.

Once these largely un-coordinated set of forces set the industrial revolution in motion, it unleashed a flood of deregulation and liberalisation, 

Statute of Artificers repealed 1814, the enumeration clauses of Navigation Acts in 1822, artisan exports in 1824, machine exports in 1843, the Bubble Act in 1825, the Corn Laws in 1846—the turning point had been reached. Liberalization was a response to the inadequacy of mercantilist and patronage-based legislation in a modernizing industrial world. Even the entrance of manufacturing interests into Parliament was probably a result of their economic success, not a precondition for it... Langford (1991) called it “a great bog of uncoordinated lawmaking, ever expanding but always unplanned.” We must also distinguish between factors that facilitated industrial change and factors that drove it. And for the latter, we need to look at different forces—at Britain’s precocious urbanization, international commercial success, and manufacturing productivity. If there were institutional sources, they lay elsewhere and operated over a much longer period than the century-and-a-half separating the coronation of William and the Congress of Vienna.

Fascinating read.

The twin problems of modern finance

This post will argue that the biggest problem with modern finance lies in the twin problems of widening degree of separation of ownership from the asset, and widening of differential between value and price. Taken together, they are the recipe for financialisation of the economy, with all its consequences outlined in The Rise of Finance. 

Consider this story. Once upon a time widgets were a precious commodity, whose ownership was coveted. But there were only a few widgets going around and there was big demand to own it. Some enterprising among the original owners decided to monetise their ownership by notionally slicing a widget into small pieces and selling those pieces in the form of notional shares of the widget. This was the first degree of separation of asset and ownership. Someone physically kept the widget, even as other people partially owned the widget. 

So a widget worth $100 was sliced into ten shares of $10 each. Slowly a market emerged in trading of widget shares, where the laws of supply and demand determined the trading price. In good economic times, as disposable incomes soared, the demand for widget shares rose and the price buyers were willing to pay for the same widget share increased sharply. This price rose much higher than the cost of producing the widget itself. In due course there was a complete decoupling of the price of a share of widget from its underlying production cost or any other kind of tangible value. This was the first differentiation between value and price of the widget. 

This gave some enterprising people other ideas. Instead of directly owning a part of a widget through a share, why not create an instrument which seeks to anticipate the price of the share? This derivative instrument would draw on the expectations of the price of the underlying share. It would have no tangible value beyond shadowing and anticipating the price of the widget share. This constituted the second degree of separation of asset and ownership. The derivative holder was two degrees separated from the original widget. 

This degree of separation and the difficulties associated with forecasting the price of the widget shares meant that the price of the derivatives themselves were even more unhinged from the original value of the widget. The more uncertainty there is about something, greater the dissonance. This was the second level of differentiation between value and price of the widget. 

In due course, more enterprising people enter the market. If a widget whose underlying value was so far separated could spawn such a market, what was the need for the widget itself? One could dream up a Widgecoin, create some hype and aspiration around it, and seek to monetise its ownership. All it needed was faith and associated willingness to buy the Widgecoins. There were precedents. The central banks issued currencies whose underlying value was merely one of faith in the sovereign. In this case, the asset had no real world existence and was a figment of the collective imagination of the market. This constituted the third degree of separation of asset and ownership. The owner was owning an asset which existed only in imagination!

The Widgecoins too spawn their derivatives. In simple terms, a buyer of a Widgecoin derivative was betting on a perception (the strike terms and price of the derivative) on a perception (the Widgecoin price) in a collective faith in a non-existent asset. It was imagination cubed. It is the third level of differentiation between the value and price of the "asset". 

The problem with such degrees of separation of asset and ownership is that it distorts incentives and also obscures information. The investor has little or no idea of the real claim of the underlying asset he's holding, and therefore the real extent of his risk. An objective pricing of risk and therefore the asset becomes impossible. Any kind of rational assessment goes out of the window and value becomes sidelined in the face of an irrational but highly salient perception contest that determines the price. The value and price separate out wide and far. 

As a note, what matters here is the "degree of separation" and "widening of differential", the extents of separation and differential. Some level of separation and differential is desirable and forms the basis for finance itself. But with financialisation, the extents of separation and differential become so excessive as to cause far more damage than good. And this happens in an environment of weak regulation and pervasive information deficits, and driven by perceptions and herd mentality of investors. 

Okay, a widget does not generate any income. There is therefore a case that its price is also its value. But replace the widget with an income generating asset like a company or an infrastructure asset. Its value can be captured by discounting its future expected incomes. The story replicates just as same. I have illustrated with the example of infrastructure finance here. The differential between valuation and pricing of startups is another. These are all examples of financialisation gone rogue. 

This post has been motivated by a friend who beautifully characterised the evolution of finance in Hindu scriptural terms and through the story of rustic Chaturanan Pandey. Initially, in the Krita Yuga, Chaturanan Pandey owned a small factory. In the Treta Yuga, Pandeyji decided to separate ownership from the asset and issue shares of his factory. In due course, the Dvapara Yuga arrived when he realised that the price of those shares had little to do with the value of his factory's production. Finally, Pandeyji achieved nirvana when he realised that he could actually make money by issuing shares in the name of a fictitious factory. The Kali Yuga had arrived. 

Weekend reading links

1. Steve Mnuchin is the latest addition to the US Government-Business revolving door,

Japan’s SoftBank has followed Saudi Arabia’s Public Investment Fund and Abu Dhabi’s Mubadala in backing a new $2.5bn private equity fund set up by former US Treasury secretary Steven Mnuchin just eight months after he left office. Mnuchin launched Liberty Strategic Capital earlier this year after serving four years in the Trump administration. The fund is intended to focus on financial services and technology... During his time as Treasury secretary, Mnuchin nurtured close ties with a number of Gulf countries. His last foreign trip in office, around the time of the January 6 attacks on the US Capitol, involved stops in Saudi Arabia, Qatar, the UAE and Kuwait. In late October 2018, Mnuchin met Prince Mohammed, despite international outrage over the murder of journalist Jamal Khashoggi...

It has become common for former Treasury secretaries to turn to private equity after leaving public office. John Snow, who served under George W Bush, moved to Cerberus Capital Management, while Tim Geithner, Barack Obama’s first Treasury secretary, is president of Warburg Pincus. Jack Lew, Obama’s second Treasury secretary, is a managing partner at Lindsay Goldberg, and Hank Paulson, who also served under Bush, is executive chair of a climate investment fund at TPG.

2.  How marginal income tax rate in the US has evolved over time.

3. From Adam Tooze's newsletter

4. Article in The Ken (or this) on the growth challenges facing MedPlus, India's second largest mostly offline Pharma retail chain. 

Gangadi had claimed that MedPlus would establish 5,000 stores by 2011. In 2015, it revised that projection upward to 10,000 stores by 2019. Today, the chain’s store count stands at just 2,100. Apollo Pharmacy, MedPlus’ fiercest competitor, has nearly double that. “A promoter is always ambitious. One can talk of 5,000 stores, but how do you get that kind of money? For each store you need Rs 20 to 25 lakh ($27,000-34,000), of which Rs 6-8 lakh ($8,000-10,850) is deployed towards capital expenditure, and Rs 15-18 lakh ($20,350-24,400) goes towards inventory. Are you geared up for this at the same time? You have to be reasonable when you come at the ground level,” says a former executive of the company.

The report indicates that while off-line chains have a 0.6-1X revenue valuation, their online only counterparts command 3-4X valuation.

5. As Angela Merkel leaves office, NYT has a feature on her 16-year term. While she has several achievements, she'll perhaps be most remembered for her bold step of admitting nearly a million migrants in 2015-16. This is a striking factoid,

Germany’s immigrant population has become the second largest in the world, behind the United States. When Ms. Merkel came into office in 2005, 18 percent of Germans had at least one parent who was born outside the country. By now it is one in four.

This summary is apt,

Many of her postwar predecessors had strongly defined legacies. Konrad Adenauer anchored Germany in the West. Willy Brandt reached across the Iron Curtain. Helmut Kohl, her onetime mentor, became synonymous with German unity. Gerhard Schröder paved the way for the country’s economic success. Ms. Merkel’s legacy is less tangible but equally transformative. She changed Germany into a modern society — and a country less defined by its history.

This is most interesting, a great example of keeping apart personal and professional choices,

“She saw where the country was going and allowed it to go there,” said Roland Mittermayer, an architect who married his husband shortly after Ms. Merkel invited conservative lawmakers to pass a law permitting same-sex marriage, even though she herself voted against it... Ms. Merkel never backed same-sex marriage outright, but she allowed lawmakers to vote for it, knowing that it would go through.

6. Tamal Bandopadhyay has a very good primer on the new bad bank, the National Asset Reconstruction Company Limited (NARCL). It would aggregate bad assets and manage them till their resolution. In return for the assets, NARCL would offer banks 15% of the value in cash and 85% in the form of Security Receipts, and receive a government guarantee of Rs 30,600 Cr. An India Debt Reconstruction Corporation Limited (IDRCL) which is majority owned by the private sector, would then take the bad assets off the NARCL balance sheet and resolve them. In the first phase, Rs 2 trillion worth assets are being transferred to NARCL from the banks. These assets have been valued at 18% or Rs 36000 Cr, thereby leaving banks with Rs 5400 Cr in upfront cash receipt. NARCL will have a tenure of five years to resolve these and other assets subsequently transferred to it. 

This promises to be one of the most interesting experiments in India's financial markets. How much will the banks ultimately recover from this process? What share of assets will be revived and what will have to be liquidated? What incentive and other distortions will emerge from this in the financial and political markets? How good will NARCL and IDRCL be in their corporate governance? Can the IDRCL avoid either willingly or unwillingly being captured by private equity and other financial market interests? Will the IDRCL be able to avoid crony capitalist tendencies? 

7. Interesting graphic highlighting the shifting composition of farmer incomes

The three important takeaways - the share income from farming itself is declining and only a little more than a third of the farmer's income; the share of income from non-farm business has almost halved; and the shape of income from animal husbandry has quadrupled. 

8. This's a stunning data about corporate democracy in Indian board rooms,

194 of the 48,000+ resolutions (less than 0.5 per cent) assessed by IiAS in the last six years have been turned down.

The reasons can be found in the data on the ownership and voting patterns in listed Indian companies. 

For all the occasional headlines, promoters remain firmly in the saddle. Just 8% of NSE 500 companies are institutionally owned and held widely. 

9. Britain's truck drivers shortage has caused gas stations to run dry,

The government is sending out a letter to nearly 1 million people who hold a license to drive a heavy goods vehicle, urging them back onto the road. And it is relaxing visa restrictions for thousands of foreign workers, in the hope of luring them into temporary work in Britain... Tens of thousands of drivers from the European Union have left the country — in large part because Brexit made it clear they were not wanted — and prospective drivers couldn’t take their qualification tests for over a year because of the pandemic. Long dominated by men, the drivers industry has done little to add women to its ranks. As a result, Britain has a shortage of up to 100,000 truck drivers, according to the Road Haulage Association... Prime Minister Boris Johnson upended his post-Brexit immigration rules when he approved the issuance of five thousand temporary visas for foreign drivers until the end of the year... 

For truck drivers who have long felt underappreciated and increasingly stressed by difficult work conditions, lower pay and neglected truck stops, the fact that employers are struggling to find workers wasn’t a surprise... The emergence of long-overlooked drivers as an essential cog in the nation’s economy is reminiscent of the first year of the pandemic. Workers who had been considered low-skilled and who were poorly paid — many of them migrants — captured the nation’s attention and gained newfound respect. Across Britain, people came out onto their doorsteps to clap for National Health Service workers. Supermarket assistants and public transport employees were no longer invisible, and featured on the front covers of publications like British Vogue. 

10. A new study by Krishna Kumar Choudhary, Sayan Das, and Prachinkumar Ghodajkar uses data from three rounds of the National Family Health Survey (NFHS) (II 1998-99, III 2005-06, and IV 2015-16) to show a trend of decline in heights among women and men in India. A summary,

Between NFHS-III (2005-’06) and NFHS-IV (2015-’16)... women between 15-25 saw a decline in their mean height by 0.12 cm, while women between 26-50 showed an improvement by 0.13 cm. During the same period, men between 15-25 saw a decline of 1.10 cm in their mean height and those between 26-50 years had a decline of 0.86 cm... For women in the ages 15-25, between NFHS-III and NFHS-IV, the average height of tribal women saw a decline of 0.42 cm while women from the poorest wealth fell by 0.63 cm. This is significantly worse than the average decline for the entire age group (0.12 cm)... In the age group of 26-50, women from the poorest wealth category saw a significant decline in their average height – 0.57 cm – while women from the middle, richer and richest wealth categories saw their average heights improve. Women from urban areas saw their average heights improve by 0.20 cm while rural women only saw an increase of 0.06 cm.

However, a friend informs that the magnitude of the decline is tiny and perhaps not meaningful enough to draw any inference.