Sunday, October 4, 2015

Government as engine of innovation

Mariana Mazzucato has a brilliant TED talk on government as investor, risk-taker, and innovator which questions the conventional wisdom on private sector as leading technology innovation with cognitively striking examples of Apple and the pharmaceuticals industry. 

Driving home the message that government, and not entrepreneurs, is the real engine of innovation, she informs that the NIH funds 75% of all revolutionary new drugs and that all the core technologies of iPhone (internet, cellular communications, GPS, solid-state memory, siri, touch-screen, capacitive sensors, and microchips) were the result of public innovation. She claims that government spending on research and innovation does more than fix market failure, it creates new products and whole markets. Further, interestingly, this and most other similar innovations and their commercial exploitation is largely confined to the United States. 
She argues that there is no substitute for long-term, patient government funding for scientific innovation and though the private sector in turn should be allowed to build on these innovations there should be a mechanism to plough back a bigger share of their profits to refinance more public spending on research. She gives the example of Finland's state research agency, SITRA, which retained its investments in Nokia and used the returns to finance newer research areas. 

Saturday, October 3, 2015

Weekend Reading Links

1. Dani Rodrik makes and assessment of India's economic prospects that deserves the attention of policy makers. When asked about the world's most over-rated economy by Tyler Cowen, Dani replied,
I think India, because I think the kind of growth that India has had, I don’t think it’s sustainable. Partly going back to our earlier discussion about premature deindustrialization. I think they have these plans to significantly strengthen their manufacturing base. I just don’t see it happening. I think India can grow at 4, 5 percent per year on a sustainable basis. I don’t think it’s going to be 8 or 9 percent. When this sinks in, I think there’s going to be a negative overreaction, would be my fear.
One could quibble about whether it is 4 or 5 or even 6, but I would tend to agree that 8-9% on a sustainable basis looks more hope than realism. India just does not have the base - infrastructure, consumers, industries, public spending, agricultural productivity, credit, and skilled labor - to support such growth for too long. These deficiencies feed into the other and constrains rapid growth, beyond very short bursts. On top of all these stand the biggest deficiency of them all, weak state capability. 

2. Lant Pritchett is as provocative on learning outcomes as only he can be,
If you want to find a child who lacks education today, the place to find them is in school. That’s because nearly all children are in school. That’s the good news. Governments have built schools and hired teachers. Parents have seen that schooling is key to their child’s future and are sending their children to school... But the bad news is that hundreds of millions of children are starting school, going day after day, year after year, but not really learning. One study found that almost three-quarters of a recent cohort of youth in Zambia were innumerate and six of 10 illiterate. But only 7% of these youth had not attended school. In fact, half of those who were innumerate and a third who were illiterate had not just started school but completed grade 6. These children were being schooled but not educated.
And interesting the call for greater research on learning outcomes,
Research will be an integral part of reaching learning goals. Knowing what you need to know isn’t the same as knowing it or knowing how to do it... Progress on learning goals requires getting systems of education on a much faster pace of improvement. But too little is known about how to do that – which accounts in part for the slow progress. The British government has recognised that and is funding research to generate the practical knowledge needed to improve systems of education.
3. Fascinating map (via FT) that captures the average monthly cost of renting a one bedroom flat within a kilo meter of all London's 250-odd tube stations. See the larger version here
The FT summarizes the affordability challenge,
For the 250-odd Tube stations in London, only a quarter have one bedroom flats costing £1,000 a month or less to rent. As you might expect, these locations are all concentrated at the extremities of lines, meaning a long journey and £225 a month for a zones 1-6 Travelcard. Across the capital, the average rent for a one-bedroom flat within walking distance of a Tube station works out to £1,327. And there are 20 locations where, if you were mad enough, it would cost you above £2,000 a month (all bang in the centre).
Here are interesting sites which show which areas in London are more accessible by bicycles or public transport, another which trades-off average commute times and average rents, and this map of rents on each tube line.

4. Guardian points to the findings from the World Bank-Gallup Global Findex Survey 2014, which asked over 150,000 respondents in 143 countries how and why they access financial services. As the map shows, the North-South divide is clearest in terms of where people spend their borrowed money.
Unlike the North, where mortgage dominates borrowing, in the South the largest share of loans are consumed by education and health care. In India, 21% of people took loans to finance health care needs, 10% to finance education, 9% for business, and just 4% for mortgage.  

5. I have blogged earlier about the corrosive political economy impact of the assault on incentives. A disturbing trend may have been initiated by the Maharashtra government in imposing a "drought surcharge" on items like fuel, liquor, cigarettes, jewelry etc for a period of five months to raise Rs 16 bn in tax revenues. Cash-strapped governments are likely to adopt policy interventions like these to circumvent the constraints imposed by the forthcoming national GST.

6. Early this week, the IMF released its assessment of emerging market corporate debt. The graphic below shows the status of non-financial corporate debt to GDP ratio of the largest emerging economies. 
Developing countries quadrupled their corporate borrowings from $4 trillion in 2004 to well over $18 trillion in 2014.

7. On the back of declining corporate capex investments comes news of fall in capital expenditure by public sector units (PSUs). Underlining the weak demand conditions, the Business Standard finds that the capex by 36 largest listed PSUs, who have been sitting on a cumulative cash reserve of over Rs 2000 bn, declined by 23.5% to Rs 1290 bn in 2014-15.

An RBI survey of ex-ante capital expenditure investment decisions of Indian corporates found that in 2014-15, 830 firms intended to invest in Rs 1459 bn, as against 1056 companies' investment plans for Rs 2081 bn in 2013-14. The time phasing of the investment intentions of these companies indicate likely investments worth Rs 1933 bn in 2014-15, 27% lower than 2013-14.

8. The Institute of International Finance (IIF) estimates that net capital inflows into emerging economies may turn negative for the first time this year, with more a trillion dollars of outflows as repayments of foreign currency loans by EM corporates, especially in China. 
The IIF estimates that indebtedness at EM non-financial corporates has risen five-fold over the past decade to $23.7 trillion. This is a good illustration of the scale of potential debt induced instability,
The IIF estimates that currency depreciation has increased corporate debt in Brazil by an amount equal to 7.3 per cent of gross domestic product, and 6.2 per cent in Turkey, for example.
9. The latest figures on stalled projects in India being tracked by CMIE points to an increase in their stock from Rs 8.8 trillion to Rs 9.9 trillion over the three months to end-September 2015. Interestingly, nearly a quarter of projects are stalled due to lack of promoter interest or commercial unviability. 
The stalling rate, or stock of stalled projects as a share of all projects under implementation rose to 11% in the last quarter, up from 9%.

10. Finally, amidst all the concerns about Japan's low female workforce participation rate, MR points to this graphic which shows that Japan has overtaken US in female workforce participation.
Funny that this fact escaped the attention of everyone calling for the release of third arrow of Abenomics.

Thursday, October 1, 2015

Winner's curse in auctions - minerals and telecom spectrum in India

It was inevitable and it now has surfaced on the horizon. Livemint points to a PwC/CII report that the power project developers who bid aggressively to secure coal blocks in recent auctions are reluctant to mine them on the face of the government's decision to cap fixed charges based on regulatory considerations. 

All the power sector coal-block auctions had gone into forward-bids, where not only would developers not pass on the cost of coal to customers, but, in some cases, even pay the government an additional premium (over and above the mandatory royalty and reserve price). It was claimed that the 66 blocks, awarded through auctions and allotments to state-owned firms, will generate revenues of Rs 3.35 trillion and electricity tariff benefits worth Rs 693 bn to consumers. Power producers, instead of bidding at a discount on the reserve price, even offered to give money to the government. Since you cannot buy something and give that free for 25-30 years, these bidders, all of whom have sunk investments in plants which are currently idle and bleeding money, were presumably betting on "smuggling" in the fuel costs elsewhere.
It was abundantly clear during the auctions that the developers had bid aggressively for fuel in the hope that they could recover the costs by transferring it into the fixed capacity charges for the untied part of the plant capacity (aside from the already existing PPA) and/or by the sale of the 15% of generation capacity as merchant power. Livemint also points to an ICRA report which estimated the under-recovery in fuel cost in the range from Rs.0.39/kwh to Rs.1.02/kwh on a levelized basis over a 25-year period and the aggregate under-recovery for the bidders at Rs.8 billion in FY2015-16 and about Rs.18 billion by FY 2017-18. 

At that time, Partha Bhattacharyya, who knows a thing or two about coal mining, had this interesting observation in an oped,
However, whether it is conducive to promoting sustainable mining depends only on the premise that the bidders be fully aware of the implications of their actions. Unfortunately, self-destructive bidding is not unknown in the Indian context. Bidding for ultra mega power projects (UMPPs) has provided examples in the not too distant past, with winners throwing up their hands after finding it impossible to deliver power at the offered price. Analyses of the root cause in all of these cases indicate an inadequate core competence in coal mining or coal sourcing as the underlying reason. In the present case of bidding among end-users, the possibility of a similar inadequacy cannot be ruled out.
Now that the government has capped the fixed capacity charges and the spot markets are down on their knees, the developers have no choice but to take unsustainable losses. In fact, even if the government had not capped the fixed charges, it is unlikely that developers would have been able to realize higher charges given the perilous state of discom finances. It is undeniable that the lack of clarity in the tender documents on the calculation of capacity charges and the failure to quell the doubts in unambiguous terms before the auctions encouraged the aggressive bids.

Much the same story is repeating in telecommunications, with call drops being the commonest manifestation. Irrespective of whether the spectrum available is adequate or not, it cannot be denied that telecom operators, who bid very aggressively in the 3G auctions, have, for some time now, been skimping on capacity improvement investments. As Shyam Ponappa describes, there are other failures arising from the quest for revenues maximization,  India's telecoms spectrum market,
India brought in more operators than other markets, didn't provide as much commercial spectrum, fragmented what it had, and priced it out of sight. Consequently, substantial spectrum is idle with the government, while large operators with very little spectrum and the legacy of underdeveloped fixed networks have over 100 million customers each, with high voice and growing data usage. This situation is likely to worsen as more spectrum holdings come up for renewal.
The widely acclaimed telecoms spectrum auctions realized revenues worth nearly $17 bn. Unlike with coal, spectrum already under use by incumbents was re-allocated through auctions. This left existing operators, who have massive fixed investments, with little choice but to bid aggressively to retain their spectrum. The net result is that India has become one of the costliest telecoms spectrum markets.
The exorbitant cost of spectrum adds to other headwinds that telecoms operators have to navigate. Though one of the fastest growing telecoms market in the world by customer-base, operator margins are squeezed by the lowest average revenue per user (ARPU) of about $3, less than a tenth elsewhere. This is exacerbated by cut-throat competition, with nearly ten operators in each circle. And now, the high cost of spectrum has sharply increased the debt burden of  operators, leaving them with little room to raise resources to invest on network expansion, maintenance, and upgradation.

This leaves operators with no option but to raise tariffs significantly, which will certainly constrain demand, and thereby work against the government's ambitious Digital India objectives. In a highly price-sensitive market where just one in hundred have access to high-speed broadband, and where the baseline penetration of data-services is very small, affordable prices are critical to expanding both customer base and services. 

The aggressive bids made both in the reverse auction (for coal blocks designated for power plants) and forward auction (for non-use specified blocks), and telecoms spectrum, and the attendant squeezing of possible margins, raises more questions about the unqualified acceptance of auctions in the allocations of natural resources.

There is a compelling argument that in the spectrum and mineral allocation auctions, government's immediate fiscal considerations have crowded-out larger sectoral objectives. In other words, the details of the auction design may have been skewed towards maximizing auction revenues than sustainable introduction of new technologies into the telecoms market or delivery of power at a reasonable price and rate of return. 

Interestingly, this skew may reflect the institutional power balance within the Ministries of Government of India, in particular the balance between the Ministry of Finance (MoF) and the respective line Ministries, Power and Telecommunications in this case. The MoF has a very hands-on approach in any such contract formulation, applying due diligence that invariably revolves around the binary "public interest" touchstones of expenditure control and/or revenues maximization. The recommendations of the respective regulatory commissions tend to get sidelined in the face of "public interest". The recent history of scandals and the chaotic investigations and prosecutions that followed, may have only amplified this trend. Not only have the advocates of "public interest" become stronger, the voices of the primary stakeholders, the respective Ministries, have become more wary of being seen to be doing anything which would appear to support the private market participants.  

To the extent that the operator or developer's cost is directly translated as the government's revenues, the MoF's role is clearly that of an agent of the government. Therefore, if the MoF prevails in setting the terms of contracting in such auctions and the departments abdicate their responsibilities as neutral arbiters in the auction, it necessarily becomes an one-sided contract. Winner's curse and renegotiations invariably follow.   

One of the oldest axioms of life is that there is no free lunch. The examples of natural resource auctions and public private partnerships (PPPs), which governments have come to view as as a resource mobilization opportunity and the latter as a means to avoid committing large resources for infrastructure investments, and their respective failings, are forceful reiteration of this axiom.

Tuesday, September 29, 2015

A housing market for the super-rich?

A few weeks back I had blogged about how property prices in Mumbai had exploded over the last decade, pricing all but a handful of those at the very highest level of the income ladder out of the market. As Michael Skapinker writes, this is true of London too,
Tiny apartments for £750,000. Family homes in the millions. This is in areas that, in recent memory, were poor and rundown. You can venture into neighbourhoods that still are, but you won’t do much better. The average London home cost £493,000 in February, according to the Office for National Statistics. And renting is no easier, taking a large chunk out of all but the highest salaries. Average London rents grew by 3.2 per cent in 2014-15, compared with 1.5 per cent in the rest of England... Many middle-class professionals are struggling to live in London: teachers, university lecturers, doctors, journalists. Look at the job ads. A senior house doctor in the urology department at University College Hospital: annual salary £30,002 to £47,175, plus a small London supplement. Assistant professor in international political economy at the London School of Economics: £51,908.

It was not always this way. Twenty-four years ago, when we bought a house in one of London’s loveliest neighbourhoods, our neighbours were, and still are, people who do the jobs described in these ads. None of us could afford to move into the area now.It is difficult to see how the successful candidates will find somewhere to live in a city where house prices are many multiples of their salaries... London boasts some of the world’s leading research hospitals and scientific institutes. Who will staff them? And if well-qualified professionals cannot afford to live in London, what of all those essential workers on even lower salaries: nurses, ambulance drivers, firefighters?

So, we live in an age where housing is unaffordable not only to the foot-soldiers of urban growth (janitors, small-service providers, small traders, lower-level public officials, and informal sector workers), but also to the knowledge workers and higher-level service professionals (senior public officials, academicians and researchers, professionals, and managers). In all these cases, a house of a standard that their parents (or the earlier generation) with similar relative incomes would afford, is simply out of reach, even if they use all their life-savings for the house. 

In the bigger cities on average, a Rs 10 million house (itself, a fast increasing lower limit), with a 30% upfront payment, would require an EMI of nearly Rs 75000, on a 25 year loan at an average of 12% interest rate. Assuming a third of income goes for housing, only families with annual income of around Rs 2.5 million can afford this. On the demand-side, in 2011-12, just 1.3% of all tax payers, or 3.9 lakh people in a country of 1.1 billion, had income above Rs 2 million! Multiply the number four fold, 1.6 million, and you realize that the affordability gap is staggering by several orders of magnitude. 

At the risk of repetition, it is abundantly clear that all urban housing, but for a marginal proportion at the top of the income ladder, has become unaffordable. Given the acute scarcity of vacant land within the city, the only answer to the problem is to go up vertically. Policies that promote addition of stock - higher FAR and lower property taxes (for vertical units), especially along transit corridors, coupled with release of large land banks locked up with various public entities - should take the center-stage of government's urban housing policy. This should complement the traditional affordable housing policies for the poor, like public housing programs, infrastructure grants, and mortgage interest subsidies. 

In fact, public policy should be tailored towards increasing the stock of housing, of any kind, without being unduly concerned with the details of means-testing and other regulation. For sure, this would result in some diversion to "ineligible" beneficiaries. But the demand is too huge at every level (except at the top-most tier), affordability heavily skewed, and the supply too limited for us to be micro-managing the housing market through unenforceable regulation. 

Further, as cities like London, Paris, and New York are finding out, it is also necessary to ensure that housing units and trophy properties do not become pure and highly remunerative investment avenues, which end up squeezing the housing supply itself. Underlining this, it is estimated that 28% of the wealth held by ultra-high net-worth Asian individuals (wealth above $30 mn) was in real estate, to 8% by Europeans and 6% by Americans. A telescopic property taxation system, with very high property tax rates for larger houses, and prohibitive enough vacant land tax on large land parcels, may be necessary to deter such rent-seeking. 

Monday, September 28, 2015

Is there no "missing middle" in India's industry?

Livemint recently had a graph which pointed to research which questions the hypothesis of "missing middle" in India's manufacturing. It shows that mid-sized firms (employing 100-1000 people) are the country's biggest employers.
Economists Chang-Tai Hsieh and Peter Klenow have this graphic which too does not reveal any missing middle.
The claim of "missing middle" comes from the work of Anne Krueger and others and is reflected in the graphic below taken from this IFC report.
Economists Chang-Tai Hsieh and Benjamin Olken question the "missing middle" hypothesis and claim that the "missing middle" came due to transformation of data (a bimodal distribution emerges when firms are categorized into three groups of less than 10, 10-49, and 50 and more employees) and using the distribution of employment share by firm size and not the (more relevant) distribution of the number of firms by size.
Their analysis leads to the following conclusions,
First, while there are fewer middle-sized firms in developing countries than developed countries, there is no missing middle in the sense of a bimodal distribution. Second, the average product of labor and capital is significantly lower in small firms when compared to larger firms. This is important because some theories say that small firms do not grow because they face high marginal costs of capital; if so, the marginal product of the capital that they do have should be higher. While we do not directly observe the marginal product of capital, it appears that the average product of labor and capital is significantly lower in small firms when compared to larger firms. To the extent that marginal and average costs move together, this fact suggests that large firms rather than small firms are the ones suffering the large fixed costs or shortage of capital that could stifle their growth.

Third, we consider the possibility that regulatory obstacles generate a missing middle, but find no evidence of meaningful discontinuities in the firm size distribution. We focus on regulations that kick in at a certain size threshold and test whether there are an unusually large number of firms right under the threshold and an unusually small number of firms right above the threshold: specifically, we focus on a size threshold of 100 employees in India where various labor regulations kick in; a revenue threshold in Indonesia above which firms are required to pay value-added tax; and a revenue threshold in Mexico above which firms face higher tax rates. However, we find no economically meaningful bunching of firms around these thresholds, which suggests that stories based on thresholds due to formality or regulations are unlikely to be causing major distortions in the economy.
The last point and the graphic above assumes significance in light of the conventional wisdom in India that restrictions on labor retrenchment for firms with more than 100 workers has been responsible for keeping firms small and unproductive. As can be seen, there is no statistically significant discontinuity as the firm size approaches 100 (the small kink seen for informal firms would amount to just 418 firms for all of India!). The authors also do not see any discontinuity that is claimed by conventional wisdom around tax notches in Indonesia and Mexico. While the restriction imposed by the Industrial Disputes Act is undoubtedly distortionary, there is little empirical evidence to suggest that it is an important constraint, leave aside being a binding one.

Apart from the bi-modal distribution, another interpretation of the "missing middle" is the absence of sufficient number of intermediate sized firms. This assumes significance since firms generally start small and only a small proportion of them grow into large enterprises, leaving a significant share of intermediate sized firms. Given that the greatest marginal job creation and value addition happens when small firms grow into intermediate size ones, the deficiency of such firms is a matter of undoubted concern for India.

Anyways, missing middle or not, the bigger problem for India's economy is the small size of its overwhelmingly vast majority of firms and their very low productivity, which does not increase with time. Neither do plants grow as they age...
... nor does their productivity rise with age.

This is the nature of the beast that the country needs to overcome. Improved ease of doing business, better infrastructure, access to affordable credit, steady supply of skilled man power, and less of corruption are all essential ingredients in this pursuit. In any case, the works of economists like Chang-Tai Hsieh exploring the reasons for the wide income differentials across nations draw attention to the role of resource misallocation across sectors, across firms within a sector (small Vs big), and within firms (negligence on management practices) as possible contributors to the dominance of such dwarfs and unproductive firms. 

Sunday, September 27, 2015

Weekend reading links

1. Livemint reports that thermal plant capacity utilization levels have touched lows last seen 15 years back. It points out that while capacity addition grew at 13.7 annually in the three years to 2015, consumption grew at just 6%.
The weakness of the consumption may actually be grossly understated by the growth figures, which in 2014-15, was an apparently healthy 8%. In the Indian electricity context, where demand is heavily suppressed by load-shedding and diesel and other high cost generation, any increase in demand is a mixture of both reduction in suppressed demand and actual increase due to new economic activity. In fact, contrary to the CEA figure of 4%, the rating agency ICRA estimates the true power deficit to be about 15%. Therefore, the headline figures are likely to be an over-estimate of the actual demand growth.

2. The boom in engineering college seats, which increased by over 250% in the 2006-07 to 2012-13 period, has burst. The AICTE estimates that nearly 600,000 of the 1.67 million engineering college seats in the country's 3470 engineering colleges may have to be shut down. More on the carnage in technical education,
Educational institutions have sought the AICTE’s permission to close down around 1,973 courses in technical subjects, citing a poor employment scenario and flagging student interest in 2015. The regulator has allowed the discontinuation of 757 such courses this year... Of the 757 technical and professional courses or departments that have been allowed to shut, the overwhelming majority of 556 were engineering courses, followed by 89 in pharmacy, 57 in computer application and 54 management, according to the regulator. In addition, some 83 colleges, including 46 management and 31 engineering colleges, have closed down so far this year. As much as 45% or 345 of the technical education courses closed so far this year are in Telangana and Tamil Nadu alone.
This is a timely reminder about what can happen when things grow faster than the system can support.

3. Livemint points to this research report by brokerage Nirmal Bang which finds India's Gross Financial Savings (GFS) to have touched a 25 year low in 2014-15 and is declining further,
According to the Reserve Bank of India (RBI) data, NFS of Indian households increased from 7.4% of GDP in FY14 to 7.7% last year. Although it is the highest level in the past four years, it remains way below the average of ~10% in the post-liberalisation period. The increase in NFS was primarily driven by the collapse in financial liabilities, as GFS fell to 9.8% of GDP, marking its lowest level in the past 25 years. A detailed look at GFS shows that households increased their exposure to risky assets (up 76% YoY) and long-term safe assets (up 25%), while their savings in deposits (on incremental basis) declined 25% in FY15. As risky assets account for only 4% of GFS, increased exposure to shares and debentures failed of offset the negative impact of deposits (which account for ~50%), as a result of which GFS fell last year. While NFS was up in FY15, the collapse in financial liabilities indicates lower physical savings, which forms a larger portion of total household savings. Consequently, the latter may have been lower in FY15. Not only this, a look at leading indicators reveals that GFS may have declined further in FY16.Incremental bank deposits are down ~22% YoY in the first five months of FY16, while currency holdings slipped by ~25%. Moreover, addition to assets under management of mutual funds was also down ~8% YoY in April-August 2015. Overall, households’ (gross) financial savings are most likely to have declined further this year.
4. Revealing Larry Summers quote as told by Elizabeth Warren,
After dinner, “Larry leaned back in his chair and offered me some advice,” Ms. Warren writes. “I had a choice. I could be an insider or I could be an outsider. Outsiders can say whatever they want. But people on the inside don’t listen to them. Insiders, however, get lots of access and a chance to push their ideas. People — powerful people — listen to what they have to say. But insiders also understand one unbreakable rule: They don’t criticize other insiders.
5. Fascinating article on the heavily subsidized Japanese rice farming sector and the JA-Zenchu rice farmers union, which has campaigned to limit imports, and keep out corporate farming,
Since the 1970s, Japan has effectively paid farmers not to grow rice, the so-called “set-aside” programme that has used hefty subsidies to encourage an ever greater proportion of Japan’s 2.5m hectares of rice paddy to lie fallow. In 1971, some 541,000 hectares were out of use. Today, the total stands at just over 1m hectares. “Even at that level of paddy fields out of use, JA is finding that it is still too small to maintain the desired price because demand is continuously declining. Also, rice farmers are reaching the limit of how much area they want to set aside: for emotional reasons, they want to keep on farming rice and are too old to learn the completely different skills of growing barley or wheat.
6. Doesn't this cartoon reliably caricature the hyper-sensationalistic, night-time news television in India?
7. The latest MGI report on gender disparity and economic growth shows that India can raise its incremental output by about 16%  or $ 0.7 trillion by 2025 if it merely matches the increase in female labor force participation rate of the fastest growing country in the region.  

India sits with Middle East and North Africa in its gender disparities. But increasing women's workforce participation would, more than enabling public policies, require large-scale social transformation on a scale equivalent to that which led to the weakening of caste barriers in Indian society over the later part of nineteenth century and early part of the twentieth century.

Thursday, September 24, 2015

Why do we gloss over state capability deficiencies?

Why do we consistently under-estimate state capability deficit and see technology and other innovations as the solution to public policy problems?

Consider three examples. One, using GIS to improve property tax collection. Two, technology interventions (GIS mapping, SCADA, smart meters and smart grids, etc) or financial engineering of state balance sheets to reduce distribution losses in their electricity distribution companies. Three, state-of-the-art regulation and processes to improve the effectiveness of regulatory institutions. All have been tried ad-infinitum not just in India, but across the world, with minimal success. 

It is not to say that these are not useful, but just that the underlying problems are fundamentally about weak state capability (at local government, public sector unit, and state/central government levels respectively above), and without atleast partially addressing them, the fixes suggested will hardly make a dent on the problem. In all these cases, policy makers over-estimate the contributions of technology interventions and process re-engineering in delivering the desired policy objectives. In fact, there are atleast six distinct biases that nudge us into an unqualified embrace of such interventions.

1. The desire for the tangible and conclusive. It has become part of the social internalization that everyone now views a policy intervention in terms of norms and components, clearly defined processes, time-lines, and a list of outcomes, all of which should form the basis for scaling up. Even when operational flexibility is afforded, the overall architecture is generally self-enclosed.

Unfortunately, most such policy interventions are transactional, requiring continuous engagement by officials at the cutting-edge with other human stakeholders. Such engagements, the quality of which is critical, cannot be prescriptive and decreed into implementation. They require capable and engaged individuals, who are sufficiently empowered (with resources and operational freedom), to discharge their responsibilities in an environment which allows them the freedom to do so.

Given that all these assumptions are questionable in the median case, the scaling-up challenge becomes simply humongous. We need less prescriptive and uniform approaches to dealing with the problem. But such approaches involve providing considerable program design and implementation autonomy with attendant delegation of responsibilities, which would make monitoring far more difficult (in fact, the current type of monitoring pretty much impossible) and outcomes less certain. In other words, this is an altogether different program design, implementation and monitoring paradigm. It would need greater tolerance for failures and turmoil and adoption of more dynamic program management approaches.

2. The partial equilibrium bias. In our problem solving moments, even when we are most logical, we rarely go beyond the first order problems. Accordingly, once we can do a GIS mapping of all the properties, the tax administration is reduced to a simple process of tagging and matching. This assumes that it is easier (than doing the same manually) to do GIS mapping and generate analytics, and then act on them to expand tax base and improve collection efficiency.

What if the implementation process of GIS mapping itself can be interminable (how many cities have completed even one iteration of city-wide GIS property mapping)? What if the process of constant updation of the GIS database can be a challenge (this assumes that the Town Planning guys have all the information available on the changes made to houses and new construction)? What if getting the tax collectors to act on the analytics may prove insurmountable (do we seriously believe that the bill collectors in their area or the Commissioner for the city as a whole already does not know about who are the big defaulters)? These, and many more, second and third order issues remain far from out thoughts when we support such interventions.

The neatness and simplicity of the partial equilibrium of the interventions, and the false sense of comfort that it provides, blinds us to the general equilibrium dynamics that are invariably generated and should necessarily be overcome for any such intervention to succeed.

3. Convenience bias. All of us are primed towards embracing something that appeals as neat and simple, and one which increases our convenience. For sure, GIS mapping and regulatory reforms appear very neat and simple, and are better than the existing systems to tackle the problem being addressed. It has always been the case that we demand "more and better, even when less is enough".

4. Optimism bias. It is always the danger that project teams under-estimate the magnitude of the task entrusted and see the road ahead with more optimism than it should merit. Accordingly, officials who champion a technology or process intervention are instinctively likely to under-estimate the problems and over-estimate their chances of success. 

5. Doing-something-new (or innovation) bias. When something is persistently wrong or a failure, we tend to over-react and assume that the existing design and processes have failed and we need to adopt something new. We have deeply internalized that failures are due to lack of innovation with design, process, and technology. Very rarely do we step-back to see whether the original design and processes themselves were rigorously implemented or not. It is very comforting to rationalize away failures by blaming it on the design and other extraneous factors, rather than questioning our implementation capability.

6. Best-practice bias. Occasionally, amidst the gloom surrounding the implementation canvas, we see bright-spots and embrace them as best-practice models to be transplanted across the world. Accordingly, the best-practice regulatory architecture is transplanted into a system which neither has the resources nor the pre-requisite environmental conditions for the effective implementation of the best-practice model. Little do we try to examine whether the bright spot was due to the extraordinary personal initiative of a committed individual or group of individuals or due to some systemically built (and therefore replicable) capacity. 

7. Finally, the illusion of control bias. No policy maker or political leader wants to face up to the reality that their primary implementation instrument, the bureaucracy, in its present condition, is just not capable enough to implement the proposed intervention, leave aside achieve the desired outcomes. Once this assumption is shaken, it can be a very unsettling process for bureaucrats and politicians to craft a policy intervention and its implementation plan. In fact, unlike earlier, when you only had to design a policy intervention (a best-practice model), now you have to also craft an implementation plan. Worse-still, you need to tailor the policy intervention, conditional on your implementation capability. Apart from being personally unsettling, the challenge associated is, in any case, now far more complex than before.

It is more likely that all of them bind in varying degrees nudging policy makers and political leaders to under-estimate state capability problems.