Thursday, September 21, 2017

Gaming the rules - the case of India's Bankruptcy Code

I had blogged earlier about the challenges associated with the effective implementation of the Insolvency and Bankruptcy Code (IBC). In particular, I had alluded to the likelihood of capture of the valuation agency, Insolvency Resolution Personnel (IRP), Insolvency Professional Agency (IPA), and the Insolvency and Bankruptcy Board of India (IBBI) and the round-tripping of assets back to promoters. 

Well, on the face of it, both concerns appear to have materialised in the very first case settled through the process! 

The resolution of Synergy Doorays is nicely described by Debashis Basu here. The modus operandi is simple. Get proxies (of the promoter) to submit Resolution Applications (RAs). Get another proxy as the majority debt holder in the Committee of Creditors (CoC), by either cutting a deal with the majority creditor or transferring the major share of loans to that creditor. Then force down massive haircuts. And if you can capture the IRP, an easy picking on most occasions, then everything becomes all the more easy. There will be small sub-plots that vary with cases, but the script would more or less remain the same. Welcome to the real world of implementing IBC!

I am not one bit surprised and and will not be surprised if such subversion becomes the norm. In fact, I would surprised if it does not become so, especially if we stretch the system with too many cases to start with. After the first blush of cases occupy the handful of good IRPs and resolution agents and the limited market size in stressed assets buyers starts to bind, gaming will become easier still. 

Why shouldn't it be the case? Consider the ingredients. Very high stakes. Resolution institutions populated by existing market participants, many of whose reputations were never covered in any glory. Weak institutional capacity. Government agents prone to being captured. Promoters desperate to retain control.   

In this milieu, it is very difficult to expect institutional integrity, of both private and public participants, to remain unscathed. 

Though I have not examined the procedures in detail, it does appear that there were no clear technical and financial qualification norms for the RAs or norms that govern creditors and transfers among them. Let's face it, these playbooks are pretty well known and at least some of these egregious violations could have been avoided.

But a more effective approach to ensuring effective implementation of such regulations is to have the approach explained here and here. Get the best possible version of regulations out, and then keep  resources and personnel ready to respond swiftly and credibly to emergent problems. A few iterations and with good luck, you could potentially have settled on a good and practical set of regulations. Easy to do? Yes, in theory. But requires leadership and professional competence of a very high order. Unfortunately, both very scarce resources.

This is also a teachable moment in making regulations. There is no point in having state-of-art regulation if the real world in which it has to function cannot be expected to bear them. What is the use of grafting an elaborate insolvency architecture if its implementors are most certain to be seriously compromised? Wouldn't second-best options have been better? Or maybe, we should just graft state-of-art regulations and then hope that things mature and fall into place in a couple of decades? Or, and I really hope so, I am being very pessimistic!

Sunday, September 17, 2017

Weekend graphics

1. There is limited correlation between exchange rate movements at the margins and export competitiveness. That India has a problem with its exports is undoubted. Buoyed by green shoots in US and Europe, as well as rebound in China, emerging market exports have been growing at their fastest pace in volume terms in six years. Emerging Asia has been at the forefront of the rebound in global trade. 

While rising commodity prices have given many predominantly commodity exporters a leg up, it has been only one driving factor, and in value terms for the year to July 2017, among exporters, India competes with Turkey for the wooden spoon!
But it is incorrect to blame exchange rate appreciation for that. For one, emerging market currencies have strengthened against the dollar. 
And, till end-March this year, far from strengthening, compared to its EM peers, the rupee has actually been among the weakest performers. And those which have appreciated significantly like Russia, S Korea, Mexico and Taiwan have done far better than India, despite its far smaller appreciation.
In fact, till now, compared to its EM peers, the rupee has been very stable against the dollar. On REER too, India comes middle of the pack over the past 12 months. 
And it is not as if India's currency problems have cropped up in the last one year. From the Bruegel database, the REER of India's main EM peers weighted against 138 trading partners since end-2007 shows that rupee has appreciated more than all others except Vietnamese Dong, Bangladeshi Taka, and Chinese Yuan. The appreciation has been continuous since the taper-tantrum in mid-2013,
But for the same period, from WDI database, while India clearly has suffered a vertiginous drop in exports, especially since 2010, others with stronger or similarly moving currencies like Bangladesh, Vietnam, China, Indonesia, and Philippines have done better with their exports,



Clearly, there is more at play here than exchange rates. In any case, even assuming we need to weaken rupee, do we have the instruments at hand to manage it. Apart from sterilisation costs as well as the opportunity cost of holding low yielding dollar assets, open market operations come with risks of being marked out as a currency manipulator. 

2. From John Mauldin's latest newsletter, this stunning graphic shows the impact of search for yields. Euro junk-bond yields have converged with US Treasuries!
The Euro high-yield bonds is only representative. The spread between US Corporate Bonds and Treasuries are inching towards their pre-crisis lows.  

As a measure of the search for yields, the total assets managed by the 100 largest alternative investment managers rose by 3% to $3.6 trillion in 2016. Pension funds and insurers, squeezed by low yields in traditional fixed-income assets and the need to invest for long-term, have been forced into moving their portfolio allocation towards alternative investments which sit at the riskier end of the spectrum. 

In this context, the risks from a slowdown, and its attendant adverse impact on these high-yield issuers and asset categories, are enormous. They have the potential to freeze up the financial markets immediately more than in earlier times with far lower exposures. 

3. Alternative investors are not the only ones to have increased the demand for fixed-income corporate assets. FT has a nice story on the emergence of large corporates, with their massive and growing surpluses, as important buyers in the $8.6 trillion US corporate debt market. Thirty US companies have amassed cash, securities and investments worth $1.2 trillion, with some of the corporates rivalling even the larger asset managers. Roughly $840 mn of the $1.2 trillion were held in investments outside the US. As FT writes,
These companies, each with more than $10bn of cash, equivalents and other financial investments, own roughly $423bn of corporate debt and commercial paper securities, $369bn of government and agency debt and disclose holdings of more than $40bn of asset and mortgage-backed securities.
These investors' risks arise from the steep falls in bond prices with any likely increases in interest rates.

Ironically this situation of massive cash surpluses and their investments in corporate bonds, sits alongside a reality of large borrowings by the same corporates,
Apple, Microsoft and others have borrowed to fund activities that are easily financed with cash, like distributions to shareholders and share repurchases. The iPhone maker has raised more than $28bn through debt markets this year to fund, in part, shareholder returns, according to Dealogic. It is cheaper for those companies to borrow than it is to pay tax on repatriated cash.
4. Staying with the same theme, and reminding us about the risks associated with such search for yields, the FT has a nice graphic that maps asset yields against their respective ten year volatility.
Clearly higher yields come with higher volatility. And underlining the dangers of cross-border capital flows, EM local currency corporate bonds have the highest volatility. Another reminder about the risks of capital floods followed by sudden-stops and crises.

5. Finally, Warren Buffet appears to have all but won his famous 2007 bet that passive investing would outperform active fund managers, excluding their high fees, over a ten year period. An update shows that S&P 500 has outperformed hedge funds in nine out of the ten years.
One more reminder about the fallacy of picking stocks!

Thursday, September 14, 2017

Piketty, price markups, and Houston floods

There are two ways to critique something which questions strongly held conventional wisdom. The honourable way is to question the core of the argument, and a less honourable way is to detract attention from the core issue by picking holes on incidentals. 

Consider three examples - Thomas Piketty's book highlighting the issue of rising incomes at the top of the ladder and widening inequality, a recent paper on rising markups in US businesses, and the Houston floods and the debate on zoning regulations in urban areas.

Take Piketty. Never mind that the primary takeaway from the book was the fact that inequality is  increasing alarmingly across the world, the right-wing critique of the book was focused on picking holes at Piketty's argument that the returns to capital was higher than economic growth, thereby increasing the incomes of the rich and widening inequality. No, they argued, capital, especially the modern information technology based ones, depreciates fast enough to offset any high returns. Or, that among all returns to capital, it is increases in property prices that forms the vast majority of wealth creation.

Sure, there are some policy implications based on what are drivers of widening inequality, but is it a necessity for taking action on the first order issue that incomes at the top of the ladder are rocketing up even as those of the overwhelming majority are stagnating or declining?

As to the debate about whether r > g, the recent work of Alan Taylor, Oscar Jorda, and Co, on the returns to property, equity, bond, and government bills for 16 countries for the 1870-2015 period is only a confirmation of Piketty's argument. I have not seen too many blogposts in Marginal Revolution on this or their extended work! 

Or the just released work of Jan De Loecker and Jan Eckhout who find out,
In 1980, average markups start to rise from 18% above marginal cost to 67% now. There is no strong pattern across industries, though markups tend to be higher, across all sectors of the economy, in smaller firms and most of the increase is due to an increase within industry. We do see a notable change in the distribution of markups with the increase exclusively due to a sharp increase in high markup firms.
Tyler Cowen highlights his main takeaway - "In 1980, average markups start to rise from 18% above marginal cost to 67% now". And his response is grudging,
That sounds like big news, and probably it is.
He then goes on to conflate the fundamental issue of rising markups, and whether it is leading to rising profits and is the result of business concentration. He detracts attention from a first order problem by quibbling at flaws in data sources, arguing about monopolistic competition, and so on. What is the meaning of being disingenuous? Heck, monopoly profits or not, markups are markups, and they are happening! 

As Noah Smith nicely summarises the growing pile of evidence - business concentration has been increasing, is correlated with declining labour's share in national income, executive salaries have gone up with deregulation, profits have risen substantially, there has been a slackening of anti-trust enforcement, prices go up while productivity does not after mergers, business investment declines has been associated with market power, and so on. Isn't all this adequate to connect the dots? Do we need to get exact evidence? In any case, is real world policy-making so exact a science that it requires information on causal channels with great precision? 

Finally, consider the case of the recent floods in Houston and the loss of lives and damage caused, especially among those living in areas vulnerable to flooding. The city has long been the poster child for deregulated zoning regulations, reflected in its affordable housing, and contrasted with the zoning intensive San Francisco's exorbitant housing prices. 

Forget Houston and zoning laws. Take any large Indian (or developing country) city beside a river. Encroachments on river banks and liberal building permissions in areas vulnerable to floods are commonplace. Flooding is an annual feature, with some deaths, houses washed away, and huge damages. In fact, large parts of Indian cities, with either poor or no enforcement, are the closest anywhere in the world to free market in housing development. 

Instead of confining the debate to the issue of regulating construction on areas prone to flooding, the ideologues have been waging war on whether construction is responsible for flooding or not. While the left have blamed climate change and deregulation, the right has used the opportunity to blame everything from historical reality of Houston's flood pronenesss to subsidies on flood insurance. Since the ideological fort is under attack, the defenders have to mount their defence. In the din, the real issue of regulating (and it is not incentives that work here) housing on flood plains and, more importantly, promoting vertical development in the remaining areas has been lost. An opportunity to promote zoning regulations that work in this direction may have been lost.

In all the three cases, attention from the central issues - widening inequality, markups and business concentration, and unfettered construction in flood plains - have been scattered by splitting hairs on important, but secondary concerns. 

In all these cases the narrative, as I see it, is this. Central tenets of ideological beliefs that have shaped both your life and career for atleast over 30 years are now being threatened. So you push back aggressively, even if it means stretching the boundaries of everything we call truth and decency. Everyone faces it once in a while, but ideologically prone individuals are the most vulnerable and possibly the worst offenders. It is as much true of the right as it is true of the left!

Tuesday, September 12, 2017

Housing and financial market instability

Is real estate trends the biggest force for macroeconomic distortion? I have blogged earlier about the work of Mathew Rognlie which highlights the central contribution of housing prices to widening inequality. 

Now, following on from the work of Atif Man and Amir Sufi, √íscar Jord√°, Moritz Schularick, and Alan Taylor construct historic housing price data for the 1870-2012 period for 17 countries and find,
First, we discuss long-run trends in mortgage lending, home ownership, and house prices and show that the 20th century has indeed been an era of increasing “bets on the house.” The strong rise in aggregate private debt over GDP that can be observed in many Western economies in the second half of the 20th century has been mainly driven by a sharp increase in mortgage debt. Mortgage credit has risen dramatically as a share of banks’ balance sheets from about one third at the beginning of the 20th century to about two thirds today. As a result, the intermediation of savings into the mortgage market has become the primary business of banking, eclipsing the stylized textbook view of banks financing the capital formation of businesses.


Second, turning to the cyclical fluctuations of lending and house prices we... show that throughout history loose monetary conditions were closely associated with an upsurge in real estate lending and house prices... Broadly speaking, when countries peg to some base currency they effectively import the base economy’s monetary policy, even if it is at odds with home economic conditions. Exchange rate pegs therefore provide a source of exogenous variation in monetary conditions. By conditioning on a rich set of domestic macroeconomic controls, we are able to isolate exogenous fluctuations in the short-term interest rate imported via the peg and trace the effect of these fluctuations over time on other variables. Third, we also expose a close link between mortgage credit and house price booms on the one hand, and financial crises on the other. Over the past 140 years of modern macroeconomic history, mortgage booms and house price bubbles have been closely associated with a higher likelihood of a financial crisis. This association is more noticeable in the post-WW2 era, which was marked by the democratization of leverage through housing finance.
Their data construction allows them to identify causal pathways and converge on two important findings, 
Loose monetary conditions are causal for mortgage and house price booms, and this effect has become much more dramatic since WW2... Mortgage and house price booms are predictive of future financial crises, and this effect has also become much more dramatic since WW2.
The case study of how in the aftermath of EMU when countries lost their monetary policy autonomy, monetary accommodation increased mortgage lending, and engendered housing bubble in Spain and Ireland is fascinating. 
As can be seen, for the 1999-2007 period, coinciding with the first years of the monetary union, the optimal monetary policy rates for Ireland and Spain should have been much higher than the ECB policy rates, given the rapid growth rates experienced by them during that period. The loose policy boosted mortgage lending which doubled in eight years, and in turn inflated housing prices by 65-75%. This contrasts with Germany, with its moderate growth and resultant tighter monetary conditions, stable mortgage lending, and declining property prices. 

Its implications are clear. One, policy actions, like macroprudential tools, have relevance in the regulation of the market failures arising from the inevitable excess of mortgage lending. Two, central banks should be cognisant of the fact that the side effects of monetary accommodation can destabilise financial markets, with housing being a major channel of instability. Three, it may be time to re-examine the dominant role of dollar and the attendant effect of its pegging other currencies, which creates the channel for importing financial instability. In simple terms, the dominance of dollar effectively invalidates the Mundell-Fleming trilemma and makes monetary policy always significantly dependent on the US Fed's policy actions. 

Monday, September 11, 2017

Arbitrage and efficiency - externalising costs and capturing gains

This post is triggered by Neil Irwin's fantastic article that I blogged here.  

Consider these. Robots replacing human workers to reduce defects and increase output. Companies focusing on their core-competencies by outsourcing non-core activities. Companies that either outsource or off-shore their production facilities to lower costs. Executives and companies that cut costs by aggressive reduction of their workforce and hiring contract labour, all in the name of competitiveness. Internet-based companies that reduce market frictions by bringing together buyers and sellers of goods and services. Constructing complex ownership structures that enable cross-border shifting of profits so as to minimise tax obligations. Supercomputers that connect to the exchanges through dedicated optic fibre cables over the shortest distance to promote high frequency trading that claim to increase market liquidity and thickness. 

The common thread in all these stories is the search for efficiency and value for money, both in turn aimed at maximising profits, even if, and often because so, at the cost of jobs or the quality of jobs. These trends are considered essential and desirable attributes in today's capitalism, in fact even the ultimate objective of the business enterprise. But this has not always been the case.

The traditional idea of a good business firm was of one which created jobs, productive jobs. Apart from being socially responsible, this was also sound economics. After all jobs provided the demand that sustained businesses, the economy itself. In other words, the firm's actions contributes to the creation and sustenance of the market itself. It is capitalism which generates a win-win equilibrium of private and social gains. It also involves both the firm and the workers accepting trade-offs to create a mutually beneficial system.  

Fast forward to today and the conception of a good business firm has changed dramatically. Ironically, today's good business firm is one which maximises shareholder value, even if by inflicting unacceptable social costs. This in most cases, translates to cutting costs, by among other things, reducing the expenses on labour. The embrace of labour-displacing robots is only the most direct and extreme manifestation of this trend. In other words, today's business firm is an entirely private entity, with limited social responsibility and aimed at maximising private gains. Sustenance of the soil on which the enterprise itself grows, the market, is the least of considerations.

Whereas annual reports of companies earlier took pride at highlighting the number of jobs created that year, today it is all about the bottom-line, even proudly mentioning the savings from lay-offs and tax avoidance. 

In the pursuit of individual business models that rely on realising returns through arbitrage and externalising the associated costs while appropriating all the benefits, capitalist enterprises are collectively chipping away at the sustainability of the market, and thereby capitalism, itself.  

In the cases mentioned at the beginning, it is debatable as to how many of them would be sustainable if all the social costs are internalised. In many of them, far from directly improving the net productivity (across markets) by way of inventing a new technology or a new business model, the efficiency gains arise from arbitraging across markets. These arbitrage opportunities arise from differences in input costs (outsourcing, offshoring, contracting) arising significantly from failures to internalise costs, regulatory standards (digital commerce, tax avoidance), information access (HFT), and so on. The gains from these arbitrages are privately captured, whereas their costs are borne by the society at large. In simple terms, where possible, today's business enterprise seeks to privatise gains and socialise costs.

This is not to decry all arbitrage opportunities. In fact, all economic transactions involve some form of arbitrage, including the mother of all arbitrages, comparative advantage in the natural order of things. Accordingly, labour wages in developing countries are lower than in developed ones, or farm produce is cheaper in villages than in the cities, and so on. Outsourcing and off-shoring can be legitimate productivity enhancing business models. Where these and others become less benign is, as aforementioned, when the private party appropriates all the gains in the arbitrage transaction and externalises all costs. 

It is disturbing when arguably some of the most exciting business opportunities of our times - e-commerce and sharing economy firms - is in making money pursuing activities whose competitiveness lies in regulatory arbitrage that allows externalisation of the negative social and other costs inflicted by them. It is equally disturbing sign when the most admired business leader and company of our times, Steve Jobs and Apple, have made their staggering fortunes not by fulfilling market "needs" but almost exclusively by creating market "wants". Finally, it is disturbing that both these cases are considered today's touchstones of a shift towards a higher trajectory of economic progress.

Saturday, September 9, 2017

Weekend reading links

1. I had blogged briefly earlier about the challenges associated with compliance with standards in Indian Railways. This is a much under-appreciated problem with most things done by governments - delivering in an environment of acute scarcity of resources, time, and capacity.

Alok Kumar Verma, a retired Railway officer, shines light on the problem and argues at how safety and speed have been crowded out by priorities of capital intensive modernisation and new trophy projects. The article deserves to be quoted at length,
The recent accident near Khatauli station on August 19, which resulted in the death of 23 passengers, is a reminder of the dangers of the excessive over-utilisation of the lines. The section where the accident occurred carries 35 trains a day against a capacity of 25 trains. Reportedly, block (temporary suspension of traffic) for carrying out repairs to a broken rail was refused... According to the latest data, utilisation exceeds the capacity on 65 per cent of busy routes. It is 120 per cent to 150 per cent on 32 per cent of the routes, and utilisation exceeds 150 per cent on 9 per cent of the routes. For optimal performance, utilisation should be 80 to 90 per cent of the capacity. Over-utilisation is leaving little time for safety inspections and essential maintenance of track and other infrastructure as well as the rolling stock. The focus of IR has shifted to daily fire-fighting, to somehow keep trains running, leading to all sorts of maladies like inter-departmental tussles and low morale. Arguably, IR has one of the highest incidences of accidents due to material, equipment and human failures.
From 1985-2000, IR acquired locomotives, coaches and wagons and carried out modernisation and upgradation of track and other infrastructure, with massive infusion of funds. But it kept deferring the last mile works (which include the easing of sharp curves, strengthening some bridges, improving track geometry to tighter tolerances, cab signalling etc.) that are needed to unlock the full potential of an upgraded network. The last mile works are tough to execute, requiring immaculate planning and precise execution. Blocks will be regularly needed for which some services may have to be diverted or curtailed temporarily. Services that can be catered to by road transport, like short distance passenger trains, shall have to be closed altogether.
A comparison with the Chinese Railway (CR) is illustrative of the magnitude of IR’s failure. Till the 1990s, the speed of trains on CR was limited to 100 to 120 km/hr. But in the 10 years (1997-2007), it undertook a “speed-up” campaign in six rounds and raised speeds to 160 km/hr on 14,000 km and to 200 km/hr on 5,370 km route-lengths. Simultaneously, the speed of freight trains was raised to 100 to 120 km/hr. With the streamlining traffic flow, line capacity was increased by 60 to 70 per cent... Indian Railways has remained stuck at 130 km/hr since 1969, while congestion on the trunk routes sky-rocketed. It’s time to shift focus to the core network that carries more than 80 per cent of the total traffic. The last mile works for upgrading the trunk routes which were repeatedly deferred should be undertaken on a priority basis so that the entire nation can realise the benefits of faster and safer travel. Else, safety on Indian Railway will only worsen.
This is a classic problem in governments. Addressing last mile gaps is unsexy and does not bring laurels. Maintenance of existing assets is invariably overlooked for new projects, where ribbons can be cut, inauguration done, and personal credits apportioned. It is the same everywhere - power transmission and distribution, water and sewerage, and all existing infrastructure elsewhere.

Let's face it. This is a big choice that Railway Ministry, led by the Government of India, has to make. Identify two or three objectives - safety, raising speeds, increasing freight - and single-mindedly pursue them for a decade or so. In doing so, the leadership will have to acknowledge the costly and often politically difficult trade-offs that are necessary.

2. Ananth points to an excellent article by Chris Balding that highlights the wave of academic censorship sweeping China and how western universities are helping its spread. He points to the decision by Cambridge University Press to take down 300 articles from its Chinese website at the request of Chinese government and writes about the choice facing Western academia and how they have chosen to respond,
It was the fact that a respected publication was bending the knee to censorship and what this represented about the broader complicity of Western organizations, universities, and academics in helping China export its academic censorship around the world... Western universities’ traditional response to criticisms on China’s restrictions on free inquiry was to claim that they could help liberalize their Chinese counterparts by establishing contact with them. What has happened instead is that they’ve ended up importing Chinese academic censorship into their own institutions. Cambridge University Press censoring on behalf of Beijing is not the first time elite British universities have opted for the bottom line over principle in accepting Chinese censorship contributions... Aiming for a diverse student body or announcing opposition to U.S. President Donald Trump’s immigration ban is a low-cost form of opposition that helps a university establish liberal credentials at home. No foreign university, however, has demonstrated willingness to show the same level of opposition to demands made by the Chinese government that it would deem unacceptable at home. The opportunities are too big, and their principles turn out to be surprisingly pliable. Western universities, academics, and publishing houses face a stark choice. If they continue to obey Beijing, they make themselves complicit in promoting censorship and human rights violations. If they walk away, they turn their backs on large revenue streams and potential donors.
I had blogged earlier here and here about the larger point that Ananth makes about the hypocrisy of the western liberals who on the one side criticise Trump (and rightly so) and cry hoarse on issues that involve no trade-offs but pliantly ignore those that inflict costs. It is one thing to demonise Russia and aggressively pursue the low-cost option of forcing the tightening of sanctions on that country. It is an altogether different thing to incur personal costs and go beyond mere bleeding heart articles and force actions on things like executive compensation or business concentration and anti-trust action

New America Foundation, a left leaning think tank, of which Google and Eric Schmidt are major donors was at the centre of a recent controversy. It removed Eric Lynn, a scholar who had posted an article praising the European regulator's decision to levy a $2.7 bn fine on Google on anti-trust actions, reportedly at Eric Schmidt's behest. Annie Marie Slaughter, a darling of the liberal elites for her no trade-off and "talk is cheap" views on several social issues, summoned Lynn and fired him for "imperilling the institution as a whole". 

Both the protagonists, Eric Schmidt and Annie Marie Slaughter, are important, reputed, and credible voices of the liberal establishment, and their hypocrisy when faced with personal costs is what creates events like Brexit and Trump. 

3. Business concentration and the rising power of monopolies has been a constant theme of this blog in recent times. Noah Smith has a very good article that summarizes the literature,
In the past few years, researchers have found that industrial concentration -- measured by the market share of the four biggest companies in an industry -- has indeed been increasing in most parts of the U.S. economy. They’ve documented a correlation between industrial concentration and a decline in labor’s share of national income. They’ve confirmed that profits have risen substantially. They’ve documented a slackening in the enforcement of antitrust law. And they’ve found some evidence that after mergers, prices go up while productivity doesn’t improve. A paper by economists Jan de Loecker and Jan Eeckhout, has caused quite a stir... find that markups -- the amount that companies charge over and above their costs -- have been on the rise since about 1980. Back then, according to the authors’ estimates, the average company charged a price that was about 18 percent above costs -- now, the number is 67 percent...
A second paper, by German Gutierrez and Thomas Philippon... look at historical episodes where competition increased -- an unusual wave of new companies in the 1990s, and increased Chinese competition in the 2000s. In each situation, industries where competition increased more also tended to invest more... Gutierrez and Philippon have another paper where they test eight different economic theories to explain falling business investment, and find that market power -- along with corporate short-termism -- is the most likely explanation. Another paper, by Gustavo Grullon, Yelena Larkin and Roni Michaely... find that in industries that have become more concentrated, profits have risen. And they verify that concentration has been caused by megamergers among public companies, not by some companies going private and disappearing from the records. A final paper, by economists Mihir Mehta, Suraj Srinivasan and Wanli Zhao, finds evidence of political influence driving antitrust enforcement. Mehta et al. discover that when a company trying to do a merger happens to be headquartered in the district or the state of a politician who oversees antitrust enforcement, the merger is more likely to be approved. 
4. The gains for the Indian economy from lower oil and commodity prices have been very significant.  Sample this
The decline in crude prices has led to a significant reduction in import bill from Rs 8.6 lakh crore in FY14 to Rs 4.7 lakh crore in FY17, resulting in savings of approximately Rs 8-10 lakh crore... Since crude bill is paid in dollars, this has led to a saving of foreign exchange of $150 odd billion in the last three years. The bulk of the increase in forex reserves from May 2014 to current date is on account of the above. The decline in crude prices has had a significant impact on inflation. This has resulted in an increase in disposable income of Indians by 3.3 percent of GDP as per an IMF report, which in turn has provided a boost to private consumption...


While crude oil price, inclusive of adverse exchange rate movement, has declined by 49 percent, petrol prices have reduced only by 8.5 percent... All this has led to a significant decline in petroleum subsidy bill from Rs 65,000 crore in FY14 to Rs 27,000 crore in FY17... On an aggregate, Rs 11-13 lakh crore have been savings/additional receipts to the Modi government on account of low crude oil prices. This accounts for around 3 percent of aggregate GDP of FY15-17. The higher excise duty receipts have helped GoI maintain its fiscal deficit targets.
These are very significant numbers. Without this good fortune, we may well have been staring down the abyss. 

5. Ta-Nehisi Coates takes issue with the Trump-as-a-white working class reaction and frames it as Trump-as-a-white America reaction (not just to a just concluded black American presidency but a deep-rooted white supremacist belief). Sample this,
According to Edison Research, Trump won whites making less than $50,000 by 20 points, whites making $50,000 to $99,999 by 28 points, and whites making $100,000 or more by 14 points. This shows that Trump assembled a broad white coalition that ran the gamut from Joe the Dishwasher to Joe the Plumber to Joe the Banker. So when white pundits cast the elevation of Trump as the handiwork of an inscrutable white working class, they are being too modest, declining to claim credit for their own economic class. Trump’s dominance among whites across class lines is of a piece with his larger dominance across nearly every white demographic. Trump won white women (+9) and white men (+31). He won white people with college degrees (+3) and white people without them (+37). He won whites ages 18–29 (+4), 30–44 (+17), 45–64 (+28), and 65 and older (+19). Trump won whites in midwestern Illinois (+11), whites in mid-Atlantic New Jersey (+12), and whites in the Sun Belt’s New Mexico (+5). In no state that Edison polled did Trump’s white support dip below 40 percent. Hillary Clinton’s did, in states as disparate as Florida, Utah, Indiana, and Kentucky. From the beer track to the wine track, from soccer moms to nascar dads, Trump’s performance among whites was dominant. According to Mother Jones, based on preelection polling data, if you tallied the popular vote of only white America to derive 2016 electoral votes, Trump would have defeated Clinton 389 to 81, with the remaining 68 votes either a toss-up or unknown...


The focus on one subsector of Trump voters—the white working class—is puzzling, given the breadth of his white coalition. Indeed, there is a kind of theater at work in which Trump’s presidency is pawned off as a product of the white working class as opposed to a product of an entire whiteness that includes the very authors doing the pawning. The motive is clear: escapism. To accept that the bloody heirloom remains potent even now, some five decades after Martin Luther King Jr. was gunned down on a Memphis balcony—even after a black president; indeed, strengthened by the fact of that black president—is to accept that racism remains, as it has since 1776, at the heart of this country’s political life. The idea of acceptance frustrates the left. The left would much rather have a discussion about class struggles, which might entice the white working masses, instead of about the racist struggles that those same masses have historically been the agents and beneficiaries of. Moreover, to accept that whiteness brought us Donald Trump is to accept whiteness as an existential danger to the country and the world. But if the broad and remarkable white support for Donald Trump can be reduced to the righteous anger of a noble class of smallville firefighters and evangelicals, mocked by Brooklyn hipsters and womanist professors into voting against their interests, then the threat of racism and whiteness, the threat of the heirloom, can be dismissed. Consciences can be eased; no deeper existential reckoning is required... 
the argument that America’s original sin was not deep-seated white supremacy but rather the exploitation of white labor by white capitalists—“white slavery”—proved durable. Indeed, the panic of white slavery lives on in our politics today. Black workers suffer because it was and is our lot. But when white workers suffer, something in nature has gone awry. And so an opioid epidemic among mostly white people is greeted with calls for compassion and treatment, as all epidemics should be, while a crack epidemic among mostly black people is greeted with scorn and mandatory minimums. Sympathetic op‑ed columns and articles are devoted to the plight of working-class whites when their life expectancy plummets to levels that, for blacks, society has simply accepted as normal. White slavery is sin. Nigger slavery is natural.
This is the central point that Coates is making,
An imagined white working class remains central to our politics and to our cultural understanding of those politics, not simply when it comes to addressing broad economic issues but also when it comes to addressing racism. At its most sympathetic, this belief holds that most Americans—regardless of race—are exploited by an unfettered capitalist economy. The key, then, is to address those broader patterns that afflict the masses of all races; the people who suffer from those patterns more than others (blacks, for instance) will benefit disproportionately from that which benefits everyone. “These days, what ails working-class and middle-class blacks and Latinos is not fundamentally different from what ails their white counterparts,” Senator Barack Obama wrote in 2006...

Obama allowed that “blacks in particular have been vulnerable to these trends”—but less because of racism than for reasons of geography and job-sector distribution. This notion—raceless antiracism—marks the modern left, from the New Democrat Bill Clinton to the socialist Bernie Sanders. Few national liberal politicians have shown any recognition that there is something systemic and particular in the relationship between black people and their country that might require specific policy solutions... Certainly not every Trump voter is a white supremacist, just as not every white person in the Jim Crow South was a white supremacist. But every Trump voter felt it acceptable to hand the fate of the country over to one... White workers are not divided by the fact of labor from other white demographics; they are divided from all other laborers by the fact of their whiteness.
It is indeed surprising that this very plausible narrative foresee has hardly found its way into the mainstream.

6. Finally, from MR, this letter reveals the very fine mind that James Buchanan had, 
Given the state monopoly as it exists, I surely support the introduction of vouchers. And I do support the state financing of vouchers from general tax revenues. However, although I know the evils of state monopoly, I would want somehow, to avoid the evils of race-class-cultural segregation that an unregulated voucher scheme may introduce... We should not want a voucher scheme to reintroduce the elite that qualified for membership only because they have taken Greek and Latin classics. Ideally, and in principle, it should be possible to secure the beneficial effects of competition, in providing education, via voucher support, and at the same time to secure the potential benefits of commonly shared experiences, including exposure to other races, classes, and cultures. In practice we may not be able to accomplish the latter at all.
I had blogged earlier about Ken Arrow's cautious case for socialism. Genius is not about figuring out complicated models or crunching numbers to tease out social trends, but is about connecting research to fundamental, but glossed over, nuances of real life. There are very few such minds today.

Friday, September 8, 2017

Why policy makers do not use evidence?

Some serious claptrap here, this time trying to explain why policy makers do not use evidence.

Till some time back, I had only one explanation. Development is a faith based activity and evidence can, at best, have an effect at the margins, in hastening the formation of a narrative strong enough to tip the balance in favour of the change. 

Now, as one sees more of the nature of evidence being churned out in prestigious research journals, there may be another dismal dimension. What if the outcomes on which evidence is being generated did not require any evidence at all? What if the type of evidence required may be of an altogether different nature? Worse still, what if those generating the evidence do not even know about it - an unknown unknown?

No serious policy maker disputes that surprise inspections, or third-party quality audits, or Teaching at Right Level, or supporting entrepreneurship and skill development, or providing consulting services to Small and Medium Enterprises, or nudging on everything, or environmental protection zones, or introducing congestion pricing, or graduation programs, or outcomes-based stuff, or PPPs... are all good, even great. Lack of evidence or difficulty in appreciation of evidence is not the reason for their non-adoption.

It is just that it is super hard to navigate the plumbing challenges and effectively implement them in weak systemic (weak state capacity and/or very limited or small markets) environments. Or, there are just no physical and human resources available to do so. Or catalysing the markets is very difficult. In case of politicians, it is as Jean Claude Juncker said, "We all know what to do, it is just that we don't know how to get re-elected after we've done it"!

Researchers would do well to go beyond looking for such "soft" evidence and trying to generate evidence which can help at least a few interested policy makers move forward with implementation. Unfortunately, even assuming we navigate the plumbing challenges and start searching for evidence that can help inform implementation, there are unlikely to be too many generalisable or actionable evidence.

Monday, September 4, 2017

The rise of contracting

Neil Erwin has a fantastic article that shines light on the labour costs minimising contract jobs creating nature of modern capitalism.

It compares the lives of a janitor in two of the leading companies of their respective times, Eastman Kodak in the early eighties and Apple today. The former started out as a full-time employee of the company, with all the attendant benefits, and rose up to become a full C-suite executive there and elsewhere. In contrast, the latter is a contractual employee of an outsourced service provider, with few benefits, and with limited prospect of moving up the labour or income ladders.

This contrast is reflected in their respective employers,
Eastman Kodak was one of the technological giants of the 20th century, a dominant seller of film, cameras and other products. It made its founders unfathomably wealthy and created thousands of high-income jobs for executives, engineers and other white-collar professionals. The same is true of Apple today. But unlike Apple, Kodak also created tens of thousands of working-class jobs, which contributed to two generations of middle-class wealth in Rochester. The Harvard economist Larry Summers has often pointed at this difference, arguing that it helps explain rising inequality and declining social mobility. “Think about the contrast between George Eastman, who pioneered fundamental innovations in photography, and Steve Jobs,” Mr. Summers wrote in 2014. “While Eastman’s innovations and their dissemination through the Eastman Kodak Co. provided a foundation for a prosperous middle class in Rochester for generations, no comparable impact has been created by Jobs’s innovations” at Apple...
But when Kodak and similar companies were in their prime, tens of thousands of machine operators, warehouse workers, clerical assistants and the like could count on steady work and good benefits that are much rarer today. When Apple was seeking permission to build its new headquarters, its consultants projected the company would have 23,400 employees, with an average salary comfortably in the six figures. Thirty years ago, Kodak employed about 60,000 people in Rochester, with average pay and benefits companywide worth $79,000 in today’s dollars. 
Job creation is increasingly detached as a priority for successful business enterprises of our times,
Part of the wild success of the Silicon Valley giants of today — and what makes their stocks so appealing to investors — has come from their ability to attain huge revenue and profits with relatively few workers. Apple, Alphabet (parent of Google) and Facebook generated $333 billion of revenue combined last year with 205,000 employees worldwide. In 1993, three of the most successful, technologically oriented companies based in the Northeast — Kodak, IBM and AT&T — needed more than three times as many employees, 675,000, to generate 27 percent less in inflation-adjusted revenue. The 10 most valuable tech companies have 1.5 million employees, according to calculations by Michael Mandel of the Progressive Policy Institute, compared with 2.2 million employed by the 10 biggest industrial companies in 1979. Mr. Mandel, however, notes that today’s tech industry is adding jobs much faster than the industrial companies, which took many decades to reach that scale.
Many of the professional jobs from those companies in the 1980s and ’90s have close parallels today. The high-paying positions setting corporate strategy, developing experimental technologies and shaping marketing campaigns would look similar in either era. But a generation ago, big companies also more often directly employed people who installed products, moved goods around warehouses, worked as security guards and performed many of the other jobs needed to get products into the hands of consumers. In part, fewer of these kinds of workers are needed in an era when software plays such a big role. The lines of code that make an iPhone’s camera work can be created once, then instantly transmitted across the globe, whereas each roll of film had to be manufactured and physically shipped.
Apart from not creating jobs, these enterprises also pride on enhancing business efficiency and value for money by contracting out every possible service, without any concern for the social negative externalities that follow.
But major companies have also chosen to bifurcate their work force, contracting out much of the labor that goes into their products to other companies, which compete by lowering costs. It’s not just janitors and security guards. In Silicon Valley, the people who test operating systems for bugs, review social media posts that may violate guidelines, and screen thousands of job applications are unlikely to receive a paycheck directly from the company they are ultimately working for. And the phenomenon stretches far beyond Silicon Valley, where companies like Apple are just a particularly extreme example of achieving huge business success with a relatively small employee count. The Federal Express delivery person who brings you a package may well be an independent contractor; many of the people who help banks like Citigroup and JPMorgan service mortgage loans and collect delinquent payments work for contractors; and if you call your employer’s computer help desk, there’s a good chance it will be picked up by someone in another state, or country.
Apple claims that it creates far more jobs, more than 2 million jobs in the US itself, through all the economic activities associated with the Apple products eco-system. However this line of reasoning overlooks not only the similar eco-system effects associated with all products and with Apple's own competitors in the modern economy. And mind you, it still does not address the fact that the overwhelming majority of these jobs are exactly the minimal protection, temporary contract jobs that impose massive social costs. 

Its social effects are corrosive,
But it is also clear that, across a range of job functions, industries and countries, the shift to a contracting economy has put downward pressure on compensation. Pay for janitors fell by 4 to 7 percent, and for security guards by 8 to 24 percent, in American companies that outsourced, Arindrajit Dube of the University of Massachusetts-Amherst and Ethan Kaplan of Stockholm University found in a 2010 paper. These pay cuts appear to be fueling overall inequality. J. Adam Cobb of the Wharton School at the University of Pennsylvania and Ken-Hou Lin at the University of Texas found that the drop in big companies’ practice of paying relatively high wages to their low- and mid-level workers could have accounted for 20 percent of the wage inequality increase from 1989 to 2014... In interviews, tech industry contractors in Silicon Valley describe a culture of transience. They can end up commuting to a different office park that houses a new company every few months; in many cases 18 months is the maximum a contractor is allowed to spend at one company. “I would rather have stability,” said Christopher Kohl, 29, who has worked as a contractor at several Silicon Valley companies, including a stint doing quality assurance on Apple Maps. “It’s stressful to find a new job every 12 to 18 months.”
For Silicon Valley’s contracting class, there are reminders large and small of their second-class status. Contractors generally do not receive the stock options that have made some midlevel Silicon Valley workers wealthy over the years, nor the generous paid time off for vacation, illness or the birth of a child. The health insurance plans tend to be stingier than those that the tech giants they serve provide for their direct employees... The problem with contracting is, you could walk in one day and they could say, ‘You don’t need to come in tomorrow.’ There is no obligation from the companies.
This is a very nice analogy that captures the way employers view labour,
When an automaker needs a supplier of transmissions for its cars, it doesn’t just hold an auction and buy from the lowest bidder. It enters a long-term relationship with the supplier it believes will provide the best quality and price over time. The company’s very future is at stake — nobody wants to buy a car that can’t reliably shift into first gear. But when that same automaker needs some staplers for the office supply cabinet, it is more likely to seek out the lowest price it can get, pretty much indifferent to the identity of the seller.
Labor exists on a similar continuum. The right product engineer or marketing executive can mean the difference between success or failure, and companies tend to hire such people as full-time employees and as part of a long-term relationship — something like the transmission supplier. What has changed in the last generation is that companies today view more and more of the labor it takes to produce their goods and services as akin to staplers: something to be procured at the time and place needed for the lowest price possible.
And this lies at the heart of the matter and is telling,
There’s no inherent reason that work done through a contractor should involve lower compensation than the same work done under direct employment. Sometimes it goes in the other direction; when a company hires a law firm, it is basically contracting out legal work, yet lawyers at a firm tend to be paid better than in-house counsel. But as more companies have outsourced more functions over more time, a strong body of evidence is emerging that it’s not just about efficiency. It seems to be a way for big companies to reduce compensation costs. Firms in the United States are legally required to offer the same health insurance options and 401(k) match to all employees — meaning if those programs are made extra generous to attract top engineers, a company that doesn’t outsource will have to pay them for everyone. More broadly, there are a whole set of social pressures and worries about morale that encourage companies to be more generous with pay and benefits for employees who are on the same payroll. 
Nice article. Wish there were similar articles on the effects of the use of robots in Maruti or Volkswagen's Pune car factory or the widespread use of contract labour by our manufacturing firms.

This highlights the difficult choice for governments in countries like India in the area of labour market reforms. Whether we like it or not, flexibility in labour markets is an important contributor to business competitiveness in a globalised market. Outsourcing services to specialised labour contractors is central to this flexibility. The natural policy response should have been to mandate that contract labour too enjoy all the same benefits and social protections. But, as we read above, if the primary objective of contracting is to reduce compensation costs, then such policies run counter to them. But perpetuating this arrangement, apart from its political risks, also creates an unsustainable economic system.

A strong social safety net that goes beyond just the poorest and covers a majority of citizens is a possible solution. But this, in turn, raises the troubling question of fiscal sustainability.

These are really difficult challenges and representative of many social or economic issues, with no satisfactory answers. Governments often make judgement calls, which are always likely to be perceived as sub-optimal, in directions based on the political imperatives that motivate the decision. It is very easy to miss the big picture and criticise governments when passing judgement on policies.

Sunday, September 3, 2017

Weekend reading links

1. The Kenyan Supreme Court's decision by a 4-2 verdict to overturn the just concluded Presidential election results in favour of incumbent President Uhuru Kenyatta is hugely significant. Kenyatta had been declared winner over long-time opponent Raila Odinga, winning 54% of the votes in the elections held in early August. Odinga had contested the results claiming massive fraud in the electoral process. The Court nullified the results and has directed another vote within 60 days.

The decisions comes as a massive surprise given the generally subservient nature of courts across African countries, especially since Kenyatta has been President since 2007. The unprecedented nature of the decision elevates the Supreme Court's institutional credibility. Adding to the good news and signalling a maturity in Kenya's democratic polity, Kenyatta has said he will accept the verdict and abide by the Court's decision. 

Interestingly, foreign election observers and western officials had declared the elections mostly free and fair and found no signs of "centralised manipulation". They had also called on Odinga to accept the electoral verdict. This decision of the Supreme Court should raise questions about the credibility of such observers.

2. It is reported that the All India Council for Technical Education (AICTE) wants to close down about 800 engineering colleges across India as there are no takers for their seats. AICTE has closed down more than 410 colleges across India since 2014-15.

In all the wailing about the poor quality of school education, we overlook the equally dismal standards in higher education. Sample this from Devesh Kapur, 
Look at the way our vice chancellors are selected. Many of them would not get a job as a lecturer in a decent college. There are reasons to believe that at least in some cases, they have paid their way there. Between 2000 and 2015, we set up almost six new colleges a day, every single day over 15 years including weekends. At its peak, the U.S., with way greater resources, set up one new college a week. And this, when we have the most regulated higher education system… the UGC (University Grants Commission), AICTE (All India Council for Technical Education), etc.
3. I will blog separately about the recently released RBI report on financial savings of Indian households. This graphic shows that capital market savings, insurance and pension products are really tiny proportion of aggregate household savings.
4. Nice Economist article on the profitability of India's formal sector firms,
Just as investors talk about a “Korea discount”, to describe chaebols’ lousy profits, so there is an “India premium”... Since 2001 the return on equity (ROE) of listed Indian firms has averaged 19%, eight percentage points above the figure for companies in rich markets and five percentage points above those in emerging ones... The leading private lender, HDFC Bank, has an 18% ROE, ranking tenth among the top 100 global lenders. Hindustan Unilever, a consumer-goods firm, has a 77% ROE, over twice that of its parent, Unilever. Even in basic industries, such as cement, returns have been relatively high.
The article talks about the scale of informality and the potential of reforms like GST to increase the formal sector market,
For big companies, formalisation could boost profits in the short term. They may take business from smaller firms: at least 40% of India’s tea, 85% of its jewellery and 70% of its dairy products are sold in the grey economy.
Couple of observations. One, the biggest impact of GST is most likely to be in contributing to formalising economic activities than increasing tax-to-GDP ratio, which is unlikely to rise by much. Second, the shift to formality will be gradual and take several years if not decades. 

5. Livemint has a good article on the data mapping done in the 83 villages of Jiwati taluk of Maharashtra's Chandrapur district. Financed by Tata Trusts and implemented by NGO partners, the initiative has surveyed 160,000 households and collected 6.9 million data points covering demographics, status of access to various utilities and welfare services, human resource needs etc. The information has been collected through an one-time survey exercise. The captured information is apparently rendered in simple dashboards to facilitate officials use it as decision-support.

While this is all good, I have two concerns. The most relevant concern is how the data collected will keep getting updated. The similarity with GIS mapping cannot be missed. For sure, with persistence and effort, it may be possible to ensure that the data on government benefits and services delivered can be captured. But even this is tricky. For example, gas connections can be given and the household may use for three months and then relapse. Similarly electricity connection status can easily revert back after a big rain or thunderstorm. In neither of these cases, the data is likely to get updated. Then there are other data like skill acquisition and so on, where the individuals may be accessing them separately and may not get updated. So, over time, the baseline data available becomes dated and useless as a decision-support. 

The other concern is on how actionable this information is. For example, information on people without ration cards or skill training or housing is no guarantee for provision of those. That is a function of budgets, state capacity, and other factors, most of them beyond immediate systemic solutions. 

But all these cannot be a reason for not encouraging such data collection since it is the first necessary step in any meaningful planning and decision-making which is based on evidence and other objective considerations. 

6. The week saw the French President Emmanuel Macaron unveil his much expected labour reform proposals, which are to be placed before the Parliament later this month. The proposals include,
The measures... will cap the damages that courts can make employers pay in cases of wrongful dismissals, except in discrimination cases. They also reduce the statute of limitations for workers to bring cases from two years to one year and make it easier for companies to close lossmaking French plants. Businesses with fewer than 50 workers — encompassing 95 per cent of French companies — will be able to negotiate specific deals directly with employees and without union representatives on areas such as working hours, pay and overtime. Larger companies will be able to negotiate ad hoc agreements with unions, instead of having to abide by more rigid sector-wide rules. Under certain conditions they will be able to organise employee referendums to overcome any failures to reach agreements. The reforms also cut from four to one the number of statutory bodies representing workers within companies... As part of the reforms, unions have secured a 25 per cent rise in the severance packages that employers have to pay. Large companies will also still need the consent of unions representing half of workers to agree deals on working hours.
The reforms take a leaf out of the German Hartz reforms by making companies the focus for negotiating working conditions, instead of the current nation-wide sectoral working conditions contracts. Predictably businesses have welcomed the proposals while unions have opposed it. This may well be France's Hartz IV moment.

7. The graphic below shows that the very richest have not only recovered their wealth destroyed by the Global Financial Crisis but also have sharply increased their wealth since.

8. Finally, the always incisive John Kay points to the financialization of global economy,
Apple’s market capitalisation today exceeds $800 billion, and Alphabet the holding company for Google, is not far behind. For both these companies, operating assets account for about $30 billion of that value. Modern businesses like these employ very little capital, and such assets as they do use mostly need not be owned by the company that operates from them and typically are not. As a source of capital for business, equity markets no longer register on the radar screen. In Britain and United States, the countries with the largest equity markets, funds withdrawn from these markets through acquisitions for cash and share buybacks have recently routinely exceeded the amounts raised in rights issues and IPOs. At the same time, savings have become institutionalised. Initially such institutionalisation took place mainly through the investment activities of pension funds and insurance companies. Today much of their activity has been outsourced and while pension funds and insurance companies are still important players, the equity investment chain is today dominated by the major asset managers – Blackrock, Vanguard, Fidelity and their competitors. And sovereign wealth funds are an increasingly important fraction of public market equity ownership. 
The paradox of modern capital markets is that although there is less and less need for market activity from the point of view of either the end users of finance, or the investors who are the ultimate beneficiaries of finance, the volume of market activity has increased exponentially. And yet policy towards capital allocation places more and more emphasis on markets.
He also has this excellent observation on the nature of people who make up today's financial market intermediaries,
An intermediary who genuinely adds value will generally be one who has some specialist knowledge of one or both of the end-users of finance – either the borrowers and the beneficiaries of equity investment, or the depositors and investors whose savings are necessarily the ultimate source of such finance. A few minutes on a trading floor today demonstrates that the principal knowledge many intermediaries have is that of the behaviour of other intermediaries. When I was a schoolboy in Scotland in the 1960s, joining the Bank of Scotland or the Royal Bank of Scotland was a career for the boys in my class who were not going to get good enough grades to go to leading universities. Even when a few years later I began my teaching career at Oxford, careers in the City of London were mostly for undergraduates who were not academically distinguished but nevertheless socially polished and well-connected. All that has changed, and not altogether for the better, as was evident when the Bank of Scotland and the Royal Bank of Scotland failed in 2008, after three centuries of prudent success, under the stewardship of able individuals with good degrees from the finest universities and business schools.
Larry Summers, former president of Harvard and US Treasury Secretary, once observed that finance had once been the preserve of people whose primary skills were those of good companions at the 19th hole of the golf course, but had become the province of people with the sophisticated mathematical skills required to price complex derivatives. Summers, with skills better adapted to solving differential equations than conviviality at the 19th hole, noted this shift with evident approval. I am not so sure.
In today's world, we wrongly consider smartness as something which encompasses every other desirable attribute - industrious, diligent, sincere, sociable and so on. The worst is of course to confuse smartness with wisdom!

Saturday, September 2, 2017

Assessing Doklam

Whatever spin and interpretation is given, it is difficult not to come to the conclusion that the end to the Doklam stand-off between China and India has been a victory for India on points

At the least, it has successfully thwarted China's efforts to build a strategic transportation link that would have exposed India's "chicken neck" border area. Further, it has also signalled to China that India will not hesitate to intervene on behalf of smaller countries in its neighbourhood in case of their disputes with China. The framing of the negotiations between the two countries was unmistakably one of a bilateral dispute when the fact remained that India was negotiating on behalf of Bhutan. More importantly, it has clearly sent out message to China that India has the appetite to confront China and engage in a military stand-off. 

To this extent, unlike India's no trade-off feel-good foreign policy of the past three years, this episode should count as among the very rare genuine successes of Indian foreign policy not just of this government but also over the past couple of decades. In fact, it is arguable that, for those conversant in the nuances of foreign policy, this may be one of the very few occasions in recent memory of  China leaving a confrontation with another country as the second-best. Coming on the back of India's refusal to endorse and participate in Xi Jinping's high stakes OBOR launch, it does clearly signal a very combative stance by India with respect to China. This is all the more important since none of the others including Japan and S Korea have been willing to go this far.  

The best analysis of the border stand-off comes from a Stimson Centre article by Oriana Skylar Mastro and Arzan Tarapore. Their assessment,
Monday’s agreement to end the standoff returns to the situation to the status quo ante, exactly as India and Bhutan demanded. Troops from both sides have disengaged, and China claims it will continue patrolling and asserting its sovereignty claims. The official statements are vague on some details, presumably to save face among their respective publics. Most importantly, the statements only imply — rather than saying outright — that China will abandon the road construction that triggered the crisis. Beijing seems to have blinked.
They describe a classic four-stage playbook of Chinese diplomacy in such border disputes - use its military strength to gradually develop a larger or more permanent physical presence in areas where it already has a degree of de-facto control; coercive diplomacy to get the target state to change its policies or behaviour and engage them in bilateral negotiations; use legal rhetoric and principles to present its position as legitimate and lawful; use media to highlight its narrative and issue threats. The same playbook was used in Doklam. But the difference was that India instead of protesting actually entered the field and physically stopped the encroachment. 

Their takeaways from the episode, 
Chinese behavior in territorial disputes is more likely to be deterred by denial than by threats of punishment. China will continue the combination of consolidating its physical presence and engaging in coercive diplomacy, lawfare, and media campaigns unless it is stopped directly. This is what India did at Doklam — it directly blocked Chinese efforts to change the status quo... the agreement to disengage suggests that Beijing’s position in crises can be flexible, and perhaps responsive to assertive counter-coercion... Finally, the Doklam agreement, even if it is temporary, tells us that when China confronts a significantly weaker target, such as Bhutan, it will only be deterred by the actions of a stronger third party — in this case, India. Had India not acted, China would likely have been successful in consolidating its control and extracting territorial concessions from Bhutan... The lesson of Doklam for the United States is that arming small states and imposing incremental costs may not be enough. Washington may have to accept the greater risks associated with intervening more directly if it hopes to counter Chinese expansion in East Asia.
And one cannot also but not get the impression that the episode has stung the Chinese. This reaction by the Foreign Ministry spokesperson advising the Prime Minister of India to not raise Pakistan's support for terrorism during the forthcoming BRICS summit in China was baffling and ill-advised. It gives the impression of a side which has been rattled. It was inexplicable that such advise be given in a press conference. It is only common sense that such messages are best conveyed in private. 

In fact, instead of deterring India from raising Pakistan's sponsorship of terrorism, the spokesperson's advice is most certain to have ensured that India will raise Pakistan, if only to counter the remarks. And once that happens, it is likely to leave the Chinese even more on the defensive.  

For others reading the tea-leaves on how to deal with China, this would be more encouragement to take a leaf out of India's playbook. Talk about self-goals!

India should be grateful that Bhutan at very high risk and future consequences to itself stood by India.  It is unlikely that any other country would have allowed India to engage on their behalf. Also China is unlikely to forget this in a hurry and one can expect something over the coming months, if only to wrest back some of the psychological initiative.

One swallow does not make a summer. Whether we like it or not, the region and the Indian Ocean-Arabian Sea-Bay of Bengal areas will most likely be terrains for great power politics, often bordering on the violent, in the decades ahead. This momentum should be leveraged to take action on at least the following four fronts

1. Develop long-term defence capabilities including modernising and expanding India military capabilities.

2. Continue to deepen partnerships with neighbours, regional powers, and the US, with a clear strategic dimension in each relationship, using the country's growing economic importance as a leverage.

3. Develop and strengthen naval facilities in its seas, including in the strategically located Andamans in order to be able to exercise some control over the adjoining maritime routes or at the least deter alien powers in the sub-continental waters.

4. The maritime strategy should be supplemented with opening up transportation corridors connecting India's vulnerable northeast with the Far East so as to forge economic links that can mitigate the risks arising from the creeping Chinese influence over countries like Myanmar.

All this will of course not come cheap or without trade-offs.