Weekend reading links

1. For all practical purposes Apple appears to be a Chinese company. Tim Cook has ensured the near complete surrender of the company to the Communist Party. Jay Newman writes in FT Alphaville that the biggest driver of its share price may be the close relationship Cook has cultivated with China.

Entente cordiale with the Chinese Communist party affords Apple a charmed existence when it comes to manufacturing and selling products in China... Cook has embedded Apple ever deeper in China over the past 20 years. After inking a secretive 2016 agreement to invest $275bn in China’s economy, workforce, and technological capabilities, the iPhone became a best-seller. In reality, Apple is now as much a Chinese company as it is American. Almost a fifth of its revenue comes from sales in China, and operating profits in greater China — Hong Kong, Macau, Taiwan, and the mainland — topped $31.2bn in 2022. That’s a hefty chunk of Apple’s earnings (though given the near impossibility of getting large sums out of China, those profits may not even be money good). Apple provides more than cash and intellectual property. Relations are enhanced by the credibility Apple’s brand bestows on a repressive, autocratic state, and the (cough) flexibility it demonstrates in supporting CCP objectives. When it comes right down to it, Apple just can’t say no...

Apple is tiptoeing — frantically — towards the exit: moving production of iPhones to India, AirPods to Vietnam, Macs to Malaysia and Ireland... But these efforts seem futile: Apple likely will never be able to completely exit China. Even small shifts risk retaliation by Chinese overlords who might retaliate by turning Chinese consumers against Apple products. Will China — which has contributed hugely to Apple’s success — allow it to slink away? Why would they? These are problems Apple made: for the foreseeable, Apple has no choice but to do what China wants.

I would not be surprised if Apple becomes an example of how corporate greed and lack of foresight brought about the downfall of the world's largest company and its most famous brand.

2. In another article Newman and others points to the problem of US companies in China not being able to repatriate their profits back. 

As a practical matter, from the perspective of capital investment, that makes China a roach motel: you can get money in, but you can’t be sure of how, when, or at what value you’ll be able to get it out. The renminbi isn’t freely convertible. So, as a threshold matter, Chinese regulators not only control the price of the currency but, implicitly, the value of investments. More important: withdrawal of capital and the repatriation of profits through dividends are discretionary. Chinese law forbids anyone from sending more than $50,000 out of China in any given year without government approval, and the Chinese state controls an extensive bureaucracy that administers those rules. If the CPC is feeling anxious about hard currency reserves, the payment of dividends to foreign investors may not be its highest priority. And, if a sanctions regime against China or Chinese entities expands further, all bets are off... There is nevertheless an argument for Western companies’ Chinese cash to be viewed as a stranded asset — and accounted for as such. In the event of a hotter Cold War, foreign investments in China could be held hostage, and the ability to repatriate significant amounts of capital could devolve, without much warning, into coerced transfer of technology and a geopolitical quagmire.

The reason why US companies continue to invest in China appears to be because the financial markets value it

Even without much evidence as to how much Chinese revenues actually contribute to the bottom line, financial markets appear to prize it. Back-of-the-envelope calculations suggest Western investors ascribe significant value to Chinese revenue on the books of Western companies — far more than the value ascribed to equivalent sales by their Chinese counterparts. A simple price-to-sales ratio points to Chinese revenues booked by Western companies being worth 50 per cent more than they would be on the books of Chinese entities...

Through the magic of arbitrage, international capital markets can be used to transform Chinese revenue from indistinct income statement entries into opportunities for Western executives and shareholders to sell their shares on American and European stock exchanges. Stranded revenue from sales within China has been a boon to the share values of Western companies: illusory Chinese renminbi have become dollars and euros.

It's only a matter of time before the high valuations of US companies investing in China would revert to their true valuations. Apple may be the biggest loser. 

3. In a definitive break from the past, the US National Security Advisor Jake Sullivan made it clear that it's not the US Government's responsibility to protect US business interests in China, thereby signalling a clear discouraging of US business investments in that country. 

“Our priority is not to get access for Goldman Sachs in China,” Sullivan said at the White House. “Our priority is to make sure that we are dealing with China’s trade abuses that are harming American jobs and American workers in the United States.”

4. Europeans tighten scrutiny of Chinese investments in Europe

Chinese investment into Europe fell to its lowest point in almost a decade last year as European countries tightened rules to stymie a slew of Chinese acquisitions. The 22 per cent decline in investment in 2022... reflects Europe’s recent moves to police the sale of assets to China after years of enthusiastically courting investment from Beijing. The researchers found that at least 10 out of 16 investment deals pursued in 2022 by Chinese entities could not be completed in the technology and infrastructure sectors, principally because of objections raised by authorities in the UK, Germany, Italy and Denmark. Several of the aborted deals, such as proposed semiconductor acquisitions in Germany and the UK, were blocked following reviews into the specific technology targeted by the Chinese investor... The overall level of Chinese investment into the EU and UK declined 22 per cent to €7.9bn in 2022, the report said. The level of investment was a fraction of the €47.4bn recorded in 2016 and the lowest total recorded since 2013. The totals include investment into new operations as well as mergers and acquisitions.

5. The Chinese government has made it an art to say one thing in public and pursue another thing in private. The latest is the efforts to woo back private investments being accompanied by restricting access to information and raids on foreign companies. Sample this about raids on the expert network group Capvision which was shown primetime on national television,

Capvision specialises in connecting international investors and management consultants, such as those from Bain and McKinsey, with its network of 450,000 subject specialists. More than 500 of the 700 employees of the company, which was founded in 2006, are based in the mainland, according to public records... Billed by state media as part of a nationally co-ordinated campaign to clean up the consulting industry in the world’s second-largest economy, it follows other raids in recent weeks on blue-chip US firm Bain & Company and due diligence group Mintz. The campaign is making it more difficult than ever for foreign investors to glean even basic information on potential acquisitions, Chinese partners or suppliers. That is at least partly by design as Beijing also methodically curtails foreign access to once openly accessible public data such as academic theses and business ownership records. The clampdown comes despite a charm offensive by Li Qiang, China’s second-ranked leader after President Xi Jinping, to woo foreign and private investors back to the country after coronavirus pandemic controls crushed growth last year...

The clampdown on expert networks comes as China has cut off foreign access to data, ranging from shipping transponders that relay global supply chain information in real time, to public databases. Last month, the country’s largest academic database CNKI, home to university theses, dissertations and other academic papers, began blocking foreign access. Private and government-run databases with Chinese corporate information, patent information, court records and procurement tenders have also snapped shut.

These raids and their public screening have been sought to be rationalised as over-kills by the lower level bureaucrats on directions from the top. To an extent lower level bureaucrats tend to overdo stuff. But in a tightly run ship as China is, if the over-kills end up hurting the purpose of the leadership to attract back foreign investors then it's difficult to believe that they would not rein in such overkills. Besides, the airing of the raids on primetime television should leave us in no doubt about the intentions of the Chinese authorities to send out a strong message to its own citizens against sharing any information with foreigners. 

Beijing believes that it can pull off the contradictory actions of wooing investors on the one side while undertaking raids and clamping down on ease of doing business for foreigners, because it feels foreign investors are greedy and short-sighted and will collectively overlook such actions when wooed individually by the Chinese government.   

See also this long read on how restrictions on travels and information access is making it difficult for Americans to understand the latest trends and issues in China.

6. Rana Faroohar has some numbers on China's concentrated market power in important sectors,

According to a 2022 US-China Economic and Security Commission review, 41.6 per cent of US penicillin imports came from the country, which also has 76 per cent of global battery cell manufacturing capacity within its borders, 73.6 per cent of permanent magnets (a critical component of electric vehicles), and from 2017 to 2020, supplied 78 per cent of US imports of rare earth compounds.

Given the pervasive concentration in markets, Faroohar writes

I’m beginning to think that we should institute a new market principle that Barry Lynn, the head of the Open Markets Institute, an antimonopoly think-tank in Washington DC, calls “a rule of four”. In crucial areas, from food to fuel to consumer electronics, critical minerals, pharmaceutical products and so on, no country or individual company should make up more than 25 per cent of the market. What’s more, countries should apply this rule both locally and globally.

7. Quiet transformation in the Business Process Outsourcing sector in Philippines.

Before the pandemic, 75% of the Philippines’ IT professionals worked in Metro Manila—the centre of BPO companies since the early 1990s. Now, it’s down to 50%, according to real-estate services provider KMC Savills... In 2022 alone, it generated a revenue of US$32.5 billion, more than 8% of the national GDP... The exodus is spreading BPO facilities across the nation as prospects for growth emerge in other regions... The migration from Manila started in 2020. However, the homecoming of workers has accelerated only recently... In 2022, 31% of BPO jobs were located outside Manila, 17 percentage points higher than in 2021... BPO companies are relocating because of a basket of reasons. One main motivator is that their staff have stronger spending power outside of Manila, and costs for those operators are lower in other major cities. It’s an equitable situation for everyone involved. Meanwhile, a new breed of companies—knowledge outsourcing process services like animators, game developers, and telehealth providers—is slowly filling in the physical void left behind by BPOs that have departed Manila... KPO service providers handle tasks that cannot be automated and require more specific skill sets, such as animation, game development, and telehealth.

8. More signals of worsening trends in American health care industry. This time NYT reports that large corporations and health insurers are gobbling up small primary health care practices.

CVS Health, with its sprawling pharmacy business and ownership of the major insurer Aetna, paid roughly $11 billion to buy Oak Street Health, a fast-growing chain of primary care centers that employs doctors in 21 states. And Amazon’s bold purchase of One Medical, another large doctors’ group, for nearly $4 billion, is another such move. The appeal is simple: Despite their lowly status, primary care doctors oversee vast numbers of patients, who bring business and profits to a hospital system, a health insurer or a pharmacy outfit eyeing expansion... The growing privatization of Medicare, the federal health insurance program for older Americans, means that more than half its 60 million beneficiaries have signed up for policies with private insurers under the Medicare Advantage program. The federal government is now paying those insurers $400 billion a year... It’s a one-stop shop for all your health care dollars...

The absorption of doctor practices is part of a vast, accelerating consolidation of medical care, leaving patients in the hands of a shrinking number of giant companies or hospital groups. Many already were the patients’ insurers and controlled the distribution of medicines through ownership of drugstore chains or pharmacy benefit managers. But now, nearly seven of 10 of all doctors are either employed by a hospital or a corporation, according to a recent analysis from the Physicians Advocacy Institute. The companies say these new arrangements will bring better, more coordinated care for patients, but some experts warn the consolidation will lead to higher prices and systems driven by the quest for profits, not patients’ welfare.

Insurers say their purchase of medical practices is a step toward what is called value-based care, with the insurer and doctor paid a flat fee to care for an individual patient. The fixed payment acts as a financial incentive to keep patients healthy, provide more access to early care and reduce hospital admissions and expensive visits to specialists. The companies say they favor the fixed fees over the existing system that pays doctors and hospitals for every test and treatment, encouraging doctors to order too many procedures.

Under Medicare Advantage, doctors often share profits with insurers if the doctors take on the financial risk of a patient’s care, earning more if they can save on treatment. Instead of receiving a few hundred dollars for an office visit, primary care doctors can be paid as much as $14,000 a year to manage a single patient.

More evidence of the corrosive effects of private equity in health care. Envision, a hospital staffing company owned by KKR is lurching towards bankruptcy after "crumbling under the weight of a $7 billion debt load it accumulated as part of its 2018 buyout".

9. After oil, the new area for tension between India and west could be on diamond trade. The west, led by the US, is exploring ways to establish traceability and restrict diamond exports from Russia, the world's largest diamond miner. Russian diamonds, from the world's largest diamond mining company Alrosa, find its way into Surat which polishes 90% of the world's diamond supply. Russian diamonds, which are smaller in size and therefore require more people to cut and polish, are the main source of employment in Surat. The diamond industry employs around 1 million people in India.

10. TT Ram Mohan examines the US Federal Reserve's report on the Silicon Valley Bank failure and draws lessons for India

The RBI's... intrusive approach is a better safeguard for banking stability than the light touch elsewhere. However, supervision can only be a third layer of defence against bank instability. Regulations are the primary layer, followed by the board. The RBI must find ways to get bank boards to do a far better job. A radical change would be to alter the way independent directors are appointed at banks. At present, the promoter or CEO has the dominant say in the appointment of independent directors (at both private and public sector banks). The RBI may want to insist that, for instance, one independent director be chosen by institutional investors and another by retail shareholders (from a list of names proposed by the Financial Services Institutions Bureau). Until we have independent directors who are distanced from the promoter and management, it’s unrealistic to expect board oversight to improve.  

The RBI is hosting a conference for bank directors later this month. Here are two suggestions. One, in the interests of transparency and accountability, the RBI may want to commission a review of the failures at IL&FS and Yes Bank. Two, it may prescribe the FRB’s review of SVB’s failure as one of the “readings” for the conference. It may also include the report of the UK’s Financial Services Authority on the failure of Royal Bank of Scotland during the GFC. At least, bank directors can’t say they weren’t warned.

11. Latest data from the implementation of the IBC

According to the Insolvency and Bankruptcy Board of India (IBBI), 611 insolvencies that yielded a resolution plan by the end of December 2022 took, on average, 482 days. Similarly, about 1,900 cases that went for liquidation took, on average, 445 days. There is clearly a need to reduce the amount of time taken to resolve insolvencies.

12. India warehousing market facts of the day

India’s warehousing stock of grade A and B facilities has grown to 330 million sq ft today, from 140 million sq ft in 2017, according to estimates by JLL, a property advisory... The US added 333.8 million sq ft of new warehousing space in 2022 alone—that’s higher than India’s overall warehousing stock as of now... ... while 51.8 million sq ft of warehousing space was leased in 2021-22 in the eight primary markets, through grade A and B warehousing, another 15 million sq ft was leased across India’s 13-15 secondary markets.

13. Vivek Kaul points to the latest data set on India's small consumption class,

As the Indus Valley Report 2023published recently pointed out, 1% of Indians take 45% of flights, 2.6% of Indians invest in mutual funds, 6.5% of users are responsible for 44% of UPI transactions, and 5% of users account for a third of the orders placed on Zomato. As Zomato recently reported: “Customers with annual order frequency >50 as a % of annual transacting customers have increased from 1.4% in 2018 to 4.7% in 2022." Basically, this means around 5% of Zomato’s customers order from it at least once a week. So, as the Indus Valley Report points out: “Much of the consumption is driven by a tiny super-user set… [The] broad user base narrows sharply when it comes to paying users."

This is the Indus Valley Report 2023 mentioned. This graphic is interesting and highlights the point about the small consumption class.  

The rise and rise of JP Morgan and BlackRock

The global financial markets are dominated by two institutions as never before - JP Morgan Chase in banking and BlackRock in asset management. The two institutions are bigger than too big to fail, and their Chief Executives Jamie Dimon and Larry Fink command extraordinary influence in policy making. They are the two individuals policymakers in the US turn to at times of financial market distress. In fact, it would not be a hyperbole to say that in some areas they are the market itself.

The recent decision by the US Government to sell the failing First Republic Bank to JP Morgan makes the latter even more systemically important. With this, in the space of 15 years, JP Morgan has been responsible for taking over Washington Mutual in 2008 and First Republic Bank, the largest two bank failures in US history. 

This is a brief description of the First Republic deal

The First Republic deal was different from the structures agreed for Silicon Valley Bank and Signature Bank, the two lenders that collapsed in early March, but similar in that it was another ad hoc solution to the sector’s problems. All deposits were taken over by JPMorgan, which meant the US government did not have to declare the bank a “systemic risk” to protect deposits over the $250,000 guarantee limit. At the same time, JPMorgan secured a loss-sharing agreement with federal regulators to avoid any hit from the most problematic loans on First Republic’s books, a crucial sweetener for the buyer.

The bank now holds slightly less than 15% of all US banking sector deposits. This further increases the too big to fail (TBTF) moral hazard. Its rise in recent years has been meteoric

JPMorgan today, with $3.7tn in assets and 250,000 employees, is the result of a centuries-long consolidation process. Its heritage includes a company started by the US founding father Alexander Hamilton, the investment bank run by legendary financier John Pierpont Morgan as well as lenders that financed the Erie Canal, the Brooklyn Bridge and the UK and French armed forces in the first world war. Even as recently as 1991, the retail bank that would eventually become a global banking juggernaut had only $37bn in deposits. The group now has almost $2.5tn and its market share has grown by 10 times, from 1.5 per cent to 14.4 per cent.

... it was under Dimon, who joined the bank in 2004 when it took over Chicago-based Bank One, that the group really pulled ahead. JPMorgan is now the largest bank in the US by assets, deposits and market capitalisation, with Chase bank branches in 48 states. It also earns more from investment banking fees than any other Wall Street bank, consistently outranking Goldman Sachs, Morgan Stanley and Bank of America.

Max Abelson and Hannah Levitt (HT: Adam Tooze) wrote this in Bloomberg about JP Morgan and Jamie Dimon,

If you’re tempted to compare it to BlackRock Inc., remember that the money manager’s $9 trillion of assets are in funds it oversees for clients. JPMorgan, by comparison, finances the world (and has an asset management operation that’s itself about a third the size of BlackRock). And it processes more than $5 trillion of payments a day. You can think of it as an empire all its own. Bloomberg Opinion columnist John Authers goes further, calling Jamie Dimon the sun around which the financial system revolves and describing JPMorgan as a kind of public utility, big enough for the government itself to depend on... 

Dimon likes to say that the bank has a fortress balance sheet, an image that political economist Mark Blyth elaborates on. “If the only game in town is a medieval fortress, I want to be inside,” says Blyth, who runs the William R. Rhodes Center for International Economics and Finance at Brown University. “Hey, we have the castle. Don’t you want to be in the castle? It’s dangerous out there.” In the first three months of the year, as other banks saw savers depart, deposits at JPMorgan rose. But there’s a problem with everyone wanting to be in the castle. “What happens if the castle walls get breached?” Blyth asks. “We’re all screwed.” Economic power in the US runs in eras. As Blyth puts it, after World War II, when society more or less had to be rebuilt, the fiscal capacity of the US Treasury dominated. When inflation became the enemy and the Fed had the power to fight it, fiscal dominance gave way to monetary dominance. Now too-big-to-fail banks’ becoming bigger could usher in something new. “We may be in a world of financial dominance,” he says. “I don’t know, but it sure smells that way.”

JP Morgan took over First Republic in an auction that had three other smaller banks, PNC, Citizens Bank, and Fifth Third, whose combined assets were less than a third of JP Morgan's. The bid parameter was the least loss to the FDIC, and JP Morgan's was the cheapest at $13 bn of estimated loss. But as the FT article writes, the sheer size of JP Morgan put it at a clear advantage compared to the three competitors. Besides given its sheer size, the Treasury and regulators would have naturally thought that a takeover by JP Morgan would have had a greater confidence-building effect on the banking system. Patrick Jenkins highlights the problem with such thinking 

The Federal Deposit Insurance Corporation, which manages US bank failures and administered the First Republic transaction, made clear JPMorgan had won the deal ahead of other bidders, essentially thanks to its heft. It could afford to offer a better value package to the FDIC — and the organisation has a legal duty to choose the “least-cost” solution. But this is a self-perpetuating argument, and with the banking turbulence of recent months turning into a full-blown regional banks crisis, JPMorgan could well become the natural buyer of other troubled banks. That feels neither healthy nor sustainable. Respecting the “least-cost” law, without considering the longer-term bigger picture, is myopic.

This is perhaps an example of an instance where the government and regulators in the US ought to have kept life-cycle cost (instead of current cost-benefits) as a factor in their decision. It's one thing to ask JP Morgan to take over when nobody was willing (and JP Morgan had declined to take over Silicon Valley Bank at the height of the current banking crisis), but an altogether different thing to hand over the failing bank to JP Morgan when there were others willing to do so. Even at a higher cost, the regulators could have avoided JP Morgan and sent out a message. But that's unlikely given the political capture of decision-making in the US by Wall Street and Big Tech interests. 

It also highlights how deeply entrenched the moral hazard of bailouts has become in the US. As Ruchir Sharma and others have pointed out, it's become all too evident that the policymakers are too scared of letting anything fail that they'll anyways come up with a bailout at the end. And the market participants have internalised this belief. 

All failures have costs. But such bailouts have even greater costs. The real issue is this - do you want to suffer the immediate pain of a bank failure, or invite much bigger long-term harm through distortion of incentives and encouragement for recklessness which erodes the disciplining powers of financial markets and irreparably weakens the foundations of capitalism?

The rise of BlackRock in the asset management industry has been even more meteoric. Founded in 1988 as Blackstone Financial Management, it really took off after the global financial crisis. This is a good primer. 

Its assets under management have risen spectacularly since the financial crisis, more than quintupling to briefly touch $10 trillion in early 2022. 

This while a bit dated (from November 2020) is still relevant 

The hit to the big banks from the 2008 financial crisis allowed it also to swoop on Barclays Global Investors, then the world’s largest fund manager, in time for the longest bull market in equities since the second world war. That acquisition included iShares, the exchange traded fund unit that has grown seven-fold on the back of a massive shift to passive investing and now accounts for a third of BlackRock’s assets. The iShares unit now accounts for 40 per cent of global ETF assets...

BlackRock amounts to a perpetual reinvention machine that has continually added new sources of growth, most recently from technology services to investors, including chunky contracts for its Aladdin risk management platform. Its $1.3bn acquisition last year of eFront, a risk analysis company, was the biggest deal for BlackRock since the Barclays purchase. The combination of economies of scale from client inflows and these new tech revenues allowed BlackRock to set a new record for operating margin in the third quarter, which at 47 per cent would draw the envy of the tech companies that have led the market this year

The most stunning graphic is this below - BlackRock on its own is about the size of all of the hedge fund and private equity and venture capital industries combined. 

Its AUM has recovered to $9.1 trillion after a decline of $1.4 trillion in 2022, and the Fund is actively engaging on the alternatives side, an area dominated by the likes of Blackstone and KKR. It recently tried and failed to buy Credit Suisse. 

Like with JP Morgan, BlackRock's large size gives it enormous advantages. It's amplified by its presence across the spectrum - asset management, ETF wealth management platform, risk management platform, advisory services, etc. As an illustration, its advisory arm was selected by the FDIC to help sell $114 bn portfolio of securities (mortgage-backed securities, collateralised mortgage obligations, and commercial mortgage-backed securities) inherited after the government takeover of Silicon Valley Bank and Signature Bank. 

BlackRock’s Financial Markets Advisory arm has long been the go-to team for central banks and governments when they need to deal with messy assets acquired during financial rescues. The financial powerhouse helped the US sell off assets from the 2008 collapses of Bear Stearns and AIG, evaluated troubled banks for the Irish and Greek governments, and advised both the Fed and the European Central Bank on asset purchase programmes.

Business transactions involving the Advisory arm and Aladdin feed into BlackRock's asset management business in many direct and indirect ways, and confer it an unfair advantage. In the circumstances, it's again not clear as to why BlackRock should have been selected for such sales, when the same could have just as well been done by others, perhaps at a slightly higher cost. 

BlackRock is also one among the Big Three that dominate the global asset management industry, the others being Vanguard and State Street Global Advisors. A paper by Lucian Bebchuk and Scott Hirst found

We document that the Big Three have almost quadrupled their collective ownership stake in S&P 500 companies over the past two decades; that they have captured the overwhelming majority of the inflows into the asset management industry over the past decade; that each of them now manages 5% or more of the shares in a vast number of public companies; and that they collectively cast an average of about 25% of the votes at S&P 500 companies... We estimate that the Big Three could well cast as much as 40% of the votes in S&P 500 companies within two decades. Policymakers and others must recognize — and must take seriously — the prospect of a Giant Three scenario.

As an update

As of the end of 2021, the Big Three collectively held a median stake of 21.9% in S&P 500 companies, which represented a proportion of 24.9% of the votes cast at the annual meetings of those companies. 

In their latest paper, Bebchuk and Hirst refute with great detail the arguments against systemic risk creation and market concentration by the Big Three officials, and caution at the rising power of the Big Three. They argue that the diffused ownership in public companies and the prevailing market structure present the Big Three with the ideal conditions to influence major corporate decisions. 

Even among the Big Three, BlackRock tops in its market influence,

Given that many shareholders don’t actually bother to vote at annual meetings, BlackRock, Vanguard and State Street now account for about a quarter of all votes cast on average, which will rise to 41 per cent over the next two decades, the academics estimated... In reality, calling it the Big Three is a misnomer. State Street’s inclusion is the legacy of its invention of the ETF, and its size and growth rate is far more modest than BlackRock or Vanguard’s. In practice, there is an emerging duopoly, and BlackRock’s pole position — and Fink’s willingness to throw its heft around more than Vanguard — has made it a target across the political spectrum... A host of former government officials work at BlackRock, and others have departed for plum jobs in the Biden administration. To some critics, BlackRock is the new Goldman Sachs.

The Big Three's power is amplified by the rise of ETFs. BlackRock is the world's largest ETF fund manager. ETFs, like other index funds, have a unique issue - the underlying stocks of an index fund are not owned by the retail (and other) investors who buy the index fund, but by the fund manager, who there also owns the vote. This makes the fund managers of passive funds massively influential in so far as becoming a large voting shareholders in many companies. A US Senate working paper has documented several instances of strategic voting by the Big Three in the name of "investment stewardship". The paper makes several recommendations, mostly to enhance transparency and disclosure by the Big Three. 

I can think of at least three problems with size on its own, each of which in itself is sufficiently strong enough to discourage corporate bigness, especially but not only in financial and technology markets. One, apart from the economies of scale, the magnitude of their size confers on these institutions several implicit advantages, including the cheaper cost of capital, preferential access to talent and market resources, leverage over the market ecosystem, additional margins for risk assumption, preferential treatment by regulators, and a carte-blanche backstop arising from too big to fail. 

Two, given the complex and deeply interconnected nature of financial markets, institutions of the size of JP Morgan and BlackRock are too big to manage. These are bigger than all but a couple of countries. Three, a size of such magnitude is invariably accompanied by a seat at the top of the decision-making table. Given the stakes involved and the inexorable dynamic of market incentives, such access invariably translates into being able to decide the rules of the game. Such political capture corrodes capitalism and democracy. 

The behemoths among Wall Street and Big Tech companies are the most egregious exhibits. It's time that regulatory scope expands beyond present and future consumer welfare and looks at these far more dangerous factors. 

Ten things on development that conflicts with conventional wisdom

For an insider looking at the development discourse, there are several misconceptions about the theory of change in development, about how ideas get adopted and implemented. 

This post will highlight ten important aspects of the development discourse where reality runs contrary to conventional wisdom. Some of them have been very clearly articulated by Lant Pritchett in his works.

1. Evidence-based policymaking may be the most misleading phrase in today's development discourse. In reality, evidence has only a very marginal role in policymaking. 

Political economy and other factors prevent the termination or significant modification of any flagship program even if there is clear evidence that it's not generating impact. And new policies and programs in any major area, as we will see next, are very few.

Further, evidence of headline efficacy of an intervention is almost completely irrelevant, given the countless confounders associated with any implementation. Instead, the importance of evidence lies in triggering and contributing to debates that gradually change opinions. In other words, evidence contributes to the gradual creation of a body of knowledge on the issue. 

The most effective evidence is that which is of proximate relevance as decision-support in policy making and, especially, in implementation. This comes from the analysis of administrative data from implementation, comparative data, benchmarks and norms, historical records, etc. Unfortunately, these are also not considered rigorous or serious enough to be accepted as 'evidence' in the rarefied environs of development research. I don't recollect a single peer-reviewed paper in a reputed journal in recent years that has its findings based on administrative data analysis. 

2. Effective development is mostly about doing things better and only marginally about doing new things. 

Even with all the technological advances and other changes over time, the basic processes of most development interventions - learning and skilling, maintenance of cleanliness and hygiene, maternal and child health care, children's nutrition, agriculture productivity enhancement, women's empowerment, maintenance of law and order, targeting and selection of welfare beneficiaries, etc - remain the same and cannot also be done any differently. For sure, the contextual changes can marginally impact the core activities. However, given the low baseline of implementation quality and outputs in all these areas, instead of struggling to figure out the implementation of a new approach (which also requires strong state capabilities), it's better to improve capabilities to execute the familiar processes better. This is likely to generate the greatest marginal impact. In general, to move a system from poor or average to good, doing things better may be the most appropriate strategy. 

Further, in reality, those ideas presented as new interventions are either tinkering with an ongoing intervention or marginal addition to the main intervention. So, for example, new interventions like nudges to change behaviours and increase uptake are almost always marginal complements and cannot be a substitute for the core tasks. 

Wanting to change and do new things is a common human reflex when things are not going well. This urge is reinforced by modern management theories and the practices followed in the private sector. However, like with the other New Public Management ideas, this too has its limitations in the context of development.

Therefore, on average, new is required only as a distant secondary addition to primarily doing more of the same better. 

3. In the aggregate, it's more useful to be banal than be innovative in development implementation. 

Innovations are mostly of relevance in the field of product development, whereas in the case of economic development improvisations may have greater relevance. While development also involves products (IT systems, medical drugs, etc), it's mostly concerned with processes and their implementation. Unlike innovations which generally tend to emerge suddenly as mutations, improvisations tend to happen iteratively. 

Further, most often, innovations are a distraction, which displaces effort and resources from real tasks. The design and implementation of innovations require considerable systemic bandwidth. 

4. Policy implementation is much much more important than policy formulation, except in a handful of areas. And the main problem in development is pervasive implementation deficits. Most policies and programs fail due to bad implementation (and not bad design). 

The design space for policy formulation is much smaller than the possible degrees of freedom in its implementation. The scope for getting things badly wrong in implementation is far greater than getting the design completely wrong. In fact, it's rarely the case that the policy design is very bad unless it's a conscious choice. But implementation strategy can be flawed or weak in several ways, and its execution can go wrong in even more ways. 

5. The adoption and implementation quality of an intervention/program differ widely, translating into variable outcomes. This conflicts with the assumption and requirement of uniform outcome expectations. 

This expectation of uniform adoption, implementation, and outcomes shrinks the space available for experimentation and failures. It encourages officials to game the processes and manipulate data to mislead monitoring. 

Instead, we should be comfortable with variable implementation and outcomes. The strategy should be to engage actively with the implementation, collect feedback on what's going right and wrong, rectify the mistakes and adapt implementation processes, and iterate continuously. Successful implementation is almost completely dependent on the quality of this iterative adaptation.

Such iterative adaptation is also one reason to discount the obsession with getting the best policy design since the design features can be refined during implementation. 

6. A very important requirement for successful implementation is not the accounting of the accountability, but the account within the organisation of the accountability. 

Any implementation is monitored using a logical framework of accounting that's used to fix accountability. It's believed that such tight top-down monitoring can ensure effective implementation. But this belief is flawed on at least two counts. One, this log frame cannot capture the important small details of implementation, especially involving the aspects of quality, which are critical to the success of the intervention. Two, even if they can be captured for monitoring, in interventions where quality is of the essence, these aspects are not amenable to top-down direction. 

Instead, successful implementation requires organisational commitment to the cause or the account of accountability. This depends on the ownership, motivation, and intent of the individual officials and the collective organisational purpose. Both are endogenous and feed on each other. 

In fact, the inherent top-down control preference of a bureaucracy ends up conflicting with the bottom-up account cultivation requirement for successful implementation.

7. Effective implementation of new ideas, technologies, and interventions requires high state capability. State capability is the binding constraint to the adoption of reforms and execution of new ideas. 

Except in a few cases like certain legislative enactments, deregulation, and new drugs, where implementation is like turning on a tap, the vast majority of new development interventions require continuous and high-quality engagement by the system. This is particularly so with IT interventions where the initially installed design version will need to be debugged and iteratively improved for some time before we can get it right. This iteration will also help overcome the inevitable gaming by the entrenched vested interests who stand to lose from the new intervention. 

8. Most policy design and implementation decisions are exercises of judgment and not about making technical choices. Technocracy is unlikely to substantively improve development outcomes. 

There are very few cut-and-dry issues and contexts in development policy design and implementation. Decisions will have to be made under conditions of considerable uncertainty. These decisions are then about weighing the different technical and other factors and exercising good judgment. Good judgment is also about the experience. It requires the application of both expertise and experience and not merely expertise (technocratic). 

9. The most important factor in the process of getting policies approved or pushing reforms is not its technical merits but the management of the policy-making process and environment, and the policymakers. 

In democratic polities, even initiatives with broad political support must go through the elaborate bureaucratic process of consultations with different departments. There's a process of negotiations and bargaining, involving mainly the Finance, Law, and Personnel Departments. This tends to constrain the program's flexibility, local discretion, resource availability, etc in the guise of retaining bureaucratic control and limiting expenditure. Navigating this system and getting approval without seriously compromising the design elements require considerable skill and effort.

Apart from this, there's the need to articulate and present the ideas or policies, or reforms in a manner that is able to convince important decision-makers. Most often it's only one or two individuals who matter in the entire decision process. And narrative, framing, articulation, timing, and trust matters more in these decisions than evidence and logic. This is the much under-appreciated specialised expertise of the generalist.

10. In any successful implementation of a large quality-dictated intervention, the greatest contributor to success is invariably plain good luck! This good luck comes by way of the fortuitous confluence of several requisite factors - political resolve, bureaucratic leadership and commitment, ownership and active engagement among the implementing officials, community and societal support, stakeholder/user receptivity and interest, etc. 

As can be seen, these are all non-technical factors. None of them can be consciously planned and managed into being. Therefore the need for good luck.

Interestingly, the most important determinant of all these aforesaid factors is economic growth and the stage of national development. One more reason why getting economic growth right is the most effective development strategy.

Weekend reading links

1. Indian Express has an editorial which points to datapoints on trends and insights about the state of the Indian economy

Across a range of sectors such as housing, automobiles, two-wheelers, mobile phones, the incoming data points towards a continuing divergence in consumption patterns — robust sales at the top end of markets, alongside subdued sales at the lower end of the spectrum... Maruti Suzuki accounts for a significant share of the cars sold in the country. In the fourth quarter, sales of its cars in the mini and compact segment (this segment accounts for almost two-thirds of the company’s total sales) actually contracted. In comparison, sales of its utility vehicles continue to grow at a robust pace... In the case of housing, there are also indications of the affordable housing segment coming under pressure. As per Anarock research, the segment’s market share has dipped from 38 per cent in 2019 to 26 per cent in 2022 due to a combination of factors, including the economic condition of buyers. And with demand for this segment coming under stress, Anarock observes developers changing gears, launching more projects in the mid and premium segments. Reports do point towards healthy demand for these segments across major cities. Similarly, as per Counterpoint Research, even as India’s smartphone shipments have actually declined, the premium segment has registered robust growth, and is likely to have almost doubled its share during January-March 2023 as compared to the same period last year. In the case of two wheelers — another indicator of household demand at the mid and lower segments of the income distribution — while domestic sales did rise by 17 per cent in 2022-23, they still remain lower than levels seen in 2018-19 as per data from SIAM. And while the number of individuals working under MGNREGA have fallen from the highs observed during 2020-21, they remain higher than pre-pandemic levels.

2. A much-needed realistic assessment of India's over-hyped start-up sector. I think, for a country like India, instead of channelling policy attention to technology start-ups with questionable claims to innovation, the priority should be MSMEs in manufacturing. The start-up hype has also misallocated scarce risk capital, whose opportunity costs are very high.

3. Some stats about electricity and water tariffs in Indian states

In 2020-21, the average cost of supplying power was pegged at Rs 6.19 per unit. In comparison, the revenue from discoms operations worked out to only Rs 4.21 per unit. This means that for every unit of power sold, discoms were able to recover only a little more than two-thirds of the cost.

In the case of water, the recovery is even lower. According to some estimates, water boards across the country are on average able to recover only around a third of their operation and maintenance costs. For instance, in Tamil Nadu, the operational cost is about Rs 20.81 per kilolitre. But as per the state’s White Paper in 2021, only Rs 10.42 per unit was levied from urban local bodies and Rs 8.11 per unit from rural bodies. In the case of the Delhi Jal Board, in 2021-22, its projected income was insufficient to cover its operating costs and its interest liability. And in Haryana, the tariffs proposed for treated wastewater are less than half the total costs of water supply estimated at Rs 11.67 per kilo litre.

4. FT report on ethics violations within the US Supreme Court

For years, Supreme Court justice Clarence Thomas quietly enjoyed a close friendship with eccentric Republican political donor Harlan Crow. The conservative judge travelled on the billionaire’s private jet; accompanied him on holiday to Indonesia; and vacationed at his Adirondack estate, where Crow commissioned a portrait of the two men, and three others, relaxing with cigars on the deck... The ProPublica report said Crow had purchased Thomas’s childhood Georgia home from the justice and his family, a transaction that Thomas did not publicly disclose despite a law requiring justices to do so for any real estate deals larger than $1,000. Thomas also did not disclose his lavish vacation on Crow’s yacht nor his repeated use of Crow’s jet — disclosures that should not have been exempted, according to legal experts... Crow’s donations to a group founded by Thomas’s wife, Virginia “Ginni” Thomas, a conservative activist, have also raised eyebrows... other justices, including the late Antonin Scalia and Ruth Bader Ginsburg, had taken trips subsidised by wealthy businessmen, donors or universities... In a separate investigation Politico recently reported that Neil Gorsuch, another conservative justice, sold a Colorado property he co-owned to the head of big US law firm Greenberg Traurig, which has had multiple cases in front of the court...

In a statement, Thomas said he had been advised by colleagues on the judiciary that “this sort of personal hospitality from close personal friends, who did not have business before the court, was not reportable”... “The fact that justice Thomas not only accepted these gifts, but claims he’s gotten advice from other judges indicating that he did not have to disclose [this] information demonstrates that we have some problem much bigger than justice Thomas,” said Donald Sherman, deputy director of the watchdog Citizens for Responsibility and Ethics in Washington.

Edward Luce argues how the politicisation of appointments to the US Supreme Court and its own actions are undermining its credibility and creating conditions for institutional decay. 

5. The Arab Spring turns full circle as Tunisia, where the pro-democracy revolts began in 2011 and was held up as a beacon of democracy in the region, appears to be sliding back to autocracy under President Kais Saied, a former constitutional law professor who won power in 2019 promising to clean up corruption. This comes amidst a dire economic situation and an IMF bailout is under negotiation.

6. Chile moves to take control of its lithium mines from private miners and conduct operations in a PPP mode through entities which are majority owned by the government's mining companies.  

Lithium prices have crashed from $80,000 per tonne to below $30,000 per tonne this year on the back of weak Chinese demand and rising supply from Australia, Argentina and several African countries.

7. Taiwan fact of the day

Ninety two per cent of all high-end semiconductors are made in Taiwan.

8.  A primer on quantum computing. 

9. A new paper finds that in the US, the wages for the low earners have risen fastest since 2020

According to a paper by the National Bureau of Economic Research, real hourly earnings for the lowest earners rose by 6.4 per cent between January 2020 and September 2022.

10. In the US and Canada, two-thirds of new cars sold are SUVs and the average car weighs more than 1750 kg. 

Why are we not talking about regulating SUV sales to reduce carbon footprints?

11. Industrial policy in the US starting to show some results in terms of attracting foreign investments. But investments have also come with a race to the bottom in states and local governments offering massive subsidies.

12. Business Standard reports that the Government of India have decided to stop building new coal-fired power plants, apart from the 28.2 GW of thermal plants at various stages of construction. It's being planned to bring a new provision in the National Electricity Policy to this effect. 

In contrast, China's National Development and Reform Commission said in a March 2022 document that outlined its energy policy, that the world's largest coal user "will rationally build advanced coal-fired power plants based on development needs." China plans to build some 100 new coal-fired power plants to back up wind and solar capacity.

This comes even as the thermal capacity being added every year remains high and the majority,

Bank financing for energy supply totalled $1.9 trillion in 2021. Of that, $842 billion went to low-carbon energy projects and companies, and $1.038 trillion went to fossil fuels.

Such abrupt decisions may not be in the country's interests. Even climate change mitigation decisions have their costs-benefits assessment.

The global oligopolies in financial services market

The global market in financial market services is characterized by implicit collusive oligopolies. Consider management consultancy, auditing and assurance, credit rating, and credit/debit card payment processing. There are 3-4 firms that dominate the global market in each of these. In fact, many core financial services - M&A advisory, underwriting, asset management, etc - are also oligopolies. The problems with these gatekeepers are not just about monopoly, but also about systemic risk creation. 

In 2020, the big four accounting firms - EY, Deloitte, KPMG, and PwC - made up 74% of the market share, and audited the vast majority of the biggest firms. The three big rating agencies - Moody's, S&P's, and Fitch Ratings - control 95% of the global rating market, with the first two alone controlling 80%. In 2021, Visa, Mastercard, and Amex made up 97.8% of the US credit card payment processor market, with the first two alone making up 87.3%. Globally, Visa, Union Pay, and Mastercard made up 96%, with Union Pay being the Chinese equivalent. These are all staggering numbers and point to a vice-like grip on these markets. The situation is not much better in financial services like M&A advisory and debt issuance underwriting, especially with large and cross-border transactions. 

What makes the aforesaid markets distinctive and therefore a matter of serious concern is that they are almost essential services in their respective markets. Consultants and auditors are either a necessity or a statutory requirement for businesses. Credit ratings are an essential signature to operate in the financial markets. And payment processors are the gatekeepers to the primary retail transactions platforms. And, all these are all global services with global networks and economies of scale, thereby further increasing the entry barriers. 

These markets are all oligopolies. Oligopolistic markets are characterised by a small number of firms that have similar business models and pricing structures, and who therefore present a similar supply side to an effectively captive market. Besides, their implicit collusion forms insurmountable entry barriers and makes them price givers. Finally, these firms also pose concentration risks, which in turn create perverse incentives. 

FT recently pointed to the common factor behind the three recently failed US regional banks - Silicon Valley Bank, First Republic, and Signature. KPMG was the auditor in all three cases. The FT writes,

In all three cases, KPMG gave the banks’ financial statements a clean bill of health as recently as the end of February... Scrutiny of KPMG’s work was likely to fall on whether its staff were sufficiently independent from the banks they audited, whether they paid proper attention to red flags, and whether they had the right skills to judge the quality of financial statements in an environment that had changed significantly because of rising interest rates, accounting experts said. 

If this were a competitive market, three high-profile failures in just over a month, with clearly documented internal audit failures, would have been enough to tarnish the reputation of the auditor. But unfortunately, in all these markets, egregious omissions and commissions with disastrous consequences for their clients have been common. But the service providers have faced little by way of financial or reputational losses and appear Teflon coated. 

I have blogged about the problems posed by auditors (here and here), consultants (here, here, here, here, and here), and credit rating agencies (here, here, here, and here). The role of egregious auditing omissions by EY in the collapse of payments firm Wirecard is now well documented. Despite numerous high-profile failings with serious adverse impacts, they have continued to offer their services as though nothing has happened. 

In fact, the markets for gatekeeping services of modern capitalism offer good examples of the failure of market discipline. These recurrent revelations are also an indictment of the audit regulator in the US, the Public Company Accounting Oversight Board (PCAOB). This is all the more inexcusable given PCAOB's own assessment showing deficiencies in more than a fifth of audits by the Big Four and in nearly 60% among KPMG's non-US affiliates.

The biggest irony about risk mitigation is that the market which provides assurance and internal controls assessment services itself suffers from an unhealthy level of risk concentration. 

There could also be questions about KPMG’s broad role in the financial system. The firm holds a singular role as auditor of more US banks than any of the other Big Four, and it audits a larger proportion of the country’s banking system by assets than any other firm, according to data from Audit Analytics. As well as being auditor to Wells Fargo, Citigroup, Bank of New York Mellon and three dozen other listed banks, it also audits the Federal Reserve... Publicly listed banks paid the firm more than $325mn in fees in 2021, the last year for which full data is available, with the sector accounting for about 14 per cent of KPMG’s fees from public clients. That compared to 8 per cent at PwC, 3 per cent at EY and 2 per cent at Deloitte.

This market concentration poses several concerns. It ensures monoculture and a lack of internal diversity in auditing practices. There emerge collective blindspots, often conveniently deliberate oversights, within the industry. Apart from firms being left with limited choices, safeguards like auditor rotation become virtually meaningless exercises. 

While revolving doors and conflicts of interest in the consulting industry and policy-making are now widely documented, the extent of perversion in this instance is shocking. 

KPMG alumni have also gone on to play significant roles in the banking sector, including at former clients. The chief executives of Signature and First Republic were both former KPMG partners. Accounting professors said regulators were likely to pay close attention to Signature’s appointment of Keisha Hutchinson, who was the lead partner on the KPMG audit team at the bank, to be its chief risk officer in 2021, less than two months after she signed the 2020 audit report. Securities and Exchange Commission rules require a 12-month cooling off period before an audit partner is hired by a company into a role that oversees financial reporting, although that is usually interpreted to mean chief financial officer or financial controller roles.

Such conflicts of interest arising from revolving doors and cosy personal ties are a much bigger problem with the big management consultants and Wall Street banks. In fact, in recent years, this has been a concern in central banks too.

The economic growth-regulation trade-off

How much regulation is too much? 

Works in Progress has a very good article that highlights the trade-off between regulation and economic growth in the context of developed economies in infrastructure construction. The case in point is environmental and other safeguards-related permissions required for infrastructure projects in developed countries. 

Consider this on the prohibitive costs of environmental and other safeguards documentation required to obtain permissions for large infrastructure projects in the US,

1,961. That’s the number of documents contained within a single planning application for a wind farm off the northeast coast of England – capable of powering around 1.5 million homes. The environmental impact assessment and environmental scoping documents alone totalled 13,275 pages. To put that into context, that’s 144 pages longer than the complete works of Tolstoy combined with Proust’s seven volume opus In Search of Lost Time... EDF Energy had to produce 44,260 pages of environmental documentation for Sizewell C, a new nuclear power station to be built on the same site as two existing nuclear power stations in Suffolk, England.... a Freedom of Information request from New Civil Engineer magazine recently revealed that the UK’s National Highways agency spent £267 million preparing a planning application to build a 23-kilometer road. The planning application, which featured 30,000-plus pages of environmental documentation, was the longest ever prepared... 

It takes, on average, ten years for an electricity transmission project to be completed. But before you get to that point, it can take as long as 13 years just to get approval for the project. For example, Harvard’s Belfer Center cites the case of the 732-mile Transwest Express high-voltage transmission line. It applied for its permit in 2007, but did not receive full approval for construction to begin until 2020. It’ll come online in 2026, 19 years after that first permit application was filed... Using the average environmental page count from a sample of 18 projects (11,756) gives us an average per-project cost of £98 million. And that’s before the projects have put a single spade in the ground and before any spending on environmental mitigations has taken place. Think what could be achieved with even half of that nearly £100 million cost per project.

In stark contrast, sample this from history

France responded to the oil shock of 1973 with the beautiful slogan: ‘In France, we do not have oil, but we have ideas’. Over the next 15 years, the French built 56 nuclear reactors. To this day, France gets more than two thirds of its electricity from nuclear power... consider the construction of Britain’s national electricity grid in the 1920s–1930s. In the space of three years, Britain devised a plan to connect over 100 of the UK’s most efficient power stations into seven local grids across the country, and passed legislation needed to enable the plan and begin work on it. It took five more years for the project to be completed, with 4,000 miles of cables running across 26,000 pylons around the country. A year after the seven local grids were built, a group of impatient and rebellious engineers decided it was easier to ask for forgiveness than permission, and switched on the connections between the seven grid areas themselves to form a single national system. That national system remains to this day. It is hard to imagine projects of similar scale taking place today at similar speeds.

This debate has important relevance in the context of developing countries. In many areas, developing countries tend to adopt state-of-art regulations from their developed counterparts - labour standards, environmental protection, corporate and financial markets regulation, etc. In fact, they are actively encouraged to do so by multilateral lending agencies. But this has consequences that adversely impact their growth. 

Regulation is an incremental cost that gets added to the cost of production. It manifests in the form of additional equipment or building or infrastructure, slack or redundancies, increased construction times, etc on the grounds of safety, pollution abatement, employee welfare and working conditions, community welfare, social inclusiveness etc. This is a simple model of how regulation increases costs, lowers demand, and reduces economic competitiveness. 

Therefore, historically, the scope of these regulations has expanded progressively with the country's development. In fact, the historical trajectories of economic growth of today's developed economies point to a Maslowian hierarchy of values. The values associated with a subsistence economy are very different from that of an aspirational middle-income economy or a rich post-modern economy. 

The early development pathway of all today's developed countries, including that of China recently, have been characterized by large-scale externalisation of costs by all economic agents. The industrial revolution happened in a very loosely regulated world. In fact, it could not have happened with the modern world regulations. 

While gains are privatised, environmental and social costs are externalised on the society. Looser regulations and their enforcement, corruption, crony capitalism, etc are inevitable accompaniments to rapid economic growth from a low baseline. Once countries reach a certain income level and command adequate tax revenues, they venture into the higher levels of the values hierarchy. This is a messy reality of development. Nothing has changed to warrant a revisit of this theory of change.

Many developing countries, or regions there, continue to remain in the pre-industrial stage of economic development. Forget the fourth, they are still to fully realise the benefits of the second industrial revolution. In this debate, the irony of developed countries that have enjoyed lighter regulations during their growth phases now turning around and forcing developing countries to adopt tighter regulations should not be missed. 

Further, the commentators and opinion makers in developing countries, who inhabit the post-modern world, too tend to foist the social and economic values they share with the developed countries on the collective choices of their nations. Politicians and policymakers in developing countries should keep this in mind while making policy decisions on regulations.

The problem with this is that once we accept lower regulation, there is a slippery slope of exploitation by all kinds of economic interests. The markets are not known for restraint and social responsibility. So the challenge is to get regulation right. This has to be borne in mind as policymakers in developing countries adopt progressive regulations. 

These aspects should also inform global policy formulation on such issues. The energy transition debate where developing countries are being asked to sharply cut their carbon footprints at a very early stage in their economic growth is a case in point. Steep cuts and rapid changes by developing countries will erode their global competitiveness, besides also raising questions of affordability and market demand (see this and this). It's also an existential issue for people in many developing countries - poverty will get you before climate change can. I'll write about this in the coming days.

Is the "convenience" economy displacing the "productive" economy

It's now widely acknowledged that the consumer-facing innovations of the digital economy - social media, e-commerce, food delivery, sharing services etc - have dramatically improved our productivity. This post will seek to question this view and raise a few questions. 

How much substantive impact have they had on human productivity? Do they always lead to aggregate improvements in productivity? More importantly, have they adversely impacted productivity? Is there an opportunity cost to the production and consumption of these innovations? Do these impacts and costs vary between developed and developing countries? Who's actually setting the agenda on such global trends?

E-commerce in retail and food delivery can be viewed as an industry that has monetised convenience. People prefer to pay that marginal rupee to get the convenience of having things delivered to their homes. Similarly ride-hailing and many parts of the sharing economy. A major part of social media too is about the convenience of connecting with others. For these reasons and for simplicity, I'll describe these innovations as conveniences. As I've blogged here, they will also include areas like Edtech. All of them can be broadly described as being part of the "convenience" economy. They make life simpler. But for those who can afford it - with the time and money to spare. 

Given that the main users of e-commerce and consumer technologies in India are those with sufficient disposable incomes and this is a small sliver of the consumer class and also the main domestic risk capital providers for investments, it's relevant to ask the question of whether these are good uses of the scarce risk capital. 

Take the example of e-commerce. India's e-commerce logistics industry is set to exceed 10 billion parcels in deliveries by 2027-28, according to Redseer Strategy Consultants, up from 4 billion in 2022-23. One estimate is that it's set to increase in value from $2.9 bn in 2019 to $11.5 bn by 2027. In simple terms, by 2027, there will be an $ 11.5 bn monetisation of conveniences. In other words, in 2027 a disposable income of $11.5 bn would be spent on these conveniences.

This misallocation reflects at the macro-level in terms of where scarce risk capital is flowing into the economy. The latest Bain Capital report on private equity and venture capital in India shows that consumer technology and fintech have formed the largest destinations for PE/VC flows.

In a country with scarce investible savings (financial, long-term, and risk capital), there is an opportunity cost to such resource allocation, even if market-directed. Is this a good use of the scarce savings? Are more productive economic activities being displaced by this allocation of consumption on this convenience? Agreed that foreign capital will flow into areas where it perceives high returns. But to the extent that this foreign capital also leverages domestic capital, are the disproportionately large flows into these 'convenience' sectors crowding out the scarce risk capital that would have otherwise gone into more productive areas like manufacturing? 

Supporters of the convenience economy will point to several reasons to critique this line of thinking. This allocation of resources is market-based, reflecting what people want; it provides employment to millions of people; it fosters innovation in the logistics market, etc. But each has its set of equally compelling responses - we now know (especially, but not only, from financial markets) market-based allocation can be terribly inefficient and undesirable (anyways, who wants 30-minute delivery?); the quality of these gig jobs are not very good and poses many negative social externalities; among the countless competing use-cases is e-commerce logistics the best use of the scarce capital available for innovation, etc. Note that I'm not even talking about the philosophical and social concerns that these innovations raise. 

In general, instead of reflexively accepting these trends as good and inevitable, there should be serious public debates on the opportunity cost in terms of capital deployment, nature of jobs created, types of innovation pursued, etc. 

Why should governments provide tax and other concessions to research and development spending that pursues automation across the board or certain kinds of generative artificial intelligence which not only only benefits a few firms but also inflicts potentially large social costs? For example, there's a need to start differentiating between good and bad R&D so that public policy can be used to incentivize the former and discourage the latter. There's a case for limiting all benefits like tax benefits, interest expense deductions, etc for businesses that engage with such activities and force them to internalize their social costs. 

Such innovations are examples of how the progress agenda of the world is being set by the priorities and concerns of developed countries. Interestingly, even within developed countries, agendas are being set less by elected governments and more by corporate interests. 

Unfortunately, this agenda often conflict with the development interests of developing countries. Consider the example of automation, which is part of the cost-reduction strategy for efficiency and profits maximizing corporates and perhaps a priority for some demographically challenged developed economies. In a recent Foreign Affairs article, economist Lant Pritchett wrote, 

In the world’s most productive economies, the capital and energies of business leaders (not to mention the time and talents of highly educated scientists and engineers) get sucked into developing technology that will minimize the use of one of the most abundant resources on the planet: labor. Raw labor power is the most important (and often the only) asset low-income people around the world have. The drive to make machines that perform roles that could easily be fulfilled by people not only wastes money but helps keep the poorest poor.

The issues of technology-related changes like automation should become an agenda in global forums just as climate change is today. After all, who decides what are global problems? Who decides on the strategies to address these problems? What's the basis for such decisions? 

Why should climate change be a global problem, while labour mobility is not? Why should the increase in temperatures due to building new coal plants in India be worthy of global restrictions (and therefore a priority to cap and reverse) whereas the increased use of Sport Utility Vehicles and several kinds of high-carbon footprint luxury consumption by consumers in the US is not subject to any similar restraints? Why should tax avoidance by multinational corporations and regulatory arbitrage by technology companies when facilitated by pin-stripe-suited consultants be any less repugnant than tax evasion by small businesses and regulatory avoidance by informal sector businesses? 

These are issues with large distributional consequences, which impact developing countries adversely. 

Further, there are certain values and considerations which underpin this progress agenda set by corporates and others based in developed countries. They include maximization of convenience, efficiency, and profits. Missing here are other equally important ones like resilience, equity, community, and sustainability.