Tuesday, March 31, 2015

The hot-hands fallacy revisited

Aeon has a nice essay that points to recent empirical studies which appear to question one of the most famous cognitive biases - the 'Hot-Hand fallacy', or the mistaken perception of lucky streaks among sports persons.

In the first study, Andrew Bocskocsky, John Ezekowitz, and Carolyn Stein, examined videos of 83000 shot attempts from the 2012-13 US NBA season, and argue that a player in form is emboldened to take more difficult shots,
They showed, first of all, that players who felt 'hot' did in fact start taking harder shots. And, after controlling for the difficulty of each shot selected, they found a small yet significant hot-hands effect - that is, those who did well began to do even better over time. 
Another study, by Jeffrey Zwiebel and Brett Green, analyzed twelve years of data from Major League Baseball, and found that
how a player performed the most recent 25 times at bat was a significant predictor of how he would do the next time. They also calculated that a hot player was 30 per cent more likely to get a home run than if he were not on a winning streak. Lucky streaks are real and not just an illusion, they said. 
Yet another study by Juemin Xu and Nigel Harvey, which analyzed about half a million sports bets, found that those on winning streaks were much more likely than not to keep winning, and those on losing streaks were more likely to keep losing. They tried to understand the reasons why these streaks persisted,
As soon as bettors realized they were winning, they made safer bets, figuring their streaks could not last forever. In other words, they did not believe themselves to have hot hands that would stay hot. A different impulse drove gamblers who lost. Sure that lady luck was due for a visit, they fell for the gambler's fallacy and made riskier bets. As a  result, the winners kept winning (even if the amounts they won were small) and the losers kept losing. Risky bets are less likely to pay off than safe ones. The gamblers changed their behaviors because of their feelings about streaks, which in turn perpetuated those streaks. 

Sunday, March 29, 2015

China cement consumption fact of the day

An old graphic, from Vaclav Smil, via Bill Gates, that puts in perspective the fantastic growth of China
In 2013, China's cement production was 2.42 bn mt. In contrast, India, the 2nd largest producer globally, produced just 280 mt!

Friday, March 27, 2015

Debt laden corporate sector and India's recovery

Following on from the dismal story of debt-laden balance sheets of real estate firms, Business Standard has a nice graphic that captures the magnitude of indebtedness in corporate India,
It is not so much the share of corporate debt as percentage of GDP that is frightening. While rising, non-financial corporate debt is still below that in many other large economies. The more worrying parameters are the high debt-to-equity ratios - in highly unsustainable double-digits for some of the largest infrastructure firms - and the low debt-service coverage ratios (DSCR) - at end-2013 nearly 40% of the corporates had DSCR lower than one, or inadequate earnings to cover even interest payments. Add to this the rising exposure to unhedged short-term external debt due to the liberalization of External Commercial Borrowings (ECB) inflows, and corporate India has to navigate very strong headwinds.
Their high indebtedness, and the resultant applications for corporate debt restructuring has led to many of the largest infrastructure companies from being barred from bidding for new projects. Of the 45 core infrastructure companies, 20 are currently in CDR and have been barred from contracts in many states. It is not just infrastructure, automobile sales, especially those of cars, has been stagnant for five years. With interest rates being sticky downwards, the sales growth of consumer durables and vehicles face a daunting challenge.

Corporate de-leveraging is therefore an essential requirement. But it runs counter to the government's expectations that predominantly privately financed infrastructure spending will do the heavy lifting for restoring economic growth to near double-digit rates. In any case, with banks hobbled with rising non-performing and distressed assets, credit availability for corporate India looks extremely uncertain. 

Wednesday, March 25, 2015

The "re-nationalisation" of Network Rail in UK and lessons for India

The Business Standard reports that the Bibek Debroy Committee constituted to make recommendations to reform Indian Railways is likely to advocate private participation in the running of passenger and freight trains. In this context, it may be instructive to take stock of the latest problems being faced by Britain's controversial rail privatization.

For the record, the British rail privatization had unbundled the system into three parts. An infrastructure company, Network Rail (earlier Railtrack) owns the track, rolling stock operating companies (ROSCOs) own the trains, and train operating companies (TOCs) run the trains. There are currently 17 TOC franchises (down from the original 25), operating both long distance inter-city routes as well as urbanized commuter lines. The ownership of the franchises have changed hands many times. 

I have already blogged about a comprehensive study on British rail rolling stock private franchising which found large private profiteering without capital investments and costing large subsidy outflows from the government. It found that the franchising policy boosted the profits of privately owned TOCs, without investments in network expansion or upgradation, and loading debt into the publicly guaranteed Network Rail. Faced with rising train ticket prices, the British government was forced to intervene by capping commuter fares in 2013.

As regards rail tracks, the British rail regulator, Office of Rail Regulator (ORR), has criticized the recently "re-nationalized" monopoly rail infrastructure operator, Network Rail (NR), of poor performance and declining standards in all aspects of its business. The ORR has said that NR is failing badly in meeting its new investment commitments on electrification and signalling, and standards on punctuality, service reliability, and track and signal maintenance. This criticism comes on top of a study few years back that found that privatized British rail performed the worst in comparison to its mostly government controlled peers in seven other European countries.

In September 1, 2014, the 1994 British railways privatization turned full circle as NR, the private entity which operates and develops Britain' fixed railways infrastructure - over 2500 railway stations, railway tracks, signalling systems, bridges, tunnels, and railway crossings - was formally "re-nationalised" as a public entity. This followed the government assuming the £38bn debt that NR had accumulated. 

NR, the successor to the failed Railtrack, is listed on the London Stock Exchange and has a private market sourced management. It was set up in 2002 as a private company with no shareholders, though its finances were guaranteed by the government. Though now public, its governance structure provides for an arms-length relationship with the government, thereby ensuring commercial and operational freedom. NR is regulated by the Office of Rail Regulator (ORR).

NR's operating revenue comes mainly from three sources - 60% as grants from Department of Transport, 27.8% from track access charges paid by train and freight operators, and 10.6% from income from property and shops. While it has previously raised debt directly from the market, the re-nationalization means that it will borrow directly from the government, by way of a £30.3 billion loan facility for its current (2014-19) five year investment plan. In the current plan, NR intends to spend £35 billion - £12.5 billion on new and upgraded stations, electrification, and platform lengthening, a third on track renewals, and the remaining third on running the railways. It spent £36.2 billion in operating, reviewing, and maintaining tracks in the previous five year period (2009-14). 

Its management argues that NR is being squeezed by onerous cost reduction targets and rising service standards at a time when passenger traffic is growing at record rates. It claims to have reduced operating costs by 40% over the past decade and says that any further reductions are difficult. The result has been rising ticket prices, which has generated popular resentment and political opposition.

As it proceeds with reforming Indian Railways and introducing private participation, its administrators would need to take a more nuanced view of the whole process rather than a simple strategy of allowing franchising in passenger and freight traffic segments. 

Tuesday, March 24, 2015

Widening inequality and declining returns to labor

The conventional wisdom on increasing inequality across the world lays the blame on rising returns to capital complemented by declining (or stagnant) returns to labor.

These two trends revolve around three causal factors - trade, technology, and politics. Globalization and trade liberalization has increased the global supply of labor relative to capital; technological changes have lowered the price of capital and increased the substitutability of capital and labor, especially less skilled labor, thereby lowering the demand for labor; and political ideological shifts have undermined labor bargaining capacity. Four recent papers lend credence to the aforementioned factors.

1. Holger Mueller, Elena Simintzi, and Paige Ouimet, using firm-level data, find that "wage differential between high and either medium or low-skill jobs increase with firm size". This coupled with the increasing share of employment by the largest firms appears to point to rising firm-size as contributing to widening inequality. The benefits of size are appropriated by the skilled and senior workers at a firm - a cleaner or salesman in a small retail shop or big chain retailer gets similar salaries whereas the wage differential for managers is substantial. And the big chain retailers have been squeezing out the small shops.

2. Albert Bollard, Peter Klenow, and Huiyu Li examined manufacturing sector in US, China and India over 1982-2007 and find a rising trend towards larger sized firms. They reason that bigger firms have higher productivity, which in turn raises the barriers to entry for new and smaller competitors and entrenches the incumbents. The increased entry cost stems from "rising cost of labor used in entry, as well as higher output costs of setting up a business to use more sophisticated technologies".

3. Lukas Karabarbounis and Brent Neiman document a secular (across countries and industries) decline in global labor share of income over the past 35 years. They credit it to decrease in the relative price of investment goods, often attributed to advances in information technology and the computer age, which in turn induced firms to shift away from labor and toward capital.

4. Francisco Rodriguez and Arjun Jayadev document a similar secular decline in the labor share of income in manufacturing sector over the past three decade. They also find that "this decrease is driven by declines in intra-sector labor shares as opposed to movements in activity towards sectors with lower labor shares", thereby appearing to corroborate the findings of Karababounis and Neiman. 

Saturday, March 21, 2015

India real estate market fact of the day

From Livemint, adding to the long list of badly indebted corporates, comes debt-laden property developers, whose problems are exacerbated by unsold inventory,

At brokerage Kotak Securities, analysts estimate unsold inventory held by a group of leading Mumbai developers alone now stands at some Rs.53,400 crore—with an additional Rs.36,800 crore of project launches in the pipeline. That puts the current, unsold area in Mumbai at almost the value of the total sold in the 2014 calendar year. The backlog, analysts estimate, could take more than a decade to clear... It now takes developers about four-and-a-half years to turn property inventory into cash, more than a full year longer than it takes developers in China, according to Thomson Reuters Starmine data.
Another article points to a study by Knight Frank India which highlights the large volumes of inventory piled up across the largest cities. For example, in Delhi, even if no more properties are added to the market, the current inventory will take about 14 quarters to be sold.
However, this glut, mainly at the middle and upper end of the market, stands in stark contrast to the severe shortage at the lower middle income and lower income level (Rs 5-20 lakhs) markets. This trend points to a market failure in the housing market, demanding public policy action. 

Monday, March 16, 2015

The flawed orthodoxy - case of infrastructure contracting

The Economic Survey's advocacy for a strategy of "combining construction and maintenance responsibilities to incentivize building quality" in infrastructure asset creation is classic example of theory sans reality. It is also an example of how orthodox approaches can end up costing more than prudent strategies designed based on the existing market structure.

The fundamental assumption is unexceptionable - good building quality is critical to life-cycle costs, and a combination of building and construction aligns incentives to minimize life-cycle costs. But a first order requirement for this assumption to hold is that the construction contractor has a stake in operation.

In an ideal world, life-cycle costs minimization can be achieved by assembling a project development consortium of construction and operation and maintenance (O&M) contractors as well as financiers. As construction is completed, the construction contractor gradually exits, allowing the O&M contractor take over the project. But in the real world, especially in developing markets like India where the distinction between construction and O&M contractors is blurred, such tight alignment and seamless transitions rarely, if any, happen. Here, a GMR or HCC, after outsourcing the O&M to smaller contractors, sells their assets to infrastructure funds like SBI Macquarie or IDFC India Infra Fund and abruptly exits the project. This does little to align incentives towards minimizing life-cycle costs since the project developer predominantly performs the role of a construction contractor.

Conditional on the difficulty of combining construction and maintenance responsibilities, the most optimal strategy would be to de-couple the two activities. The road map,
  1. Establish a Special Purpose Vehicle (SPV)
  2. Put in place professional management and good governance practices (arms-length relationship with the government department/ministry)
  3. Construct, using mainly public funds, and off-load construction risk
  4. Stabilize the project and lower commissioning risks
  5. Contract out O&M as long-term concession
  6. Regulate the concession
The benefits are substantial. Public financing lowers the cost of capital for construction. Once the project is commissioned, real project information becomes available, which enables concessionaires to bid with far greater assurance. It also enables government agencies to write more complete contracts, which minimize re-negotiation risks. All this enhances transparency and limits political risks. On the other side of the risk assessment ledger, the biggest downside risk, which assumes significance given the country's state capability deficit, involves the governance of the SPV which is critical for both construction time and its quality.