Thursday, February 22, 2018

India Jobs Deficit graph of the day

This blog has long advocated that India's biggest challenge is not about generating more entrepreneurship but creating more productive salaried jobs in the formal sector. 

This Livemint graphic from a World Bank report is stunning in the magnitude of the problem compared to even our peers and neighbours,

This is arguably India's biggest economic challenge!

Tuesday, February 20, 2018

More evidence on business concentration

Here is the short-history of 21st century capitalism. Despite global savings glut, ultra-low interest rates, and massive corporate surpluses, the dynamics of modern capitalism has delivered business concentration and declining competition, regulatory capture, resource misallocation away from productive investments towards financial market speculation, higher profits and wage stagnation, greater share of income going to capital and away from labour, and widening of inequality. The evidence continues to mount. 

The latest comes from Gauti Eggertsson, Ella Getz Wold, and Jacob Robbins who argue that the driving force behind this dynamic is "an increase in monopoly power together with a decline in interest rate". They find,
An increase in firms’ market power leads to an increase in monopoly rents - economic parlance for profits in excess of competitive market conditions - and thus an increase in the market value of stocks (which hold the rights to these rents). This leads to an increase in financial wealth and to what’s known as Tobin’s Q, the ratio of a firm’s financial value (market capitalization) to the value of its assets (book value)... With an increase in market power, the share of income consisting of pure rents increases, while the labor and capital shares both decrease. Finally, the greater monopoly power of firms leads them to restrict output. In restricting their output, firms decrease their investment in productive capital, even in spite of low interest rates.

Their suggestion carries great relevance,  
Greater monopoly power tends to depress economic growth and increase income and wealth inequality. With high levels of monopoly profits, it may be optimal to have higher taxes on corporate income than would be suggested by analyses that assume perfect market competition.
If businesses are anyways unlikely to invest and most certain speculate in financial markets, higher levels of taxation can both curb such speculation and also generate more public revenues without crowding out any productive economic activity. 

Sunday, February 18, 2018

Weekend reading links

1. The Economist has a fascinating survey of the harmful effects of occupational licensing in the US. Sample this,
In 1950 one in 20 employed Americans required a licence to work. By 2017 that had risen to 22%... Most studies find that licensing requirements raise wages in a profession by around 10%, probably by making it harder for competitors to set up shop... Forty-one states license makeup artists, as if wielding concealer requires government oversight. Thirteen license bartending; in nine, those who wish to pull pints must first pass an exam... manicurists are licensed everywhere but Connecticut. Louisiana licenses florists... Such examples... are not representative of the broader harm done by licensing, which affects crowds of more highly educated workers... Among those with only a high-school education, 13% are licensed. The figure for those with postgraduate degrees is 45%. More educated workers reap bigger wage gains from licensing. Writing in the Journal of Regulatory Economics in 2017, Morris Kleiner of the University of Minnesota and Evgeny Vorotnikov of Fannie Mae, a government housing agency, found that licensing was associated with wages only 4-5% higher among the lowest earning 30% of workers. Among the highest 30% of earners, the licensing wage boost was 10-24%. Forthcoming research by Mr Kleiner and Evan Soltas, a graduate student at Oxford University, uses different methods and finds no wage boost at the bottom end of the income spectrum, but a substantial boost for higher earners... In particular, licences are more common in legal and health-care occupations than in any other.
2. In the context of assessments of historical figures and events, Livemint invokes John Rawls to offer a three point Rawlsian test,
The first point Rawls made was that the giants of the past had to be understood in the context of their times rather than ours. Any moment in history should then be seen from their point of view rather than ours. It is fundamentally wrong to pass sweeping judgements, with the benefit of perfect hindsight, on people making complicated choices in real time. The next point Rawls made was that any scholar has to strive to offer the ideas of a historical figure in their strongest form. They have to be assessed in the best light possible... Rawls once quoted John Stuart Mill in this respect: “A doctrine is not judged at all until it is judged in its best form.”... The third lesson from Rawls is that one should approach the great figures in history with modesty. “I always assumed that the writers we were studying were always much smarter than I was…. If I saw a mistake in their arguments, I suppose they saw it too and must have dealt with it, but where? So I looked for their way out, not mine.”
3. In the context of the debate surrounding whether macroeconomic theory needs revision or not, Srinivas Thiruvadanthai makes a very valid point that perhaps we need to go back and construct certain stylised facts from real world data. He suggests some which are all contrary to the orthodoxy - demand shortfalls have persistent effects; fiscal policy is effective in recessions; private debt matters enough to cause recessions and worse, whereas public debt matters less so; investments are not very sensitive to interest rate changes, both reductions and increases.

I can add a few more - capital grows faster than national incomes; technology markets converge to monopoly; financial markets cause misallocation of capital and human resources; higher marginal tax rates do not appear to reduce effort or investment decisions etc.

4. This story highlighted the bruising work culture among white collar employees in Amazon. It does appear that the story is even worse with blue-collar workers.

Highlighting the fact that jobs do not translate into higher incomes as well as the features of jobs in the logistics industry, City Lab illustrates with the example of San Bernardino, 60 miles east of Los Angeles, where since establishing base in 2012, Amazon has come to employ more than 15000 full-time workers in 8 fulfilment centres (where goods are stored and packed for shipment) and one sortation centre (where packages are organised by delivery area).
In San Bernardino, the unemployment rate that was as high as 15 percent in 2012 is now 5 percent... Yet in many ways, Amazon has not been a “rare and wonderful” opportunity for San Bernardino. Workers say the warehouse jobs are grueling and high-stress, and that few people are able to stay in them long enough to reap the offered benefits, many of which don’t become available until people have been with the company a year or more. Some of the jobs Amazon creates are seasonal or temporary, thrusting workers into a precarious situation in which they don’t know how many hours they’ll work a week or what their schedule will be... the experience of San Bernardino shows, Amazon can exacerbate the economic problems city leaders had hoped it would solve. The share of people living in poverty in San Bernardino was at 28.1 percent in 2016, the most recent year for which census data is available, compared to 23.4 in 2011, the year before Amazon arrived. The median household income in 2016, at $38,456, is 4 percent lower than it was in 2011... according to a report by the left-leaning group Policy Matters Ohio, one in 10 Amazon employees in Ohio are on food stamps.
This contrast between the labour markets of two eras is striking,  
In 2012, Amazon seemed like a lifesaver. San Bernardino’s unemployment rate was at 15 percent, home values had fallen 57 percent since 2007, and the city, facing a $45 million budget shortfall, would file for bankruptcy in August of that year... The jobs that used to dominate San Bernardino were unionized ones with good benefits, at the Kaiser steel mill, the Santa Fe railroad maintenance yard, and the Norton Air Force Base. Now, jobs like the ones Amazon creates pay less and aren’t unionized, and require multiple members of a household to work, often more than one job.
In terms of the Amazon effect, this is illuminating,
According to available data from the Bureau of Labour Statistics (BLS), warehouse workers in counties where Amazon operates a fulfilment centre earn about $41,000 per year, compared with $45,000 per year in the rest of the country, a difference of nearly 10% (see chart 2). The BLS data also show that in the ten quarters before the opening of a new Amazon centre, local warehouse wages increase by an average of 8%. In the ten quarters after its arrival, they fall by 3%.
The one thing that comes to mind is that this fabulous wealth of the world's richest man has been effectively built on what should arguably constitute "slave labour" in the world's richest country!

5. After having overtaken the US in exports and manufacturing, the final frontier for the Chinese economic march may be the technology sector
In some of the cutting-edge areas of technology like artificial intelligence, facial and speech recognition, the Chinese are breathing down the Americans on most parameters.

6. Finally, the graphic below puts the Chinese debt orgy in perspective - in 2009-17 its official and shadow bank lending was more than $20 trillion during 2009-17, whereas US Fed, BoJ, ECB, and BoE together added just $13 trillion in their respective fastest ever balance sheet expansions!

This is truly scary. The only thing that would be of some comfort is the Chinese government's commitment to address the problem and its credibility in terms of translating talk into actions. As a measure of that consider two data points - the crackdown on capital outflows led to it collapsing from $640 bn in 2016 to just $60 bn in 2017; shadow bank lending in January 2018 was the lowest January level since 2009 at just $25 bn, 90% lower than in January 2017. Not too many governments anywhere can pull off such feats. 

Saturday, February 17, 2018

Corporate cash hoards invested in bonds

Rana Foroohar points to a just released Credit Suisse study by Zoltan Pozsar which documented the massive off-shore corporate savings of US S&P 500 firms invested in high yielding corporate bonds. She describes them as being as influential on the bond markets as some of the investment banks. Of the $1 trillion savings of about 150 firms, 80% belong to the largest and most intellectual property rich 10% of firms. 

The savings of the 150 firms shows that IT and pharmaceuticals dominate, with the top 10 names controlling over $600 bn of the off-shore savings, with Apple alone having a trove of over $200 bn!
The next figure shows how the total savings (offshore plus onshore, though 90% are held offshore) of the top 10 have evolved over time in terms of categories of investments.  
Observe the striking coincidence with the global financial crisis, as savings ballooned from just over $100 bn in 2008 to over $700 bn by end-2016. 

Highlighting the relevance of IT companies with their ability to shift profits across borders through IP, Pozsar writes,
Corporations that rely on booking revenues derived from intellectual property (IP) assets in tax havens are more efficient at shielding earnings from the IRS than firms that don’t (IP assets range from the integration of design and hardware into a phone to the formulas of blockbuster drugs). This explains the greater concentration of savings in the first segment. Compared to the first segment, the second segment of the universe is less reliant on IP assets – there ain’t no “killer” apps, brands, codes, designs or formulas in the auto, energy, industrial and medical equipment manufacturing sectors. The strategy to book revenues generated by a portfolio of IP assets in tax havens is not easy to apply in these industries.
The paper has several interesting graphics. There are two graphs which show how the corporate's holdings of US Treasury bond and agency debt as well as corporate bonds, ABS, RMBS etc compare very favourably with those of the largest investment banks.

Friday, February 16, 2018

Holding the mirror on corporate India

Much has been written about how government regulations have shackled private sector growth in India. While it is undoubtedly true that restrictive regulations have constrained private business growth in the aggregate, for a country of India's size this cannot explain the near total absence of world-class companies and brands from India.

Even in the much acclaimed software sector, none of the Indian companies have progressed beyond being outsourced service providers. All this despite enjoying all the textbook requirements for success - cheap supply of skilled manpower, very low taxes, preferential government policies, benefits of exclusive zones or software technology parks, a massive and voracious global market, and the strong tailwinds of recurrent technology disruptions. There are no major commoditised IT solutions nor are these companies at the cutting-edge of work on areas like data science, artificial intelligence, internet of things, cloud computing, blockchains etc.

In terms of research and development (R&D) spending, our IT titans are minnows, with nothing special to show for in the last quarter century of rollicking growth. But the IT sector is no exception in this trend of skimping on R&D.

The recent economic survey holds the mirror on India's very vocal corporate sector and shows how woefully they lag behind others in their share of gross expenditure on R&D.
Several sectors have had multiple opportunities to benefit from protectionist industrial policies. The most classic recent example is of the solar industry. Despite local content restrictions and other forms of protectionism, Indian solar cells industry can supply less than 10% of the annual domestic requirements.

Another example comes from medical devices. The government has showered the industry with several concessions over the years. Nothing of any note has emerged beyond a few copy-cats. The pricing regulations imposed by the National Pharmaceuticals Pricing Authority (NPPA) on diagnostic devices offers yet another opportunity for this industry to generate world leaders in at least some important diagnostic products.

The other example is defence, where the current government has done possibly everything it could have to promote indigenous defence production. The results so far in terms of corporate India seizing the opportunity has been an utter disappointment.

As a comparison, one only needs to look at how Chinese firms have conquered the world in industry after industry by benefiting from their large domestic market and protectionist policies, two factors that Indian companies too enjoy. We can safely assume that even if NPPA holds the line for 10 years (which was for long the case since all these items were strongly regulated for decades), nothing much would have changed in terms of domestic production.

Apart from all this, I have blogged here, here, here, and here about the failure of the country's startup eco-system to generate innovators and innovations which have had a transformational effect on the country's development or on a pervasive development challenge.

But there is one area where our corporates top - in having among the worst corporate ethics! Consider this,
India was ranked the most unethical of 13 major economies in the 2016 Global Business Ethics Survey, behind even Brazil and China. Last year, Ernst and Young’s Asia-Pacific Fraud survey found that unethical practices are rife in India’s business community with 78 per cent of Indian respondents surveyed saying that bribery and corrupt practices occur widely, while 57 per cent said that senior management would ignore the unethical behaviour of employees to attain revenue targets... Foreign investors and companies complain that Indian businessmen don’t understand the concept of good faith in negotiations. Legal agreements are routinely flouted — often in cahoots with the authorities or the court system. Creative accounting is a commonplace hazard, as is illegal diversion of profits by promoters. The non-performing loan crisis in India’s banks is largely due to bare-faced cheating and fraud by crony capitalists with the connivance of pliant bank executives.
And it appears that questionable corporate ethics has not spared even the start-up entrepreneurs

Wednesday, February 14, 2018

The volatility trade casino

Ananth points to two links that highlights the casino that implied volatility trading has become. 

The market for exchange traded products (ETPs) in equity implied volatility, VIX futures, has exploded spectacularly with handsome returns since the turn of the decade. In the turmoil early last week, short positions which had been built up in the confidence complacency arising from the recent period of extraordinary stability in VIX, despite several signatures of bubbles, unravelled over just a few hours. Sample this
The scale of the returns the trade offered dulled the risks. Buying the largest short volatility ETP — run by Credit Suisse and known by the ticker XIV — at the start of 2015 and holding it to the end of 2017 generated a return of 320 per cent. Holding it from the start of 2015 to after Monday’s eruption, resulted in a total loss of 85 per cent... There are about 40 Vix-linked ETPs, according to Goldman Sachs, and most allow investors to bet on volatility rising... many have become popular, ranking among the most frequently traded exchange products, and rivalling the stocks of companies such as General Electric. 
And the systemic consequences have been, like with commodity futures, less than benign, with futures trading fuelling feedback loops into VIX itself,
“Volatility has become both an input for risk-taking, and something you can trade,” says Christopher Cole of Artemis Capital Management. “Volatility has become a player on the field.” In turn, the behaviour of the ETPs has helped fuel the Vix contracts that form their basis. So much so that it has led to concern that the financial products built to make money from tracking the Vix are now feeding back into the ingredients from which Vix is calculated. Traders say that at the end of Monday, the ETPs that ran into trouble from an initial rise in Vix scrambled to cover positions by buying large amounts of Vix futures, sending the price of the contracts soaring. The Vix, in turn, rose further and the S&P 500 sank.
And how did the markets respond to the unravelling of short positions - by swinging to the other extreme with the biggest ever weekly change into long-positions and the highest level of net long positions as a share of open interest in VIX futures since December 2009! 

Monday, February 12, 2018

The false dawn of blended finance in infrastructure

Blended Finance is the new buzzword in international development. Nancy Lee has a new paper in the CGD website which examines the potential of blended finance to crowd in private capital to finance infrastructure projects in developing countries. It suggests reforms to the private sector windows (PSWs) of multilateral development banks (MDBs) and development finance institutions (DFIs) to achieve this objective. 

She writes
Many were optimistic when the United Nations Sustainable Development Goals were launched in 2015 that the private sector — and domestic resource mobilization — would fund much of the investment needed to achieve these goals — especially as public aid flows stagnate. As 2018 begins, we would do well to reassess these optimistic projections for private finance for development, and ask are the “billions to trillions” materializing?... Many changes will be necessary, but I would highlight two as fundamental: First, greater risk tolerance and lowered expectations for risk-adjusted returns, and second, a major cultural shift to encourage collaboration rather than competition among the MDBs... Current data do not suggest that private investment of sufficient scale will emerge under the status quo, or that poor countries have a real chance to capture a larger share.
The paper suggests several reforms to the environment as well as the structures of PSWs of MDBs and DFIs - off-balance sheet financing of riskiest projects; aligning institutional incentives to doing more stuff like credit guarantees; consolidation and rationalisation of multiple trust funds; collaboration between the PSWs of all institutions to share pipeline, harmonise and pool financial instruments; assuming more leverage and risk; specialise in high-risk greenfield infrastructure etc. 

Unfortunately, none of these reforms are likely to make any significant dent (turn "billions into trillions") on the problem and change the status quo. This naive optimism glosses over fundamental structural factors which strongly militate against the use of foreign private capital to finance infrastructure in developing countries to any meaningful extent.

For a start blended finance is not new in infrastructure. Further, the use of blended finance instruments cannot meaningfully address the deep underlying problems. My guess is that this blog alone has atleast a hundred posts which explore different dimensions of the challenge with making private capital work in infrastructure sector, except a few areas (telecommunications and power, in particular). 

The challenge facing foreign private capital financing of infrastructure in developing countries centre around questionable premises about the use of both foreign and private capital in infrastructure sectors,

1. The total volume of dry powder from all types of sources, including alternative investment funds, available for developing countries (excluding China) is very small. They are minuscule for the low income countries. The report itself says that they received just 1.7% of total private capital flows to developing countries in 2016!

2. While the revenues of most infrastructure projects are in local currency, the repayment or profit repatriation is invariably to a foreign currency (dollar). For countries prone to macroeconomic vulnerabilities, the currency mismatch risk can by itself be a major source of instability. 

3. There are limits to the foreign currency liabilities (of all kinds - debt and equity) that developing countries can assume and the desirability of assuming them. Foreign capital as a share of gross fixed capital formation  (and infrastructure is just one of the destinations) even among the East Asian economies and China during their high-growth years have rarely crossed even 10%. Many African countries are still struggling to recover from the last round of Eurobond issuances. The perils of the original sin and the risks of sudden-stops and capital flights from cross-border capital flows are recurrent and too well documented to be repeated. 

4. Infrastructure projects, especially the large ones and in sectors requiring land acquisition and right of way, invariably get delayed and suffer cost over-runs, often causing escalations which are multiples of original cost, are commonplace. Private parties cannot be expected to bear the associated construction and commissioning risks.

5. Private borrowing is far more expensive when compared to government borrowing. The cumulative costs, as the recent UK NAO report shows, can be very significant. 

6. Even in the developed economies, such infrastructure projects invariably end up in renegotiations within a few years of the concession being granted or project being commissioned. In countries with limited state capacity, weak contract enforcement mechanisms, and poor governance such renegotiations can be very tricky and impose prohibitive ongoing risks for investors.

7. Finally, for all the aforementioned reasons, the returns required to make infrastructure investments attractive enough in developing countries (for both domestic and foreign investors) would be too high for most infrastructure assets to be able to provide. 

While several more challenges can be outlined, historical experience from across the world shows that the aforementioned factors can be insurmountable.  

For sure, developing countries should try to attract foreign private capital to their infrastructure sectors and the reforms suggested by Nancy Lee should be implemented. But these efforts are unlikely to improve things meaningfully and foreign private capital is most certain to remain a marginal contributor to financing infrastructure in developing countries.

In conclusion, the premise of private capital, and foreign one at that, as a major contributor to finance greenfield infrastructure investments in developing countries is doubtful. Developing countries will have to rely on domestic savings and predominantly government revenues to finance such investments. Blending or not, there are no innovations around this stark reality! Turning "billions into trillions" through private foreign capital will remain a dream.