Friday, November 28, 2014

Dual price market in bad bank loans

A few days back I blogged about the distortions caused by the dual price market in labor wages. Another dual price market created by administrative fiat, in the aftermath of the global financial crisis, is on the classification of impaired assets by India's banks. Non-performing assets (NPAs) and loan restructuring have risen steadily since 2008. The RBI allowed a differential loan book classification of both types of assets in the aftermath of the crisis.
If an account becomes an NPA, it requires 15 per cent provisioning, while a restructured asset needs 5 per cent provisioning. 
The result has been bank managements scrambling to recast bad loans through debt restructuring and avoid NPA classification, thereby kick the can down the road, possibly to a successor CMD, on increased provisioning. It has also served to paper over the dregs of crony capitalist orgy over the past decade. The RBI Governor has been emphatic in denouncing such "risk-less capitalism".

Fortunately, unlike other dual-price markets, this has a sunset - the RBI mandates 1 April, 2015 as the end of this regulatory forbearance.

Thursday, November 27, 2014

Importance of racial diversity and persuasive power of graphs

Two interesting Upshot posts

1. The first article points to a new study that highlights the importance of racial diversity in trading rooms in preventing bubbles. They conducted trading simulations among groups of people with financial background and similar analytic capabilities to value imaginary stocks. Their finding,
We find that price bubbles are fueled by the ethnic homogeneity of traders. Homogeneity, we suggest, imbues people with false confidence in the judgment of co-ethnics, discouraging them from scrutinizing behavior. In contrast, traders in diverse markets reliably price assets closer to true values. They are less likely to accept offers inflated offers and more likely to accept offers that are closer to true value, thereby thwarting bubbles. This pattern is similar in Southeast Asia and North America, even if the two sites differ greatly in culture and ethnic composition, in what is implied by “ethnic diversity” and how it is operationalized...
we suggest that biases may stem not only from the limits of individual cognition, but also from the social context in which decisions are embedded. Homogeneity (or diversity) is not a feature of individuals, but of a collective: a team, a community, or a market... More broadly, homogeneity may play a critical role in herding—the convergence of people’s beliefs and behaviors through interaction—also known as (or related to) cascading, social contagion, peer effects, informational social influence, social proof, or institutionalization. If, as we find, markets populated by skilled traders possessing complete information are still so affected by homogeneity, it may have an even more pronounced role in other instances of herding, such as the spread of fashions, fads, false beliefs, and riots...
In our experiments, ethnic diversity leads all traders, whether of majority or minority ethnicity, to price more accurately and thwart bubbles. Ethnic diversity was valuable not necessarily because minority traders contributed unique information or skills, but their mere presence changed the tenor of decision making among all traders. Diversity benefited the market... Diversity facilitates friction. In markets, this friction can disrupt conformity, interrupt taken-for-granted routines, and prevent herding. The presence of more than one ethnicity fosters greater scrutiny and more deliberate thinking, which can lead to better outcomes.
In other words, diversity has an importance that goes beyond its moral imperative and is a positive contributor to improvement in collective performance. Just as an individual with a more diverse network of interactions and access to information is more likely to be successful, a more diverse group of people are likely to be more productive.

2. The second article points to a field experiment which highlights that graphical messages, by conveying the impression of scientific rigor, have a much greater persuasive power in conveying information than mere statements.
People who were given graphs or formulas along with claims regarding medication efficacy displayed greater belief in medication effectiveness. Such effects occurred for both graphs and chemical formulas, and for different populations: an online panel, a campus population, and a general population. The prestige of science appears to grant persuasive power even to such trivial science-related elements as graphs. Ostensibly, graphs signal a scientific basis for claims, which grants them greater credibility. This does not seem to be because graphs help cognitive processing. 
The effects of graphs hold even when no additional information is supplied or even implied by the graphs, and it is not moderated by increased understanding or retention of information. The effects of graphs are also not due to their visual nature—similar non-visual scientific signals also increase persuasion... It also appears that it is the general belief in science that is at least partly responsible for the persuasive power of graphs... Given that they signal scientific credibility, graphs have a greater effect for those who have faith in science. The effects of graphs on persuasion might exemplify a broader inferential process:

The information contains a graph (premise); Graphs signal a scientific basis (premise); Therefore, the information has a scientific basis (conclusion); A scientific basis indicates truth (premise); Therefore, the information is true (conclusion).
Furthermore, people who saw charts were found to be more likely to recall the results than those who read the text description. While this points to the power for graphs (and maps) in conveying information, it also highlights its potential of being abused to mislead people. 

Tuesday, November 25, 2014

Reforming the dual-price market in labor wages

Mainstream debates on labor market reforms in India focus on easing hiring and firing regulations. In an excellent column Manish Sabharwal points to another important labor market distortion - the massive difference between gross and net pay. He writes,
Current labour laws... require employers to confiscate 45 per cent of the salary of employees whose wages are under Rs 1.8 lakh per annum and hand it over to various programmes and agencies like the Employees’ Provident Fund Organisation (EPFO), Employees’ Pension Scheme, Employees’ Deposit-Linked Insurance Scheme, Employees’ State Insurance Corporation... government data is clear that employees with wages this low do not have any savings. It is impossible, or at least very difficult, for them to live on half their salary... divergence between what employees call chitthi-waali salary (gross pay) and haath-waali salary (net take-home pay)... - part of the difference is funnelled into schemes that offer poor value for money, bad service and are humiliating — breeds informal employment. In the case of informal jobs, gross salary is equal to net salary. 
And about the inefficient deployment of these hard earned savings,
There are 55 million dormant accounts, more than half the total number of accounts, in the EPFO. Hard-earned money is abandoned by employees because they are frustrated with the organisation’s incompetence, corruption and inefficiency. Additionally, the EPFO’s charge of 440 basis points makes it the world’s most expensive government securities mutual fund — other mutual funds charge 25 basis points for gilt funds. The Employees’ State Insurance Corporation has India’s worst health insurance claims ratio — it only pays 49 per cent of contributions as benefits — and offers rotten care, while sitting on Rs 28,000 crore of idle financial investments. 
I agree with Manish that instead of the controversial hire-and-fire reforms, the next round of labor reforms should involve addressing this dual-price market in labor wages, though the details may vary. This is one more in the long list of dual-price markets in India - market and registration value for property transactions, market and subsidized price for essential goods, MSP and market price for food-grain harvest, production cost and tariff for utility service, etc - that need to be urgently dismantled.

But there is a fundamental problem with the issue which is likely to surface when discussion starts on its reform. Employee social protection is typically financed either through a combination of employees and employers contribution. But at these low wage levels, it is difficult for the employees to contribute their share and any employer's share is generally a transfer involving a reduction in employee pay-check. Any reform that dispenses with the social protection is not only undesirable but also unlikely to pass muster.

The only option available may be some form of publicly funded social protections - pension and insurance. But such protections comes with fiscal burden. However, it can be mitigated by limiting them to salaries below a certain level or certain sectors or types of employment, with a gradual phase out of the same over a 10 year period. The Hartz reforms in Germany embraces these principles for low and mid-level jobs. In any case, instead of frittering public resources on unproductive indirect subsidies and incentives, this may be a more effective and less distortionary approach towards encouraging small enterprises into becoming formal. 

Saturday, November 22, 2014

The role of management in schools

Fascinating new paper by Nick Bloom and three others which compares management practices in high schools in 8 countries across the world, including India. Their finding is that improving management could be an important way to raise school standards,
Autonomous government schools (i.e. government funded but with substantial independence like UK academies and US charters) have significantly higher management scores than regular government schools and private schools. Almost half of the difference between the management scores of autonomous government schools and regular government schools is accounted for by differences in leadership of the principal and better governance...
Having strong accountability of principals to an external governing body and exercising strong leadership through a coherent long-term strategy for the school appear to be two key features that account for a large fraction of the superior management performance of such schools... Autonomy by itself is unlikely to deliver better results, however, finding ways to improve governance and motivate principals are likely to be key to make sure decentralized power leads to better standards.
The differences in the quality of management in all types of schools among different countries is captured in the graphic below. The good management tail is virtually absent in India. This is in line with management practices elsewhere in India - fractions of manufacturing firms, hospitals, and schools, scoring above 3 is 22%, 10%, and 1.6% respectively.
Another graphic captures the difference in management scores across different types of schools - public, autonomous public, and private - in each country. Note that, unlike other countries, the aided schools do almost as bad as others while the private schools stand out as far better than others. Difficult to say whether the latter finding is a testament to the quality of private schools or its near-total absence in public schools.
A few observations.

1. The poor performance of aided schools in India is a testament to the deeply politicized and corrupt nature of allotment of these schools. Interestingly, Brazil runs its autonomous schools, which receive most of its funding from government, with such great success. In other words, there appears to be a massive "discount" associated with any activity that involves interface with government.

2. I see Prof Bloom's studies on management practices in business enterprises and now schools as important in highlighting the important role of guidance, monitoring, and supervision in the success of any enterprise, private or public. Given the poor quality of these attributes in public (and private) systems, a reflection of state capability deficiency, there is a terrific opportunity here. But I am not sure whether the conventional strategies to improve governance quality can be effective here.

3. There is a strong case (the high coefficient for India on Table II, Column 6 is reflective of this) that the quality of management is the foundation on which the various standard schooling inputs work their way. In other words, even if the students and teachers attend school regularly, the school has all physical infrastructure, and children are equipped with learning materials, the effectiveness in translation of teaching into learning is strongly dependent on the quality of management (leadership, governance, guidance, capacity building etc). In other words, the poor management of Indian schools may be having a value subtracting effect on the other interventions. 

Population density visualized

Two superb graphics which highlight how population density can affect the spatial dynamics of countries. The first shows the space, in term of area of US states, required to accommodate the total world population at the same density as in some global cities.
The second (sent by a friend) shows the sizes of different cities and their population. Note the relatively similar populations of New York and New Delhi, and Tokyo and Dhaka, and the manifold difference in their sizes.  
This blog has several other interesting similar graphics. 

Tuesday, November 18, 2014

The rich and the super-rich

The real story in inequality is the explosive growth of income and wealth at the topmost tier of the income ladder, the top one-hundredth. While the incomes of the top 1% have surged, those of the top 0.01% have rocketed.

Times has this story of how this is reflecting in the market for luxury consumption in the US,
The wealthy now have a wealth gap of their own, as economic gains become more highly concentrated at the very top. As the top one-hundredth of the 1 percent pulls away from the rest of that group, the superrich are leaving the merely very rich behind. That has created two markets in the upper reaches of the economy: one for the haves and one for the have-mores. Whether the product is yachts, diamonds, art, wine or even handbags, the strongest growth and biggest profits are now coming from billionaires and nine-figure millionaires, rather than mere millionaires...
For decades, a rising tide lifted all yachts. Now, it is mainly lifting mega-yachts. Sales and orders of boats longer than 300 feet are at or near a record high, according to brokers and yacht builders. But prices for boats 100 to 150 feet long are down 30 to 50 percent from their peak... The private jet market is splitting in two. Sales of the largest, most expensive private jets — including private jumbo jets — are soaring, with higher prices and long waiting lists. Smaller, cheaper jets, however, are piling up on the nation’s private-jet tarmacs with big discounts and few buyers... According a jet market report from Citi Private Bank, deliveries of new so-called light jets — the smaller, cheaper models — were down 17 percent last year from 2012 and 67 percent from their 2008 peak. But deliveries of the biggest new private jets jumped 18 percent last year...

Sunday, November 16, 2014

Scandinavian economy facts of the day

Times reports about Denmark's reliance on Moeller-Maersk,
Revenue at AP Moeller-Maersk, publicly traded but family controlled, equals more than 14 percent of Denmark’s gross domestic product.
And FT has this about the spectacular size of Norway's Oil Fund,
Every day for the past thirteen-and-half years, Norway's oil fund has grown by an average of $165 million... It has quintupled its assets in the past decade to $860bn and transformed itself into the world’s biggest sovereign wealth fund, with a 100-year plus horizon. Today, it owns the equivalent of 1.3 per cent of every listed company in the world.