Mid-week reading links

1. The world according to Trump

2. Buoyed by cheap capital, bond market capital raising hit a new high of $6.62 trillion in 2016, with corporate bonds contributing nearly half. 

Eight of the ten largest bond offerings this year were by corporates, who competed to take advantage of the cheap borrowing to finance a wave of mergers and acquisitions. 

The flip side to this is the risks it engenders as interest rates appear to be one the cusp of an upward cycle. Reflecting this, US 10 year bond yields have surged from a record low of 1.36 per cent in July to 2.57 per cent. The impact of a steep enough rise on the indebted corporate balance sheets can be devastating. 

3. Another study finds no evidence of link between executive compensation and company performance. The FT has a report on the study commissioned by the CFA Society of UK and done by the Lancaster University Management School. 

In a study of more than a decade of data on the pay and performance of Britain’s 350 biggest listed companies, Weijia Li and Steven Young found that remuneration had increased 82 per cent in real terms over the 11 years to 2014. Much of the increase was the result of performance-based pay. But, the report’s authors say, the metrics used to assess performance — such as total shareholder return and earnings per share growth — are unsophisticated and short-termist, acting against the interests of long-term investors. The research found that the median economic return on invested capital, a preferable measure, was less than 1 per cent over the same period... A separate research study, by Vlerick Business School’s Executive Remuneration Centre earlier in December found that the median UK chief executive earned €6.175m last year, 50 per cent more than the average counterpart in Germany, the next best paying country.

This really is getting so egregiously embarrassing in a world which increasingly claims to be evidence-based. The brazenness with which such claims are made is shocking. Worse still, instead of being stamped down on, the world continues to be tolerant of the evidence-free claims of the supporters of corporate compensation.  

4. Gavyn Davies has got this spot on. This will be one of the dominant themes of economic and political debates not just in 2017 but in the years ahead. 

How should we compensate the losers from globalisation?

Maurice Obstfeld, the IMF Chief Economist, has called for "trampoline policies" that act as springboard to new jobs as against just the conventional "safety net" policies. 

It is also a teachable moment in intellectual dishonesty and duplicity among the so called "economists" and "public intellectuals" in the west like Mr Davies. For at least three decades, developing markets, or at least significant population groups there, had been at the receiving end of the trade liberalisation agenda. Though the country as an aggregate may have gained, trade liberalisation and globalisation have destroyed local markets and livelihoods, disrupted their social fabric, and engendered political instability. Now, with the shoe in their feet and "economic nationalism" threatening to disrupt social and political status quo, the same worthies in developed economies who then insensitively waxed eloquent about the benefits of unfettered free-trade, have now suddenly turned sceptics. They argue for policies that protect local communities from cheap Chinese exports. 

Worse still, this revisionism cannot be construed as a matter of late realisation due to a mistaken analysis. The same people still support harmonisation of policies especially in labor standards and environment, despite its same consequences on developing country markets. 

Anyways, the issue by itself assumes equal or greater significance for developing countries, where population categories adversely affected by trade are even bigger and public resources required to mitigate much higher proportion of public spending. The challenge is compounded by the weaknesses in markets and state capacity to effectively administer such redistribution.

5. After this, Manas Chakravarthy swings to the other extreme in urging caution on informality. He's as much spot on this time as he was off the mark last time. He writes,

A 2014 paper by Rafael Porta of the Tuck School of Business and Andrei Shleifer of Harvard University, published in the Journal of Economic Perspectives, concluded thus: “we are skeptical of all policies that might tax or regulate informal firms. Rather than encourage informal firms to become formal, such policies may have the effect of driving them out of business, leading to poverty and destitution of informal workers and entrepreneurs. The recognition of the fundamental fact that informal firms are extremely inefficient recommends extreme caution with policies that impose on them any kind of additional costs.”

In other words, shock therapy such as demonetisation could very well turn out to be counter-productive. Instead, Porta and Shleifer say the cure for informality is economic growth. The evidence shows that informality declines, albeit slowly, with development. An 2009 OECD paper on Informality and Informal Employment also came to the conclusion that policies that make it more difficult for informal firms to carry out their activities and stricter enforcement of laws and regulations “have contributed to increased poverty and vulnerability by pushing already vulnerable groups of people into even more difficult situations.” What the government should instead aim for is expanding the formal sector, by making it easier for firms to operate there.

I am in complete agreement. To repeat, my concern with the debate on informality is that it is mistakenly seen through the lens of tax evasion. That is completely missing the point, since informality and tax evasion are inevitable because firms cannot become formal and stay competitive in an extremely price sensitive market where the vast majority of consumers are very poor.

6. Ajit Ranade makes a very strong case for raising income tax rates on capital gains. He advocates treatment of short-term capital gains as similar to regular taxes and taxing long-term capital gains, especially given the Government's decision last year to amend the Mauritius tax treaty.

(This) was a relatively unsung but revolutionary tax reform. Opponents had warned that there would be hell to pay as foreign investors would flee India if deprived of the freebie Mauritius route. Nothing of that sort happened... The amount of tax foregone because of tax-free LTCG can be gauged from data released by the tax authorities this year. In assessment year 2014-15, the total amount that escaped the tax net due to LTCG was Rs 64,521 crore. A recent research report published in the Economic And Political Weekly estimates the loss to the exchequer due to capital gains tax exemption at Rs 45,000 crore. Just by way of comparison, in the US, all short-term gains are taxed as regular business income, and long-term gains are taxed at a rate of 15%. It must also be remembered that most foreign investors (FII) who come into India are long-only funds, with a minimum time horizon of three years. So for these investors, gains made in one year are immaterial. Hence it is inconsequential to them if gains beyond one year are made tax-exempt. It, of course, matters a lot for the exchequer. So, ideally, the LTCG tax exemption should kick in after completing three years. Anything shorter, the capital gains should be like regular income. Such a non-discriminatory and transparent tax regime will do away with arbitrage between gains in listed versus unlisted stocks and also foreign versus domestic investors.

7. Finally, the foreign policy victor of 2017, Vladimir Putin and Russia. Consider this from David Gardner,

The Kremlin seems to be getting away with its cyber intervention in the US election. It is having some success in dividing Europe and erecting an illiberal democratic pole inside the EU. And President Putin has a new admirer in US president-elect Donald Trump. President Recep Tayyip Erdogan of Turkey and President Abdel Fattah al-Sisi, the former army chief who rules Egypt, are already Putin fans. Benjamin Netanyahu, Israel’s rightwing premier, has cultivated the Russian leader. Mohammed bin Salman, the young deputy crown prince in de facto charge of Saudi Arabia, has developed what one Arab official calls “a functional relationship” with Mr Putin.

The Great Stagnation

MR points to a new paper by Nick Bloom, Charles Jones, John Van Reenan, and Michael Webb which finds declining ideas TFP (research productivity per researcher, or number of new ideas per researcher) across sectors. They write,

Our robust finding is that idea TFP is falling sharply everywhere we look. Taking the U.S. aggregate number as representative, idea TFP falls in half every 13 years — ideas are getting harder and harder to find. Put differently, just to sustain constant growth in GDP per person, the U.S. must double the amount of research effort searching for new ideas every 13 years to offset the increased difficulty of finding new ideas.

They claim that the relatively stable economic growth in recent decades has been the result of increased research effort (number of researchers), which has off-set the declining ideas TFP. They find the signatures everywhere. In the economy on aggregate,

Across agriculture crops,

Even in semiconductor chips, despite the much acclaimed Moore's law,

In pharmaceuticals research for new molecular entities,

And in medical research

But their conclusion has interesting implications for growth theories,

The only reason models with declining idea TFP can sustain exponential growth in living standards is because of the key insight from that literature: ideas are nonrival. And if idea TFP were constant, sustained growth would actually not require that ideas be nonrival... fully rivalrous ideas in a model with perfect competition can generate sustained exponential growth in this case. Our paper therefore clarifies that the fundamental contribution of endogenous growth theory is not that idea TFP is constant or that subsidies to research can permanently raise growth. Rather it is that ideas are different from all other goods in that they do not get depleted when used by more and more people. Exponential growth in research leads to exponential growth in At. And because of nonrivalry, this leads to exponential growth in per capita income.

This raises questions about the prevailing intellectual property rights regime.

India "missing middle class" graph of the day

We had argued here that India suffers from a "missing middle class". More evidence comes from the ICE 360 survey (The whole Mint series on this is informative). Globally the middle class are overwhelmingly composed of salaried workforce. In India though, less than 20% of the entire workforce is composed of salaried employees. Take out the nearly 30 million public sectors employees, and the share drops to very low single digits!

This is a strong reminder of the fact that India needs more formal jobs. This, in turn, links up with the "missing middle" in the distribution of business enterprises. Jobs get created when firms start formal and grow into middle-sized entities. Unfortunately, India has millions of enterprises which start informal as gnomes and dwarfs and remain so. Filling the "missing middle" in firm distribution therefore appears to be the path to raise the "missing middle class"!

Thomas Schelling insight of the day

From this obituary by Henry Farrel,

The U.S. stationed a small garrison in Berlin, which was embedded deep in East German territory, and indefensible against any serious attack. As Schelling described it, these soldiers’ job was not to defend the city but to die if it were attacked. This would then trigger a large scale U.S. response, since no U.S. president could tolerate the USSR killing American soldiers and not retaliate. Hence, by the logic of credible threats, the USSR would not attack Berlin, since it knew that the U.S. would have to punish it harshly, since it had effectively bound itself to deliver on the implied threat. Similarly, Schelling argued that the loss of thousands of American soldiers in the Korean War was a small price to pay if it preserved the U.S. reputation for resolve.

This explanation of Schelling's chessboard experiment, one of my favourite economic concepts, is brilliant.  A DIY version here. The exposition of such counter-intuition is a genius at work!

Why doesn't India have its Internet sensation?

Sample this about Tencent,

Tencent, a $225bn internet company whose social platforms have become a part of the very fabric of Chinese lives... It is, says one banker, “a social enterprise powerhouse”: under one roof, it has amassed China’s answer to Facebook, WhatsApp, Spotify, Kindle and ApplePay. Chi Tsang, internet analyst at HSBC, says Tencent has “the most killer apps in the world”. Weixin, along with the WeChat app outside China, has 846m active monthly subscribers.

Tencent also has a huge multibillion investment portfolio, ranging from stakes in Didi Chuxing, China’s biggest ride-sharing company, through to start-ups. It dabbles in artificial intelligence, electric cars and bike sharing. Its posse of champion hackers managed to gain remote control of Tesla’s Model S, forcing the US carmaker to roll out a security patch... The company employs 30,000 workers, more than half of whom are in research and development. While its home market is by far and away the largest, Tencent has an overseas presence in many sectors — its WeChat payments app can even be used at Caesars Palace in Las Vegas. “They are everywhere, the US, Europe — especially among Chinese speakers because if you want to contact business or family in China there is only one way to contact them, and that’s WeChat,” says Elinor Leung, a research analyst at CLSA...

And it has been more innovative, restrained, and principled, than their Silicon Valley peers,

"Tencent has a better corporate governance than Google or Facebook,” says Richard Windsor, founder of independent research company Radio Free Mobile, pointing to its spurning of the dual-class shareholding allowed in the US but banned in Hong Kong... Like Alibaba, Tencent “has gone well beyond copying [the west],” adds another banker. “They are inventing and reinventing what their businesses should be”. Tencent’s Moments feed on WeChat prefaced Facebook’s addition of Messenger and the $22bn acquisition of WhatsApp. Payments are another case in point. China’s online third-party smartphone payments market dwarfs that of the US: iResearch estimates it to be worth Rmb15.7tn in 2016 — 28 times the $62.5bn forecast by eMarketer for the US in 2017 — and Rmb28.5tn in 2018... 

Tencent favours a cautious approach to monetising its database of active monthly users. Rather than blitz Moments with ads and risk the sort of backlash dished out to Facebook, Tencent has restricted itself for now to a maximum of one ad per user each day. UBS estimates WeChat Moments’ ad load at about 1 per cent of non-advertising content, compared with 7-10 per cent for Facebook, leaving big scope for growth. In 2015, online advertising made up 17 per cent of revenues. China’s mobile ad market was worth Rmb90bn in 2015, according to iResearch, up 178 per cent year on year, and is forecast to grow at a compound annual rate of 54 per cent from 2015 to 2018. Yet monetising the subscribers — and its database — offers the real keys to the kingdom for China’s BAT contingent and their global peers.

The market valuation of Baidu, Alibaba, and Tencent (BAT) is more than a quarter of India's GDP. I just can't put my finger on why India struggles to produce even any local social enterprise (or any internet space) brands. And each one of its me-too e-commerce sites run the risk of being gobbled up their global competitors.

If I am to stick out my neck and make a prediction, then I will hazard one potential area where India can lead the global race and Indian companies emerge as global pioneers. The Unified Payments Interface (UPI) and the RuPay payment gateway has the potential to unlock India's internet champions. Specifically, if UPI moves ahead quickly to embrace third party payments (as it should), given the Aadhaar identify layer, it could disrupt the cards-based payments eco-system. And the identity layer opens up possibilities that go beyond that offered by online payment services like Paypal or Alipay. 

But this can happen only with a revision of the way India's government looks at catalysing markets. The Indian state has played an exceptional and far sighted role in developing public goods platforms like Aadhaar, RuPay gateway, and the UPI. It now needs to put in place a light-touch regulatory regime (with strong privacy and data security protocols) and step back to let the internet entrepreneurial eco-system play itself out with digital disruptions. Some of them, like Paytm, will surely make windfall gains, piggybacking on the public good platforms. 

But we need to have the political maturity and bureaucratic guidance to allow this market catalysis. And, given the relatively small middle-class, fragmented and largely informal market, entrepreneurs should have the vision and patience to build the platforms and play the long game. And, more importantly, they should eschew the temptation to play on things like regulatory arbitrage and crony capitalism, a characteristic feature of much of corporate governance in India.  

For a country that spares no effort to follow China, it is a great opportunity to emulate how the country created its own payment gateway, Union Pay, and let its internet champions emerge. 

IMF's prudent assessment of globalisation

IMF continues the post-crisis revisionism of some of the central tenets of economic orthodoxy in its latest edition of F&D magazine. 

Sebastian Mallaby makes the most prudent assessment of globalisation and free trade. He decomposes cross-border capital flows and shows that cross-border lending has declined dramatically since 2007. 

To some extent—indeed, probably to quite a large extent—the retreat from cross-border lending represents a healthy correction... there has been a reappraisal of the case for cross-border finance. For one thing, some of its theoretical advantages appear to be just that: theoretical. In principle, financial globalization allows savers in rich countries to reap high returns in fast-growing emerging market economies, thus easing the rich-country challenge of paying for retirement. Meanwhile, it supplies foreign capital to emerging market economies, allowing them to invest more and thereby catch up faster with the rich world. But in reality, many large emerging markets have grown by mobilizing domestic savings, exporting capital rather than importing it. The textbook case for financial globalization exists mostly in textbooks.

If the upside of financial globalization has been elusive in practice, the downsides have grown more obvious. First, global capital tends to rush into small open economies during good times, aggravating the risk of overinvestment and bubbles; it flees in bad times, exacerbating recession. That has led middle-income nations to experiment with capital controls. Second, cross-border banking involves large, complex, and hard-to-regulate lenders, which poses risks to society that became evident during the 2008 bust. Because of those risks, regulators in the rich world have discouraged banks from foreign adventures, which has added materially to deglobalization. Forbes, Reinhardt, and Wieladek (2016) show that, in the case of Britain, regulatory discouragement of foreign lending can be remarkably powerful, accounting for about 30 percent of the attrition in cross-border lending by U.K. banks during 2012–13.

Although there is no denying that finance is less international than it used to be, it is debatable whether this retrenchment is best described as “deglobalization,” with its connotations of retreat, or as something more positive—“sounder global management.” After all, the new regulatory restrictions are at least partly a response to the risks of cross-border financing, which suggests a desirable level of flows considerably lower than the 9.9 percent of global output during 2002–04. If the optimal ratio were, say, around 5 percent, today’s degree of financial globalization might be just about right.

He argues that the apparent slowdown in global trade since 2008 may be due to statistical illusion (lower dollar price of commodities like oil), shifts in supply chains (China makes more intermediate goods itself instead of importing them), increased consumption of services as against manufactures as economies develop, and shrinking current account balances. To that extent, he finds that the decrease may not be something to be alarmed about. 

Maurice Obstfeld makes a long delayed case for having policies that redistribute the gains from trade to cushion those adversely affected. However, the focus on safety nets seems to be confined to developed countries, whereas one would argue that developing countries need them more. He also makes the distinction between safety nets (which protect those subject to job loss) and trampoline (which offer a springboard to new jobs, through trainings etc), and favours the former. 

But Paul Krugman is disappointing in his assessment. Two examples. The first is a benign assessment of international trade till eighties,

And for a long time—from the 1940s into the 1980s—trade liberalization proceeded remarkably smoothly. The losers from growing trade didn’t seem that obvious or numerous, largely because much of that growth took the form of intra-industry flows between similar countries, which had minimal effects on distribution.

I think the fundamental reason why there is a backlash against trade liberalization now is because the shoe (in terms of being at the receiving end of terms of trade) is on the feet of the developed economies. When unfettered free trade was critiqued in the eighties and nineties by those in developing countries as being detrimental to their economies and societies, the very same people used to mock the critics as marxists and socialists!

On the more prudent response to anti-globalisation sentiments, he writes,

The best attitude might well be to treat globalization as a more or less finished project, and turn down the volume on the whole subject.

Really! What about the third wave of globalisation, in terms of migration? 

Weekend reading links

1. Who is the best-selling music artist of the year?

Wolfgang Amadeus Mozart beat Drake, Beyoncé and Adele to become the year’s biggest-selling artist, according to Billboard, shifting 1.25m CDs in five weeks.T

This, thanks to Universal’s recent 200-CD compendium Mozart 225, released to mark the anniversary of his death at 35 in December 1791. 

2. Who is the most successful business leader of our times? In the real world, the choice would be a struggle between the likes of Lee Iaccoca, Jack Welch, Bill Gates, Steve Jobs, Jaime Dimon, and Mark Zuckerberg. In an ideal world, the choice is simpler. Arguably, Amancio Ortega, the founder of Inditex, the owner of Zara, and with a personal worth of nearly $80 bn! 

He defies all the conventional moulds of successful business leaders and went against the grain of outsourcing and off-shoring, and Inditex has been the standout performer among its competitors for many years now. I had blogged earlier about the firm's strategy of iterative adaptation. Surprising that management gurus who swoon over Jack Welch's ruthlessness or Steve Jobs' disruptiveness gloss over the profound wisdom of iterative adaptation. 

3. Talking about management theories, Economist does a brilliant take down. It shows that the four basic ideas that underpin management theories - business is more competitive than ever, we live in an age of entrepreneurialism, business is getting faster, and globalisation is both inevitable and irreversible - stand on clay foundations.

4. The recapture of Aleppo from rebel hands after four years of very violent fighting should count as a seminal moment in global geo-politics. Even as the US was busy grappling with Donald Trump, Russia, Iran, and Turkey have proceeded to carve out a historic diplomatic achievement, and entrenched themselves as important arbiters in the region for the foreseeable future. It may be the beginning of a truly multi-polar global order. 

It is estimated that the five year civil war has displaced more than half the country's 21 million population, nearly 5 million as refugees, and left over 450,000 dead. 

It is all too easy and tempting to denounce President Obama for not intervening decisively to bomb Bashar Al-Assad's forces even when they crossed the red-line and deployed chemical weapons against the rebel held areas. If the US had intervened more forcefully, it would only have played into the ISIS hands, strengthening them and hastening their progress. Apart from mutilating Syria and Iraq, it would also have left President Obama with no choice but to embrace the politically suicidal option of having boots on the ground to prevent an even more toxic brand of barbarism. 

When all possibilities are equally bad, it is not a bad idea to stand aside. It may be slightly easier, when, on relative barbarism at least, Assad comes out better, if only slightly. The brilliant Robert Fisk has this excellent article that highlights the duplicity associated with the mis-concieved angst at the recapture of Aleppo.

5. India's export engine is in reverse gear. Ajay Shah points to this,

From Q4/2013 onwards, the compound average growth rate of exports (of non-finance non-oil listed companies) has been minus 17.5% per year.

The FTP with the target of doubling trade to $900 by 2019, clearly unrealistic ab-initio, is in shambles.