The off-balance sheet debt problem in the US

John Mauldin has a series of US debt crisis. The ticking bomb is the unfunded social security and health care unfunded liabilities, which sits atop the $21.2 trillion federal government debt (105% of GDP) and $ 3.1 trillion (15% of GDP) of state and local government debt. Consider this,

These estimates of when the trust funds run out depend on a slew of assumptions. To estimate revenue, they must know how many workers the US has, their wages, and at what rates those wages will be taxed. To estimate expenses, they mustknow how many retirees will be drawing benefits, the amount of those benefits, and how long the retirees will live to receive them. They also have to assume an inflation rate on which thecost-of-living adjustment is based. A small deviation in any of those can have huge long-term consequences. For what it’s worth, then, Social Security says it has a $13.2 trillion unfunded liability over the next 75 years. That’s the benefits they expect to pay minus the revenue they expect to receive. Medicare projections require even more assumptions: what kind of treatments the program will cover, how much treatment senior citizens will need, and what those treatments will cost. Allthese could vary wildly but the “official” assumptions put Medicare’s 75-year unfunded liability at $37 trillion. It could be vastly more or, if we all get healthier and healthcare costs drop, could be less... 

Larry Kotlikoff estimates the unfunded liabilities to be closer to $210 trillion. That’s a far cry from the $50 trillion official estimate. So, at a minimum, we can probably assume Social Security and Medicare are at least another $50 trillion in debt on top of the $21.2 trillion (and growing) on-budget federal debt. And then you come to the scary part. This doesn’t include civil service or military retirement obligations, or federal backing for some private pensions via the Pension Benefit Guaranty Corporation, or open-ended guarantees like FDIC, Fannie Mae, and on and on... CBO numbers show that by 2041, Social Security, health care, and interest expenditures will consume all federal tax revenue. All of it. Everything else the government does (including defense) will require going into more debt.

The article nicely lays down how these are most likely the best case scenario given the uncertainties associated with making such estimations as well as the headwinds that would have to be overcome.

A few mid-week reading links

1. FT reports of the US decision to suspend Rwanda's access to a preferential trade agreement, African Growth and Opportunity Act (AGOA), in retaliation for that country's decision to restrict the import of used clothes from the US. As a matter of fact, Rwanda's policy on promoting domestic industry follows the much more mercantilist industrial policies adopted by all developed countries during their own growth phases. 

The article also points to the strongly patronising reaction in the UK to Rwanda's decision to promote its tourism potential,

There is a parallel in the harsh reaction Rwanda got when it announced last month it was spending £30m on sponsoring the shirts of Arsenal football club. The Daily Mail, a populist UK tabloid, blustered that what it called a Rwandan dictator was blowing the cash of his impoverished people on a vanity project. Never mind that the sponsorship deal was part of a joined-up strategy to turn Rwanda into a convention and tourism destination. Rwanda has gorillas, a game park with the big five animals, good air links and an impressive new convention centre in Kigali, the well-functioning capital. But, thundered the Mail, it got £62m in British aid and should not be spending its money this way. That message is essentially the same as Washington’s. If we give you any aid or encouragement, we expect to set your policies and your priorities. If you try to lift your country out of poverty, then we will cut you off.

This has resonance with the "evidence-based" belief in international development circles questioning the efficacy that investments in rural roads and rural electrification. 

2. We live in the age of superstar CEOs. Apart from the Wall Street titans, there are the founders of the various technology and other startups who have been endowed with extraordinary abilities and feted by the media and opinion makers. This is despite a very rich body of evidence that disputes this conventional wisdom. So, conditional on the basic entrepreneurial attributes (and smartness, intelligence et al), quite how much of the success of startup CEOs is plain good luck of being at the right place at the right time? I am inclined to think most of it!

FT has this to write about Elon Musk's latest series of outbursts,

The performance has stoked long-simmering questions about whether Tesla has adequate checks and balances to control a chief executive who thrives on shattering convention. One analyst who covers Tesla for a large bank says many observers believe Tesla lacks “grown ups” to rein in Mr Musk’s outbursts, particularly on Twitter, where he goads journalists and promises to “burn” speculators who short the company’s shares. “For a while it was endearing, but he [Mr Musk] has gone full Trump. The pressure, the need for attention — it’s weird, his mental state is deteriorating,” says the analyst, who asked to remain anonymous. An industry executive who knows Mr Musk adds: “If any other CEO on earth exhibited the behaviour he is doing they would be out in an instant.”

As the examples of Travis Kalanick and Mark Zuckerberg shows, much of these reputations vest on plain good fortune.

3. If we are talking of risk appetite and thinking super-big, SoftBank's Masayoshi Son, with his $100 bn Vision Fund, would beat the likes of Elon Musk hands down. Consider this,

SoftBank is shifting the relationship between the tech sector and capital markets. At a time when start-ups are minded to stay private for as long as possible, SoftBank allows its portfolio companies to pursue growth without worrying about burning cash. Some venture capitalists even quip that “SoftBank has replaced the IPO”. Stephen Schwarzman, the billionaire co-founder of private equity firm Blackstone, says Mr Son is redefining technology investing. “No one has ever done that before at this kind of scale,” he says. “It’s unprecedented but it’s meeting a market demand.”

At the least, Son has the $145 bn worth stake in Alibaba from a 2000 investment to show for. More than what can be said about many superstar VC managers from Silicon Valley. 

4. As LIC assumes a controlling stake in IDBI Bank, Bloomberg Quint raises concerns about what it means for LIC's shareholders. Consider this,

LIC currently holds 11 percent in IDBI Bank. Hypothetically, if it were to buy another 40 percent stake to get to 51 percent shareholding, it would cost the insurer Rs 9,600 crore at current market value... India Ratings estimates that IDBI Bank’s total stressed portfolio (including non-fund based faclities) is 35.9 percent of total loans... This means that... in 2018-19, IDBI Bank will need more than the Rs 10,000 crore that it received from the government last fiscal. Even if you take a conservative estimate of Rs 10,000 crore in capital needed, that takes LIC’s immediate capital commitment to IDBI Bank to over Rs 20,000 crore. Is that money well spent by LIC? It’s tough to argue in favor of that given that the bank has reported losses for six consecutive quarters now... Note that no private investor has shown an interest in IDBI Bank even though the government has been wanting to sell equity for over two years now.

And the systemic risk consequences posed by LIC's growing exposure to the banking sector,

As part of its investment activities, LIC has been an active investor in public sector banks. This was particularly true in 2015 and 2016, when LIC bought into preferential share issues of a number of government run banks to cover for the shortage of capital. As a result, LIC’s shareholding in these banks has risen. Shareholding data from stock exchanges shows that LIC holds more than 10 percent in at least six government banks. Apart from holding equity in banks, LIC invested in debt securities issued by banks, including additional tier-1 bonds. As such, its connectedness to the banking system is already significant.

5. Livemint has a two past series on traffic congestion in Indian cities that draws on anonymised Uber data from 2016. It shows that Indians have among the longest commute times and this has been worsening in recent years. As a measure of the congestion, commute times almost doubles during the peak times when compared to off-peak hours. 

6. Paul Krugman has this assessment of the consequences of a global trade war. He estimates tariffs to rise buy 32-60 percentage points (he approximates to 40 percentage points), a 70 per cent decline in global trade, and a permanent reduction in world GDP by 2-3 per cent. In simple terms, the world economy would be back to 1950s in terms of trade.

Don't know whether they have been factored into the studies mentioned by Krugman, there are two important collateral damages likely. Consumers in developed economies will be hurt by the imported inflation arising from higher tariffs. And exporters in developing countries would be hit by costlier imports of intermediate goods which would end up increasing the final prices of their finished products.

7. Businessline has a good article that puts India's low tax base in perspective. Contrary to conventional wisdom it does not find tax compliance to be a major problem. Sample this,

The latest Labour Bureau’s Annual Employment-Unemployment Survey in FY16 covered 1.5 lakh households. It found that over 87 per cent of the households earned less than ₹20,000 a month (₹2.4 lakh a year). This included full-time workers, part-time ones, casual workers, as well as the self-employed. This effectively means that only 13 per cent of the 25 crore Indian households (about 3.2 crore households), may be earning enough to pay income tax. If income tax collections are held back by low income levels, corporate tax collections in India seem to be afflicted by the poor scale and low profits reported by the vast majority of businesses. In India, business is dominated by the 6.3 crore unincorporated enterprises that are mostly run from home. Registered companies number just 17 lakh. Of the registered companies, only about 11 lakh are active and about 7 lakh companies filed their I-T returns in FY17. But again, as many as 5.3 lakh of those companies reported an annual income of less than ₹2.5 lakh! The above data also explain why, as the taxman has trained his guns on evaders in the last three years — tracking down non-filers and issuing a flurry of notices — he has mostly netted only small fish. Between FY14 and FY18, India saw the number of I-T return filers expand by 80 per cent from 3.79 crore to 6.84 crore. But the direct tax kitty grew by a far lower 55 per cent. Nearly a fourth of the current return filers fall in the zero-tax bracket.

This was the central message of Can India Grow?

8. Amidst the uncertainties surrounding debates on peak oil, the oil market is going through the latest cycle of investment contraction. Consider this

In the second half of this decade total capital expenditure by the large oil and gas groups is projected to fall by almost 50 per cent to $443.5bn from $875.1bn between 2010-15, according to Norwegian consultancy Rystad Energy. Although partly offset by a fall in oilfield development costs, the drop also coincides with the big groups ploughing more capital into shorter-term projects, which pay off quickly, as well as renewable energy.

This comes even as prices are experiencing downward pressure due to the convergence of renewables and the falling cost of production itself due to technological advances. 

The article points to oil majors preferring renewables and short-cycle shale projects rather than long-gestation conventional projects.

9. Finally, the Times points to the flattening yield curve in the US, a portend for recession. The flattening yield curve sets the stage for its inversion, wherein the long-term rates fall lower than the short-term ones. All but one of the nine recessions since 1955 have been preceded by an inversion of the yield curve.

In normal times, markets expect long terms rates to be higher than short-term ones, a reflection of the inflation expectations over the longer term. However, an inverted curve points to market expectations about weaker economic growth prospects and consequent lower rates.

The next frontier for China - global electricity grid?

FT reports on China's latest global endeavour, the Global Energy Interconnection (GEI) initiative, the equivalent of an internet for electricity.

It is a plan to create a global electricity grid by producing electricity, especially hydro, in China's mountainous hinterland and other low-cost locations around the world, and then transmitting it through underground ultra high voltage (UHV) cable lines as far away as Germany. The country's world leading state owned electricity companies would lead the charge. 

Consider this,

Chinese companies have announced investments of $102bn in building or acquiring power transmission infrastructure across 83 projects in Latin America, Africa, Europe and beyond over the past five years, according to RWR. Adding in loans from Chinese institutions for overseas power grid investments brings the total to $123bn. Throw in all power-related Chinese deals overseas, including investments and loans to power plants as well as grids, and the number almost quadruples. Between 2013 and the end of February 2018, total overseas power transactions announced reached $452bn, up 92 per cent from 2013 levels, according to RWR, which strips out of its calculations deals that are announced only to be subsequently cancelled... The first stage, set to run until 2020, involves investment in domestic grid assets within other countries. The second phase would see the knitting together of some of those grids and that generation capacity...

The state-owned power companies that are hitting the acquisition trail overseas rank as global heavyweights. State Grid is ranked as the world’s second-largest company after Walmart in the 2017 Fortune 500 list. On important issues such as GEI these companies partly co-ordinate their actions through the China Electricity Council, an official body reporting to the State Council, China’s cabinet. The financial firepower at the disposal of these state-backed companies to sweeten bids for assets overseas is underwritten by China’s policy banks, the China Development Bank and the Export-Import Bank of China... China has already demonstrated the UHV technology’s performance at home. The 37,000km of UHV cable that is laid or under construction in China can carry a load of 150GW, equivalent to 2.5 times the maximum electricity load in the UK... Steven Chu, a former US secretary of energy, has called China’s strides in UHV technology a “Sputnik moment” for the US, alluding to the Soviet Union’s 1957 launch of the first earth-orbiting space satellite, which marked a technological leap ahead of the US.

The Chinese push in the development of globally interconnected electricity grid creates the possibility of the country being able to exercise the sort of influence in the electricity sector that US currently does over the internet. This becomes a likelihood at least in Africa, parts of Asia, and Latin America as Chinese loans and power generation, transmission, and distribution companies have made massive investments that give them a dominant stake in the respective markets. 

While there are also significant technical, practical and political barriers to be overcome to realise the vision that Xi Jinping has laid out through the GEI initiative, much less exercise sufficient control over its evolution, its likelihood is not as remote as one would imagine. Therefore the geo-political risks posed by the access to such an essential resource like electricity are very real and significant.

This assumes significance also in the context of China's similar policy in the ports sector.

In the context of Sri Lanka and the Hambantota port, The Times has a nice story about how Chinese investments in the port sector have both created military and strategic concerns as well as engendered indebtedness in the host country. The article highlights the extent of influence that Chinese were able to exert on the Sri Lankan government of Mind Rajapaksa as a quid pro quo for the port deal.

Transformations within governments

New MGI report on achieving success with transformational programs within governments. The report studied 80 cases of transformation projects within governments across 50 countries and came up with five essential ingredients for any successful transformation.

1. Committed leadership 

2. Clear purpose and priorities

3. Cadence and co-ordination in delivery

4. Compelling communication

5. Capability for change

The report claims that embracing these five "disciplines" more than triples the likelihood of success with transformational implemenations. It advocates a combination of the five ingredients with three new age concepts - focusing on citizen experience, design thinking, and agile implementation.

While more or less all such case study examples are more likely an exaggerated illustration of the specific use cases and its channels of impact, and also an advertisement for McKinsey involved transformations (and therefore to be taken with a pinch of salt), the larger message is well taken. 

There is no substitute for passionately committed and decisive leaders who lead from the front, prioritise on a few objective, have a clear but flexible enough plan, have put in place a dedicated team with requisite capabilities, monitor implementation closely and intensely, co-ordinate among all government agencies, and engage deeply with all those affected by the change and communicate with them.

Three new business concentration graphs

Market concentration and its harmful effects on the economy is well documented. But important decision makers (and opinion makers), especially in the US, remain unconvinced by the growing evidence. Or is it a matter of them being captured?

The latest comes in the form of the decision last week by a US Federal Court judge allowing the $85 bn merger of AT&T and Time Warner. The former provides phone, internet, video and data services (or distributes content), while the latter owns television channels across news, entertainment, and sports (produces content), and together they "can count as customers practically every household in America". The Judge ruled against a very weak challenge by the US Justice Department that the combination of a major producer and distributor of content could substantially lessen competition in media industry. The Steven Pearlstein in Washington Post has very nicely described the judgement as a "hatchet job" involving selective and biased evidence by a "judicial scoundrel"!

Be that as it may, here are three latest graphs that highlight the growing market concentration.

David Leonhardt has two graphs on economy-wide business concentration in the US from Business Bureau's Business Dynamics Statistics. The first captures the rising share of businesses with more than 10000 workers and the declining share of those with less than 20 workers.

And companies with more than 10000 workers employ more people than those with less than 50 workers. 

His documentation of the changes in the past quarter century are stunning,

In the late 1980s, small companies were still a lot bigger, combined, than big companies. In 1989, firms with fewer than 50 workers employed about one-third of American workers — accounting for millions more jobs than companies with at least 10,000 employees... The share of Americans working for small companies fell to 27.4 percent in 2014, the most recent year for which data exists, down from 32.4 in 1989. And big companies have grown by almost an identical amount. Today, companies with at least 10,000 workers employ more people than companies with fewer than 50 workers.

The third graphic covers a forthcoming IMF study on business concentration in developed and developing economies using data for publicly listed companies in 74 countries. It captures a measure of market concentration, average mark ups (or how much a company charges for its products compared with how much it costs to produce an additional unit of this product, expressed as a ratio).

The rise since the early nineties in the developed economies is capitalism gone berserk! Markups have increased by 43 percent since the eighties in those countries.

Ananth has a nice post on the irony of how the elites and decision-makers, even at places like the IMF, continue to pay lip-service to the evidence that their own research department comes up with.

The challenge with implementing public policy

You can have the best structured and incentive compatible policies and yet not have much impact on the ground in addressing the underlying problem. And this state of affairs can persist for years, even decades. Not for nothing is state capacity, in the opinion of this blogger, the biggest challenge facing India. 

Crop insurance and foodgrain procurement are two examples of where acute last mile gaps come in the way of realising desired outcomes. In both cases, it is easy enough to announce the best possible design of a crop insurance or crop procurement policy. But those announcements mean nothing when the rubber hits the road. In case of the former, the constraint is the insurance payout, while with the latter it is the actual physical procurement itself. There are no magic pill universally replicable innovations out of these problems.

Indian Express carries a story on the troubles faced by farmers selling off their produce at the public procurement centres at a mandi in Vidisha district of Madhya Pradesh.

Roop had received an SMS eight days ago from the cooperative society with which they are registered, asking him to come to the mandi on Wednesday, but the father and son chose to come a day earlier... Their token number, a chit issued the day they reached, is 234 — there are 233 farmers ahead of them in the queue. No more than 40 trolleys can be weighed in a day, which means the duo will have to spend at least five days before their turn comes... Until last year, trading at the mandi would happen between noon and 4 pm, when farmers would come, post-lunch, with their produce, which would be auctioned in the presence of mandi officials. This year, after chana prices started crashing due to a bumper crop and less demand, the government decided to buy directly from farmers — at Rs 4,500 per quintal — for the Central pool. Selling to the government offers farmers better returns than selling to private traders, which explains the rush... While the Singhs own their tractor-trolleys, many other farmers have hired vehicles to transport their produce to the mandi. “The rent for the first day is calculated according to the weight of the produce (anywhere between Rs 40 and Rs 80 per quintal of produce). From the second day onwards, we have to pay a daily rent for the trolley,” says Roop... The farmers wonder if a dharma-kanta (a weighbridge) would have eased their woes unlike the existing practice of unloading the produce on the floor of the mandi, packing it in bags, weighing each of them and sealing them, the entire process taking nearly 80 minutes for 40 quintals... Six days after they arrived at the mandi, the Singhs managed to sell chana from one of their trolleys. But they were told the chana in the second trolley had impurities. They will now get it cleaned and come back.

Consider the problems. Immediately after harvest, with chana prices crashing following a bumper harvest, farmers rush to offload their produce at the procurement centres over a very short time window. The procurement centre, without any weigh bridge or other logistics, has to get the produce graded, packed into gunny bags, and weighed. All this takes up an inordinate time for a single farmer and farmers stand in line for hours days! This wait in turn inflicts heavy tractor rental charges and other opportunity cost on the farmers. And even after waiting for days to get their chance, farmers face the prospect of being turned away and being asked to come back after rectifying some defect or other!

Much the same (difficult last mile gaps) applies to the Soil Health Cards or electronic national agriculture market place (eNAM). Sample this series of actions suggested on eNAM,

The following steps should be taken in a concerted manner: (i) unyielding focus on agri-market reforms starting with basics of assaying, sorting, and grading facilities for primary produce as per nationally recognised and accepted standards; (ii) creating suitable infrastructure at mandi-level (like godowns, cold storages, and driers) to maintain those standards; (iii) bringing uniformity in commissions and fee structures that together do not go beyond, say 2%, of the value of produce; and (iv) evolving a national integrated dispute resolution mechanism to tackle cases where the quality of goods delivered varies from what is shown and bid for on the electronic platform.

Each of the four steps, after putting in place the enabling implementation frameworks, need to be materialised. And that is where state capacity, persistent action, and committed leadership becomes necessary. 

Programs like Fasal Bima Yojana, Bhavantar Bhugtan Yojana, Soil Health Cards (see this and this), and eNAM are examples of reforms where enacting the rules and regulations is the easier part. But when the rubber hits the road, state capacity and other systemic constraints start to bind. There is only so much (mostly tinkering at the margins) that can be done with technology and innovation.

In simple terms, successful implementation of these require committed and stable leadership at the Ministry/Department level for atleast five years, maybe as mission-mode projects, with the mandate being to fix the plumbing challenges and demonstrate success with at least a few models. And they need to be complemented with responsive systems both at the level of the District Collector and the Joint Directors (or equivalent) of Agriculture in the District, in at least some of the districts. And it needs to be done in a phased manner with diligence, practical compromises and improvisation where required. 

And also, a one speed nationwide roll-out of such things may not be possible (state capacity) nor desirable (since it may run into political economy challenges). We need to look at the possibility of doing such stuff as a multi-speed campaign (which would also not concentrate discontent) - get everyone to the starting line with all the enablers (both regulations and requisite documentation), make available a practical implementation plan with the likely constraints and possible solutions around it, let the districts/states run with it at different speeds, and foster healthy (but not high enough stakes) competition among them. 

Many things which can be done relatively easily at the district level may not be possible for the States or Government of India to prescribe. It demands more of a gradual and bottom-up diffusion approach than a top-down, one-speed, universal coverage approach. 

This applies as such to the IBC too. As we go ahead, some or all of the following are likely - the Resolution Professionals (RPs) will be captured, judiciary will intervene indiscriminately, NCLT will be compromised, promoters will create hurdles even after resolution, and so on. We need some concerted systemic effort to be at it for a reasonably long enough period of time to allow some hysteresis to set in. 

A practical agenda for a government is to identify no more than 10 schemes/priorities, structure them as Missions, appoint an appropriate Joint Secretary/Mission Director for each for five years, give them a clear (but practical) road map, equip them with sufficient resources, and let them run with it for 5 years. And monitor them closely for five years at different levels.

Social protection programs and impact on poverty

A recent article in the Economist pointed to success of Ethiopia's social safety net programs. It said that social safety net programs formed 1.5% of GDP in Sub-Saharan Africa. It writes,

Ethiopia’s rural scheme is widely regarded as a success. It has reduced rural poverty and helped the poor buy food during a severe drought in 2016 that might have led to famine.

Now this is deceptive. What do we mean reduced poverty? Does it mean that people's lives have undergone a significant change? I guess all this goes back to the artificial minimalistic thresholds that we have constructed around per capita incomes to define poverty levels. 

The World Bank defines Social Protection (SP) programs as consisting of social insurance (mainly public pension schemes covering old age and disability), social assistance (cash and in-kind transfers and workfare schemes, often targeted to the poor), and labor market programs (training, entrepreneurship support, unemployment benefits).

Martin Ravallion and Co explore the impact of social protection programs on the poorest, the floor level of incomes,

The bulk of the impact of SP in developing countries is due to public pensions, which lift the floor by $0.38 a day. This too is below the mean spending on such pensions, which is $0.67 per day. Social assistance on its own only raised the floor by $0.015 per day on average—merely 8% of the (already low) level of average spending on social assistance. The bulk of the impact of SP on the headcount index (5% points) is also due to contributory pensions. Social assistance on its own reduced the poverty rate by 2% points. Countries that spend more on social protection tend to have a higher floor. The correlation coefficient is 0.751. Mechanically, this relationship reflects both differing levels of SP spending and differing transfer efficiencies. Transfer efficiency in reaching the poorest varies greatly. We see that very few countries attain a value of FTE of unity or more. (Recall that this is the ratio of the gain in the floor due to SP to mean spending.) For the bulk of countries (87% of the sample), the gain to the poorest is less than mean SP spending. FTE tends to be better for social assistance on its own, for which the median value is 0.934, as compared to a median of 0.630 for all SP; 43% of countries have FTE for social assistance greater than unity. In addition to FTE, we measure the efficacy of SP in reaching the poorest 20%, giving our second measure of transfer efficiency, GTE. The two measures are correlated (r = 0.505), but certainly not perfectly; some countries are better than others at reaching the poorest people given their efficacy in reaching the poorest 20%. GTE is positively correlated with spending per capita (r = 0.656), but that is not true for FTE (r = -0.021). As countries spend more on social protection, a larger share of that spending tends to reach the poorest 20% but not the poorest.

Now the takeaways in English. We need to make the distinction between poverty alleviation (allows people to have three meals a day compared to two) and poverty eradication (allows people to have meat twice a week, or a more dignified human existence). SP programs in almost all the developing countries help address the former. It will keep people meaningfully above the biological poverty line. It does little, on their own, to help the poorest transition to any meaningfully higher income level. This is just stating the obvious - social safety nets are for poverty alleviation, and not elimination.

If this is the case, then how appropriate is to use indicators like increase in savings or increase in aggregate consumption to measure the impact of social assistance programs like cash transfers? A more relevant measure of impact would be just the change in food consumption - having enough to eat three meals against the typical one or two, or eating meat once a week, or something like those.

This is a bit like the debate about the role of women self-help group movement. It is often confused as an instrument of economic empowerment, when its more relevant utility may be as a tool of social empowerment.