Monday, May 30, 2016

Minimax capitalism

The second principle of justice enunciated by the late John Rawls involves the maximin rule (or difference principle). It states that social and economic inequalities should be arranged so that "they are to be of the greatest benefit to the least-advantaged members of society".

As an extrapolation, a maximin society would be one where the incomes of the least disadvantaged rises the most. So which are the maximin societies?
This gets amplified when we see the trends for income growth at the top of the income ladder, which is most likely to be a mirror image, but with the orders reversed and magnitudes scaled up significantly, especially in countries like the US. For another example see the trends with hourly minimum wage.
What is it about American capitalism that makes it so much inegalitarian, so much of a minimax society, than any other capitalist society? And given that the country has one of the lowest inter-generational mobility among developed economies, it is not even as though it is a meritocracy. 

But for all these flaws, it continues to remain the "land of opportunities", if only for those equipped with the skills to be able to compete and embrace them. In other words, it remains the go-to place for the elites. No wonder then that Andrew Sullivan calls the rise of Donald Trump as an "extinction-level" even for American democracy and liberal order. 

Saturday, May 28, 2016

Weekend reading links

1. Livemint points to latest IMF figures which paint a dismal picture of rising inequality and poverty reduction in India. Net of taxes and transfers, India has the one of the highest inequality rates in the world at 51.36 in 2013, higher than even Latin America, and lower than only Papua New Guinea and China. And inequality rates rose faster than any place other than China. Reflecting on the possible causes, it finds that India does far worse in poverty reduction than China, Indonesia, Vietnam and others
And does a similarly bad job with middle class creation.
Taken together with the fact that China has produced a much larger middle-class, albeit also a much richer top 1%, India's inequality is worser than even China's. It is an inequality borne more out of the richest 1% becoming richer with stagnant incomes elsewhere. 

2. Charles Assisi has a very good longform analyzing Apple's intentions in the backdrop of Tim Cook's recent visit to India. I agree with him that manufacturing, which is what India hopes to convince Apple, may be a long shot. As to whether India can become a China-like market for Apple's premium products, I am not sure. In fact, given the figures above, the Indian premium market is likely to be no more larger than Indonesia's for the foreseeable future. 

3. Despite the high headline growth rates Indian Express, drawing on evidence from cement, steel, and passenger vehicle sectors, has this not so sanguine report about economic recovery in India,
In 2009-10, the operating rate of the companies was about 85%, and in the next two years, it varied between 75% and 78%. In 2015-16, latest data suggests, it was just about 69-70%. The average annual capacity addition then was 35-40 mtpa and now is just 10-15 mt. In the south, the industry actually shrunk by 1% last year... the industry is operating at an abysmal 55% capacity utilisation... The cement industry - which traditionally grew 1.1-1.2 times the GDP growth rate - grew just about 5% last year. In steel, which is more a globalised sector unlike cement, monetary and fiscal stimulus led to huge capacity addition and steel firms were operating at 80-83%. A dramatic shift has brought the operating rate down to 73%... The problem is huge capacities were set up during 2011-12 premised on much higher domestic demand and also external demand. But both slumped in the last couple of years... In 2010-11, car sales stood at 25.01 lakh units. Last year, it was 27.89 lakh. Even after five years, the industry has grown just 10% against a long-term average growth rate for cars has been 12-13% every year. The robust numbers in medium and heavy commercial vehicles too are largely driven by fleet replacement by big operators.
4. Excellent consolidation of the electoral map of European countries based on the ideological predispositions of their parties. As can be seen, the far right has made impressive strides in Austria, Denmark, France, Finland, Hungary, Poland and Switzerland.
In Austria, Norbert Hofer of the Nazist Freedom Party came close to winning 50% of the vote and narrowly lost the Presidential election run-off. Viktor Orban, the Hungarian Prime Minister, and his Fidesz Party have won the last two elections.

5. Business Standard reports that distressed assets sales have run into problems with very few deals consummated. Among the 33 assets worth $12.29 bn (Rs 82,343 Cr) put for sale since April 2015 by the Credit Suisse's ten most indebted corporate groups, just six (the value of four is just $379 m) have found buyers.

Such deals face pressure from both sides. On the one hand, the owners are hoping that a revival of the commodities and economic cycle will restore growth back to the heady days and repair their balance sheets. Creditors are reluctant to take haircuts for various reasons, including scrutiny by vigilance authorities. On the other side, buyers are wary of the regulatory concerns, including their ability to control the assets given that most of them are on lien to creditors, not all of whom agree on the way forward. Further, some of the projects are ab-initio unviable and would require significant markdowns.

6. A RBI survey has found that a third of the ATMs in India are not functional. Indian banks expanded their ATM network spectacularly, from 27000 in 2007 to nearly 200,000 by April 2016. As to the reasons for the non-working ATMs,
Bankers in India say that ATM machines may be out of order for a variety of reasons, from mechanical failure and paper jams, to software malfunction or lack of electricity, a common occurrence in India. If the ATM has run out of cash, then also it becomes temporarily unavailable for use.
One more reminder about the perils of rapid growth in any area in an environment where the capital base (human and physical) to support such expansion is not available.

7. In its efforts to achieve a better work-life balance, the Swedish town of Svartedalens has been experimenting with six hour work week (from eight hours) with no pay cut for nearly a year now. The Times writes,
Many Swedish offices use a system of flexible work hours, and parental leave and child care policies there are among the world’s most generous. The experiment at Svartedalens goes further by mandating a 30-hour week. An audit published in mid-April concluded that the program in its first year had sharply reduced absenteeism, and improved productivity and worker health.
Apparently, as people get more leisure and less work time, they tend to focus more and shirk far less. The net result is higher productivity, which more than makes up for the reduced work hours.

8. While I am no outright China bear, I completely agree with everything that Christopher Balding has to say about the implications of China's debt problem. It is very unlikely to have a soft-landing. The RMB-USD crawling peg is a binding constraint on policies to inflate away debt or further increase debt and stimulate the economy.

9. Switzerland will next month vote on handing out an unconditional basic income of SFr30,000 ($30,275) a year to every citizen, regardless of work, wealth or their social contribution. The idea has been championed earlier in 20th century by thinkers on the left, such as John Kenneth Galbraith and Martin Luther King, as a means of promoting social justice and equal opportunity, and on the right, including Milton Friedman, as a way of restricting the coercive state and restoring individual choice and freedom.

The emergence of technological changes and digital revolution presents both the threats (in terms of job losses and need for social security) and opportunities (in terms of ability to target and transfer cash) for initiating a universal basic income scheme. The Swiss referendum will in all likelihood fail this time. But the underlying idea of a robust social safety net to assure a dignified life for everyone in a world economy buffeted by uncertainties arising from forces like globalization, skill-biased technological changes, and automation is only likely to strengthen with time. 

10. Livemint shines light on credit rating agencies in India. The recent examples of Amtek Auto (CARE) and Ricoh India (India Ratings), where rating agencies abruptly downgraded the firms without assigning any reason have been big blows to the credibility of rating agencies. This is not one bit surprising given the poor corporate governance standards and pervasive corruption. 

11. I have blogged earlier about the Thames Tideway Project. Bazelgette Tunnel Limited, the project company established by Thames Water, London's monopoly water supplier, and the UK Government, has launched a bond sale to to raise £200m-£400m to finance the £4.2 bn Thames Tideway (or "super-sewer) project. The 25km long and 7.2 m wide tunnel, to be completed by 2024, will be built under the Thames and will supply sewerage services to Thames Water on a 125 year concession. About a quarter of the cost of construction will comes from Thames Water through an increase in customer's water bills, and the remaining £2.8 bn will be raised by the project company whose shareholders include Allianz, Dalmore Capital, Amber Infrastructure, DIF, Swiss Life Asset Managers and International Public Partnerships, all of whom have invested £1.2 bn of equity themselves. The remaining finance is to be raised by the company and includes a £700m 35-year loan from the European Investment Bank granted earlier this month, the largest ever for a water project.

Such projects are most certain to suffer delays and cost over-runs. Investors generally bear a major share of the construction risk given that project revenues start to kick-in only after the construction is completed. In order to mitigate these construction risks, the Tideway project is structured in a manner that the investors will receive an income, funded through consumer water bills, from the first day. In other words, the consumers act as "the backstop or insurer on the project, bearing the brunt of any cost overruns or incidents during construction". 

12. Conservative commentator Andrew Sullivan finds a parallel in Trump's rise to Plato's Republic. At the 'late-stage democracy', when democracy has widened enough to make elites lose authority, the populist demagogue enters the vacuum and seizes the opportunity, and democracy turns into a tyranny. He feels that the rise of media democracy during this century by "erasing any elite moderation or control of democratic discourse" strengthens the trend,
And what mainly fuels this is precisely what the Founders feared about democratic culture: feeling, emotion, and narcissism, rather than reason, empiricism, and public-spiritedness. Online debates become personal, emotional, and irresolvable almost as soon as they begin. Godwin’s Law — it’s only a matter of time before a comments section brings up Hitler — is a reflection of the collapse of the reasoned deliberation the Founders saw as indispensable to a functioning republic... We have lost authoritative sources for even a common set of facts. And without such common empirical ground, the emotional component of politics becomes inflamed and reason retreats even further. The more emotive the candidate, the more supporters he or she will get.
He draws historical parallels and concludes with a scathing assessment of the Trump phenomenon,
To call this fascism doesn’t do justice to fascism. Fascism had, in some measure, an ideology and occasional coherence that Trump utterly lacks. But his movement is clearly fascistic in its demonization of foreigners, its hyping of a threat by a domestic minority (Muslims and Mexicans are the new Jews), its focus on a single supreme leader of what can only be called a cult, and its deep belief in violence and coercion in a democracy that has heretofore relied on debate and persuasion. This is the Weimar aspect of our current moment. Just as the English Civil War ended with a dictatorship under Oliver Cromwell, and the French Revolution gave us Napoleon Bonaparte, and the unstable chaos of Russian democracy yielded to Vladimir Putin, and the most recent burst of Egyptian democracy set the conditions for General el-Sisi’s coup, so our paralyzed, emotional hyperdemocracy leads the stumbling, frustrated, angry voter toward the chimerical panacea of Trump... Trump is not just a wacky politician of the far right, or a riveting television spectacle, or a Twitter phenom and bizarre working-class hero. He is not just another candidate to be parsed and analyzed by TV pundits in the same breath as all the others. In terms of our liberal democracy and constitutional order, Trump is an extinction-level event. It’s long past time we started treating him as such.  
I am inclined to believe that this rationalization belies Sullivan's conservative bias. In fact, he equates widening of democracy to "our increased openness to being led by anyone; indeed, our accelerating preference for outsiders". The fundamental trigger for Trump's rise is the discontent and anger that the vast majority feel about an establishment that they feel has been captured by the elites. Trump has been peddling his policies to fuel this discontent. The American democracy could have matured without allowing such dramatic widening of inequality and egregious elite capture of the establishment. The conservatives should take the biggest share of the blame for this.
Talk about drawing wrong lessons from a crisis. 

The essay though is a great read.

13. Finally, Ananth is spot on with his assessment. No matter which way you look, the collateral damage inflicted by one individual is immense. If commentators start attributing motives to monetary policy actions and if the same echoes with popular gossip, then monetary policy making becomes fraught with dangers. In a country with a very noisy and cantankerous media, the incentive distortion for future central bankers can be damaging. 

India though is not alone in this. Look no further than the vilification campaigns by the like of Rand Paul, some of which even threatened physical harm on the Fed Chairman, Ben Bernanke, for allegedly debasing the currency with ultra-low rates. Maybe Andrew Sullivan has a point about the debasement of democracy by the democratisation of media. 

Friday, May 27, 2016

Asymmetric ignorance and monetary policy

Forward guidance has assumed a central role in monetary policy making in recent years as central banks try all possible means to stimulate economic growth. The forward guidance literature makes the distinction between Delphic guidance about public statements about “a forecast of macroeconomic performance and likely or intended monetary policy actions based on the policymaker’s potentially superior information about future macroeconomic fundamentals and its own policy goals,” and Odyssean guidance that involves clarifying ex-ante on the policymaker’s professed commitment. 

In this context, Ippei Fujiwara andYuichiro Waki argue that unlike Odyssean guidance, the Delphic guidance on private information available with central banks can be destabilising. Using a New Keynesian model, they find,
The underlying mechanism is simple and operates through the forward-looking, price-setting behaviour of sellers, i.e. the New Keynesian Phillips curve. Imagine that the sellers also receive some (private) information that is useful in predicting future cost-push shocks. Such information influences their inflation expectations and, therefore, the prices they set today. Their price-setting decisions become more susceptible to future cost-push shocks, and, everything else being equal, inflation becomes more volatile. Conveying news about shocks to the central bank’s loss function and shocks to the natural rate of interest has the same effect. In contrast to Odyssean forward guidance that helps stabilise inflation and the output gap, Delphic forward guidance can destabilise them in New Keynesian models.
A little asymmetric ignorance would help.

In this context, this GMO study by James Montier and Philip Pilkington assume relevance. They document very significant positive effect on equity prices over the past 30 years on FOMC meeting days after the meetings announcements. Their analysis found that since around 1985 the markets started to react significantly to FOMC days. Using a strategy of going long (buying) on the meeting days and zero on all other days of the year, over the years, they find
The authors write,
This means that we removed around 18 days a year in the 1960s, 14 days a year in the 1970s, and 8 days a year from 1981 onwards. During the period 1964 to 1983 there was absolutely no effect from removing these days. But, from 1985 onwards, removing fewer days began to have a major and increasing impact on the market. In fact, FOMC days account for 25% of the total real returns we have witnessed since 1984... the chance of this occurring randomly was only 0.0086% (that is, 86 out of 1 million).
Breaking down the effects over periods, they find that the average returns on FOMC days in the 2008-12 period were 29 times higher than the average on non-FOMC days!
In fact, the result was not, in a statistically significant manner, any different even when the Fed was tightening.
As the authors say, "it appears that the stock market reaction wasn’t driven by easing so much as it was by the fact that the FOMC was meeting at all!" Their monetary adjusted CAPE (cyclically adjusted price-to-earnings ratio), obtained by replacing the FOMC day returns with non-FOMC day average, leaves the markets significantly lower than today.

Thursday, May 26, 2016

Campaign finance fact of the day

Washington, too, is so deeply tied to the ambassadors of the capital markets—six of the 10 biggest individual political donors this year are hedge-fund barons—that even well-meaning politicians and regulators don’t see how deep the problems are.
I have blogged earlier about how the most corrosive effect of widening inequality may not be the inequality itself, but its effect in terms of how it enables capture of political decision making. The truism that "he who pays the piper calls the tune" is no different today than earlier.

The most telling example of this was the response in the US to the sub-prime mortgage crisis which left both financial institutions and homeowners fighting for survival. While the vast majority of the TARP was directed mainly at the financial institutions to save the TBTF institutions, the homeowners with negative equity were left with marginal assistance. It should not have been a surprising outcome given the grossly skewed participation in the discussions leading up to the finalization of TARP. The result,
A lack of real fiscal action on the part of politicians forced the Fed to pump $4.5 trillion in monetary stimulus into the economy after 2008. This shows just how broken the model is, since the central bank’s best efforts have resulted in record stock prices (which enrich mainly the wealthiest 10% of the population that owns more than 80% of all stocks) but also a lackluster 2% economy with almost no income growth.
It is in the political and social battleground that inequality wreaks its greatest damage. And it assumes even greater significance for India, which already has one of the highest and fastest rising net Gini index, since the antecedent social and other practices are likely to exacerbate the political capture problem.

Wednesday, May 25, 2016

The power of mild preferences

I have blogged earlier, pointing to the famous Schelling chessboard experiment, about how even mild preferences (among agents) can have surprisingly large macro-level general equilibrium effects. 

My examples focused on school choice and the use of vouchers - this on the dynamics associated with how school choice ends up enfeebling public systems and this on how voucher advocates confuse the merits of vouchers with the relative superiority of private schools. Intuitively school vouchers should be great - they enable choice and lets parents seek out the best schools, thereby fostering school competition and generating desirable outcomes all round. Surprisingly, the evidence from across the world (US, Chile, Colombia, Mexico, Sweden etc) in terms of improving learning outcomes (test scores), retention rates, and years of schooling is very mixed. In fact, in the most recent study from New Orleans (post-Katrina) reveals that it lowered learning outcomes. 

Now, Allison Shertzer and Randall Walsh examine neighborhood-level data to study segregation in US cities over the 20th century and comes to similar conclusions. They point to a similar trend contributing to the distinct US urban segregation pattern of white suburbanization and black core, 
Whites began resorting themselves away from black arrivals in the first decades of the 20th century, decades before the opening of the suburbs. Our analysis isolates the channel of white flight from institutional barriers that constrained where blacks could live in cities. We argue that accelerating white population departures in response to black arrivals at the neighbourhood level can explain up to 34% of the increase in segregation over the 1910s and 50% over the 1920s. Importantly, our analysis suggests that, while discriminatory institutions faced by blacks were clearly important, segregation may have emerged in US cities even in their absence simply as a consequence of market choices made by white families... Our results indicate that one exogenous black arrival was associated with 1.9 white departures in the 1910s and 3.4 white departures during the 1920s.
Their conclusion is very important,  
Policies that reduce barriers faced by blacks in the housing market may not prevent or reverse segregation as long as white households continue to resort themselves away from potential black neighbours.
But there may be one more wrinkle to this story. Such policies, whether in housing or schooling, is unlikely to directly achieve its desired objective of increased mixing among communities. But what if the desegregation contributes to attenuating preferences and making mixed habitations less unacceptable? What if it contributes to greater social integration? What if, over a long period of time, the general equilibrium effect in favor of social integration is greater than the similar effect towards segregation? 

Tuesday, May 24, 2016

Globalization and taxation

In recent times, amidst weak global economic prospects and rising protectionist sentiments, an intense debate about globalization has resurfaced. Peter Egger, Sergey Nigai, and Nora Strecker have a new paper which adds to the debate by raising the possibility that globalization may have had the effect of increasing the reliance of governments on less mobile middle-class tax bases. They examined a taxation database of 65 countries in the 1980-2007 period, and find significant effects as globalization gathered pace post-1994. 

Their narrative is simple. As economies open up and globalises, businesses and high-income individuals become footloose or to paraphrase Charles Tiebout, "vote with their feet". One way countries compete to retain and attract them is by lowering the corporate and marginal tax rates. In the process, among developed economies, on the average and when there is limited induced economic activity, tax revenues from these sources decline, forcing governments to rely more on the relatively immobile middle-class incomes. The authors write,
When goods and factors became relatively more footloose after 1994, evidence suggests that OECD governments found it more difficult to tax (arguably highly mobile) high-income earners. Moreover, in light of competition for such often high-skilled individuals, countries have further sought to decrease those individuals' personal income tax rates and compensated the foregone revenues by increasing taxes on individuals with middle incomes (and lower bargaining power than high-income earners)... under the threat of flight of high-skilled workers, governments reduced taxes for mobile high-income earners and increased them for the immobile middle- and upper-middle-income classes. 
Consider this. Middle-class income tax rates have increased by around two percentage points across 65 countries, whereas corporate and marginal tax rates have declined significantly. 
And, for the OECD countries, the burden has been carried by those at the middle, especially post-1994.
This effect is likely to get amplified as other technology-driven trends like e-commerce and remote working gains ground. The losers of globalization will perceive that their jobs are being taken by foreigners and their tax rates are rising. The widening inequality will exacerbate the discontent and generate more backlash against globalization.

There are no easy solutions. A two-pronged response may be the only way forward. One, the losers will have to be compensated by way of a stronger social safety net complemented with re-skilling programs that equip them with occupational mobility. The corollary of this though is to increase tax rates on the winners so as finance the benefits for the losers. But this redistribution runs into the Tiebout problem.

This brings us to the second response, which is about international coordination on taxation policies to prevent a race to the bottom. More so at a time when the global economy is weak, investments anemic, and international trade stagnant, and income growth confined to the highest earners, any competitive tax reduction is most likely to be a zero-sum game for all countries put together. No country gains without hurting others. In other words, tax reduction merely increases arbitrage opportunities without any commensurate increase in productive efficiency and output. In the absence of some form of global coordination or restraint, economies will be encouraged to indulge in competitive tax reduction that would only increase the relative tax burden on the middle-class everywhere. 

Monday, May 23, 2016

Shaping expectations - taming inflation and corruption

Both inflation and corruption are a function of expectations. Further, both have high levels of hysteresis and the resultant tendency to get entrenched. Once internalized, dismantling requires vigorous efforts to reshape expectations. In the process, collateral damage is inevitable.

In an environment where inflation expectations were unhinged, India's central bank Governor Raghuram Rajan has sought to cement low inflation expectations through an extended period of monetary tightening, even at the cost of economic growth. It has been acclaimed by experts, who have hailed him as India's Paul Volcker. 

On a similar vein, in an environment where corruption in senior level postings had become pervasive, the Government of India's Department of Personnel and Training has sought to reshape expectations by adopting an extremely rigorous process of screening. Unsurprisingly, the multiple levels of due-diligence for integrity and efficiency have come at the cost of causing delays and leaving many posts vacant/unfilled for long periods. Senior level positions in banks and public sector units have remained unfilled for long periods. The same experts complain that the delays in filling up posts have caused administrative paralysis.    

While the jury is still out on whether inflation has been slain or not, it can be fairly confidently asserted that the expectations on personnel deployments have been favorably reshaped. But not if you have been following the mainstream media. Clearly what is sauce for the goose is not sauce for the gander!