Tuesday, June 28, 2016

The Panama Canal Locks and perils of low-ball bids

As the new Locks to the 50 mile long Panama Canal, constructed at a cost of $5.4 bn, opened for traffic on Sunday, the Times has a fascinating account of the problems faced during construction
On July 8, 2009... after an intense two-year competition, a consortium led by a Spanish company in severe financial distress learned that its rock-bottom bid of $3.1 billion had won the worldwide competition to build a new set of locks for the historic Panama Canal... Disputes quickly erupted over how to divide responsibilities. Some executives appeared not to fully grasp how little money they had to complete a complex project with a tight deadline and a multicultural team whose members did not always see things the same way. Internal arguments soon gave way to bigger problems. There would be work stoppages, porous concrete, a risk of earthquakes and at least $3.4 billion in disputed costs: more than the budget for the entire project.
Seven years later, and nearly two years late, the locks have finally been declared ready to accept the new generation of giant ships that carry much of the world’s cargo but cannot fit in the original canal. To mark the occasion, Panama has invited 70 heads of state to watch on Sunday as a Chinese container ship becomes the first commercial vessel to attempt the passage from the Atlantic Ocean to the Pacific through the larger locks.
The bid process that led to the developer selection appears to have been flawed,
Three consortiums — including one led by Bechtel, an American company with an international reputation for taking on big, difficult projects — pursued the contract. The financially weakest consortium was led by a Spanish company, Sacyr Vallehermoso, which American officials called “nearly bankrupt” in one cable and “technically bankrupt” in another. Sacyr’s consortium included a Panamanian company owned by the family of the canal administrator at the time, Alberto Alemán Zubieta. The company, Constructora Urbana, in which Mr. Alemán himself previously owned stock, had already done millions of dollars in business with the canal. The other two members were Impregilo, a large Italian contractor, and Jan De Nul, a Belgian company that specializes in dredging and excavation. In March 2009, after 15 months of contentious negotiations, the three consortiums submitted their sealed bids... That July, with the nation watching on television, the bids were opened, and the result was a shocker: The underdog Sacyr group had won... When one of the bidders makes a bid that is a billion dollars below the next competitor, then something is seriously wrong
And the rock-bottom bid has thrown up the expected deficiencies,
In simple terms, to be successful, the new canal needs enough water, durable concrete and locks big enough to safely accommodate the larger ships. On all three counts, it has failed to meet expectations, according to dozens of interviews with contractors, canal workers, maritime experts and diplomats, as well as a review of public and internal records. The low winning bid, a billion dollars less than the nearest competitor’s, made “a technically complex mega-project” precarious from the outset, according to a confidential analysis commissioned by the consortium’s insurer, Hill International... 
Among the biggest risks is the concrete that lines the walls of the six mammoth locks punctuating the path between the seas. Last summer, water began gushing through concrete that was supposed to last 100 years but could not make it to the first ship. The Hill analysts had warned that the consortium’s budget for concrete was 71 percent smaller than that of the next lowest bidder. The budget also allotted roughly 25 percent less for steel to reinforce that concrete. Then there is the lock design. Tugboat captains say they cannot safely escort the larger ships because the locks are too small with too little margin for error, especially in windy conditions and tricky currents. In fact, in a feasibility study... the Panama Canal Authority had earlier concluded that the tugs needed significantly more room. The tugboats themselves are a problem, especially the 14 new boats purchased from a Spanish company, mostly for the expanded locks. To maneuver safely, they must be precisely controlled, but according to captains, they are so unstable that they operate best going backward, something that cannot be done while towing ships through the canal... the canal authority bought the tugboats for $158 million from a company later represented by the son of Jorge L. Quijano, the canal’s administrator.
The new locks exist for one reason: so that huge “neo-Panamax” ships can move far greater quantities of cargo through the canal. For them to do that, the waterway must remain deep enough so that fully laden ships do not hit bottom. But canal officials discounted warnings that they needed new sources of water, and during a recent drought, shippers had to significantly lighten their loads. Canal officials had assured the country that no new reservoirs were needed.
Poor quality of concrete and other materials, skimping on standards, and cronyism appear pervasive in the project. And then there are the standard issues of emergent project risks, like water availability in the Gatun Lake which supplies water to the Locks and design challenges with the size of locks, numbers of tugboats, and so on.

This is yet more evidence that in large infrastructure projects, it is always better to structure the bid process in a manner that emphasizes the importance of technical proficiency and financial capability of the bidder over merely the lowest bid amount. In fact, in mega projects like the Panama Canal extension, with several unknown unknowns, and where cost over-runs are inevitable, it may even be appropriate to have internal benchmark pricing for major components and disqualify bids that low-ball estimations below a certain floor threshold on each of those major heads. 

Monday, June 27, 2016

Liberal democracy in the age of globalization

Since the fall of the Berlin Wall in 1989, politics and economics have mostly moved in one direction, with the elites on both sides of the Atlantic favoring policies like the North American Free Trade Agreement with Canada and Mexico, the introduction of the European currency and the entry of China into the World Trade Organization. Business has applauded these moves, but voters are not necessarily on board as they once were... The Brexit vote... reflects a deep distrust of the benefits of the global economic system among a wide swath of voters in Europe and the United States, and a broadly held view that government institutions — whether in Washington or Brussels — are calcifying and don’t work well.
As more analysis of Brexit pours in, I am reminded of Dani Rodrik's "inescapable trilemma". It claims that "democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full."

As I argued yesterday, in the case of Britain, increased integration with Brussels unleashed both economic and political insecurities. At the economic level, the competitive pressures engendered by migration and imports hurts at least some sections of both labor and capital. Politically, the erosion of "the symbols and benefits of national citizenship" amplifies the adverse effects of economic competition. Democratic governments will invariably feel the backlash from this constituency.

Assuming that democracy is a non-negotiable attribute, we are left trading off national sovereignty and economic integration. It is here that the broad sweep of time and historical perspective assumes significance. The trade-off is done most seamlessly if economic and political integration happens gradually over a few generations. But such scripts rarely pan out as planned in the real world. Instead, such transitions are invariably a series of back-and-forth movements between progress and setbacks. And Brexit is no more likely to be one more such setback in the sixty year European Project.

One could argue whether the single currency was introduced too soon. Could they not have waited longer for the norms of economic integration to have become more internalized? Should the forces of financial market integration have been allowed to play out more before the currency union was introduced? Should greater fiscal integration have preceded a currency union? Should Europe have waited for its political institutions to attain more credibility before its push forward with monetary union?

I would be inclined to answer in the affirmative to all these questions. But the political dynamics of European integration expedited the transition. The push-back was therefore inevitable. The supporters of the European Project will now have to assess their failings, address them, and resume the path towards integration. 

Sunday, June 26, 2016

Brexit explained in graphics

Correlation is not causation. But this set of graphics from FT (HT: MR) may be a good place to look for the underlying factors that contributed to the victory of Leave. Analysis of data from the UK's 382 counting areas (local government districts) revealed that there were five strongly correlated indicators.
The areas with large proportion of degree-educated voters and jobs requiring degrees were the biggest votaries of Remain. In contrast, those who had never left UK, were among the strongest supporters of Leave, 
In the recent London Mayoral Election, we carried out a similar analysis and found that areas where many people did not hold a passport — indicating they would not have been abroad recently — tended to yield high votes for the far-right Britain First party. The same pattern emerges here. After education and occupation, the share of people not holding a passport was the next most strongly correlated characteristic with the Leave vote.
And going against the conventional wisdom that economic integration is the path towards political integration, the Leave vote was strongest in those areas which were economically most dependent on EU, in terms of economic output exports.
Analysis of British Election Survey found that the strongest predictor of this counter-intuitive result comes from the attitudes towards immigration. Very interestingly, these are also the regions where immigration is perceived as most damaging. 
Citizens of regions where immigration is perceived as damaging are much more likely to vote for Brexit. Presumably, the unifying forces of economic dependency are more than offset by those of competition for jobs from migration and by more latent suspicions of immigration (the Survey question was "‘Do you think that immigration undermines or enriches Britain’s cultural life?")

I am inclined to agree with David Goodhart that the persistent economic weaknesses, widening inequality, and the "disappearance of a once familiar industrial working class culture and the declining status of much non-graduate employment" may have increased the attachment to the symbols and benefits of national citizenship. This squares up with much of the public commentary on the support base of Donald Trump, Front National, Five Star Movement, and others across Western Europe. 

This goes back to a theme that I have written about on numerous occasions. A robust national social safety net which assures a basic dignified human life consistent with the country's economic and social development is an absolute necessity to pacify the losers from globalization and liberalization and thereby prevent populist backlashes. This is as much sound politics as it is economics. And there are very few such areas where there is political and economic convergence. 

Saturday, June 25, 2016

Weekend reading links

1. On the US Pharma industry,
A recent Plos One study found that about 36 percent of all new drugs approved in the United States between 1988 and 2005 were protected solely by secondary, or trivial, patents.
There are as many as 8.2m assault-style weapons at large in the US, which almost certainly exceeds that of any uniformed armoury in the world, barring the Russian and Chinese militaries. That is without mentioning the more than 300m estimated smaller firearms in US homes.
3. Is Uber leading a race to elimination in the car aggregator market? The company plans to undertake more fund-raising, bringing its total mobilization to $15 bn since starting out in 2009 and its valuation to $68 bn, and it has no plans in the foreseeable future to go public. To put this in perspective, when Amazon went public in 1997, it raised $54 million and was valued at $438 million! So what is the game plan?
Every time Uber raises another $1 billion, venture capital investors and others may find it less attractive to back one of Uber’s many rivals: Didi Chuxing, Lyft, Gett, Halo, Juno. In other words, Uber’s fund-raising efforts have seemingly become part of the contest: It’s not just a rivalry over customers and drivers; it’s a war of attrition, a mad scramble to starve the competition of cash. At the moment, Uber’s success has had the opposite effect: It has spawned a long list of rivals, big and little guys who say, “We can do it too.” But over time, as the smaller competitors run out of cash — after heavily subsidizing riders in an effort to steal business from Uber — venture capitalists should be less inclined to put up even more cash to go up against Fortress Uber. 
Uber’s fund-raising arms race comes against the backdrop of falling valuations for many Silicon Valley unicorns — private companies worth $1 billion or more. So there’s clearly a rush to take the money while it’s still available... So far, Uber is clearly winning the valuation game: It is worth more than virtually all of its rivals combined... Uber is currently on track to lose about $2 billion annually in China and India as it heavily subsidizes customers and drivers to gain market share.
This is clearly a race to the bottom, where only those with enough firepower will survive. But the end game could turn out different than anticipated, especially if the markets itself shrinks considerably once the subsidies are removed. 

4. More on this from this fascinating essay on Uber's challenges in China, where Didi Kuadi dominates, and where ride-sharing apps and aggregators are still not fully legal, and Uber China is an independent entity,
Typically, Uber takes a cut of about 25 per cent of the passenger’s fare and passes the rest of the fare on to the driver. Costs are kept low because Uber doesn’t employ the drivers, or own the cars. However, in China, Uber pays drivers a multiple of the passenger’s fare, meaning that the company loses money on most rides. Other Chinese ride-hailing companies employ a similar strategy... Many drivers for Uber say they would not be driving if it weren’t for the bonuses, while passengers also say they would ride less if the services became more expensive... While Uber’s services include luxury cars, cheaper rides are a bulwark of Uber’s business in China. Uber’s carpool service, with fares as low as Rmb2 (21 pence) accounts for more than half of rides in several key cities... removing subsidies altogether will not be easy. Examples from other markets show that heavily subsidised businesses sometimes just evaporate once the subsidies disappear. The taxi-hailing business of Didi and Kuaidi, which was initially fuelled by subsidies, is now a tiny fraction of their merged business and generates no revenues. Smaller ride-hailing companies in other markets, such as EasyTaxi in Jakarta, found that their business dried up completely when subsidies ended.
5. Livemint points to an India Ratings report on the asset quality of the country's top 500 corporate borrowers. It classifies their loans into four categories - stressed, elevated risk of refinance (ERR), medium ease of refinance (MER) and high ease of refinance (HER). The stressed loans form a counter-party to the Rs 5.8 trillion stressed loan book of the country's banks as on end-March 2016. The report says,
240 of the top 500 borrowers belong to the stressed and ERR (elevated risk of refinance) categories and will remain exposed to significant refinancing risk during FY17. These 240 borrowers hold about 42% of the total outstanding debt of Rs.28.1 trillion i.e. Rs.11.8 trillion, of which Rs.5.1 trillion is stressed and another Rs.6.7 trillion falls in the ERR (elevated risk of refinance) category
 And the larger share of refinancing requirement in 2016-17 is for stressed and ERR loans.
6. Livemint, again, points to the elevated debt to equity ratios and decadal low of return on equity on 303 manufacturing firms in the BSE 500.
One observation from this is that indebtedness is pervasive among the country's corporate and not the exclusive preserve of infrastructure firms.

7. Livemint feels that the "key to affordable and egalitarian housing ought to unlock India’s vacant houses first". As per census 2011, there were 2.47 vacant houses in India, or 90% of the number of rented houses in the country.
8. The Times points to the latest EPI study of income inequality in the US. The picture is very alarming.
Between 2009 and 2013, for example — a period that encompasses most of the post-Great Recession era – the top 1 percent captured all of the income growth in 15 states (Connecticut, Florida, Georgia, Louisiana, Maryland, Mississippi, Missouri, Nevada, New Jersey, New York, North Carolina, South Carolina, Virginia, Washington and Wyoming)... In all, the top 1 percent in the United States captured 85.1 percent of total income growth from 2009 to 2013. In 2013, the 1.6 million families in the top 1 percent made 25.3 times as much on average as the 161 million families in the bottom 99 percent. Those and other figures are reminiscent of conditions in the Roaring Twenties. In 1928, the peak year of that decade’s boom, the top 1 percent took home 24 percent of the nation’s income. In 2013, the top 1 percent nationally took home 20.1 percent of all income, while in five states (New York, Connecticut, Wyoming, Nevada and Florida) the income share for the top 1 percent exceeded the peak from 1928.
9. Bloomberg points to the shifts in the source and volume of US oil imports.
While Canada has become the country's largest source of oil imports, Middle East continues to play an important role.

10. The World Bank's latest report on Private Participation in Infrastructure (energy, transport, and water projects) in low and middle-income countries reveals that total investment in 2015 was $111.6 bn, compared to $111.7 bn in 2014 and $124.1 bn over the previous five years. Transportation and energy, as usual, dominated the investment destination by sector. Excluding Brazil, China, and India, investment rose 92%, on the back of Turkey’s US$35.6 billion IGA Airport (New International Airport) investment commitment. Solar energy investment rose 72% over the previous five-year average to reach US$9.4 billion and renewables captured nearly two-thirds of energy investments with private participation.
11. Ian Bremmer has this nice illustration of the web of geopolitical relationships in the Middle East.
12. Finally, on the Brexit vote, one commentator in the FT draws attention to the class divide by arguing that "the lower down the social and educational ladder you descend the greater likelihood that someone will have voted to Leave, while the best markets for Remainers is having a degree and being aged 18-29". This class divide largely replicates itself in the rise of people like Donald Trump and anti-Establishment and Far Right parties across continental Europe. But the British vote must be among the most surprising outcomes of the populist backlash against globalization, cross-national integration, and economic liberalization.

In any case, now the challenge would be about firming up the British relationship with the EU. In order to send out a strong signal to potential similar exits, the EU leaders would want to ensure that the costs of an exit are prohibitive enough. An accommodative exit for UK could encourage similar movements in other member countries. Here is a good graphic of the options available.
Another concern would be the dynamics of independence movements in Scotland, surely, and maybe Northern Ireland. The Brexit vote could well be the starting of the dissolution of the United Kingdom.

While the British exit would undoubtedly set back the European project, if the continent can weather it without further member exits or substantive reversals, it may well strengthen the Project's multi-track pathway towards integration.

Thursday, June 23, 2016

Smell test for why "this time is any different"

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

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

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

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

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

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

Tuesday, June 21, 2016

Convergence, Small Time?

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

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

Monday, June 20, 2016

On premature deindustrialization and other things

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

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

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