Thursday, June 23, 2016

Smell test for why "this time is any different"

It is commonplace for new governments and policy makers across developing countries to claim that they have a plan to address complex social problems - learning outcomes, sanitation, financial inclusion, improve health care, increase agricultural productivity and so on - whose resolution have elided their predecessors for decades. 

Almost always such intent comes wrapped in the form of a more vigorous profession of commitment and a new program, the primary differentiator most often being the scale of the ambition in terms of targets and time within which it is sought to be achieved. This alone, supporters tend to believe, would ensure success of the endeavor.

I am not sure. Instead, I'll go by a two-part smell test to assess whether this time is any different.  

1. What is being done now that was not part of earlier efforts and how will it increase the likelihood that this time is different?

2. What has been done to improve state capability in the execution of the program?

It is most likely that a vast majority of public policy interventions in these areas by governments across the world would fail the two part smell test. Development is really hard.

Tuesday, June 21, 2016

Convergence, Small Time?

The World Bank's latest Global Economic Prospects, apart from lowering global growth estimates from 2.9% to 2.4%, has an analysis which confirms a slow down or even a reversal of the economic convergence between rich and developing countries. The FT has this summary of the report,
Last year just 47 per cent of 114 developing economies tracked by the bank were catching up with US per capita gross domestic product, below 50 per cent for the first time since 2000 and down from 83 per cent of that same sample in 2007 as the global financial crisis took hold... But over the past three years, as major emerging economies such as Brazil, Russia and South Africa have slowed or fallen into recession, the slower average growth means the number of years it would take to catch up with the US has grown to 67.7 years. For frontier markets, those more fragile economies further down the development scale, such as Nigeria, the catch-up period more than doubled from 43.1 years to 109.7 years.
This also means that the number of years necessary for these countries to catch up with the US economic output level has increased.
This comes on the back of a recent report by Capital Economics which highlighted the challenge with maintaining the same pace of convergence as economies develop. The period since 2000 has been undoubtedly the high watermark of convergence,
But, as graphic below shows, going forward, convergence will slow down as per capita incomes in countries like China and India increase, and their respective potential growth rates decline. It also shows that for its economic size, and despite the high growth episode of 2003-08, India has grown at atleast four percentage points below its potential rate in the 2000-14 period.
Adding to the problems, as an OECD report highlights, is the slow pace of global trade, which has been declining continuously since the crisis. 
But, in light of the larger size of the emerging economies, the Capital Economics report argues that their growth will matter even more for the world economy,
EMs now account for about 60 per cent of global GDP, compared with 40 per cent in 2000. If developed economies grow at the 1.9 per cent annualised rate the IMF predicts in the coming five years, this suggests global growth could even be stronger with EMs growing at 4.5 per cent (but accounting for 60 per cent of the global economy) than when they expanded by 5.5 per cent but accounted for only 40 per cent of it.
It may be presumptuous to draw too many conclusions from such cyclical trends in emerging economy growth. The pre-eighties period of the last century was associated with sustained high growth among developed economies, leading some economists to describe it as a period of "divergence, big time". Since the eighties, led by the East Asian economies and China, the developing countries have grown at a much faster rate, again leading some others to describe it as "convergence, big time". Statistically, at least, for the respective periods, both were largely correct. 

But now, as the major developing countries, outside Africa, approach lower middle-income status, the pace of convergence will, not surprisingly, decline. But the overall trend towards convergence cannot be denied. We are more likely to have "convergence, small time". The final verdict belongs to the always incisive Dani Rodrik,
It’s also interesting to see how the bounce back from a former, overstated conventional wisdom generates its own exaggerations. Contrary to much grumbling at the present, I do not think economic convergence is dead. I continue to think that developing countries as a whole will grow more rapidly than the advanced economies. But some of this will be due to a trend decline in the growth rate of the advanced economies. And the rate of convergence will not be nearly as rapid as what we have seen over the last two decades.

Monday, June 20, 2016

On premature deindustrialization and other things

Tyler Cowen peeks into the economic prospects of a world buffeted by declining productivity, secular stagnation, stagnating global trade, premature deindustrialization, increasing automation, and so on.

On how little of the world economy is connected with trade,
Only a small fraction of firms export or even consider trying to export; the actual percentage of exporting firms is estimated at eighteen percent. Most firms which do export are selling a single product to a single country, and even the average magnitude here is to sell to only 3.5 countries. Most nations are not active competitors in most global economic sectors... We see also that exporting firms are much larger than nonexporting firms – 4.4 times larger as measured by sales – and that fact is consistent with the notion of a relatively high fixed cost to trading internationally.  
On the importance of manufacturing,
The lack of manufacturing exports for an economy also may feed into domestic growth by taking away potential economies of scale. Without the chance to export Toyotas, Japanese domestic cars probably would have been more expensive and of lower quality. Internally-driven growth would have less of a jump start from the export sector and also less of an ongoing surplus to draw from for future domestic investment. Manufacturing appears to create strong backward and forward linkages, whereby one set of successful manufacturing companies helps to fund input sectors and complementary sectors, also full of middle class jobs. For the United States, for instance... manufacturing accounts for about seventy percent of the country’s business research and development.
Cowen points to a "cell phones instead of automobile factories" growth path, wherein increasing returns to scale activities like IT, where research and innovation are increasingly focused, though largely produced in developed countries, will diffuse quickly and widely across developing countries, and become the drivers of economic growth there,
The new imbalance would be based on increasing returns to scale goods, which would trickle down to poorer countries, vs. constant and increasing cost goods, which would not trickle down. Developing nations thus would be very well supplied with (cheaper versions of) increasing returns to scale goods, but have relatively stagnant supplies of constant and decreasing returns to scale goods. In practice this would mean that cell phones, software, web sites, movies and television shows, pharmaceuticals, and ideas more generally would be plentiful in developing nations. Similarly, housing and many basic foodstuffs will have higher relative prices. “Living in the past,” so to speak, will become increasingly expensive, and living on or near the technological frontier may become relatively cheap, even in countries which are not thought of as especially technologically advanced. This probably would mean that younger individuals would gain more from economic growth than would older individuals, at least relative to a model of balanced growth; the younger individuals are more likely to use the newer technologies.
On the enclaves model of economic and social development, with the attendant implications for inequality,
Indian outsourcing activities, as practiced in Bangalore, Chennai, or Hyderabad, are examples of enclave construction. The outsourcing centers typically produce much of their own infrastructure, including electricity, water, web connections, and even roads. The goal is for the environment inside the firm, often set in walled-off medieval-style compounds, to approximate that of a fully developed nation. At the same time, the enclave is set in India and takes advantage of the lower wages there. It is another way of blending developed and developing country features, and future development models likely will involve a good deal of such blends, rather than the more straightforward construction of middle class societies as we have witnessed in South Korea, Japan, and Taiwan.
On India's growth prospects,
India is a striking example of a country which has been underinvesting in manufacturing. As we have seen in section two of this paper, the likely implication is that India will fail to develop a large (in percentage terms) middle class and thus will continue to develop along a path of extreme income inequality, with gains unevenly distributed and to the long-run detriment of the nation... India is not a natural candidate to succeed China as the world’s low cost manufacturing center. 
The world economy, especially for emerging economies, is at an intriguing point in their development trajectory. Apart from premature de-industrialization, there are several forces with very uncertain dynamics at play. The increasing use of robots and attendant automation of economic activities is likely to disrupt the labor market. The dynamics of modern capitalism, with skill-biased technologies and wage premiums for the higher income levels, appears to support widening inequality. 

Similar trends are visible within countries too. Consider urbanization. In contrast to the gradual and planned urbanization in developed countries, cities are developing countries are undergoing very rapid and massive, but extremely chaotic growth. This has had the effect of engendering sprawls and gentrification, both of which threatens to leave such cities with pockets of affluence and modernity in a sea of less than desirable living conditions. It is possible that most cities in developing world will never achieve the quality and vibrancy of cities like London and New York even if incomes reach the same levels.

Sunday, June 19, 2016

The Emperor returns!

This progression of headlines in the French newspaper Moniteur in March 1815 tracking the return of Napoleon from exile at Elba is stunning by any standards.

China higher education story of the day

Times has a very interesting article on how China is trying to redistribute the benefits of higher education across the country. The annual nation-wide Gaokao examinations which determine admissions to college seats is now widely seen as reinforcing urban-rural, coastal-hinterland, and rich-poor disparities. A recent decision, therefore, reserves a certain number of seats in all the major colleges to students from less developed regions. The decision has resulted in widespread protests across the coastal areas from parents of local children. 
Top schools are concentrated in big prosperous cities, mostly on the coast, and weaker, underfunded schools dominate the nation’s interior. Placement is determined almost exclusively by a single national exam, the gaokao, which was administered across China starting on Tuesday. The test is considered so important to one’s fate that many parents begin preparing their children for it before kindergarten... The exam gives the admissions system a meritocratic sheen, but the government also reserves most spaces in universities for students in the same city or province, in effect making it harder for applicants from the hinterlands to get into the nation’s best schools.
The authorities have sought to address the problem in recent years by admitting more students from underrepresented regions to the top colleges. Some provinces also award extra points on the test to students representing ethnic minorities. 
This spring, the Ministry of Education announced that it would set aside a record 140,000 spaces — about 6.5 percent of spots in the top schools — for students from less developed provinces. But the ministry said it would force the schools to admit fewer local students to make room... 

Over the past two decades, the government has opened hundreds of new institutions of higher education, and university enrollment surged to 26.2 million in 2015 from 3.4 million in 1998, though much of the growth has been in three-year polytechnic programs. At the same time, job prospects for college graduates in China have dimmed in recent years. That has left parents worried about wasting their life savings on substandard schools and even more desperate to get their children into the better ones.
Dissatisfaction with the gaokao is also rising. The test, modeled after China’s old imperial civil service exam, was intended to enhance social mobility and open up the universities to anyone who scored high enough. But critics say the system now has the opposite effect, reinforcing the divide between urban and rural students. The top universities in big cities like Beijing, Shanghai and Nanjing are the most likely to lead to jobs and the hardest to get into. Students from less developed regions are vastly underrepresented at these colleges. That is because they attended schools with less money for good teachers or modern technology and because the admissions preference for local applicants means they often need higher scores on the gaokao than urban students.
This is a dynamic that echoes with India's own reservation and other affirmative action programs, both in terms of the specific actions as well as the popular emotions it generates. At a more fundamental level, this is one more story of how extreme forms of competitive pressures (a merit based selection exam), which initially have a benign nature, accumulates anti-competitive strains (the better off have access to the resources necessary to compete on equal terms), and ends up being captured by the beneficiaries. 

Saturday, June 18, 2016

Weekend reading links

1. Ajay Shah has an excellent column examining the issue of unbundling of commercial activities,
Consider the New Pension System (NPS). Project OASIS, saw that the overall pensions problem contained three distinct industries: managing money, owning customers, and record-keeping. It suggested an unbundled architecture, where pension fund management was separated from interaction with customers. Record-keeping was centralised to harness economies of scale and ensure that it was easy for consumers to switch from one pension fund manager to another. This design caters to heightened competition. On the strength of better fund management, a new pension fund manager can steal customers, as switching is always possible. Similarly, the front end firms would live or die based on their friendliness to customers, and not on the quality of their fund management. In the conventional world, finance professionals generally focus on the deal-making required to get a new product to the customer. These finance professionals are a little shocked when, in the NPS environment, incumbent manufacturers do not control the distribution. All distributors are equally keen to push all products; all manufacturers have equal access to all distributors.
Though Shah sees unbundling as having worked in only NPS, electricity, and net-neutrality, I am inclined to cast the net wider. In particular, one could think of looking at many financial market activities in this way.

The only observation is that with the emergence of IT solutions, the entry barriers from an incumbent's entrenched presence in the downstream side of selling a service may not be as important as earlier.

2. The underlying signatures of Indian economy continue to remain weak. The capex index from IIP data comes in at the lowest since April 2010.
The RBI's latest Industrial Outlook Survey shows that the business expectations index is lowest since at least 201-11
Much the same story about expectations on industrial production, order books, and job creation. Not a happy picture at all.

3. Mexico City's air pollution levels fall back to the nineties. This stat about its vehicle population is stunning,
Developers erect skyscrapers with a dozen floors reserved for parking. The Mexican Institute for Competitiveness, an economic think tank, estimates that 42 percent of space in new developments built between 2009 and 2013 was designated for parking.
4. Livemint points to BIS data for the 2007-15 period for 18 countries which finds that housing prices in India rose the highest at 72.3%.
As the article points out, for whatever reason, housing market in India does not respond to over-supply and piling inventory by price corrections. Developers prefer to hold tight. It may just be that the margins are large enough (or supply small) to provide them the comfort to hold on to vacant units long enough.

5. Very good analysis of India's new Bankruptcy Code here. This is more likely to be an evolutionary process where the fruits will start appearing only 5-8 years hence. A very important reform though.

6. When in China Capitalists sing the Chinese tune! Consider the example of Disney. Disney opened its $5.5 bn Shanghai Disney Resort, its first facility in China, a joint venture with Shanghai Shendi Group. Times has a nice essay, which describes what Aswath Damodaran calls the "China trade-off",
In addition to handing over a large piece of the profit, the control-obsessed company would give the government a role in running the park. Disney was also prepared to drop its longstanding insistence on a television channel... Disney is sharing the keys to the Magic Kingdom with the Communist Party. While that partnership has made it easier to get things done in China, it has also given the government influence over everything from the price of admission to the types of rides at the park...

The partnership structure puts Disney in a complicated spot. Shendi is really a consortium of four powerful government-owned companies: the Shanghai Radio, Film and Television Development Company; Jin Jiang Hotels; Bailian retail shops; and a property developer, the Lujiazui Group. And each of those companies has separate business ties to Disney’s new resort. The Jin Jiang Group has a contract to provide tourism services for the park. The Lujiazui Group helped develop the world’s largest Disney Store. The Shanghai Media Group, a division of the development company, is positioned to capture a big share of the park’s television and advertising budget, since it controls the city’s biggest television stations, as well as major newspapers, magazines and radio properties.
7. Germany followed Japan and Switzerland into having its 10 year sovereign bond yield slip into negative territory. It is estimated that 40% of the $6.4 trillion Euro region debt is now trading below zero, which as one analyst said,  
Nobody buys bunds at these yield levels thinking they are attractive. Demand for haven assets is being driven by fear of Brexit and growth concern. Investors are buying bunds as a hedge against uncertainty.
Another analyst had this to say,
Every day you own a bond like that you compound a loss, and the only way to make money is when someone else is willing to pay a higher price. As a store of value I don’t see it as a very good investment.
Former PIMCO head, Bill Gross has already described negative bonds as a "supernova that will explode one day". Since retail deposit rates have not become negative anywhere, the direct impact of negative rates is not being felt by citizens. Also, since yields have been continuously on the decline, prices have been rising and investors have been making profits.

8. More evidence that we may have reached "peak ship size". With 18% of world's container capacity anchored and idled, and global shipping capacity rising by 7% last quarter even as demand grew by 1%, the shipping industry is staring down the barrel,
A study last year by the OECD found that economies of scale from today's mega-boats are four to six times smaller than those in previous periods of up-sizing. Around 60 percent of cost savings now comes from engine technologies. In other words: Building smaller boats with better engines would offer more savings than going bigger. Then there's risk. Today's largest container vessels can cost $200 million and carry many thousands of containers -- potentially creating $1 billion in concentrated, floating risk that can only dock at a handful of the world's biggest ports. Such boats make prime targets for cyberattacks and terrorism, suffer from a dearth of qualified personnel to operate them, and are subject to huge insurance premiums. 
Yet the biggest costs associated with these floating behemoths are on land -- at the ports that are scrambling to accommodate them. New cranes, taller bridges, environmentally perilous dredging, and even wholesale reconfiguration of container yards are just some of the costly disruptions that might be needed to receive a Benjamin Franklin and service it efficiently. Even when taxpayers foot the bill for such upgrades, the costs can be passed on to vessel operators in the form of higher port fees. In recent years, mega-vessels have caused traffic jams in the water and on-shore as overwhelmed ports struggle to offload thousands of containers. The expense in worker overtime and cargo delays can be significant. Making matters worse, the bigger ships make fewer port visits, leaving operators wondering if they should invest in costly renovations for what would amount to infrequent stopovers.
9. Business Standard chronicles Lavasa, the five-town smart city complex being developed independently by Hindustan Construction Company (HCC), on the foothills of the Western Ghats in Maharashtra. The project which was launched in 2004 and has so far incurred a cost of Rs 6600 Cr in the partial development of two towns (on 8000 and 2400 Acres respectively) follows the pattern of a very dense central core with sparse radial developments.

Despite the investments made, Lavasa continues to be largely a holiday destination with limited investments in services employment and other non-recreational commercial investments. Lavasa is a test case for the belief, which underpins a large part of Chinese urbanization, that "build it and they'll come". I am inclined to believe that Lavasa will be a success in the next 8-10 years and a great example for planned urbanization in India. And if that happens, the reasonable sizes of each development (a few thousand acres), will have had no small a role to play.

10. Finally, Goldman Sachs has been all over the news this week with two scandals. First, came news that Goldman Sachs advised the 2014 sale of BHS, the UK Department store chain, for £1 to Retail Acquisitions, a group of investors led by Dominic Chappell, an ex-bankrupt with no retail experience. Now with BHS with its 11000 odd employees facing bankruptcy amidst allegations of swindling and fraud, the ex-BHS chairman Sir Phillip Green has effectively blamed Goldman for clearing the sale to a person like Chappell. 

If the first was not scandalous enough, the second would put even the most unscrupulous corporates to shame. The Libyan Investment Authority (LIA), the country's sovereign wealth fund (SWF), has initiated a $ 1bn suit for damages on Goldman at London. It accuses Goldman of exploiting its limited experience in 2008 to sell nine risky derivative trades that ultimately lost the SWF $ 1.2 bn, by using "undue" influence over LIA's own employees, including delivering the services of prostitutes and providing luxurious hospitality. Goldman is accused of using one of its executives, Youssef Kabbaj, to lobby and dine LIA officials concerned to purchase the products. The description of the trial here is downright lurid and despicable. 

These come as Goldman is recovering from its role in raising upto $3 bn money for 1MDB, the Malaysian state fund at the center of a corruption scandal involving the country's Prime Minister. Goldman apparently received $300 m for this and $200 m for the LIA purchases. 

Friday, June 17, 2016

Denmark and negative rates

Bloomberg has an article on negative interest rates in Denmark. Unlike others who use negative rates as a tool of monetary accommodation to restore economic growth, the country had embraced negative rates as early as 2012 to maintain the kroner's peg against a depreciating euro.
Apart from highlighting the apparent normalcy associated with negative rates, the article points to atleast two interesting features of the Danish economy that goes against the grain of orthodox Econ 101. One, high taxation and high minimum wages may not always be bad,
Despite a minimum wage not far below $20 an hour and some of the world’s steepest taxes, unemployment is almost the lowest in Europe.
Second, despite the persistent low rates, the country's real estate market has suffered only a "froth" and not "bubbles" as would have been expected. Strict mortgage lending regulations may, after all, be effective
the country regulates the housing market to a degree unimaginable in the U.S. It’s nearly impossible for a foreigner with no connection to Denmark to buy property, preventing inflows of overseas money. Banks apply stringent financial criteria to mortgages for buy-to-let properties; it’s hard for Danes to purchase homes they don’t intend to live in. Regulatory guidelines require minimum down payments of 5 percent and stress tests of borrowers’ finances against runups in rates. With the encouragement of regulators, banks have hiked fees on flexible-rate loans, nudging buyers into fixed-rate mortgages. The rules are even tighter for properties in Copenhagen... Compared with New York, London, and even Stockholm, Copenhagen real estate is still a bargain: $500,000 buys a decent two-bedroom.
However, it should not be construed that such policies can be replicated to similar effect elsewhere. Denmark's unique social and political history and their attendant forces have undoubtedly played a critical role in the apparent relative lack of problems, maybe even success, with negative rates. But a more definitive conclusion is that this is yet more evidence that countries need to embrace a more heterodox approach and carefully select policies keeping in mind their local context and requirements. This, more than blind administration of economic orthodoxy, even with negative rates, is more likely to help economies forge successful growth paths.

As to negative rates itself, in a week when Germany joined Japan and Switzerland with negative rates on 10 year sovereign bonds, its future may well depend on the answers to at least five questions.

1. How much low can the rates fall? Beyond a point, the transmission of rates into retail and all other parts of the economy will be felt, with potentially very disruptive consequences. Fundamentally, at a certain point, the negative rate would exceed the cash storage cost.

2. How much longer can the banks hold out? Apart from having to pay the central bank for holding their reserves, banks have been constrained from passing on negative rates to depositors. This has been eroding their profitability as reflected in declining Net Interest Margins (NIMs).

3. How much long will it be before the savers revolt? These low rates are exacerbating the woes of the already insolvent pension funds in many parts of the world. Insurers are struggling for returns on their investments and asset managers are fighting to retain their investors. And, coupled with negative retail deposit rates, the cumulative effects low rates may become onerous enough to force savers out into the streets.

4. How much more skewed can the risk allocation become? As returns on conventional assets decline, it is only natural that investors move into newer and riskier areas in search for yields. But this in turn invariably amplifies risk by inflating bubbles. The more time markets stay in these regions, the steeper the fall.

5. How much longer can the markets sustain central bank purchases? The negative rates owe a lot to the massive sovereign bond (and now corporate too) purchases by central banks, especially the ECB and BoJ. But there are portfolio limits to how much of each category that the central banks can purchase. In Europe, since the ECB can buy no more than a third of any individual bond issue, there may be only 3 months worth of German bonds left to purchase at the current rate of nearly 20 bn euros a month. The Bank could be left owning a fifth of the sovereign bond market in Eurozone area by end-March 2017. In Japan, thanks to the BoJ's ETF purchases, the Japanese government is a top 10 holder in 90% of Japanese stocks.