Tuesday, September 30, 2014

The widening US income inequality in two graphs

The two graphics in an Upshot article, extracted from a paper by economist Pavlina R Tcherneva, emphatically convey the dramatic trends in income distribution within the US society.

The first graphic shows that the share of income going to the bottom 90 percent of earners in economic expansions has risen from just 20% in 1949-53 to 116% in 2009-12 (the later reflecting the fact that incomes actually fell for the bottom 90%).
The same distribution for the top 1% shows that their share of income gains from expansions rose from just 1% to 95% in the same two periods.
It would be interesting if some one could come up with similar trends of the respective shares of wealth destruction during downturns. In any case, given that the wealth increases far outstrip wealth subtraction during regular economic cycles, the overall widening of inequality is undeniable.  

Friday, September 26, 2014

Indian economy and its "crony capitalism risk"

Business Standard reports that the Supreme Court's recent decision to cancel 194 coal block allocations made since 1993, coming on the back of the cancellation of 3G telecom spectrum licenses, "reminds all investors that India is a country fraught with political risk". A more appropriate characterization of the risk would be "crony capitalism risk".

As the Indian economy liberalized in the nineties, the old license permit raj, which was underpinned by an unhealthy relationship between businesses, officials, and politicians, contrary to popular perception, got strengthened rather than weakened. A far more entrenched, pervasive, and corrosive nexus emerged as economic growth surged and private participation in many sectors expanded dramatically. Several forces were at play in accentuating this trend.

On the one side, the rising tide of private participation led to the opening of several sectors and hugely valuable public resources - land, coastline, minerals, water, spectrum, airline routes, public sector bank credit, etc - were allotted to corporate groups. The commercial stakes associated with these transactions were on a qualitatively different scale compared to anything done before. Apart from resource allocations, private participation increased in several other areas - project and facilities management, operation and maintenance, quality control, routine services, and so on - often directly substituting public personnel.

On the other, these allocations and contracting were, most often, not only done in an ad-hoc manner without a transparent, competitive, and fair policy framework, but also by system which did not have the institutional capacity to effectively design and manage these contracts. One-sided contracts which very adversely affected public interest passed through the gates of ill-equipped and compromised gate-keepers with minimal due diligence. Corporate greed, the exploding cost of electoral politics and campaign finance, and incentives within the bureaucracy aggressively fueled these forces. India's version of crony capitalism had taken stage.

History teaches us that this phase has been a feature of economic development and structural transformations across the world. The "robber barons" of the gilded age in the United States had their counterparts in East Asian "crony capitalists". The only difference from these experiences may be that our version has had egregious excesses involving massive amounts of public losses, over a very short time, and in an environment where judicial and media activism are at their peaks.

In the late nineties and most of last decade, the massive profit opportunities in opaque and customized resource allocations and public contracts helped corporates, Indian and foreign, enjoy a very high "crony capitalism premium". Then as the tide turned and the backlash started, the premium has been replaced by a steep discount. This should not come as a big surprise. Common sense tells us that there are no free lunches - disproportionate returns are always accompanied by high risks.

It is a tribute to the country's democratic institutions and checks and balances that these excesses are being corrected. It is certain that this cleansing would result in the emergence of a more healthy and stable politico-economic business environment in the country. What is not certain though is how many more cancellations and uncertainty will have to pass before that environment emerges. It is likely that more of such cancellations will happen in the months ahead. Which of oil blocks, airlines routes, space spectrum, and land is coming next?

Wednesday, September 24, 2014

Industrial Policy and Renewables Market

NYT has a nice essay on how Germany transformed the global solar and wind power markets. The article documents the adverse impact of renewables on the conventional power generators. A more interesting insight is how German public policies have incentivized a dramatic breakthrough in global renewables market,
Over the past decade, the Germans set out to lower the cost of going green by creating rapid growth in the once-tiny market for renewable power. Germany has spent more than $140 billion on its program, dangling guaranteed returns for farmers, homeowners, businesses and local cooperatives willing to install solar panels, wind turbines, biogas plants and other sources of renewable energy. The plan is paid for through surcharges on electricity bills that cost the typical German family roughly $280 a year, though some of that has been offset as renewables have pushed down wholesale electricity prices. 
The program has expanded the renewables market and created huge economies of scale, with worldwide sales of solar panels doubling about every 21 months over the past decade, and prices falling roughly 20 percent with each doubling. “The Germans were not really buying power — they were buying price decline,” said Hal Harvey, who heads an energy think tank in San Francisco.
In many respects, this is classic industrial policy and an example of why government initiative is critical to enable mass adoption of completely new technologies. For a long time the renewables market was stuck in a grid-lock. On the one hand, the lower price of conventional power made renewables an unattractive option for users, while on the other, the price of renewables could decline only as economies of scale kicked in and the market expanded and matured (leading to technological innovation).

The governments of countries like Germany and Spain took the initiative to break the stalemate by subsidizing the cost of production and guaranteeing an assured and growing demand. The result was a sharp convergence in the prices of conventional and renewable power. By this, they may have done more than any other country to advance the cause of renewable power sector and in fighting climate change.

The Chinese government too deserves some credit for this. Spotting the opportunity, the Chinese government supported domestic solar and wind equipment makers, who established dominance in the global market. The massive competitive advantage enjoyed by Chinese firms came by way of cheaper (subsidized) cost of capital and utility services, lower cost of land, fiscal concessions etc which made them runaway leaders.

While in both cases, these policies often resulted in wasteful and inefficient allocation of resources, its overall outcome has been undoubtedly positive. In other words, the industrial policies of German and Chinese governments have, unwittingly, subsidized and provided the thrust for the sustainable development of global renewables market. 

Monday, September 22, 2014

Business at the Bottom of Pyramid and secular stagnation

The Times has a nice story about how multi-national companies are investing in developing lower cost consumer durables besides exploring channels to reach out to consumers at the "bottom of the pyramid".

Two things stood out. The first is the trend of innovations for the "bottom of the pyramid" finding an even bigger market in developed economies. 
Many products are transcending their original markets and appealing to a more affluent consumer... G.E. realized more than a decade ago that products devised for the Indian market might appeal to more developed markets, and planted the company’s largest and first international research and development center here. The lab has 4,500 engineers, 1,600 of whom work on health care innovations.  “There has been a shift,” said Shyam Rajan, chief technology officer at Wipro GE Healthcare. “Before, it was in India for India. Today, it is in India for the world.” 
The MAC 400, an electrocardiograph machine, was the first product G.E. moved from here to the rest of the world. About one-third the price of the company’s higher-end EKG machines, it is battery-operated and portable. It also is made of parts that can be bought in local electric and home supply shops, rather than the proprietary components G.E. typically uses. Of the 15,000 Mac 400s that G.E. has sold, 60 percent were sold outside India. The Lullaby baby warmer, now used in Europe, was built with feedback from Indian doctors and nurses in the field.
The second observation relates to the nature of transformation in these markets which already have established and profitable products. Businesses have come to accept a two-tier market, even at the cost of their existing business lines. 
Is G.E. sacrificing sales of its Cadillac baby warmer, the Giraffe, to the Lullaby? “It’s better to cannibalize yourself than let someone else do so — and that was going to happen with these products,” he said. “Anyway, the amount of market we created that was not there before more than makes up for it.”
The larger point is that proponents of secular stagnation - average is over, lack of profitable investment opportunities etc - surprisingly overlook the role that trade and globalization can play in reviving economic growth in developed economies. The market at the bottom of the pyramid, as the article highlights, is a potentially excellent opportunity for greater innovation (low cost, environment friendly, and sustainable) and business profits.    

Friday, September 19, 2014

QE and Fed's verbosity!

For long Central Bankers had a reputation for being laconic and inscrutable. Then came the global financial crisis and unconventional monetary policies, which made Chairman Bernanke deploy the Fed's communication strategy as an instrument of monetary policy.

Interestingly, as this striking correlation between the expansion of Fed's balance sheet and the length of FOMC statements show, this strategy effectively meant a dramatic increase in the volume of Fed communications.
It is a matter of great interest whether this verbosity, as it generally does, ended up confusing than clarifying.

Thursday, September 18, 2014

Metro rail fact of the day

The Atlantic has farebox recovery figures for New York transit system,
In 2012, $7.7 billion dollars of state and local tax revenues went to New York City Transit, not counting what when to the commuter railroads and other operations. That's a lot—nearly $1,000 for every man, woman, and child who lives in New York City. Why didn't it feel like enough? Because less than half of it, roughly $3.2 billion, was reinvested in the system. The majority, about $4.5 billion, was used to keep fares low by paying operating costs. On average, each New York City transit rider paid only 43 percent of the cost of his or her ride; every $2.50 swipe of your Metrocard gets matched by $3.31 in tax dollars.
And, this about the Hong Kong model, whose self-sustainability is widely acclaimed,
Between 2001 and 2005, property development produced 52% of Mass Transit Railway Corporation's (MTRC) revenues. By contrast, railway income, made up mostly of farebox receipts, generated 28% of total income. MTRC's involvement in property-related activities - development, investment, and management - produced 62% of total income, more than twice as much as fares. 

Clearly, a subway dominated urban mass transit is not cheap and imposes a massive fiscal strain. And this is despite two of the largest passenger volumes, higher relative tariffs, and very efficient operations. 

Tuesday, September 16, 2014

Observations on the Reliance gas pricing issue

Swaminathan Aiyar proposes that the government allow Reliance to sell the gas produced from KG Basin at the market price, which is the marginal price of gas supplied or the prevailing import price.

Supporters of a market-based pricing model argue that it encourages investments in natural gas exploration, thereby curtailing India's growing gas imports. Aside from the numerous controversies surrounding the Reliance project, I have two concerns with this argument.

1. The United States which apart from being one of the largest gas producers is also a large importer does not appear to have embraced this principle in aligning incentives. In 2013, its LNG import prices varied from $6-15 per mmBTU, whereas benchmark Henry Hub natural gas prices (which is not regulated and is market-determined) averaged $3.73 per mmBTU. In other words, the market-determined domestic price for natural gas in the US was far lower than the marginal price as represented in the import price. And it continues in 2014.

This emergent general equilibrium pricing of domestically produced natural gas, which is less than half the price of the imported LNG, questions the logic that production incentives are optimized when producers in India are able to sell their produce at the import price. The far lower price in the US market has not in any way deterred massive exploration in shale gas (whose exploration cost is incidentally more than that of conventional natural gas).

In fact, while the domestic prices in the US are in the $3-4 per mmBTU range, the LNG export prices have nevertheless been in the range of $12-15 per mmBTU. Given than the combined cost of liquefaction, transportation, and re-gasification is no more than $2.5 per mmBTU, this wide differential is itself a pointer to the inefficiencies in the global natural gas markets.

2. This brings me to the objective of any gas pricing policy. Econ 101 teaches us that an efficient market price is one which while encouraging exploration and production also incentivizes investments that generate demand for the gas. In other words, the price should reflect both reasonable profit for the producer and an acceptable cost for the consumer.

This trade-off maximizes the total producer and consumer surpluses and not just the producer surplus. Therefore, instead of just "encouraging domestic natural gas exploration by maximizing profit incentives", the objective should be to "encourage domestic natural gas exploration consistent with optimal development of economic activities that use natural gas". The logic that Reliance or any other natural gas producer should get a price comparable to LNG import price so as to incentivize India's gas fields development therefore appears to be flawed.