Wednesday, November 22, 2017

More thoughts on Indian agriculture

I had written sometime back about the corrosive effects of loan waivers arguing that such "assault on incentives" are far more pernicious than giving electoral freebies. 

India has witnessed and explosion of farm loan waivers in the last year or so as part of electoral politics in states which held assembly elections. And with the next election season on, the trend continues unabated

But this issue cannot be seen in isolation. It has to be seen as part of the entire agriculture eco-system in India. 

Actually agriculture is a pretty complex system and conventional market solutions have been shown to not work. Gluts and shortages are inevitable - bad weather is a risk; good prices lead to excess cultivation next year and resultant drops, and vice-versa; global supply shocks and resultant price fluctuations are always round the corner; poor storage and other forward linkages make farm sales the only option etc. Pain and suffering follows.

Developed countries, over decades, have sought to address this problem through less distorting approaches - mainly crop insurance and/or direct payments. It helped that they have good irrigation systems, farms are bigger, forward linkages are better, credit access simple, and markets are functional.

We have none of the positive conditions, and crop insurance and direct payments are both very expensive and run into problems of effective administration.

But we have this smorgasbord of inefficient and distorting things - subsidised crop loans and their recurrent waivers; procurement and MSP (which feeds into the PDS); fertiliser subsidy; free farm power; agriculture IT exemption; minor irrigation programs like PMKSY etc. Worse still, each one has generated its set of powerful entrenched interests, which reflexively gang up as a vocal electoral constituency whenever they are threatened. Making matters complex, it cannot also be denied that each one of these, in their very sub-optimal ways, contributes to mitigating, even if partially, the fundamental problem, and the resultant pain and suffering.

So we have a very bad self-reinforcing and perpetuating equilibrium. A chakravyuha, from which exits appear very daunting.

I have not come across anything satisfactory as a path out of this. Except the gradual process of development - build irrigation systems, transition people out of agriculture, consolidate farms, let linkages and markets develop etc - and the gradual introduction of things like crop insurance. In this dismal environment, doubling farm incomes may well be the government's most over-optimistic promise yet.

There may be just a few avenues to manoeuvre. Given that the crop insurance scheme is one of the government's bigger initiatives, and one of the most progressive (as well as efficient), I think it should actually spend more energies and resources on it. As experience from across the world shows, premium support will always entail big subsidies and this may be worth paying. Can the government also think of phasing out some of these other subsidies and phasing in more of crop-insurance support? For example, it could encourage states which are willing to do farm power metering and a low agricultural tariff (to start with), to be provided a much higher premium support subsidy.

But alternatively, there is some merit in reframing both the MSP and crop-insurance. Instead of government procurement (except, and only to the extent required, for wheat and paddy), the MSP should be announced and farmers should be given the differential between the MSP and the market price, as is being tried out now in Madhya Pradesh for onions.

Similarly, there is a compelling case to dispensing with crop insurance, with all its transaction costs and reimbursement delays, and making direct payments when the crop fails. After all, if the identification of farmers affected has to be done even with insurance and a major share of the premium will have to be subsidised to make the insurance payouts meaningful enough, then the supposed advantages of an insurance model compared to direct payments looks questionable. 

Sunday, November 19, 2017

A primer on the rise of populism and a way forward

There are several narratives surrounding the rise of populism and events like the election of Trump and Brexit. I have written about it here, here, and here. This is an attempt at articulating the narrative based on news stories from the week.  

1. What is happening? The remarkable post-war economic, social, and political stability across developed societies, especially in the US, was built on an underlying consensus on certain values. This consensus revolved around the commitment to the values of free-market capitalism, liberal social order, and democracy. Political positions converged to reflect this consensus. 

But as the fascinating graphic below shows, this consensus has been breaking down and the median liberal and conservative positions in the US has diverged significantly over the past decade. 
2. Why is it happening? But this consensus was accompanied by a less benign bipartisan elite convergence (more of it latter) which effectively ended up capturing the economic and political establishment. 

The rapid and fairly inclusive economic progress achieved in the period helped underpin this consensus and paper over fissures that were developing due to forces like trade liberalisation, globalisation, de-unionisation, and skill-biased technological changes. But once growth started slowing, for a variety of factors, these fissures started to show up.

But mainstream political parties, captives as they had become of elite interests, failed to see the breakdown in social consensus. The liberal elites too became caught up in their rhetoric.    

Nothing has been more emblematic of this isolation of elites from the electorate than the staggering levels of economic inequality, which has been widening at a rapid pace since the millennium. As the graphic below shows, in the US, the share of national income going to the top 1% has nearly doubled from 11% in 1980 to 20% in 2014. 
While trade, technology, de-unionisation, immigration, business concentration etc played a role, Jonathan Rothwell argues, 
Almost all of the growth in top American earners has come from just three economic sectors: professional services, finance and insurance, and health care, groups that tend to benefit from regulatory barriers that shelter them from competition. The groups that have contributed the most people to the 1 percent since 1980 are: physicians; executives, managers, sales supervisors, and analysts working in the financial sectors; and professional and legal service industry executives, managers, lawyers, consultants and sales representatives. Without changes in these largely domestic services industries — finance, health care, the law — the United States would look like Canada or Germany in terms of its top income shares.
He also points to how the elite capture of institutions that sets the rules of the game have contributed to an elite premium and rapid widening of inequality,
The United States also stands out in terms of how much money its elite professionals earn relative to the median worker. Workers at the 90th percentile of the income distribution for professionals make 3.5 times the earnings of the typical (median) worker in all occupations in the United States. Only Mexico and Israel, which have very high inequality, compensate professionals so disproportionately. In Switzerland, the Netherlands, Finland and Denmark, the ratio is about 2 to 1. This ratio, the elite professions premium, is very highly correlated with income inequality across countries.
Others are noticing these trends. A new book, “The Captured Economy” by Brink Lindsey and Steven Teles, argues that regressive regulations — laws that benefit the rich — are a primary cause of the extraordinary income gains among elite professionals and financial managers in the United States and of a reduction in growth. This year, the Brookings Institution’s Richard Reeves wrote a book about how people in the upper middle class have shaped both legal and cultural norms to their advantage. From different perspectives, Joseph Stiglitz, Robert Reich and Luigi Zingales have also written extensively about how the political power of elites has undermined markets.
Problems cited by these analysts include subsidies for the financial sector’s risk-taking; overprotection of software and pharmaceutical patents; the escalation of land-use controls that drive up rents in desirable metropolitan areas; favoritism toward market incumbents via state occupational licensing regulations (for example, associations representing lawyers, doctors and dentists that block efforts allowing paraprofessionals to provide routine services at a lower price without their supervision).
Economic geography too has played a role. Richard Florida has documented the increasing trend of concentration of poverty, both across cities and within them. Defining concentrated poverty as neighbourhoods where 40% or more residents are below the US poverty line, he writes,
The number of people living in concentrated poverty has grown staggeringly since 2000, nearly doubling from 7.2 million in 2000 to 13.8 million people by 2013—the highest figure ever recorded. This is a troubling reversal of previous trends, particularly of the previous decade of 1990 to 2000, where Jargowsky’s own research found that concentrated poverty declined. Concentrated poverty also overlaps with race in deeply distressing ways. One in four black Americans and one in six Hispanic Americans live in high-poverty neighborhoods, compared to just one in thirteen of their white counterparts.
Similar concentrations can also explain Brexit. Sarah O' Connor has this fantastic essay on the declining fortunes of the once popular English seaside tourist resort town of Blackpool. The article shows how Blackpool has become "a net importer of ill health, unemployment, and precarious labour and a net exporter of good health and skilled labour". It talks about the "Shit Life Syndrome" that has contributed to a self-fulfilling downward spiral of despair and misery.
And this manifests in social problems that affect the current generation...
... and the future generation too.
See this commentary on the article by Ananth. The opioid epidemic that is sweeping large parts of the US mirrors Blackpool's problems across the Atlantic. And it affects all the similar groups of people.

3. So what can be done? The always incisive Dani Rodrik describes the political situation as a pooling equilibrium, recounts its consequences, and points to a solution to wean the electorate away from populist demagogues,
Conventional and reformist politicians look alike and hence elicit the same response from much of the electorate. They lose votes to the populists and demagogues whose promises to shake up the system are more credible... A pooling equilibrium can be disrupted if reformist politicians can “signal” to voters his or her “true type"... It means engaging in costly behavior that is sufficiently extreme that a conventional politician would never want to emulate it, yet not so extreme that it would turn the reformer into a populist and defeat the purpose. For someone like Hillary Clinton, assuming her conversion was real, it could have meant announcing she would no longer take a dime from Wall Street or would not sign another trade agreement if elected.

In other words, centrist politicians who want to steal the demagogues’ thunder have to tread a very narrow path. If fashioning such a path sounds difficult, it is indicative of the magnitude of the challenge these politicians face. Meeting it will likely require new faces and younger politicians, not tainted with the globalist, market fundamentalist views of their predecessors. It will also require forthright acknowledgement that pursuing the national interest is what politicians are elected to do. And this implies a willingness to attack many of the establishment’s sacred cows – particularly the free rein given to financial institutions, the bias toward austerity policies, the jaundiced view of government’s role in the economy, the unhindered movement of capital around the world, and the fetishization of international trade.
In other words, the most promising solution may be to let the house burn down completely!

Wednesday, November 15, 2017

Graphical summary of India's power sector

A graphical summary of India power sector

1. Among major developing economies, despite its much higher economic growth rates, India has had the weakest growth in net capacity addition in recent years.
2. Interestingly growth in net power consumption has remained more or less steady since 2000, even during the high-growth periods of 2003-08. In contrast, economies like Vietnam and China have had much higher net power consumption rates in their high growth years. 
3. This is even more surprising since India's very low percapita consumption ought to have a given a low base thrust. Note that, like with Indonesia, India's percapita consumption has barely inched forward over the past decade-and-half.
4. The relatively lower demand is also reflected in the remarkably stable growth in Plant Load Factor (PLF), even in the thermal sector, despite the significant increases in capacity addition in recent years.   One would have thought that with the recent increases in capacity addition, the PLF should have risen.
5. The Achilles Heel though remains the very high transmission and distribution (T&D) losses, whose decline, worryingly enough, has plateaued off this decade. Come to think of this, the two phases of accelerated power restructuring programs appear to have had limited effect on loss reduction.
This blogger has consistently held the view that India's power surplus is deceptive. It conceals the suppressed demand arising from a combination of factors - fiscally enfeebled discoms preferring load reliefs to buying power whose cost of service is not recovered in the tariffs, deficient transmission infrastructure preventing evacuation of all available power, and displaced (to diesel generators etc) and suppressed economic activity due to poor quality of supply eroding business competitiveness.

Sunday, November 12, 2017

Weekend reading links

1. An MGI article draws attention to the digital disruption of the banking industry from platform companies which dominate the distribution end of multiple businesses,
Consider Rakuten Ichiba, Japan’s single largest online retail marketplace. It provides loyalty points and e-money usable at hundreds of thousands of stores, virtual and real. It issues credit cards to tens of millions of members. It offers financial products and services that range from mortgages to securities brokerage. And the company runs one of Japan’s largest online travel portals—plus an instant-messaging app, Viber, which has some 800 million users worldwide. Likewise, Alibaba is not just an enormous e-commerce company; it is also a large asset manager, lender, payments company, B2B service, and ride-hailing provider. Tencent is making similar advances, from a chat-service base. And Amazon continues to confound rivals with moves into the cloud, logistics, media, consumer electronics, and even old-fashioned brick-and-mortar retailing—and lending and factoring for small and medium-size enterprises... 
We found that “manufacturing”—the core businesses of financing and lending that pivot off the bank’s balance sheet—generated 53.0 percent of industry revenues, but only 35.0 percent of profits, with an ROE of 4.4 percent. “Distribution,” on the other hand—the origination and sales side of banking—produced 47 percent of revenues and 65 percent of profits, with an ROE of 20 percent. As platform companies extend their tentacles into banking, it is the rich returns of the distribution business they are targeting. And in many cases, they are better positioned for distribution than banks are.
A greater potential threat for Indian banks may not be from the private sector banks, which too has not come out too favourably from the NPA problems, but from the fintech companies. Like the great Chinese companies, are the Indian fintech companies going to seize the moment?

2. It is the annual smog and odd-even vehicle season time in Delhi. Two excellent articles from Harish Damodaran and Mridula Ramesh unpacks the complex nature of the challenge arising from farmers in W Uttar Pradesh, Haryana and Punjab burning their post-harvest waste. 

The central challenge is that farmers have a limited 15-20 days to prepare their fields for the Rabi wheat season, making burning of the harvest waste as the easiest and cheapest option. One solution, which Damodaran explores is to use machines which are able to mulch and evenly spread both the loose straw residue (top-part of the crop cut by combined harvesters) and the standing stubble. Facilitating the provision of these machines through custom hiring centres, even with subsidies, may be a very good idea.

Ramesh suggests encouraging the collection and composting of the harvest materials. The compost, can in turn, be used by farmers as fertilisers or to produce biogas. She advocates a "straw-harvest" subsidy, as a Direct Benefits Transfer (DBT), to farmers based on verification of whether harvested fields have been burnt or not. 

3. A Livemint story on Bharatmala project has a graphic which captures arguably the biggest economic growth challenge - continuing weakness in private sector capex cycle, especially in the infrastructure sector. 
And it is not the traditional problems like land acquisition or financing constraints that is holding back stalled projects, but fuel/input supply and government clearances
4. The one area where work-flow automation, facilitated by technologies like blockchain, can be very disruptive is in the logistics management of global trade. Sample this,
To quantify the documentation involved in ‘business as usual’, Danish shipping giant Maersk tracked a shipment of flowers from the Kenyan port of Mombasa to Rotterdam. The process generated dozens of documents and nearly 200 communications involving farmers, freight forwarders, land-based transporters, customs brokers, governments, ports and carriers. Maersk’s blockchain-based approach, developed with IBM, puts all documents into a single, template-based workflow, kicked off when the farmer submits the packing list. As each step is completed, documents are captured and shared so participants can see what has been submitted, when, and by whom. No one party can modify, delete or even append any record without the consensus from others on the network.
5. Edmund Phelps follows Olivier Blanchard in holding on the natural unemployment rate hypothesis and their "structural" explanations,
The structuralist perspective on macroeconomic behavior led to the concept that came to be called the “natural” rate of unemployment, borrowing from the notion, which arose in Europe during the interwar years, of a “natural” interest rate. Yet the term “natural” was misleading. The basic idea of the structuralist approach is that while market forces are always fluctuating, the unemployment rate actually has a homing tendency. If it is, say, below its “natural” level, it will rise toward this level – and the rate of inflation will pick up... The “natural rate” itself may be pushed up or pulled down by structural shifts. Moreover, shifts in human attitudes and norms may also have an impact... What explains the paradox of low unemployment despite low inflation (or vice versa)? So far, economists – structuralists as well as diehard Keynesians – have been stumped. The answer must be that the “natural rate” is not a constant of nature, like the speed of light. Certainly, it could be moved by structural forces, whether technological or demographic. It is possible, for example, that demographic trends are slowing wage growth and reducing the natural rate.
The low interest rates and low inflation have been on a secular decline for more than three decades. There are real forces, not structural ones, behind these - globalisation (global production and supply chains), trade liberalisation (and global markets for goods and services), weakening of trade unions (and the erosion of employee bargaining power), skill-biased technological changes (concentrated wage increases to the top of income ladder) and so on. Ignoring them on the face of overwhelming evidence and refusing to yield ground on theoretical constructs like "homing tendency" of unemployment rate is one more example of what makes economists lose credibility. 

6. The period of regulatory arbitrage may be coming to an end for the internet superstars. A British employment tribunal, ruling on a petition by a group of 19 drivers, has rejected Uber's plea that its drivers are self-employed as independent contractors and therefore there was no need for it to pay employment benefits. The ruling means that Uber drivers will have to be given benefits like a minimum wage and paid time-off. 

The European Court of Justice is also expected to rule soon about whether Uber should be regulated as a taxi service, subjected to rigorous safety and employment rules, or as a digital platform connected independent contractors and passengers.

7. The events in Middle East, centered around the actions of Prince Mohammed Bid Salman of Saudi Arabia, and the diplomatic response to them from the US, both motivated by the desire to contain Iran, are surely fuelling the flames of a new set of crisis in the region. The forced resignation of Lebanese Prime Minister Saad Harari is clearly an attempt to weaken the power exercised in Lebanon by Iran through the Hezbollah. But this may be a bad miscalculation for a regime which is already mired with botched adventures fighting the Houthi rebels in Yemen and escalated diplomatic face-off with Qatar. And all this in the midst of a massive internal drive to round-up dissidents, ostensibly in the name of an anti-corruption campaign. Add in the Israeli dimension and you have a deadly cocktail.

8. Times captures the one area where Trump's legacy can be more far-reaching than that of any other President - judicial appointments. Sample this,
Mr. Trump is poised to bring the conservative legal movement, which took shape in the 1980s in reaction to decades of liberal rulings on issues like the rights of criminal suspects and of women who want abortions, to a new peak of influence over American law and society.
Talking of judiciary, not a pretty picture across in India on an extraordinary day in the Supreme Court on Friday. Fortunately enough, the Indian Supreme Court has managed to survive with credibility intact despite its leadership in the recent past, though it is not clear whether the same can be repeated now. If we are splitting hairs about an obvious case of conflict of interest and acceptance of recusal, then matters are clearly at a crisis point. 

9. Fascinating graphic on the evolution of container ships from a new MGI report on the future of container ship.          
10. Finally, some figures from Alibaba's record breaking Single's Day haul,
Alibaba shuttered the tills on its biggest Singles Day shopping festival to date — a $25.4bn haul that saw Chinese shoppers snap up more than $1bn worth of mobile phones, shoes and lipsticks every hour. More than 777m parcels were shipped out in what has become the biggest day by far in the global retail calendar... Nine out of 10 purchases were made via mobile phones... Alibaba has turned Singles Day — numerically written as 11.11 — into an event many times bigger than any US shopping day sales... 140,000 brands, including 60,000 international names, offered 15m items for sale.

Saturday, November 11, 2017

Tax Avoidance Nudge of the day

In the backdrop of the Paradise Papers which draws attention to the pervasive nature of tax avoidance strategies by the large corporates, Merryn Somerset Webb writes in FT,
In the meantime, if I were in charge, I would amuse myself by forcing all companies operating in the UK to list in their annual report how much tax they would pay in the UK if they were to simply subtract their UK-based expenses from their UK-earned revenues (no allowances and no profit shifting included) and how much they actually pay. It’s a small thing — but rather like forcing publication of pay ratios and gender ratios it might concentrate minds.
Talk about nudging to curb tax avoidance. Small step, but may be very useful, as she says, to "concentrate minds" and generate popular indignation.

And very nice illustration of corporate and individual tax avoidance strategies by Gabriel Zucman in Times.

Sunday, November 5, 2017

Weekend reading links - automation edition

1. John Mauldin's newsletter last week had a graphic which captures what looks likely to be the primary economic challenge of our times. The paradox of increased production with fewer workers!
What makes this scary is the pace at which this is happening. The graphic below shows how the US shale industry has dramatically increased rig count over the past two years without increasing the workforce at all. 
The amazing thing is that this transformation happened in two years; it didn’t take a generation or even half a generation. You were an oilfield worker with what you thought was potentially a lifetime of steady, well-paying – if dangerous, nasty, and dirty – work. And then BOOM! The jobs just simply disappeared. Your on-the-job experience doesn’t translate to any other industries very easily, and now you and your family are on the skids.
2. Ananth points to a nice Bloomberg spotlight on Fanuc, a 45 year old Japanese factory automation company, described in the article as the "planet's most important manufacturer". 
The $50 billion company controls most of the world’s market for factory automation and industrial robotics. In fact, Fanuc might just be the single most important manufacturing company in the world right now, because everything Fanuc does is designed to make it part of what every other manufacturing company is doing... More and more, it’s Fanuc’s industrial robots that assemble and paint automobiles in China, construct complex motors, and make injection-molded parts and electrical components. At pharmaceutical companies, Fanuc’s sorting robots categorize and package pills. At food-packaging facilities, they slice, squirt, and wrap edibles...

Fanuc manages to offer very high savings while maintaining 40 percent operating profit margins, a success... traced to the company’s centralized production in Japan, which is made possible, even though most of its products are sold outside the country, by the 243 global service centers that keep its robots operational. The company even profits from its competitors’ sales, because more than half of all industrial robots are directed by its computer numerical-control software. Between the almost 4 million CNC systems and half-million or so industrial robots it has installed around the world, Fanuc has captured about one-quarter of the global market... Fanuc’s Robodrills now command an 80 percent share of the market for smartphone manufacturing robots.
3. Finally, this New Yorker essay on the march of robots in American manufacturing has this tagline,
Once, robots assisted human workers. Now it’s the other way around.

Friday, November 3, 2017

The la la land of financial market ethics

An FT investigation shows that top executives at Guggenheim Partners, the $240 bn asset manager, invested their client's money in companies with close personal ties to its leadership, without proper due-diligence and in cases even despite red-flags raised by the firm's own compliance department. This case of self-dealing and pursuing transactions against client interests is the latest in the endless series of scandals about governance and ethics violations that have become the norm in recent years. 

While there are elaborate "safeguards" against self-dealing, insider-trading, and the like, they rest of very flimsy, often completely unrealistic, foundations. Consider this,
There is nothing necessarily improper about investing with former business partners or close associates, as long as transactions between the groups are conducted at “arm’s length”, with full disclosure of deal terms to all parties involved in the transaction.
And there are academic apologists who lend the veneer of credibility to such relationships and transactions,
James Cox, a securities law professor at Duke University, says such conflicts are normally policed aggressively by compliance departments and a series of violations would indicate a failure of leadership at any Wall Street firm.
One of the less discussed agency problems with modern financial markets is the conflicts that arise at the intersection of the executive's professional and personal roles. It is a reality that top executives in the largest financial institutions today are simultaneously managing client and personal investments within the umbrella of the same institution and sometimes even the same financial instruments. This naturally raises the possibility of conflict between their fiduciary responsibility and their personal interests. The likelihood of investing client money being dictated by personal motivations is non-trivial.

In fact, given the very high stakes involved, the ease of obscuring personal relationships and making transactions opaque, the thin line between compliance and compromise, the difficulty of establishing culpability for transgressions like self-dealing and insider trading, and the pervasive erosion of corporate ethics, it is difficult to believe that such "arm's length" transactions are likely to be the norm. Adding to this, when executives from financial market titans have been found to have indulged in malfeasance involving cross-selling, self-dealing, asset-stripping, and insider trading on numerous occasions, and have escaped without any personal damage, the incentive misalignment and agency failure is almost complete. 

This was one of the reasons why financial institutions were historically structured as partnerships. As long these institutions remained small, the individual limited partners had enough leverage to keep incentives aligned. Gradually, as these entities have expanded massively, become public, and attracted impersonal institutional investors like pension and insurance funds, the relationship between the principal and agents diffused, and the former's leverage weakened as to become insignificant. 

It would require individuals of increasingly rare personal character to be able to resist the temptations of massive returns and exercise self-restraint in elevating their personal interests over their fiduciary responsibilities. The vast majority, when presented an opportunity, are most likely to fall prey to these temptations. The belief that "Chinese walls" and "arm's length" relationships are effective at deterring malfeasance is just a figment of one's imagination. 

Wednesday, November 1, 2017

On fertiliser subsidy reform

Scroll has a very good series on why the fertiliser subsidy reform plan involving delivering the subsidy directly to farmers as a Direct Benefits Transfer (DBT) by linking land records, soil health cards (SHCs), and Aadhaar number has had to be shelved, even if temporarily. 

The reform objective was to deliver the exact amount of fertilisers to each farmer based on their respective soil nutrient content as captured in the SHC and their Aadhaar-linked land record details. The reform struggled because of poor quality of land records and SHC data and behavioural challenges. Worse still, even the apparently pure technology play of Aadhaar authentication generated surprisingly high failure rates

One of the articles writes about the challenges with getting farmers to accept the SHC reports,
Farmers in Krishna district ignored the soil health card information that appeared on the machines. “When it comes to deciding how much fertilisers should be used, we go by our traditional wisdom and by what other farmers are using,” explained Babu Rao, a farmer in Krishna district. “We understand we might be using too much chemicals. But who will be responsible for the loss if we get poor yield by using less fertiliser?”
... Thousands of farmers and dozens of fertiliser retailers in Krishna and West Godavari district did the same – they ignored the machine’s instructions. “We could not deny what farmers asked for,” explained a fertiliser dealer in G Kundur, a block centre in Krishna. “There would have been riots. Our business would have suffered.”
And the inconsistency between the strategy and objective, and targets and resources,
To issue soil health cards, officials test one sample of soil each from a grid of 10 hectares of land in dry areas and two hectares of land in irrigated areas. Experts say this methodology may not produce reliable data for individual farms since the average size of agricultural land holding in India is 1.1 hectares, with 67% of the land holdings measuring less than one hectare. Soil characteristics change from farm to farm depending on the cropping patterns and fertilisers use in those farms. Data on soil characteristics over larger areas can therefore be misleading when used to determine the inputs required on a specific plot of land... In Krishna district, where 33 lakh soil health cards were generated last year from the 95,000 soil samples analysed, said officials. The four soil testing labs in the district had the capacity to test only 21,000 samples a year. The officials claimed private consultants were hired and the labs ran day and night to complete the job.
It is difficult to believe that this experiment could have turned out any different. Consider the requirements. First, the Agriculture Department had to effectively manage the logistics of soil health data collection - maintaining the soil sample identity, transportation and storage of soil samples, their analysis, and its communication back to farmers. Second, the soil analysis had to be an accurate reflection of the soil nutrient status - the sampling had to be representative enough and the tests had to be effective. Finally, the farmers had to have the faith in the results to be willing to accept its findings. Forget the second and third, there are too many moving parts in the management of SHC logistics itself for a weak state (an even more weak Agriculture Department) to have been expected to  deliver with any degree of credibility. 

And we have not even talked about the challenges with land records - mutation and ownership updation in basic land records, sub-division in survey records, disconnect between registration and ownership, lack of accurate tenancy records, predominance of tenancy and so on. Or with Aadhaar validation - poor connectivity, concentrated load on retailers during the sowing season, training of (1,75,619) retailers, maintenance of point of sale terminals, and so on.

The takeaways. One, it is unrealistic to expect weak states to be able to perform herculean tasks covering millions of people with any reasonable degree of quality. Adding unrealistic timelines only makes the likelihood of success even more remote. Two, excessively ambitious and over-engineered solutions are unlikely to work. Practical considerations and related compromises are important. Three, technology solutions cannot paper over fundamental structural deficiencies like poor quality of land records and weak state capacity. Finally, despite the perception to the contrary, technology solutions are not always easily implemented effectively in scale. 

Monday, October 30, 2017

The coming pensions crisis

The decades long secular decline in real interest rates has been taking a toll on savers. The pay-as-you-go, defined benefit pension schemes of many local governments, other public entities, and older corporations have promised very high returns whose realization may be difficult in this environment. Hyper-aggressive wealth and asset managers have massive funds under management that promise long periods of high returns, even after excluding their exorbitant management fees. 

The business models in pension funds, insurance, and asset management look likely to be upended by the persistent and declining trend in interest rates. 

A McKinsey Global Institute report last year made alarming prognosis about investment returns in developed markets over the next two decades when compared to the past thirty years. 
Accordingly, the MGI report estimates that for US and Western Europe, annual return on equities and fixed-income securities could be respectively 150-400 and 300-500 basis points lower. Its implications include,
A two- percentage-point difference in average annual returns over an extended period would mean that a 30-year-old today would have to work seven years longer or almost double her savings to live as well in retirement.
And in the medium term and even including emerging markets, as the seven-year return predictions of Jeremy Grantham shows, the likely real returns are mostly in the negative territory.

The biggest victims of this low return environment are likely to be pension funds, especially the defined benefits plans offered by government agencies and legacy plans of the big private corporations. A world with low yields for the foreseeable future compounds the problems for pension funds across the world. In recent years, the dynamics of demographics – rising share of aging populations – has already been exerting pressure on these pension funds, many of which are grappling with massive underfunded liabilities. They now have to earn sufficient returns not only to prevent the funding gap from widening further , but also make incremental returns to bridge their deficits. But the low return environment leaves them without enough to meet even the first objective. Further, the older towns and cities have been facing the problem of stagnant or declining populations which put pressure on their tax and other revenue sources.  

A study published by AQR Capital Management finds that defined contribution (DC) pensioners have to double their current savings to achieve the same target retirement income replacement ratio (RR) of 75%. The historical real return of 7.5% from equities is expected to decline to 5%, and that from bonds from 2.5% to 1%, thereby generating a two percentage points lower annual return of 3.5% on a standard asset allocation of 60% US equities and 40% Treasury Bonds. This means that the worker now has to save 15% a year, not the current 8%, to reach the same RR. On a 2.5% real return assumption, the contributions would have to rise to 19% overall!  
California Public Employees’ Retirement System (CalPERS), the biggest US public pension fund with nearly $300 billion of assets, posted just 0.6% gains for the year ending June 2016 compared to the 7.5% return required to meet its payment obligations. This has also brought down its average investment returns over the past two decades to 7%, below its target. About 60% of US pension funds assume a return of 6-7.5%.

The Hoover Institution, a Stanford University think tank, estimates the under-funded US public pension liabilities to be $3.4 trillion. Wilshire Consulting, an investment advisory, estimates that the funding gap of public pension plans in US rose from 23% in 2014 to 27% by mid-2015. As yields stay very low and dependency ratio rises, these liabilities are likely to balloon. Mercer, the consulting firm, estimates that pension deficits of UK’s FTSE 350 companies rose by £21bn to £119bn in just June 2016, almost entirely due to the fall in gilt yields. 

In fact, estimates for the US S&P 1500 companies by Mercer reveals similar disturbing trends. As on August 31, 2016, the estimated aggregate deficit of $570 bn represented a worsening by $166 bn from the $404 bn deficit at the end of 2015. Aggregate funding level of pension plans supported by these companies stood at 77 per cent.

Or as Larry Fink, the Chairman of world’s largest asset manager BlackRock, in his annual letter to shareholders last year, said,
For example, a 35-year-old looking to generate $48,000 per year in retirement income beginning at age 65 would need to invest $178,000 today in a 5% interest rate environment. In a 2% interest rate environment, however, that individual would need to invest $563,000 (or 3.2 times as much) to achieve the same outcome in retirement.

John Authers has said that for “US public employee pension plans, the three percentage points could more than double their deficit, from $1 trillion to $2.5 trillion”. The corollary of this is that these people will now have to cut back on their consumption to save atleast enough to maintain the same level of post-retirement income.

John Mauldin has initiated a series of posts on the looming pensions crisis in the US. As he writes, most of the public pension plans are not fully funded. In fact, as the graphic below shows, the extraordinary monetary accommodation has had a devastating effect, quintupling the the total unfunded liabilities in state and local pensions over the decade. 
Mauldin has dire predictions about the pension plans of city governments in the US, with very bitter consequences for those societies.  
Pension plans cover over 15% of many city budgets, with some having more pensioners than workers. The pension costs of Los Angeles Police Department rose from just 5% of general fund budget in 2002 to 20% today, forcing the LAPD ranks to fall to below 10,000 in 2013 against the required 12500. Similarly, New York today spends more on pensions than it does on building and repairing schools, bridges, parks, and subways. 

The results are hiring freezes which lowers the quality of service delivery and cut backs on the coverage of a variety of services. All this in turn results in higher crime, poor student learning outcomes, declining quality of utility services and so on.

In a different context, India faces an altogether different problem with its pensions. A recent RBI report on household financial savings describes a "ticking pension time bomb". Unlike the US, here it is just that only 7.4% of the working age population is covered by a pension program compared to 65% for Germany and 31% for Brazil. Or unlike UK where private pension investments make up more than 95% of GDP, it is less than 1% in India. The report found that more than 50% of households plan to depend on children for support during old age and 77% do not expect to retire or have not actively planned for retirement.

For India, with its favourable demographic pyramid with rising youth population, this is the right time to encourage savings so as to beneficially smooth inter-temporal financial needs. A recent report by the World Economic Forum reports a global unfunded pension gap of $400 trillion by 2050 for eight countries including India. It estimates India's annual savings gap to grow by 10% and reach $85 trillion by 2050.