Cost and time over-runs in road projects

A recent oped in Businessline had some stunning figures on cost and time over-runs in road projects in India. Thillai Rajan and Govind Gopinath use data from the central road projects to find that

Nearly 69 per cent of them are riddled with cost overruns and 89 per cent of them are faced with time delays... The average cost and time overruns have been 16.25 per cent and 41.2 per cent, respectively... Had the projects been developed within the budgeted cost, we would have been able to build 16.25 per cent km of roads more at the same cost... if there were no delays, we would have been able to add 41.2 per cent km of roads more in the same period. Since overruns can usually be controlled by better management without any substantial infusion of capital, these numbers indicate the potential for achieving additional road capacity without additional investment.

Their findings with respect to public private partnerships (PPPs) in road sector, which has had the largest number of PPPs in India, are strikingly contrarian,

It was seen that 88.1 per cent of PPPs had cost overruns as compared with 54.37 per cent in non-PPP projects. However, a higher proportion of non-PPP projects had time overruns (92.23 per cent) as compared with PPPs (80.95 per cent). While PPPs have a superior track record in managing time overruns because of private-sector efficiency (and probably also because of the inbuilt incentive to complete projects faster), it was not the case as far as cost overruns are concerned. The average percentage cost overruns in a PPP is close to three times that of what was observed in a non-PPP project. These numbers achieve even more significance if we consider that the average project size of a PPP (Rs 382.46 crore) is about a half more than that of a non-PPP project (Rs 253.89 crore).

These are very illuminating figures and should inform policy making within the National Highways Authority of India (NHAI) in particular and in the road sector in general. Two very fundamental takeaways,

1. The blind belief in PPPs as the panacea to our road sector needs is clearly misplaced. On both fronts, PPP projects are as bad as non-PPP ones in addressing the twin challenges of cost and time overruns. In fact, as the authors write, inflating costs to boost bottomlines from such projects, so widespread across the world and in other sectors, appear to be happening in roads in India.
 
2. Both contracting and project management principles need makeovers. The former, in particular, is important because the current incentives, as the authors indicate, are clearly not aligned towards mitigating cost overruns. As the case of PPPs indicate, given the pervasiveness, to the point of inevitability, of contract renegotiations, the private sector appears comfortable with cost overruns on their balancesheet. In simple terms, the underlying financial assumptions of roads contracts need revisiting and project management, especially land acquisition, need tightening.

In road projects, it would be interesting to examine the specific reasons for cost over-runs. An NBER working paper by Eduardo Engel, Ronald Fischer, and Alexander Galetovic examined data on Chilean experience with re-negotiations of 50 PPP projects in the 1993-2006 period and finds four observable predictions - "(i) in a competitive market, firms lowball their offers, expecting to break even through renegotiation, (ii) renegotiations compensate lowballing and pay for additional expenditure, (iii) governments use renegotiation to increase spending and shift the burden of payments to future administrations, and (iv) there are significant renegotiations in the early stages of the contract, e.g. during construction."

Further, they also found that of the $2.3 bn re-negotiated and awarded bilaterally, 84% corresponds to payments for additional works, while the remaining 16% correspond to additional payments for works included in the original contract. The potential for additional works (or quantities of works) are especially high in road projects where alignment changes to accommodate problems in land acquisition (like litigation and popular opposition) are commonplace. If the cost over-runs due to such problems are rationalized (if payments are made at the same unit rate as in the original contract), the concern should therefore be with limiting additional payments on the original contract rates. But the latter forms a small share of the total renegotiated contracts.

In view of this, the low hanging fruit is in reducing the time over-runs. The massive variations in the extent of time over-runs between road projects in various states, and in particular the high percentage of time overruns in states like Bihar and UP, hold important lessons. Since other states manage to complete projects with many times less time overruns, it is important that measures be taken to shore up project management practices in the laggard states, both at the government level and private contractor levels.

Private Vs public provisioning of healthcare services

A cross-country meta-study of health care delivery in low and middle-income countries by public and private sectors questions the conventional wisdom that the private sector is more efficient, accountable, or medically effective than the public sector.

This finding goes against the grain of mainstream thinking that the path towards achieving greater effectiveness in health care services delivery lies in increasing private participation. It goes further and raises concerns that the private sector may be cornering an increasing share of the scarce public resources being spent on health care, thereby depriving public systems off investments. This is apart from the competitive dynamics between both sectors and the deeper pockets of the private sector crowding in specialist medical practitioners.

The study evaluated both types of health care systems across developing countries based on the six WHO health systems framework themes - accessibility and responsiveness; quality; outcomes; accountability, transparency, and regulation; fairness and equity; and efficiency. The authors find from the comparative cohort and cross-sectional study,

Providers in the private sector more frequently violated medical standards of practice and had poorer patient outcomes, but had greater reported timeliness and hospitality to patients... the private sector appeared to have lower efficiency than the public sector, resulting from higher drug costs, perverse incentives for unnecessary testing and treatment, greater risks of complications, and weak regulation... Public sector services experienced more limited availability of equipment, medications, and trained healthcare workers. When the definition of "private sector" included unlicensed and uncertified providers such as drug shop owners, most patients appeared to access care in the private sector; however, when unlicensed healthcare providers were excluded from the analysis, the majority of people accessed public sector care. "Competitive dynamics" for funding appeared between the two sectors, such that public funds and personnel were redirected to private sector development, followed by reductions in public sector service budgets and staff.

Since private sector is in general associated with superior outcomes, in case of healthcare with treatment outcomes, the paper's finding to the contrary comes as a big surprise. It writes,

Public sector provision was associated with higher rates of treatment success for tuberculosis and HIV as well as vaccination. For example, in Pakistan, a matched cohort study in Karachi found that public sector tuberculosis care resulted in an 85% higher treatment success rate than private sector care... In South Korea, tuberculosis treatment success rates were 51.8% in private clinics as opposed to 79.7% in public clinics, with only 26.2% of patients in private clinics receiving the recommended therapy, and over 40% receiving an inappropriately short duration of therapy...

In India, an analysis of over 120,000 households, adjusted for demographic and socioeconomic factors, found that children receiving private health services were less likely to receive measles vaccinations. Similar findings were reported from Cambodia. Studies comparing pre- and post-privatization outcomes tended to find worse health system performance associated with rapid and extensive healthcare privatization initiatives. In Colombia, following major privatization reforms in 1993, population vaccine coverage declined for several diseases in the country, and tuberculosis incidence rose significantly. In Brazil, privatization of fertility control services led to increased abortions, sterilization, and improper use of oral contraceptives (obtained without medical consultation), ultimately linked to higher mortality rates among young women.

Interestingly the study questions the claims of private sector superiority in studies by organization like the World Bank, 

The World Bank has made strong claims that investing in public–private partnerships will improve efficiency and effectiveness in the health sector, yet several of its publications revealed that these assertions were either unsupported by data or the data was not provided in sufficient detail to pass minimal inclusion criteria required for this review... Despite the lack of data about private sector performance, recent initiatives by the World Bank's International Finance Committee are underwriting the expansion of private sector services among low- and middle-income countries. For example, in sub-Saharan Africa, the International Finance Committee has created a private equity fund to make 30 long-term investments in private health companies. These conflicts of interest pose a potential threat to the validity of World Bank–sponsored studies and raise the need for independent scrutiny.

The exhaustive findings of the study should serve as a strong reminder about the limitations of privatization of essential services like health care. This is especially true of developing countries where private markets are constrained by lack of adequate breadth and depth on both the supply and demand sides. On the one hand, supply-side competition is limited, while on the other hand, demand side affordability and ability to pay are questionable. Both these contribute to several distortions and inefficiencies.

Which country has seen the highest decadal housing price increase?

A study by Lloyds TSB International (via FT) has found that India has seen the biggest rise in housing prices of any country in the world in the ten years from 2001 to 2011. In fact, emerging economies had four of the six top performers.

Real housing prices (adjusted for CPI) in India grew a staggering 284% over the 10-year period. This is almost six times the 50% rise in real UK house prices over the same period and over 10 times the 23% rise seen in the Euro area. 














Annualized, this translated into a real growth of 14.4% for the decade.

While the spectacular increase is a reflection of the dramatic rise in the country's GDP - it rose 280% over the same period - it also a reflection of certain fundamental regulatory problems in a massive country where urbanization is proceeding at a very fast clip and urban land reserves are depleting very fast.

Germany Vs Eurozone

Saving the eurozone is undoubtedly the biggest challenge facing the world economy today. Stabilizing the panic-gripped Eurozone financial markets is the first step in this process. However, an acrimonious debate is raging about how this should be carried out, in particular about Germany's financial contribution to this process.

On the one hand are those who claim that Germany should write a blank cheque to save the Eurozone for atleast two reasons. One, it is the strongest and the only country capable of providing the financial backstop given the magnitude of the task. Two, it has been the biggest beneficiary of the single currency project and therefore should now be willing to return the favor when the others are struggling. Eduardo Porter, pointing to Germany's relative economic strength amidst the dismal performances of its neighbours, summarized this claim in a recent NYT column,

Germany must ultimately underwrite the euro’s rescue, pretty much regardless of whether its conditions are satisfied. There are three good reasons. First, the euro has been very good to Germany. Second, the bailout costs are likely to be much lower than most Germans believe. Third, and perhaps most important, the cost to Germany of euro dismemberment would be incalculably high — far more than that of keeping the currency together. 

Germany has had a fairly good crisis so far... Since 2009 it has grown faster and suffered less unemployment than almost any other industrialized country... Germany owes much of this to the euro — which tethered its ultracompetitive manufacturing to the mediocre economies of its neighbors. Since the advent of the single currency, Germany’s labor costs have fallen more than 15 percent against the average labor costs of all the countries using the euro, and about 25 percent against those of the troubled nations on the periphery. If it dumped the euro for a new deutsche mark, its exchange rate would surge to make up for the difference, potentially crippling its exports, which have fed most of its economic growth over the last decade.

Others, especially the German government, strongly contest this claim. Apart from disputing the figures themselves, they point to the unfairness of asking Germany to pay for the sins (after all asset bubbles, consumption booms, and reckless government spending are all domestic sins) committed by other countries. They also claim that rewarding such behaviour will generate moral hazard and will only prevent the hard measures required by the peripheral countries to rebalance their economies. Gunnar Beck recently wrote,

Between 1998 and 2011, German exports grew by 117 percent, according to the Federal Statistical Office... German exports rose most — by 154 percent — to the rest of the world; by 116 percent to non-euro E.U. members; and least of all, 89 percent, to other euro zone members. In 1998 the euro zone still accounted for 45 percent of all German exports; in 2011 that share had declined to 39 percent. These trends are continuing. The euro zone remains very important to Germany’s export trade, but it is hardly the motor of growth.

Between 1995 and 2008, Germany saved more than most, yet it exhibited the lowest net investment rate of all O.E.C.D. countries. On average, from 1995 to 2008, 76 percent of aggregate German savings (private, governmental and corporate) were invested abroad... Germany bled capital in the years before the euro crisis — capital that fueled an unprecedented economic boom in the southern euro zone that spread out from their real-estate markets to the general economy. 

Between 1995 (the year when the details for monetary union were finalized and the single currency effectively launched) and 2011, Germany had the second-lowest growth rate in G.D.P. among all European countries, according to Eurostat... growth was equally below the European/E.U. average for the period 1998 to 2011... Over the period from 1998 to 2011, only Japan, Italy, Portugal and Greece performed worse than Germany. This is not the performance of a euro-winner.

He also points to the staggering size of the blank cheque that Germany is being forced to write to save the Eurozone,

According to Hans Werner Sinn, Germany’s total exposure currently amounts to over €700 billion, or about one third of Germany total public debt of around €2.09 trillion. If and when Germany’s losses have to be realized, Germany’s aggregate public debt could quickly approach Portuguese or Italian levels and, in a worse-case scenario, rise well in excess of 110 percent of G.D.P.  

Given the spiralling borrowing costs of Spain and Italy, it is undeniable that some form of backstop facility through a lender of last resort has to emerge to prevent their sovereign defaults. Given the size of these economies - nearly $1.5 trillion in debts coming due till 2015 - and the possibility of contagion spreading to others, one-off bailout funds may not be able to do too much to stem the plunge. In fact, it may become a case of throwing good money down the drain.

In the circumstances, all the major economies, apart from Germany, are now calling for some form of Eurobonds or debt mutualization, wherein the Eurozone balance sheet is used to let Spain and Italy raise money to refinance their debts. In simple terms, this would be leveraging the strength and credibility of the German economy to subsidize the borrowing costs for all others.

Germany naturally opposes any such arrangement and warns that it generates dangerous moral hazard. A Times article captures Germany's response to this arguement,

Germany has not ruled out the issuance of so-called euro bonds, which would be backed by the euro zone as a whole, not its individual member states, thereby presumably making the bonds more attractive to investors. But Germany insists that if it is to share risk with other nations, their governments should cede more control over their spending and borrowing. This is highly controversial in a number of euro zone countries, most notably France, where preserving national sovereignty is a central concern.

Germany's concerns and the attendant precondition is justifiable. At the least, such debt mutualization has to be accompanied with a pan-European banking regulator with powers to supervise and take decisions regarding individual national banks and national governments being willing to cede some control over their national budgets. At best, there should be a Eurozone wide banking and fiscal union.

However, given the severity of the crisis, some form of banking and fiscal union is now almost inevitable. Germany's brinkmanship is clearly an effort to wrest all possible concessions from the  peripheral and other Eurozone economies and get a deal with the lowest potential cost for the German tax payer. Given Germany's commitment to keep the Eurozone intact, it is certain that it will chip in with whatever it takes to achieve that.

Germany and EU!

(HT: NYT, from the Gable in The Globe and Mail)

The negative externalities of finanical market integration

It is now widely acknowledged that economies, howsoever strong their fundamentals, cannot remain insulated from negative global economic shocks. In simple terms, this means that irrespective of the domestic strength and size of an economy, adverse global economic events have the potential to generate macroeconomic distortions that can destabilize the economy. A fundamentally strong economy can, in quick time, become a victim of global economic events for essentially no fault of its.

Floyd Norris highlights the latest example of an economy, Switzerland, that appears to be falling victim to a crisis that it had no role in fuelling. As the Eurozone crisis progressed, investors searching for safety found in Switzerland and the Swiss franc an attractive safe haven. The country had stayed away from the Eurozone, had deep financial markets, and reasonably strong economic fundamentals.

Capital flowed in massive quantities, driving up the Swiss franc which appreciated spectacularly from its long-term stable value of around 1.4 francs to a euro to almost being on par with the euro. The Swiss central bank responded by publicly committing to not let the franc fall below 1.2 to a euro. It undertook massive purchases of euros, accummulating huge euro reserves. It also lowered Swiss interest rates to nearly zero. But despite all this, the Swiss economy has not been able to stave off the effects of the capital inflows. The declining external competitiveness has driven down exports, a consumption boom has been triggered, and a real estate bubble is rapidly inflating.

One cannot but not wonder whether Switzerland is actually paying a penalty for running its economy reasonably well! In many respects, Switzerland is facing the same challenges which many of the peripheral Eurozone economies, albeit with much less strong fundamentals, faced when they experienced a massive capital rush, again for different reasons, in the aftermath of the currency union.

As I have blogged earlier, the crisis in countries like Spain and Ireland is not the result of government fiscal profligacy but of Eurozone-wide macroeconomic forces unleashed in the aftermath of the monetary union. These countries, with relatively strong economic fundamentals, experienced a sudden and sharp lowering of borrowing costs and massive capital inflows, both of which led resource misallocation distortions and imbalances.    

All this once again highlights the importance of macroeconomic regulatory oversight in a globalized economy. If, some years down the line, Switzerland is forced to confront an economic crisis triggered off by a real estate bubble and its attendant larger macroeconomy and financial markets distortions, several questions will be asked about what the Swiss government could have done to avoid the fate. This becomes all the more so since, if that happens, it would be virtual repeat of the problems currently being faced by the peripheral economies.

In the circumstances, should Switzerland enforce some form of regulatory capital controls as it faces the massive inflows of foreign capital? It is interesting that one of the flagbearers of capitalist democracy, the International Monetary Fund, has already lend its imprimatur to some form of regulatory restraint on capital inflows so as to ensure economic and financial stability.

In fact a recent working paper by Marie-Aimée Tourres points to the success of India and China with use of capital controls to curb dangerous capital flows. She argues that "capital controls help to provide short-term monetary policy independence within the impossible trinity and that long-standing capital controls is possible leading to a mid-way path". I cannot but not be in greater agreement. 

India's micro-governance failures

I have an op-ed in today's Mint that highlights attention on India's microgovernance failures and what needs to be done to get it right.