The behavioral challenge with reforming harassment corruption

I am now firmly convinced that behavioural psychology plays an important role in all public service environments. Therefore, any effort to reform public systems that revolves around regulation and incentives, and overlooks the cognitive challenges, is most likely to be ineffective or certainly less effective than expected.

Harassment corruption, or those involving delivery of statutory services (birth registration, caste certificates, water and electricity connections, registering FIR in a police station, property tax assessments, issue of driving license etc), is the commonest form of corruption endured by citizens in any developing country. It is a classic monopoly and therefore most of the discussion to address this has revolved around process re-engineering, competition, transparency, and accountability.

An equally important dimension to the problem that has got limited attention is what I call ego depletion due to work over-load. People have a limited quantity of mental resources which they can draw on to exercise self-control and will power, at both individual level and in their inter-personal relationships. Every transaction and decision, of any kind, and its dynamics, uses up mental resources.

Let me illustrate. The service standards for a counter clerk in a customer care center in the US mandate that he/she deal with say, 20 customers an hour. Apart from an exceptional day, they deal with no more than that. This provides them the minimum time required to transact without feeling mentally strained. Similarly, a building inspector or police officer or tax assessment official, has all the time and logistics (eg. transportation facilities to inspect the property or crime site) to diligently follow-up on their mandated responsibilities without excessively depleting their mental resources. It provides them the time and mental space to connect with their client/customer, recover themselves, and then go to the next customer.

Consider the same official in India. On most days a clerk in a customer care center deals with many times more applicants than can be processed in a cognitively optimal manner. A building inspector services several applications each day, which are geographically widely dispersed, without any logistical support or clerical assistance. Additionally, most often he is entrusted with other unrelated responsibilities. To give a sense of the magnitude of the challenge, New York with 3500 eateries has 180 food inspectors, whereas Hyderabad with similar number of formal eateries and many times that many unregistered eateries (push carts, chai shops etc) has just four food inspectors.

Similar spatial, transactional, and functional over-load characterizes all other functionaries, anywhere in India. When people are exposed to the same ego-depletion day-in day-out, without any prospects of improvement even when they move up the ladder, a form of cynical and negative internalization of transactional and inter-personal norms is inevitable.

No amount of process re-engineering, while essential, can mitigate this behavioral challenge. The prevailing socio-political environment militates against either higher user fees or increased budgetary support (both of which can presumably be used to improve logistics or effectively outsource certain services) or hire more officials (which undoubtedly has its share of negatives), which are two possible approaches to start thinking about reforms. Informed opinion makers and mainstream debates sweep them under the carpet. Some others who appear to partially get it prefer to argue with homilies like increasing commitment among public officials.

The slowing escalator - has Africa missed the bus?

Dani Rodrik and Tyler Cowen have written about the bleak prospects of rapid economic growth in developing countries.

The argument goes something like this. Historically, due to its ease of replicability (of new processes and foreign technologies), sustained economic growth has been mostly based on structural transformations, in particular rapid industrialization. But this model faces challenges from three trends. Technological advances, by automating routine work, has made manufacturing much more skill-intensive and therefore less capable of absorbing large quantities of labor. Globalization has internationalized the production supply chain and increased competition among developing countries. Finally, the weak economic prospects of developed economies will make them less receptive to being passive export markets for the industrializing economies. Prof Rodrik concludes,

Manufacturing industries will remain poor countries' "escalator industries", but the escalator will neither move as rapidly, nor go as high. Growth will need to rely to a much greater extent on sustained improvements in human capital, institutions, and governance. And that means that growth will remain slow and difficult at best. 

Tyler Cowen points to efforts by Nike, motivated by rising labor costs in the factories of its traditional East Asian suppliers, to engineer labor out of its production chain using technology and innovation.

Truth to tell, even before all these studies, this fear was occasionally discussed in many forums. The rising labor costs in East Asia, especially China, and the Great Recession have brought this threat to our door-step faster than expected. So has Africa missed the bus? I believe that we need much more compelling evidence before I can agree with Prof Rodrik's pessimism. Few questions need answering.

What is the limit to the automation of factory floor work in the foreseeable future? How soon will the cost of technological innovation fall below Africa's real labor costs? Is it possible for textile manufacturers of Ghana to co-exist with their Chinese counterparts in a global market place? How rapidly will the Chinese move up the escalator, thereby vacating space for more of their own people and those from other developing countries? Which countries will occupy that space?

Most importantly, even if the aforementioned trends take hold, it will take time. Further, in the meantime, even if China's progress up the escalator slows, the space vacated will be large enough to accommodate many others. Will atleast some parts of Africa be ready to step up? If that happens, and we know that dominoes can have unpredictably surprising effects, prospects will be brighter. So there may be much more to the story before we can write its epitaph.

On scepticism and serendipity in development

I have not read any works of Albert Hirschman, but this review by Malcom Gladwell of his new biography written by Jeremy Adelman is very interesting. I plan to read Adelman's book at the earliest.

From the review, it is apparent that Hirschman saw development as a highly non-linear process, where tensions created by crises and conflicts have a beneficial role (in addition to its conventional negative consequences), and serendipity and happenstance results in good outcomes. His scepticism of grand narratives and comprehensive plans as the path towards development is similarly obvious. I am sympathetic with this world-view, though not when taken to its extremes of scepticism.

Gladwell highlights Hirschman's embrace of uncertainty and crisis, even failures, as "general principles of action" in the path towards development. He quotes Hirschman,

Creativity always comes as a surprise to us; therefore we can never count on it and we dare not believe in it until it has happened. In other words, we would not consciously engage upon tasks whose success clearly requires that creativity be forthcoming. Hence, the only way in which we can bring our creative resources fully into play is by misjudging the nature of the task, by presenting it to ourselves as more routine, simple, undemanding of genuine creativity than it will turn out to be...

While we are rather willing and even eager and relieved to agree with a historian’s finding that we stumbled into the more shameful events of history, such as war, we are correspondingly unwilling to concede—in fact we find it intolerable to imagine—that our more lofty achievements, such as economic, social or political progress, could have come about by stumbling rather than through careful planning. . . . Language itself conspires toward this sort of asymmetry: we fall into error, but do not usually speak of falling into truth.

On Hirschman's inclination to doubt (be sceptical) things since "it allowed for alternative ways to see the world", Gladwell writes,

But Hirschman would come to recognize that action fuelled by doubt allows for failures to be left behind. Spain (where he went to fight the Civil War) was a tragedy, but it was also, for him, an experiment, and experiments go awry.

Also it prevents the originators and implementers of the initiative to not become captives of their own idea. It provides a healthy detachment which lends objectivity when assessing the initiative. This is of great significance in the development policy space where bad ideas do atleast as much damage as the benefits produced by good ideas.

While Hirschman's point about the positive unintended consequences of bold schemes and plans and the importance of tensions (in development) is understandable, I cannot agree with its exclusionist tone. To say that crises and conflicts can have the seeds of success and development is one thing. But to argue that all such crises and conflicts have beneficial effects may be like saying "all dark clouds have a silver lining". Even more questionable is the argument that creativity arises only from mis-judgements and failures.

When consultants miss the "general equilibrium" effects

I have written earlier about the inadequacy of the standard consulting toolkit in "problem-solving" of social sector issues and suggested an alternative model.

In brief, typical consulting does a very good job of analyzing the situation through a "deep dive problem solving" exercise. But its prescriptions suffer from a linearity bias, in so far as it does not pay adequate attention to the "general equilibrium" effects of stakeholder interaction dynamics (most often, the behavioral changes), which is often considerable in development contexts.

A very good example of this comes from the analysis of energy savings opportunities. A 2009 study by McKinsey & Co showed that the US could save $680 bn over 10 years by improvements to efficiency of its homes, offices, and factories, through strategies like sealing leaky building ducts and upgrading old appliances. But as Brad Plumer writes,

As economists scrutinized those numbers, they realized the picture is more complex. Those engineering studies can’t account for the behavioral changes you might see in response to efficiency improvements... People could, for instance, start adjusting their thermostat if it becomes cheaper to cool the house... One recent study of Mexico, for instance, found that a government program to help people to upgrade their refrigerators with energy-saving models really did curtail electricity use. However, a similar program for air conditioners had the opposite effect — when people got sleeker A/C units, they used them more often, and energy use went up.

Similar unanticipated or unpredictable behavioral responses are commonplace with most large social programs. For example, efforts to improve learning outcomes by assessing outcomes of standardized tests, is likely to be gamed by teachers with time. Similarly, efforts to improve performance among public officials through financial incentives has the potential to be subverted in unpredictable ways. A cash transfer program to replace a food distribution system can fail because people may use the cash for other things or the local prices of food grains may fluctuate in an unpredictable manner or something else, the possibilities of which cannot be incorporated in a context analysis based one-off program design. Unlike the private sector - where designing incentive compatible arrangements is much easier and disciplining mechanisms are more effective - the emergent possibilities with public systems are far too many to be fully anticipated. No amount of theoretical and logical reasoning can anticipate all the emergent possibilities, which arise from cognitively constrained or skewed stakeholders.

In simple terms, these impacts are not likely to be assessed with regular problem-solving tools. They require iterative field experiments that can observe outcomes in real-time and try to respond to emergent scenarios using short and tight feedback loops. But they are both expensive and take time. They cannot be part of a "hourly billing" based, "high-intensity" consulting model. Thus the need for a collaborative approach to solving development problems.

The QE exit - A teachable moment

Finally, the much-awaited unwinding of Fed's balance sheet has begun. Ben Bernanke's announcement of the tapering of the quantitative easing program shows that the Fed feels that the US economy is on a sustainable enough recovery path.

He said that the Fed would start tapering its $85 bn monthly pace of asset (treasury securities and mortgage-backed securities) purchases from later this year, and continue until the end of the program sometime in mid-2014 when the US unemployment is estimated to fall to 7 percent. He also said that the pace of tapering will be adjusted depending on the economic outlook. The Fed lowered its unemployment rate forecast for end-2013 from 7.4% to 7.25% and that for end-2014 from 6.7-7% range to 6.5-6.8%, while it raised the 2014 GDP growth expectations to 3.25%.

The Fed's gradual tightening would bring an end to the age of plentiful cheap liquidity, and naturally raise the price of capital, reflected in the interest rates. Institutional investors will look to repatriate a large amount of capital back to the US, both to shore up their margins in anticipation of higher interest rates and in the expectation of recovery improving domestic investment opportunities in the US. Accordingly, the markets worldwide have reacted with broad sell-offs, despite the widespread anticipation of the announcement. Equity markets have fallen sharply and bond yields have risen, in expectation of diminished liquidity support and a reduction in the demand for bonds. The yield on 10 year US Treasuries rose to 2.36%, its highest since March 2012, up sharply from 1.6% at the start of this May.

A few observations on the announcement and its possible implications.

1. The question foremost in everyone's minds will be whether the Fed has timed its exit too early. After all, both the economy and labor market are still weak, and the Fed's decision is premised on the "expectation", and not "certainty", that the economy is firmly on recovery path. But "expectations" are just that! The premature exit from monetary and fiscal accommodation by the Bank of Japan and the Japanese government in the late nineties is thought to have been responsible for prolonging the "lost decade" of deflationary recession in Japan. In the case of the US too, there exists the real possibility that the rates may rise too high and too soon that it will adversely affect the debt-laden governments, businesses, and households.

The US federal, and many state and local governments, are heavily indebted and the recent period of ultra-low rates had served to alleviate their real debt-burden. Since many household mortgages still remain underwater and the rising rates will put upward pressure on mortgage rates, the households with un-repaired  balance sheets will be adversely affected. Finally, businesses will find their cost of investments rising precisely at a time when recovery is likely to be taking hold. A confluence of some of these factors has the potential to nip the green shoots of recovery, just as what happened in Japan.

2. A big danger for the global financial markets will come from the generational shift that will arise in moving from an era of ultra-low rates and abundant liquidity to a more normal period, even one where liquidity may remain strapped for a prolonged period. Gillian Tett makes a very important point about the markets addicted to "cheap money and the carry trade". A generation of traders have seen only cheap and abundant capital and have internalized trading strategies that revolve around them. How will the markets react to the new era of scarcer and more expensive capital?

3. Fueled by the easy money policies of the past five years, the global financial markets have been showing ample signs of froth and bubbles. There is growing consensus that the ultra-low rates had induced several distortions into an already heavily distorted global financial markets. To this extent, the Fed's decision is equivalent to "taking the punch bowl away when the party is on". In other words, the Fed has made a conscious judgement call to puncture the ongoing boom in equity and bond markets, albeit motivated by different considerations.

4. The carefully phrased nature of the announcement on tapering QE is a continuation of the Fed's recently embraced policy of "forward guidance" to steer monetary policy and shape expectations. In simple terms, the fortunes of the US economy, and thereby the world economy itself, is in no small measure being guided by gymnastics with words. Bernanke's communication is obviously intended to cause the least disruption in the financial markets, and reassure investors that there would be a seamless unwinding of the Fed's massively bloated balance sheet. It makes one wonder what role professional communications specialists have had in helping formulate phrase the Fed's "forward guidance" policy? Indeed, every word in the Fed's statements are subjected to the most intense scrutiny to get the best possible interpretation of its intentions.

5. One cannot but not notice the relative lack of any sophisticated economic models in the Fed's decision, though doubtless some monetary policy model has informed the forecasts and the predicted trajectories. However we cannot say anything with any reasonable degree of certainty about how things will pan out in the foreseeable future. This is one of the more important teachable moments in macroeconomic policy making that we have seen since the bursting of the sub-prime mortgage bubble. By all the same arguments, the Fed could have delayed the exit by another six more months, announcing this only towards the later part of this year. To that extent, one can say that the timing, sequencing, and pacing of the exit is an informed judgement call by the FOMC.

6. Its impact on India is likely to be atleast mildly disruptive in the short-run. India's problems are exacerbated by the fact that it suffers a very high and rising current account deficit. The inevitable sell-offs in equity markets and capital flight will increase the downward pressure on the rupee. The RBI will be forced into keeping rates high, so as to discourage the foreign capital from fleeing, even if inflationary pressures appear to be subsiding. To this extent, there will be an important shift in monetary policy, which hitherto had been guided only by the trajectory of inflation. Now monetary policy will have to accommodate the need to both lower inflation as well as maintain stability in the exchange rate market.

Structuring PPPs in Infrastructure

I have a column in today's Indian Express, co-authored with Dr TV Somanathan, on structuring Public Private Partnerships after off-loading construction risks.

Update 1 (6/10/2014)

Subir Gokarn feels exactly the same,

In the early stages of the process, PPP needs to be a combination of public funding and private execution. It is only at a later stage - the last two steps on the capital ladder - that private funding becomes viable. Proximity to the beginning of the revenue stream for the project - the predictability and stability that I alluded to earlier - is the determinant for effective entry of private financing into the process. Just as the entities associated with the each successive step of a capital ladder make their money by selling their stakes to the entities specialising in the next step, public funding of infrastructure can, at an appropriate time, sell stakes in projects to private entities, using the money thus made to finance new infrastructure projects. And so on. To give the concept clarity, PPP should perhaps be re-labelled FPTP - First Public, Then Private.

Insider Trading in Infosys?

The volume of Infosys shares traded in NSE on Friday, May 31, 2013, at 2.312 million, was twice the daily average for the year. On the same day, volumes in Infosys call options too surged and its share gained 3%, even as the broader Nifty itself fell 2.3% and technology scrips experienced a downward correction. By itself nothing unusual, except that the next day, June 1, 2013, a special board meeting was convened to announce the return of NR Narayana Murthy as the company's Chairman.

By any definition, one cannot but be convinced that this is enough prima facie suspicion of "insider trading" to warrant a full-fledged investigation by regulators and public debate by media and opinion makers. Based on all publicly available information, instead of rising, the share valuation of Infosys should have, given its recent travails, trailed those of its peers, all of whom experienced downsides on that day. It is clear that certain players had private information about a "positive" development the next day or so, which drove the surge in volumes and price. Given the secrecy surrounding the issue, it is perfectly logical to presume that only a select handful of top executives of Infosys, apart from Mr Murthy, knew this. Atleast one of them, possibly many of them, have benefited from the transactions done on May 31.

It is surprising that this has received so little attention in the media. None of the vocal television channels, some of whom are self-appointed conscience keepers of the nation, and who cry hoarse with indignation at corruption and injustice, real or perceived, have even discussed this, leave alone pursue it. But it should not come as a surprise given the kid-glove treatment of sections of corporate India, especially those involving certain individuals, by mainstream media and opinion makers. But we have lost a great opportunity to shine light and improve regulatory oversight on "insider trading", which given India's corporate culture and its pervasiveness even in more regulated markets, is certainly considerable.

It is good that this has caught the attention of the market regulator SEBI. It does not need much insight to argue that if the investigation is taken to its logical climax, some corporate reputations will bite the dust. It is also certain that efforts are already afoot to influence the investigations and limit any damage. If nothing comes out, and that seems most likely, the media cannot escape its share of complicity in losing yet another opportunity to improve corporate governance in Indian boardrooms.