The nuanced case for labor migration

It has taken Donald Trump and Brexit to make the intellectuals realise that unfettered trade is not desirable. In the aftermath of the global financial crisis, the IMF cautioned against unqualified capital account liberalisation. As I blogged earlier, the same realisation is also dawning on the adverse consequences of automation. Another area that is equally contentious is the impact of migration from developing countries on labor markets in developed economies.

There is a constant in all the four issues - Dani Rodrik. Even as intellectuals and the mainstream academia dug their heels in and refused to acknowledge mounting evidence on the first three, Rodrik was at the leading edge in urging caution. He has now become the mainstream in the first three areas. The fourth one is playing itself out, with the mainstream view downplaying the potentially adverse effects of migration. But there is little to feel that this is going to be any different.

His position on labor migration is articulated nicely in a new paper. The short answer is that significant migration will be bad for low-skill workers in developed economies, but less harmful than further trade liberalisation.

Rodrik puts the magnitude of the barrier to labor migration in perspective, drawing from the work of Clemens et al which documented "place premiums" of gains for migrants from different countries in moving to the US,

Assuming transport costs and cultural disamenities aside, a wage multiple of six for Pakistani workers implies that the ad-valorem equivalent of labor visa restrictions is around 500 percent. In other words, it is as if Pakistani workers were free to move but had to pay a 500 percent tax on their earnings once in the U.S. Contrast this to average U.S. tariffs on manufactured goods, which is about 3 percent, or the prevailing import barriers on sugar, which is the archetypal highly-protected industry with domestic prices exceeding world prices by 80 percent on average – and the asymmetry between freedom to trade in goods and the restrictiveness of trade in labor services becomes strikingly clear. 

Rodrik's case for easing labor restrictions is made in comparison to trade liberalisation. While acknowledging the adverse effect on low skilled labor, he makes the point that the impact in terms of redistribution of income from labor to capital (in developed countries) is likely to be far lower with easing migration restrictions than with trade liberalisation.

While there would likely be adverse effects on low-skill workers in the advanced economies, international labor mobility has some advantages compared to further liberalizing international trade in goods.

He uses a political cost (redistribution of income away from labor) benefit (efficiency gains) ratio is argue that given the very high barrier (a migration tax equivalent many times higher that import tariffs) to migration, the income redistribution needed to achieve a unit of efficiency gain is much smaller. At an intuitive level, while an imported good helps the importer capture all the gains in bulk, in case of a migrant labor, the production cost structure of the developed economy still applies when he produces something as a migrant. Thus the case for easing migration over trade liberalisation. 

Stripped off all empirics and stuff, this is insightful and applies to many other areas of debate on social policies,

Institutions are maintained either through solidarity (I care for you, so I am willing to share with you); social trust (I trust you, and know that you would do for me what I am doing for you), or enforcement (government coercion, requiring in turn legitimacy). All of these things are likely to be undermined by greater heterogeneity and inequality within countries – especially if the numbers involved are large.

So his proposal,

I have proposed elsewhere a temporary work visa scheme, administered bilaterally on the basis of specific home-country quotas. To maximize home country benefits and spread the gains around, the visas would be for a fixed period, say 3-5 years. They would not entail a path to citizenship, although guest workers would have the full protection of host country labor standard and regulations. A mix of sticks and carrots might be employed to ensure the bulk of workers do choose to return to their home countries when their visas run out. For example, a portion of guest workers’ pay may be docked in forced saving accounts, to be returned only upon repatriation. The quotas of home countries could be adjusted in relation to their success in attracting their workers back home. This would give home countries an incentive to provide repatriation inducements, just as they do with foreign capital or skilled expatriates.

I am inclined to agree. 

Stalled projects update

Livemint points to latest CMIE data to show that year-end stalled projects touched a record high by end-2016. The total value of stalled projects was Rs11.70 trillion at this time, accounting for 12.11% of the total projects under implementation.

As to the reasons for stalled projects, a fifth were due to delays in clearances. And its share has remained consistently high despite the governments best efforts to clear stalled projects.  

The failure to make much progress with declogging stalled projects has been accompanied by a decline in new public investment announcements.

This blog has argued that a very large proportion of these projects are not stalled but are fundamentally unviable projects, at least now. They may need to be scrapped and not restored. The true extent of such projects need to be recognised based on both commercial considerations and changed circumstances. A cleaner slate may be a more meaningful place to start monitoring. 

Add to this, the just released RBI's Industrial Outlook Survey of 1221 manufacturing enterprises indicated declining business expectations sentiment in the Q4 2016. 

Whatever the budget announces, this is unlikely to improve any time soon.

The automation story will go the free-trade way?

Even just twenty years back, scepticism of free trade would have been scorned upon. Among intellectuals, free trade was an article of faith. It was thought that free trade generated unambiguous aggregate benefits. There may be a few losers, but they would quickly get re-skilled and adjust to the labor market, or, at worst, could be compensated by redistribution from the winners.

As is acknowledged now, this ideological belief was contrary to the reality. Many developing countries, especially the smaller ones, were aggregate losers from free trade. The logic of Ricardian comparative advantage did not play itself out. Labor markets did not adjust as anticipated. And, compensation and redistribution were political non-starters.

Those urging caution, like Dani Rodrik, were considered left-wing. Today, even as the same Dani Rodrik has stayed firm on his convictions, the world has travelled so much that his arguments have become the mainstream.

Much the same story appears to be playing itself out in the context of automation. This rationalisation with the example of rise in human tellers in banks despite the arrival of ATMs is worthy of political rhetoric than academic research. Sample this techno-optimism from David Autor,

Automation does indeed substitute for labor—as it is typically intended to do. However, automation also complements labor, raises output in ways that lead to higher demand for labor, and interacts with adjustments in labor supply. Indeed, a key observation of the paper is that journalists and even expert commentators tend to overstate the extent of machine substitution for human labor and ignore the strong complementarities between automation and labor that increase productivity, raise earnings, and augment demand for labor... The frontier of automation is rapidly advancing, and the challenges to substituting machines for workers in tasks requiring flexibility, judgment, and common sense remain immense. In many cases, machines both substitute for and complement human labor. Focusing only on what is lost misses a central economic mechanism by which automation affects the demand for labor: raising the value of the tasks that workers uniquely supply.

This sophistry conceals the fundamental point that automation, like trade, will most certainly leave the less skilled extremely vulnerable. The negative effects of driverless cars (on drivers), speech recognition devices (on clerical staff), shop floor management devices (on retail, hospitality etc) and so on do not require any rigorous RCTs or sophisticated statistical analysis.  

Like with the unrealised labor market adjustment and redistribution to cushion the losers from free trade, the promised mitigating factors against automation like adjustments in labor supply, re-skilling, and emergence of complementary job creators are likely to remain largely unfulfilled. There is nothing to suggest that this time will be any different.

Accounting standards and pension liabilities

I had blogged earlier explaining the rise of Trump and similar movements elsewhere on the lack of elite leadership to address egregious excesses.

The FT reports that an analysis by pension consultancy JLT Employee Benefits of 2015-16 showed that UK blue-chip companies could have cleared their pension deficits with payment of one year's dividends,

An examination of the latest annual accounts for FTSE 100 companies found the UK’s leading listed businesses paid £68.5bn to shareholders, more than five times the £13.2bn they made in pension contributions... According to the research, based on accounts published up to June 30 last year, only six FTSE 100 companies paid more in contributions to their defined benefit pension schemes than in dividends to their shareholders... However, of the 60 companies that disclosed pension deficits, 46 could have cleared their shortfalls by withholding a year’s dividends, according to the analysis.

This highlights attention on the need for regulatory oversight on the issue of balancing pension accounts. For more than a generation, coinciding with the Great Moderation, equity markets were trending upward and asset returns were stable and high enough. In such times, pension plans made their returns even with the high management fees and relatively risk-free investing.

That is now history. The average annual returns on equities and fixed income assets have been on a long declining trend and likely to remain at the low levels. Pension funds everywhere are facing the heat from the declining returns and have been accumulating liabilities. It is surprising that the rise in liabilities has been accompanied by a rise in shareholder payouts. 

It is Accounting 101 that profits are calculated after excluding all costs from revenues, and that employee costs includes wages and other commitments. And pension payouts are the largest part of non-wage payments. One of the principles of corporate finance is that equity has a charge on profits only after all the liabilities are paid off. It is therefore baffling that accounting standards do not mark-to-market the pension liabilities and provision for all those liabilities before profits are calculated. Pension liabilities are no less a liability that they are superseded by the claims of equity holders.

In the aftermath of the Enron debacle, regulations were amended to introduce mark-to-market accounting in many areas. Funny that they were not extended to liabilities like pensions. Such egregious excesses are simply a blot on capitalism and underlines the point about saving "capitalism from capitalists".

Manufacturing fact of the day

The off-shoring wave and loss of jobs in manufacturing conceals important facts, 

The UN Industrial Development Organisation (UNIDO) reckons that, in 1991, 234m people in developing countries worked in manufacturing. By 2014 the number was 304m—and there were just 63m manufacturing jobs in the rich world. But the sixth of the workers in the rich world added two-thirds of the final value.

In terms of the perception that manufacturing moved to poor countries lock stock and barrel, it hasn’t helped that the low-value work which did go overseas often involved the final stages of assembly. Putting the components that make up a product together looks like the essence of the manufacturing process. But it often adds little to the finished product’s value. Even for as complex and pricey a machine as a passenger jet, assembly is a low-value proposition compared with making the parts that go into it. By some estimates, putting together Airbus airliners in Toulouse accounts for just 5% of the added value of their manufacture—even if ensuring the aircraft were put together in France has been a non-negotiable point of national pride for the French government. Similarly, assembly in China accounted for just 1.6% of the retail cost of early Apple iPads.

And on the growing importance of post-production services, 

A study published in 2015 by the Brookings Institute, an American think-tank, reckoned that the 11.5m American jobs counted as manufacturing work in 2010 were outnumbered almost two to one by jobs in manufacturing-related services, bringing the total to 32.9m. A British study conducted by the Manufacturing Metrics Experts Group in 2016 came to a similar conclusion: that 2.6m production jobs supported another 1m in pre-production activities and 1.3m in post-production jobs.

It's baaaack - the return of industrial policy!

Theresa May's ten pillar vision for Britain's industrial future signals the definitive return of industrial policy to the mainstream in developed economies. The symbolism is unmistakable. Nearly four decades after Ms Margaret Thatcher led the global movement to get governments out of business, another female British Prime Minister has signalled a reversal. 

Details may vary, but it cannot be missed that government is baaaack in the business of "picking winners". The green paper identifies life sciences, ultra-low emission vehicles, industrial digitalisation, nuclear and creative industries as potential priorities and has sought strategy documents to promote growth in these sectors. Dress it up as "sector deals" or "challenges" to industry, it cannot hide the fact that the ideological shift from generalised policies to industry specific ones constitutes a definite reversal.  

It is equally interesting that Ms May's policy turn coincides with a reversal of Reaganite policies across the Atlantic! The surprising thing about this round of historical cycles has been the short duration between the tides. 

Free-market capitalism's assault on economics, politics, and society

Unfettered free-market capitalism has distorted price signals, rules of the game in democracies, and shifted social frames of references for the worse. In simple terms, it has distorted economics, politics and the society. 

1. It is now widely accepted that while there are pockets of market failures in an economy, the markets in the aggregate are efficient and reflect the interests of the society at large. Accordingly, a rising stock market, for example, reflects promising aggregate economic prospects.   

But consider the recent gyrations in global equity markets during the US Presidential elections and its aftermath. The same markets which were initially spooked at the prospect of a Trump White House, rebounded with vengeance on the realisation that the new President's pledge to reduce corporate tax, ramp up public spending on infrastructure, and indulge in protectionism would all boost the incumbents in corporate America. If someone landed up straight from Mars and saw the post-election US equity market rally, they cannot but not get the impression that the markets are rejoicing at an expected result.

Never mind the contradiction in the prospect of reduced tax revenues and increased public spending at a time when national debt is touching record high. Never mind that protectionism, apart from "cosseting the losers", would increase prices and lower the real incomes for the vast majority of Americans. And never mind, the uncertainty associated with a capricious President Trump, including the potential for unleashing very destabilising geo-political forces. Though political and economic uncertainty has become the norm for the US, in a convergence with the developing countries, markets seem non-plussed. 

Clearly the health of Wall Street is no longer a credible touchstone for that of Main Street. 

2. The Economist, the conscience keeper of free market capitalism, commenting on the effusive response of stock markets and investors to the rise of protectionism and industrial policy that will "cosset losers" (instead of "pick winners") under right-wing leaders in UK and US, lets this slip, 

Imagine the reaction of investors if left-wing leaders were in charge. If President Bernie Sanders were berating American companies on Twitter, or Jeremy Corbyn was pledging unquantified British government support to manufacturers, markets would be plunging.

This is profound. It simply means that equity markets and investors are biased against non-right wing governments. So much so that right-wing governments can adopt completely non-right policies and still get support from investors and the market. Quite simply, the remorseless march of free market capitalism has dramatically shrunk the space available for political action. 

Consider the example of policies to address widening inequality or excessive financialization. Any meaningful effort to address widening inequality has to, perforce, involve redistribution, in some form or the other. But markets will recoil at even the mention of the R-word. Similarly, any reasonable attempt at addressing financial market imbalances will have to involve greater regulation, which would immediately arouse adverse market reaction.  

Democratic politics has become the captive of financial markets and the space for political action has receded dramatically. 

3. Finally, markets have distorted our social frames of reference. Consider the reams of stories that have been circulating around the global activities of Goldman Sachs. The tenacious and indefatigable  Matt Taibi captures these pretty undisputed facts,

Goldman has been implicated in the trafficking of toxic mortgages, a sprawling state corruption case in Malaysia, the manipulation of world commodity prices and a heinous episode involving Greece in which the bank helped to mask the country's ballooning debt while simultaneously working with JPMorgan Chase to create an index for betting against Greece's economy.

One can add the disgraceful duping of Libya and many more. None of these appear to have had any effect on Teflon Goldman Sachs. After promising to "drain the swamp", the "vampire squid now occupies the White House"! The lack of social indignation in the US is stunning. 

This takes us to the point about actions of Wall Street institutions in the lead up the sub-prime crisis. Goldman again led the pack, with the dumping of its toxic portfolio of failing mortgage investments as collateralized securities on its unsuspecting clients. In simple terms, Goldman was betting against its clients. And this had the knowledge of everyone in its Firmwide Risk Committee. The Levin-Coburn report of the Senate Permanent Subcommittee on Investigations clearly documents these transactions by Goldman. After its investigations, instead of pressing criminal charges on the Goldman leadership, the Justice Department and the Securities and Exchanges Commission (SEC) agreed for a financial settlement.

In a world of twenty or thirty years back, Goldman's actions would have seen unambiguously as criminal transgression, shaken up the public conscience, and triggered mass outrage. The Justice Department would have been been forced into pressing criminal charges against Goldman executives. Instead, the public reaction is easily deflated with a financial settlement. Never mind that the executives do not shell out even a penny and shareholders took the tab. Heads I win, tails you lose.

Today, eight years after the sub-prime crisis, not one top executive of a big financial institution has been indicted on criminal charges, leave alone gone to jail. Instead shareholders of these institutions have paid hundreds of billions of dollars in fines, while the same executives have risen further and fattened their purses.

The moral hazard has become entrenched among financial market executives that leave aside risk taking, even unethical and fraudulent practices have only has an upside - make money if the it pays off, or let shareholders take the hit if the transaction is exposed. Criminal indictment, leave aside prison terms, are off the table. And all this hardly elicits any more social indignation. Settlements, financed with somebody else's money, are the new normal for a financial market executive as well as for the society at large.

Now that the social frames of reference on financial sector misdemeanours has shifted dramatically, it may be interesting to get a social pulse about what constitutes a financial crime?