Saturday, February 17, 2018

Corporate cash hoards invested in bonds

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

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

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

Friday, February 16, 2018

Holding the mirror on corporate India

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

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

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

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

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

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

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

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

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

Wednesday, February 14, 2018

The volatility trade casino

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

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

Monday, February 12, 2018

The false dawn of blended finance in infrastructure

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Sunday, February 11, 2018

Global bond market fact of the day

There are currently about 25,000 bonds on the global market, issued by both governments and corporations. According to Kirk’s data, the average yield of these bonds is a paltry 1.9%. Back in 2000, the average bond yielded significantly higher at 6%. Average current duration is seven years, quite risky considering the low yield. If rates rose at all over that time, which is highly likely – both the Federal Reserve and the European Central Bank are indicating so – you would lose money.

Thursday, February 8, 2018

The challenge with health insurance model to universal health coverage

In the context of PPPs and the recently unveiled health insurance program in India, Karthik asks the questions (in the comments here),
If the decision of public vs. insurance model of health care is a matter of comparison between the capacity to run public hospitals vs. capacity to regulate private players... are we stuck in a trap where we don't have either of these capacities? In this context, which capacity is easier to build from the current state?
It is a good opportunity to clarify my own thoughts. I naively started out as a strong believer in the insurance model to deliver universal health coverage - see this and this. I no longer subscribe to this view. 

Here is the challenge. Any insurance model is inherently suited to address secondary and especially tertiary care. It cannot be tailored to the effective delivery of non-curative preventive and primary care, especially given the public health challenges that we face. And the cost-effectiveness of insurance by its very nature depends on the ability to limit incidence of the insured events. But the incidence of secondary and tertiary treatment episodes depends on the strength of preventive and primary care. In other words, you need to build the insurance system on a very good preventive and primary care system so that disease incidence itself is minimised. But our preventive and primary care is broken. Worse still, we have a situation where the insured are the poor who are also those with the weakest preventive and primary care and therefore the population category with the highest likelihood of incidence of the insured events. In the circumstances, the insurer faces the maximum disease incidence likelihoods. 

In fact, there is an even greater practical problem with the focus on insurance approach. It takes the attention and resources away from the more important and difficult task of fixing the broken preventive and primary care system. This is not amenable to electorally popular announcements or administrative actions like empanelling insurers, Third Party Administrators (TPAs), and hospitals. It demands persistent and painstaking work which is diffuse and beyond the abilities of systems with weak state capacity. We fall into an even worse equilibrium.

Finally, there is the impossible fiscal challenge. I have written with Lant Pritchett about the problem of doubly-universal coverage - population coverage and conditions coverage - which is an inevitable slippery slope with insurance models. The move from the limited RSBY to Ayushman Bharat is only the latest example. Andhra Pradesh's Aarogyasri Program started with a token amount for just child heart surgeries and in less than a decade (by 2014-15) came to progressively cover nearly 1100 conditions and over Rs 5000 Cr for the combined state. The only reason it did not reach Rs 10,000 Cr was because the supply-side to deliver secondary and tertiary care could grow only so fast. 

It is a only a matter of time before the fiscal limits start to bind as supply expands inexorably to meet the latent demand. The squeeze on preventive and primary care was more or less proportionate to the ballooning of the insurance costs. Even a very very modest health insurance scheme that can reasonably address the secondary and tertiary care needs would easily cost 3-4% of the GDP (if not much more), a tripling or quadrupling of current expenditures. This is a clearly unrealistic expectation for a country grappling with a 11-12% tax-to-GDP ratio. 

So here is the verdict on the insurance model from one of the most authoritative sources, N Srikant, the most outstanding CEO of Aarogyasri who tried to salvage the bloated and expensive corporate give-away that Aarogyasri had become,
We found that adding an additional layer of insurance intermediary between the trust and hospitals reduced the benefit cost ratio under the scheme by 12.2 % (p-value = 0.06). Every addition of 100 beds under the scheme increases the scheme payments by US$ 0.75 million (p-value < 0.001). The gap in claim denial ratio between insurance and trust modes narrowed down from 2.84 % in government hospitals to 0.41 % in private hospitals (p-value < 0.001)... The scheme is a classic case of Roemer's principle in operation. Introduction of insurance intermediary has the twin effects of reduction in benefit payments to beneficiaries, and chocking fund flow to government hospitals. The idea of engaging insurance intermediary should be abandoned.
There is no country in the world which has developed an effective universal health coverage by focusing predominantly on secondary and tertiary coverage based insurance. 

One approach which has the potential to be effective is the capitation model followed in countries like Thailand. But this in turn too requires a strong primary health care system. 

So back to Karthik's questions. The insurance model is simply unsustainable BIG TIME for a country like India. In fact, it is perhaps the worst scenario. So we are left with no option but focus on preventive and primary care and improve public facilities. Even with the weak state capacity, this is just the only long-term way forward. This is my theoretical assessment. 

But since the insurance genie is out of the bottle and given its powerful electoral attractions, some form of insurance cannot be avoided. In fact, in Andhra Pradesh, it is widely believed that Aarogyasri was one of the main reasons for Mr Y S Rajasekhara Reddy retaining power in the 2009 elections. In the circumstances, faced with electoral battles, no government can be faulted for thinking along these lines. So a prudent compromise may be to have an insurance model which covers a basic package of catastrophic illnesses. It should be complemented with some of the following 

1. This insurance should be operated by a Trust with its dedicated TPAs and not insurers. 

2. A high quality IT system that can manage the logistics of screening, pre-authorisation, treatment, payments, and follow-up, which was a feature of Aarogyasri, should be replicated. It should be accompanied by analytics and vigilance to monitor the problem of over-diagnosis and over-treatment. 

3. The public hospitals and government doctors should be incentivized, even with positive discrimination, to attract patients, so that the insurance program does not end up being a give-away to private hospitals.  

4. The rates should be fixed on very objective considerations, free from political interference, and through transparent process of price discovery involving strategic purchasing at an appropriate administrative level. Maybe this should vary across States. 

5. There should be a mechanism to limit the creeping expansion of conditions coverage. An institutionalised arrangement like the National Institute for Health and Care Excellence (NICE) in the UK should be in control of such decisions. 

6. It is useful to demand some limited co-payment or small premium from all but the poorest. 

7. Finally, the expenditure on this insurance cannot come at the expense of primary and preventive care as well as investments in public secondary and tertiary facilities.

If it is decided to purchase from insurers (instead of using the Trust model), there is perhaps some logic in moving away from the current one-premium-for-all model to one which uses different premia for different age-groups, albeit the same for all members in an age-group irrespective of pre-existing medical conditions (community-rating).

All easier said than done! And even if done there is nothing to stop them being changed or reversed. Therefore, the best that can be done for bureaucrats to try incorporate these elements to the extent possible to the insurance program design.

Tuesday, February 6, 2018

PPPs and Value for Money?

In the aftermath of the collapse of Carillion and the NAO report, FT has been leading the sceptical scrutiny on PPPs. I am extracting a few snippets which convey the story.

The headline takeaways on value for money from PFI,
A National Audit Office report last month found schools built using the PFI are 40 per cent more expensive and hospitals cost 60 per cent more than the public sector alternative.
Investors strip assets and leave the companies indebted,
In 1989, the water industry in England and Wales was privatised with no net debt. Yet almost three decades on, it has built up borrowings of £42bn. All but three of the 10 English water companies have been taken off the stock market by private equity investors — many backed by foreign sovereign wealth funds and pension schemes. In the meantime, all the industry’s post-tax profits have been carried off in the form of dividends. Shareholders’ funds have barely budged since 1989.

The comparison with Scottish Water, which was not privatised and remained public, is instructive,
Yet unlike the English utilities, it remains relatively unleveraged. Its borrowings of £3.8bn represent just 48 per cent of the value of its regulated assets, as against the 65-80 per cent that is prevalent in England. Meanwhile, the average bill from Scottish Water was £357 last year — 10 per cent lower than the English average of £395.
And in terms of benefits to consumers, in UK 
A study by Greenwich university claims that refinancing utility debt and equity with government bonds and scrapping dividends could save £2.3bn a year. That is equivalent to a saving of almost £100 off the average £400 water bill.
... and elsewhere in Europe,
A study of French water services in 2004 found that the price of privately-delivered water was 16.6 per cent higher than in places where municipalities delivered the service.
And from the other big example of privatisation, railways,
The cost of running the UK’s railways is 40 per cent higher than it is in the rest of Europe, according to a 2011 government report by Sir Roy McNulty, the former boss of UK aviation group Short Brothers who has long experience in transport regulation... Since privatisation, the bill has mainly been shared between the taxpayer and the passenger. The contribution from the state has almost doubled from £2.3bn in 1996 to £4.2bn in real terms in 2016-17, despite a conscious decision in recent years to push more of the cost on to users’ shoulders. Ticket prices have risen: they are now 25 per cent higher in real terms than in 1995 and 30 per cent higher than in France, Holland, Sweden and Switzerland. The latest average rise in fares of 3.4 per cent, announced on New Year’s Day, was greeted with outrage. 

Like with water, operational efficiency gains and attendant cost reduction have remained elusive, and asset stripping has proceeded apace,
Despite the vastly expanded usage, the network’s costs have not obviously come down relative to its income. According to the 2011 report, unit costs per passenger kilometre were roughly 20p in 2010, much the same as they were in 1996... Critics argue that train operators are able to make returns, and pay themselves dividends, despite contributing very little in the way of risk capital. While operating margins of 3 per cent are not high, the train companies paid nearly all the £868m operating profits between 2012-13 and 2015/16 as dividends — £634m in the four year period.

A sense of the complexity of such outsourcing and private participation,
“The train you catch is owned by a bank, leased to a private company, which has a franchise from the Department for Transport to run it on this track owned by Network Rail, all regulated by another office, and all paid for by taxpayers or passengers,” says John Stittle, a professor of accounting at Essex university. “The complexity is expensive.” 
Finally, on the public mood,
An October poll conducted by the UK’s far-from-socialist Legatum Institute showed 83 per cent of respondents favoured the nationalisation of water. For energy, the figure was only slightly lower, at 77 per cent.
But who will listen, since the regulators have been captured and the liberals are blindly anti-state and pro-market,
Ofwat, for instance, has been criticised for its focus on investors rather than customers. While the watchdog sets aside two days a year to give presentations to the City of London, there is no forum for it to meet customers.
With regulatory capture and renegotiations, the original spirit of privatisation has been cast aside in railways too,
As with other privatised monopolies, competition was supposed to ensure lower prices and sharper services. But in recent years this has faded, raising questions over the legitimacy of the franchising system. A third of train operating companies now hold their franchises by so-called “direct awards” from government, rather than auction. Successive governments, out of an apparent desire to keep the private sector onside, have been reluctant to wield their powers against poorly performing franchises. Only one train operator has ever been stripped of its contract — Connex for poor performance in south-east England in 2001 and 2003. Three more have walked away after overbidding for contracts, with minimum penalties. Last month, the government allowed Virgin Rail and Stagecoach to terminate their East Coast line franchise three years early, saving them the need to write a £2bn cheque to the government under previously agreed revenue growth forecasts. Yet with only a handful of operators bidding for franchises, the duo may end up operating the line again — on more profitable terms.
This verdict of rail privatisation contrasted with public ownership comparator is striking,
There is a growing consensus among both executives and industry experts as well as the public that Britain’s unique attempt to create competition on Britain’s rail network has not delivered. While it has led to more services, and encouraged more users to pay higher prices, it has not unleashed the productivity improvement necessary both to upgrade the network and stabilise the network’s finances. Over the same period, for instance, London’s state-owned metro network, Transport for London, has grown just as quickly and delivered much more state-of-the-art investment. 
No wonder the likes of Corbyn and Trump look attractive! 

Monday, February 5, 2018

Why do DFIs support tax avoidance?

Paddy Carter uses the platform of "liberal" think-tank Centre for Global Development to make an astonishing argument in support of the use of tax havens by development finance institutions (DFIs). Consider the straw man arguments against DFIs investing through tax havens,
The argument rests on the answers to two questions: what do DFIs use tax havens for, and what are the alternatives to using them? The short answers are that tax havens are used to compensate for shortcomings in the legal systems of the countries that DFIs invest in, and that if DFIs stopped using tax havens, they would use onshore financial centres in rich countries instead. And that would not help developing countries one jot.
The two questions are the right ones but the answers to both are wrong. 

DFIs use tax havens because they go along with the preferences of their commercial co-investors and their investees, all of whom strongly prefer to invest through offshore financial centres (OFCs). I can understand the need for a holding company incorporated in a third country without the "shortcomings in the legal systems of the countries that DFIs invest in". But let's face it, the preference of commercial investors for that company to be incorporated specifically in an OFC comes from two directions - the tax benefits and the cover of opacity. The case for tax avoidance is too well know to be elaborated. But the benefits of opacity in ownership structure and governance is equally valuable for the investors and their limited partners.

This brings us to the second question of alternatives. I agree that cutting off the OFC route will only drive investors to incorporate in developed countries, maybe the onshore financial centres in the developed world or those with double taxation agreements. While this will not address the problem of tax base loss for the developing country, it opens the possibility of higher tax receipts for developed country governments, especially given the growing pressure on onshore financial centres to roll-back their beggar-thy-neighbour tax arbitrage policies. Anyways, given the burgeoning deficits and debts, developed countries could just as well do with those additional tax revenues. Equally importantly and immediately, given the much higher standards of transparency and disclosure requirements in Western onshore financial centres, it would lift the veil of opacity that covers the ownership and governance of these entities. 

The role of DFIs and their capital should also be to influence the markets into investing in ways that promote development objectives and transparency in corporate governance, and not go along with the markets in depriving developing countries (or governments anywhere) off their tax revenues and promoting opaque corporate governance standards and systems.

I find it incredulous that International Finance Corporation (IFC) does not have the financial muscle to significantly influence other commercial investors if it took the principled view that it would not co-invest in companies in developing countries which are incorporated in OFCs. And if all the major national government funded private sector investors like OPIC, CDC, KfW etc joined hands, then it would be a good start to limiting tax avoidance, boosting domestic resource mobilisation in developing countries, and bringing transparency into such investments.

Saturday, February 3, 2018

Weekend reading links

1. The proposal in the Union Budget 2018-19 to impose tax on long term capital gains is a welcome development. This blog has been a long-term advocate of this move. 

With the Mauritius tax treaty and taxation on long-term capital gains out of the way, the next target should be on the tax deduction on interest expense, at least beyond a certain limit. The short story of India's infrastructure sector this millennium has been one of firms financing projects with excessive debt, thereby leaving them with limited skin in the game. The pile of stalled projects (and banking non-performing assets) with absconding developers is in no small measure due to this distortion. 

2. A minimum support price (MSP) may be scorned upon by orthodox economists and commentators on the right. But in the case of agriculture in developing countries like India, it may actually be among the least worse option among all the alternatives available. The budget proposal offering a 1.5X MSP on input cost is therefore understandable. The challenge is with getting the right implementation design - most cost-effective, least distortionary, most light-touch etc.  

3. Can Perovskites, a compound of calcium, titanium, and oxygen replace silicone in solar cells? The Economist has a feature on the latest research.
Today 10% is quite a modest efficiency (measured in terms of how well a cell converts light into electric current) for a perovskite cell in the coddling conditions of a laboratory. For lab cells values above 22% are now routine. That makes those cells comparable with ones made from silicon, as most of the cells in solar panels are—albeit that such silicon cells are commercial, not experimental. It did, however, take silicon cells more than 60 years to get as far as they have, and the element is probably close to its maximum practical level of efficiency. So, there may not be much more to squeeze from it, whereas perovskites could go much higher. Perovskite cells can also be made cheaply from commonly available industrial chemicals and metals, and they can be printed onto flexible films of plastic in roll-to-roll mass-production processes. Silicon cells, by contrast, are rigid. They are made from thinly sliced wafers of extremely pure silicon in a process that requires high temperature. That makes factories designed to produce them an expensive proposition... 
Eventually, Mr Averdung believes, perovskites will act as stand-alone cells—and not just in conventional panels. Because they are semi-transparent, perovskite films could also be used to turn windows into solar generators, by capturing part of the incoming sunlight while permitting the rest to pass through.
4. Tyler Cowen writes about the utility of land value capture to finance infrastructure projects. In this context, it is worth keeping in mind that India has a a Land Value Capture Policy.

5. Staying on land value capture, the Times has a very good article on how being near a metro station benefits a property.
In Manhattan’s main business corridors, from 60th Street south, the benefit of being near a subway adds $3.85 per square foot to the value of commercial property, according to calculations by two New York University economists... Gov. Andrew M. Cuomo, a Democrat, has made value capture a prominent part of his plan to salvage the subway system by proposing to give the Metropolitan Transportation Authority the power to designate “transit improvement subdistricts” and impose taxes... at a moment when the subway is facing its worst crisis in decades, there is a growing consensus that property owners should shoulder more of the cost of a subway system that has nourished their bottom lines... The governor’s proposal would allow the transit agency to establish districts around new projects for value capture that could extend as far as a mile from a station.
6. Nice column by Shankkar Aiyar that charts the chequered history of India's public sector assets disinvestments. Short story, a very large share of disinvestment has been about moving money from the right hand to the left hand of the government. Someone should do a graphic of the real disinvestment away from any kind of government ownership (including by LIC, that giant buyer of last resort) and plot against the estimates. That would be the real measure of disinvestment. 

7. A very good essay in The Economist on the proliferation of higher education and its questionable benefits. South Korea is the most stunning success,
Seventy per cent of pupils who graduate from the country’s secondary schools now go straight to university, and a similar share of 25- to 34-year-olds hold degrees, up from 37% in 2000. Students scramble to gain admittance to the most prestigious institutions, with exam preparation starting ever younger. Sought-after private nurseries in Seoul have long waiting lists.
Since 1970, the share of workers with university degrees has increased in all but nine of 265 occupation categories that make up US workforce.
Occupations with bigger increases in share of university education have seen higher wage increases, though the correlation is weak. 

The article questions the value of the graduate premium - the difference between the average earnings of those with a degree and those with secondary-school education or less, controlling for fees and income foregone while studying - which is regarded as a proxy for return on education. This metric is flawed on numerous considerations - it lumps together all kinds of degrees into one category, glosses over wage-inequality levels, does not account for those who have started university education by paying fees etc but not completed it, and most importantly does not account for the reality that  on average cleverer students would anyways earn more.
Including dropouts when calculating the returns to going to university makes a big difference. In a new book, “The Case Against Education”, Bryan Caplan of George Mason University argues that the low graduation rates of marginal students, and the fact that, for a given level of qualification, cleverer people tend to earn more, mean that the return on a four-year degree in America ranges from 6.5% for excellent students to just 1% for the weakest ones.
It writes about the pernicious effects of higher education in so far as its proliferation encourages employers to look for graduates for any job, even which require no such skills. Such crude screening is a penalty on non-graduates who get locked out of decent jobs. This has resonance in countries like India,
Across the rich world, a third of university entrants never graduate. It is the weakest students who are drawn in as higher education expands and who are most likely to drop out. They pay fees and sacrifice earnings to study, but see little boost in their future incomes. When dropouts are included, the expected financial return to starting a degree for the weakest students dwindles to almost nothing. Many school-leavers are being misled about the probable value of university.
It writes about a measure of the over-education problem,
The Economist has produced a measure of over-education by defining a graduate job as one which was staffed mostly by degree-holders in 1970. We find that just 35% of graduates work in such occupations today, down from 51% 45 years ago. Judging by job titles alone, 26.5m workers in America—two-thirds of those with degrees—are doing work that was mostly done by non-graduates a half-century ago.
This is a very important insight for policy makers and opinion leaders,
Earning a degree is partly about improving productivity, but it is also about getting ahead of your peers. Policy makers should focus on the public rather than the private economic benefits of higher education. 
Its suggestions to end the education arms race to the bottom,
Governments need to offer the young a wider range of options after school. They should start by rethinking their own hiring practices. Most insist on degrees for public-sector jobs that used to be done by non-graduates, including nursing, primary-school teaching and many civil-service posts. Instead they should seek other ways for non-graduates to prove they have the right skills and to get more on-the-job training. School-leavers should be given a wider variety of ways to gain vocational skills and to demonstrate their employability in the private sector. If school qualifications were made more rigorous, recruiters would be more likely to trust them as signals of ability, and less insistent on degrees. “Micro-credentials”—short, work-focused courses approved by big employers in fast-growing fields, such as IT—show promise. Universities should grant credits to dropouts for the parts of courses they have completed. They could also open their exams to anyone who wants to take them, and award degrees to those who succeed.
8. The Times has a story which highlights how the World Bank President Jim Kim may be embracing Wall Street and its capital as the Bank struggles to get its members to make their contributions. Kim has been courting private capital to invest alongside the World Bank.

He should remember this is what happened when state and local governments in the US embraced Wall Street.

9. Finally, Ananth has sent me the findings of Harvard-Harris poll. On immigration etc, Trump is merely channeling the overwhelming public sentiment. The liberals may feel they are representing the public mood. The only problem is that they clearly are not, and representing a small self-serving elite. 

Tuesday, January 30, 2018

The general equilibrium with nudges

Development is hard! Apparently simple solutions most often end up with unintended consequences which detract from the solution's gains.

Default auto-enrolment into savings plan has been hailed as a major progress in influencing people's savings habits. But a new study has contrarian findings,
Automatic enrollment has pushed millions of people who weren’t previously saving for retirement into 401(k)-style plans. But many of these workers appear to be offsetting those savings over the long term by taking on more auto and mortgage debt than they otherwise would have.
The findings,
The study looked at the savings and debt levels of 32,073 civilian employees the U.S. Army hired in the 12 months before Aug. 1, 2010, when the federal government adopted automatic enrollment in its $537 billion Thrift Savings Plan... After adjusting for differences in the economic cycle and in characteristics of the two employee groups, including education and salary levels, the study found that four years after hire, the employees who were auto-enrolled amassed an average of $3,237 more in 401(k) contributions than those who were left to sign up on their own. (That number includes both employee and employer contributions, but not market growth.) But the auto-enrolled employees also had an average of $1,563 more in consumer and auto debt than those who were hired before auto-enrollment. When mortgage debt is factored in, the picture becomes more complicated. The auto-enrolled employees owed $4,131 more, on average, on their homes than their colleagues who were hired before auto-enrollment. This debt more than offsets the extra $3,237 the auto-enrolled employees contributed to the plan, including the employer match.
As the article points out, the takeaway appears to be that auto-enrolment does not make you save more overall but it helps you put away a nest egg to buy a home, which in turn can contribute to a higher net worth over time.  

Monday, January 29, 2018

The Chinese rural e-commerce story

Fascinating set of articles in China Daily (even with the inevitable positive spin) about the role that e-commerce is playing in rural areas. It is described as part of a government plan to achieve "rural economic transformation with Internet plus".

e-commerce firms have established rural sites like Alibaba's Taobao, with marketing agents with the responsibility of creating trust among rural folks to use Taobao to both sell their farm and other products as well as buy things for consumption. Consider this,
The number of "Taobao villages," in which at least 10 percent of the population sells goods on Alibaba's online platform with revenues of at least 10 million yuan, has soared from 20 in 2013 to more than 2,100 (out of more than 600,000 administrative villages across the country) in 2017... The company's Rural Taobao arm is training Taobao assistants in villages and building logistics branches in rural areas, says Li Tianyu, a project manager at Rural Taobao. It is also promoting agricultural products on the front pages of online shopping websites, providing unsecured loans for farmers and analyzing big data to provide feedback to help farmers to improve production efficiency, says Li. As of March last year, the company had established a presence in 600 counties, covering 30,000 villages in 29 provinces or provincial-level regions. 
The penetration of e-commerce into rural areas depends on the availability of digital infrastructure and related platforms, willingness of the rural folks to transact on such platforms, physical transport infrastructure, and a credible standards and certification system. The government has played the important role of addressing the last two issues (1.28 million km of rural roads built in last five years, new food safety law in 2015), allowing the market to expand geographically as well as in terms of scope. In fact, market participants are now investing in the development of cold-chain infrastructure, offering extension services to improve farm productivity, and primary processing facilities.

Sample this about the government's role,
In 2014 and 2015, 256 counties were selected by the Ministry of Commerce for piloting of e-commerce in rural areas. Pilot counties received, on average, 18.75 million yuan from the central government for rural logistics, e-commerce service stations and primary processing facilities, as well as quality control systems and help with brand establishment.
Nearly 60,000 Taobao assistants such as Zhong are working in nearly 30,000 villages around China, helping millions of farmers not only get to know more about purchasing online, but also sending their products to hundreds of millions of buyers from cities... It's part of a project to promote the rural service of Alibaba Group... Cooperating with local governments and based on internet infrastructure, Rural Taobao, a branch of Alibaba, is building the bridge for products and information between urban and rural areas, taking industrial products to the countryside from the cities, and providing agricultural products from rural areas to cities. In addition to training Taobao assistants in villages, measures taken include building logistics branches in rural areas, promoting agricultural products on the front pages of online shopping websites, providing unsecured loans for farmers to improve production, and analyzing big data to give feedback to farmers on how to boost production.
One of the less discussed things about Chinese capitalism has been the important complementary role of its companies in transformational development. Just take the area of finance and technology. The likes of Huawei helped achieve world class connectivity in less than a decade, Xiaomi and Oppo brought affordable and high quality instruments to the masses, and Tencent, Alibaba, and promoted financial inclusion (Alipay, WeChat Pay etc) to credit scoring (Alibaba's Sesame Credit and JD's ZestFinance) and regular e-commerce to rural e-commerce (Alibaba's Taobao). 

It's time for Indian digital economy firms to step up and go beyond being just me-too e-commerce and digital finance platforms and complement the government's role in the promotion of inclusive growth by helping with the development agenda like rural transformation. Digital systems like Aadhaar provide an excellent opportunity. 

Saturday, January 27, 2018

The return of suburban growth?

I had blogged earlier about the existential challenges faced by smaller cities as larger ones benefit from the dynamics of the modern economy.

John Mauldin has an interesting article pointing to the work of Karen Harris and Co at Bain's Macro Trends Group. Their core idea is that the declining cost of distance lowers the advantages of densified urban areas and enhances that of rural areas. They estimate that abut 6% of the population per decade could shift out of urban centres in the US over 2010-25, or upto 24 million people in total.
They also point to how automation, by lowering the cost of operations, can change business models and make smaller scale activity commercially viable.
Mauldin offers an interesting illustration of how trends like automation coupled with the declining cost of distance can play itself out,
On the surface, automation is bad for jobs. For example, Macro Trends estimate that by employing service robots, casual dining outlets could reduce staff from 25 to 8 people. However, as automation will enable businesses to operate at a smaller scale and scope, it may create jobs net-net... While automation will reduce the number of people working at each location, by lowering operating costs, automation will make smaller scale and scope locations economically viable. In effect, the volume of stores would increase, while the number of people working at each location would fall. For the first time ever, large retailers and dining chains will be able to operate in smaller, less dense markets. The large retail stores and restaurant chains that I have the pick of here in Dallas, may open locations in the much smaller neighboring cities of Allen and Katy... a mass exodus to rural areas could create a boom in the construction industry, akin to what took place in the 1950s... Would millions of Americans switching from urban to rural living ignite a baby boom and cure our demographic problems? It’s certainly not out of the question. After all, birthrates are substantially higher in rural areas. Plus, families could dramatically reduce their cost of living by moving out of cities, allowing them to feed more mouths. 
It is never easy to predict these as there are too many moving parts. But it is here that public policy may be able to play a role with opportunistic interventions to steer the course as well as expedite favourable forces. 

Tuesday, January 23, 2018

UK NAO questions the value for money from PFI

Last week the UK's National Audit Office (NAO) released a report on the rationale, costs, and benefits of the country's much acclaimed Private Finance Initiative (PFI) to build infrastructure, the pioneering PPP experiment. The report is a very damning indictment of PFI, concluding that the country has incurred billions of pounds in extra costs for no clear benefit.

The PFI was introduced in UK in 1992 as an innovative way to leverage private capital to supplement governments investments in infrastructure. In 2010, the UK government initiated PFI2, or PF2, with some learnings from PFI and greater role for the government, focusing on smaller deals, involving facilities and services rather than buildings.  Over the past 20 years, PFI investments in social and economic infrastructure have averaged around £3 bn every year, small compared to the total £50 bn capital investments of the government. There are currently 716 PFI and PF2 projects operational or under construction with a total capital value of £59.4 bn.

Consider this on the presumed efficiency gains, 
The Department for Education is currently collecting data and developing methodology and has, so far, found that the financing route has little or no effect on the construction costs of schools being built as part of the Priority School Building Programme (PSBP)... Our work on PFI hospitals found no evidence of operational efficiency: the costs of services in the samples we analysed were similar. Some of those data are more than 10 years old. More recent data from the NHS London Procurement Partnership shows that the cost of services, like cleaning, in London hospitals is higher under PFI contracts.
On the illusion of budget flexibility, or "fiscal illusion" as a July 2017 report of the Office of Budget Responsibility described,
Private finance increases departments’ budget exibility and spending power in the short term, as no upfront capital outlay is required. But departments face a long-term financial commitment – any additional investment will need to be paid back. For example, in the first 12 years of PFI use in the health sector, PFI resulted in extra capital investment for the Department of Health and Social Care (the Department) of around £0.9 billion each year on average: £0.5 billion a year more than the a average annual spending of the Department on operational PFI projects over the same period. However, in recent years PFI has been used much less by the Department and the operational PFI contracts, which cost over £2 billion a year, have reduced the Department’s budget flexibility.
On the higher cost of capital with private finance,
Private finance procurement results in additional costs compared to publicly nanced procurement, the most visible being the higher cost of nance. The 2010 National Infrastructure Plan estimated an indicative cost of capital for PFI as 2% to 3.75% above the cost of government gilts.Data collected by IPA on PFI and PF2 deals entered into since 2013 show that debt and equity investors are forecast to receive a return of between 2% and 4% above government borrowing. However, some 2013 deals, agreed when credit market conditions were poor, projected an annual return for debt and equity investors of over 8%; this was more than 5% higher than the cost of government borrowing at the time.20 Small changes to the cost of capital can have a signi cant impact on costs – as an illustration: paying off a debt of £100 million over 30 years with interest of 2% costs £34 million in interest; at 4% this more than doubles to £73 million.
There are other ways in which PFI adds to cost. Insurance, holding surplus cash to meet stricter lender requirements, use of advisers by both government and private partner given the complex nature of private finance procurement, arrangement fees for raising money, and so on are all additional layers. The net result in terms of total capital cost,
The higher cost of finance, combined with these other costs, means that overall cash spending on PFI and PF2 projects is higher than publicly nanced alternatives. The Department for Education has estimated the expected spend on PF2 schools compared with a public sector comparator (PSC). Our analysis of these data for one group of schools shows that PF2 costs are around forty per cent higher than the costs of a project nanced by government borrowing. The Treasury Committee undertook a similar analysis in 2011, which estimated the cost of a privately nanced hospital to be 70% higher than the PSC.

Consider these snippets of the costs inflicted by way of operational inflexibility, 
The PFI structure means that changes in contracts can be expensive with lenders and investors charging administrative and management fees. For example, additional capital works of approximately £60,000 in a local authority PFI school increased to over £100,000 once fees were factored in – the local authority challenged this and the SPV agreed to reduce some of the management and approval fees although bank fees of £20,000 will still have to be paid. Department of Health and Social Care papers similarly highlight that some trusts with PFI facilities have to use alternative forms of procurement for capital variations. Government can also be locked into paying for services it no longer requires: for example, Liverpool City Council is paying around £4 million each year for Parklands High School which is now empty. Between 2017-18 and the contract end in 2027-28, it will pay an estimated £47 million, which includes interest, debt and facilities management payments, if no changes are made to the contract. The school cost an estimated £24 million to build.
On pricing in life-cycle risks, 
The Department of Health, in a paper on PFI prepared for HM Treasury in 2012, noted that “there is an inbuilt incentive to price cautiously for lifecycle risk, requiring the build up of significant reserves. This may not necessarily result in optimum value for money for the public sector, although data illustrating out-turn costs for lifecycle is scarce”. It also reported that bidders were currently pricing the cost of insurance at a 20% premium to the market price in order to provide protection against future price rises. To mitigate this, HM Treasury introduced insurance gain-share arrangements in the standard PFI contract (paragraphs 2.12–2.13). There are also other risks, for example potential tax increases, that investors may factor into the prices they bid at the outset. These risks may not materialise and in some cases subsequent changes, such as reductions in corporation tax rates, have increased rather than reduced investor returns.
And on the importance of the discount rate used to assess value for money, or comparing with public sector comparators,
The VfM assessment compares private nance costs with a government discount rate of 3.5%, which is 6.09% with inflation, known as the Social Time Preference Rate (STPR), which is higher than government’s actual borrowing costs. The higher the rate applied, the lower the present value of future payments. For example a payment of £100 in 12 years will have a present value of just £49 when discounted by the STPR. Discounting using a lower discount rate, which compares private finance with the actual cost of government borrowing, results in fewer private nance deals being assessed as VfM... HM Treasury does not consider the cost of government borrowing to be relevant in making financing decisions on PFI and PF2 deals. However, other countries, such as Germany and the United States, do compare the cost of private finance with government borrowing costs when assessing financing options like PFI.
And its legacy on the fiscal balance sheet,
The public sector will still be making PFI unitary charge payments to private nance companies in the 2040s. Future payments for existing projects are forecast to total £199 billion from 2017-18 onwards – an average of £7.7 billion a year over the next 25 years. In 2016-17, total payments amounted to £10.3 billion, of which 59% related to four departments (Health and Social Care; Defence; Education and Transport). These payments cover financing costs (debt and interest payments and a return to shareholders) and operational costs. Public bodies also have to pay for maintenance and operational costs of publicly financed buildings.
This blog has been a very consistent critic of the indiscriminate use of PPPs. It has argued that PPPs should be deployed with great discrimination, the cost of capital is much cheaper for governments than the private sector for the same project, construction and commissioning risks are best borne by governments, O&M poses massive risks of skimping on investments and cutting corners on quality, and the near inevitability of renegotiations.

Monday, January 22, 2018

Lessons from the Carillion collapse

The first month of the new year has ushered in two events which could be triggers for the definitive reversal of fortunes for public private partnerships (PPPs), not just in the UK but also elsewhere. They are the collapse of public contractor Carillion and an assessment of UK's PFI released by the National Audit Office (NAO). I shall cover them in two posts, starting with Carillion.

Carillion, a large outsourced service provider of public services and construction contractor for mostly public projects, went into compulsory liquidation on January 15 after its creditors refused any more support. Carillion, with a market capitalisation of £61 million, has left been left in the lurch with its 19500 UK employees, and £ 5bn in liabilities of which £2.6 bn goes into pensions to 28500 pensioners.

Carillion manages 200 operating theatres and 11800 hospital beds, 18500 patient meals per day, is a major contractor on HS2 rail project and Crossrail, manages 50,000 homes for Department of Defence, build and operate 150 schools, catering and cleaning at 875 schools, maintenance and repairs at half of UK prisons, many public libraries, builds substations for National Grid. These are largely public goods. None of these activities can stop, even temporarily, without enormous social and political consequences and human suffering. Irrespective of how Carillion is liquidated, in the short-term governments have no option but to take over these services.
Carillion's collapse has starkly illustrated the risks borne by governments when they outsource public services. The service provider may collapse, but governments cannot abdicate from the provision of public services and the responsibility will fall on it. This creates a potentially big moral hazard for any service provider. Imagine the situation if G4S or Serco files for bankruptcy!

For example, what prevents them from stripping assets with obscene salaries and bonuses, excessive dividend payouts, starving the company's pension fund, piling up massive debts, and then filing for bankruptcy, leaving the government to bear the liabilities? And all this while skimping on investments and cutting corners with service quality. Is there any more remunerative business to be in? Isn't this the playbook for private equity firms in public services?

This is not the only issue. There is a fundamental problem with the unqualified assumption that private providers can provide value for money from provisioning of public services. Fundamentally, there are two problems with  service delivery in public systems. The first one is the standard problem of inefficient resource deployment and management. The second less-known problem is that of constraints imposed by eco-system factors.

Eco-system constraints can vary across sectors and contexts. For example, in transportation, it may be difficult for governments to raise tariffs on a toll road operated by itself compared to a contractually obligated tariff increase. Or government employees may be captured by political and other vested interests that public managers may not be able to control. Or inter-jurisdictional co-ordination may be easier because the private management can exercise more control over their employees than government management (say, co-ordination among different sanitation wards, different property tax collectors etc). Or the private provider is better positioned in being able to ring-fence activities, cost them, and levy user fees.

The presumption is that the private provider is better positioned to reduce the significant costs these two problems impose. But if evidence from across the world over decades and across sectors is taken into consideration (a subject of several blog posts here), this presumption is just a chimera. Even if we assume that the private sector can wring out efficiencies, the second problem is not easily surmounted. In fact, addressing the second problem may be much costlier for the private sector.

This can be traced to an irony about how the public views government and the private sector. We may collectively agree that the private sector is more efficient and less corrupt than government. But when the rubber meets the road and problems surface - tariff increase, user fees, big accident, grave omissions, loss of jobs etc - debates are triggered that invariably frames the problem (correctly, most often) as one of private profiteering, and the same social mood swings violently against the private sector. In fact, the public have deeply internalised the belief that private sector delivery will be much superior that even small shortfalls in quality arouses a disproportionately (when compared to a similar failure by government) higher level of anger and public discontent.

While the public may prefer private efficiency over government sloth, they are likely to vociferously revolt at private windfalls and socialised losses. In fact, losses and quality shortfalls by private providers are certain to evoke an indignation and anger several times more than similarly sized losses and quality deficiencies by public providers.  

Further, once a service provider is large enough and service delivery interfaces closely with the civil society, it starts to face the same problems with employees and their unions, sub-contractors, local political leaders, consumer groups etc that governments struggle with. In such large entities, their managers and workers are no less prone to be captured by vested interests. And unlike the government with its institutional authority, the private provider is very badly positioned to negotiate acceptable enough bargains in such situations.

Finally, even the apparent strength of co-ordination that private providers are presumed to enjoy is questionable. More than internal co-ordination, all such outsourced activities involve significant co-ordination with external agencies, the majority of whom are again government controlled, and with civil society, which trusts the government more than a private provider. The private provider is at a big handicap compared to public providers in this regard.

Private providers and contractors hedge for all these risks. Lenders too have internalised these risks. All these add up several layers of costs. The result is higher life-cycle costs associated with PPPs when compared to the public sector comparators. In simple terms, the transaction costs due to eco-system constraints associated with outsourcing incurred by the private provider end up likely to more than offset any efficiency gains. It is this that the NAO report lays bare in great detail. 

Update 1 (01.02.2018)

The Economist has this perfect narrative of what drives the bids of large construction companies,
Construction is a perilously low-margin business to begin with. To expand the business and keep enough cash rolling in to pay creditors and shareholders, Carillion’s bosses bid ever more aggressively for public-sector contracts, especially in the wake of the financial crash in 2008, when such work was scarce... Public-sector tenders are supposed to consider the quality of bids as well as the price, but in practice contractors have found that “bidding at a low price is usually the best way to win,” says Peter Kitson, a lawyer at Russell-Cooke. Companies bank the upfront payments and hope they can make money by charging for the extra work that nearly always comes with infrastructure projects. If, as happened to Carillion, extra costs arise, the deal can quickly become loss-making.
And I do not understand why this is not a criminal misconduct, 
As Carillion was failing and its pension fund slipping into deficit, shareholders continued to receive dividends and the firm’s boss trousered a £1.5m pay package. Even the Institute of Directors, a business lobby, condemned Carillion’s board for rewriting company rules to protect executives’ bonuses if the company failed. 
And the last word,
Yet a string of failures in Britain, of which Carillion is the latest, means that the country which converted the world to “contracting out” risks becoming a cautionary tale. Voters are flirting with a Labour opposition that has already vowed to renationalise industries and now says it would bring many public contracts back in-house. The Carillion affair could mark the collapse not just of a company, but of an idea.

Saturday, January 20, 2018

Weekend reading links

1. Development of sub-centres as "wellness centres" and promotion of Ayush are two priorities of the government. But data on patient preference of different health facilities from NFHS 4 shows that this may be one hell of a challenge. The sub-centre is used by just 1.5% and 3.1% of the rural and urban populations respectively. About 1% of people use Ayush facilities. It is to be noted that only 42% in urban areas and 46% in rural areas opt for government health services. 

Another striking graphic is below about the reasons for not visiting public facilities.
Note that absenteeism is among the least of problems. Even when doctors are available, people prefer to skip public hospitals for reasons like poor quality of care.

2. Justin Sandefur uses data from the new and richer dataset of the World Inequality Report to show that the famous Elephant graph of incomes gains to world population percentiles over the past twenty years constructed by Branko Milanovic and Christoph Lakner may have to be replaced by a Loch Ness Monster graph. See the original Milanovic et al graph...
And Sandefur's Loch Ness Monster graph for the same period by using WIR data
The WIR graph for 1980-2016 looks like this
The takeaway is that incomes gains have been much smaller than expected even among those benefiting from the rise of China and India whereas that accruing to those at the top of the income ladder much higher. In simple terms inequality has worsened even more than we had thought.

3. Richard Thaler's Nobel Lecture slides here.

4. Uday Kotak makes a less discussed point about foreign ownership of Indian companies,
In 1982 when I started my career, HDFC Ltd’s total market capitalization was Rs 500 crore and foreign ownership was zero. Today that Rs 500 crore has become Rs 275,000 crore. More than 80 per cent is foreign owned. Here’s a company whose core business is money from retail savers – Indian house owners. And of the entire gain made by that company, 80 per cent belongs to foreign investors... Four out of five Indian private banks have majority foreign ownership. Only one with Indian majority is us (Kotak Mahindra Bank)... Let me give the comparison of America and China. The biggest growth companies in the US are Amazon, Facebook, Google, Microsoft and Apple. Go and check out. The majority of these companies are American owned. American savers benefited by them. In China, Alibaba, Tencents and Baidu. What’s the majority holding?
He makes the point about India's relative aversion to foreign debt as against foreign equity. This one deserves a longer post. 

5. Gautum Bhatia has a good article on why the Chief Justice of India's power to allocate cases is a matter of concern.
First, the Supreme Court now consists of 26 judges, who predominantly sit in benches of two. Compare this with the US Supreme Court, for example, where all its nine judges sit together (en banc) to hear cases, or the UK’s Supreme Court, where 12 judges often sit in panels of five (or more). The Chief Justice of the US Supreme Court, therefore, has no choice in the question of which judges will hear a case, and in the UK, the choice is significantly constrained. By comparison, the Chief Justice of India has significantly more discretion in determining which judges will hear and decide a case... 
The rise of public interest litigation has diluted the practice of strict adherence to the legal text, and the Court’s habit of sitting in multiple small benches has undermined the gravitational pull of precedents. This means that when a judge surveys the legal landscape before her, she finds that it gives her greater room to effectuate a personal interpretive philosophy than she might otherwise have. Multiple examples can be cited to demonstrate this. Perhaps the starkest is a brief period in the mid-2000s, where two Supreme Court benches were hearing cases involving the death penalty. One of these benches confirmed virtually every death sentence, while the other commuted most of the cases before it. The question of whether a person lived or died, then, depended upon the lottery of which bench his case came before or — in the Indian legal system — which bench the chief justice assigned it to.
And third, the Supreme Court is dealing with a massive backlog of cases. This means that “in the normal course of things”, a petition will take many years to be heard and decided. The chief justice, however, has the power to “list” cases for hearing. Given the huge backlog, this simple administrative function becomes a source of significant power... Backlog, therefore, allows the Court, through the office of the chief justice, to engage in the practice of judicial evasion — that is, effectively deciding a time-sensitive case in favour of one party by simply not hearing it. In a legal system where a significant percentage of the judges of the Court sit on every case, where there is at least a surface consensus about the interpretive philosophy that judges use to decide cases, and where all cases are heard within a short time of being filed, the chief justice’s power as “Master of the Roster” would be purely administrative. However, in our system, where none of these three conditions obtain, this harmless administrative power has transformed itself into a significant ability to influence the outcomes of cases.
6. More on the puzzle that global equity markets have become,
In all of 2017, the Standard & Poor’s 500-stock index experienced no decline greater than 3 percent, the first time that had happened. And a widely followed volatility index known as the VIX closed below 10 on more than 40 days in a six-month period through late November, according to Citi Research. Before that, the VIX had not closed below 10 on more than six days in any six-month period.
7. The decision by India's securities regulator, SEBI, to ban Price Waterhouse, the auditing arm of PwC, from auditing listed firms in India for two years for its complicity in manipulating accounts in the Satyam scandal may sound harsh but is a very welcome decision.

We have seen too many examples of these large institutional service providers escape with slight rap on their knuckles for even very grave misdemeanours. The expectations need to be realigned. It is therefore appropriate that the regulator took the harsh step.

8. Is Amazon under-paying its workers compared to industry standards? The Economist writes,
According to available data from the Bureau of Labour Statistics (BLS), warehouse workers in counties where Amazon operates a fulfilment centre earn about $41,000 per year, compared with $45,000 per year in the rest of the country, a difference of nearly 10% (see chart 2). The BLS data also show that in the ten quarters before the opening of a new Amazon centre, local warehouse wages increase by an average of 8%. In the ten quarters after its arrival, they fall by 3%.
And adding more evidence to the growing body of reasons supporting exercise of monopoly power by large corporates,
An NBER working paper by José Azar of the IESE business school, Ioana Marinescu of the University of Pennsylvania and Marshall Steinbaum of the Roosevelt Institute finds that a relatively small number of employers account for a large share of job opportunities in many American communities. In places where such labour-market concentration is highest, wages tend to be lower. These findings suggest that if Amazon is the only major employer in the cities and towns where it operates, the company can offer wages that are well below those of its competitors.
How much more evidence will be necessary before the likes of folks at Marginal Revolution accept the reality of business concentration and its damaging social and political consequences?

9. The competition-gone-crazy (or beggar-thy-competitor) story that is India's telecom market,
Reliance Jio’s entry in 2016, with never-before tariffs, has led to a calamitous fight for dominance over the last 18 months. It dragged down Airtel’s profit by a staggering 90% in the June-September 2017 quarter while Idea swung to a loss of over Rs 1,100 crore, 11 times worse than a year earlier. British telecom major Vodafone had to write down the value of its India business by a mind-boggling 5 billion euros, even as it worked a merger with Idea to take on its competitors.

“You have built a market that expects you to give 35 GB of data for a monthly price of Rs 400 [$6.25] per month. How will you make money?,” Kapoor said. “In the US today, you won’t get more than 3-4 GB data for $100 a month. Wireless networks are not built to give you 35 GB of data a month”.
10. Finally, this may be a simplification, but the coincidence between convergence of income shares of the top 0.1% and bottom 90% in the US and the rise of populism is striking,