Tuesday, May 3, 2016

More on saving capitalism from capitalists

Privatization of profits and socialization of losses is an increasingly common feature of modern capitalism, one which threatens the credibility and sustainability of capitalist enterprise and invariably provokes a populist backlash. It has become a disturbing feature across the world that even as promoters grow rich, their businesses become enfeebled and poor.

The latest is British Home Stores (BHS), the British department stores chain with more than 11,000 employees, and its promoter,
Sir Philip Green bought the business... for £200m in 2000. He and his family received £586m in dividends, rental payments and interest on loans before he sold BHS for just £1 last year... Meanwhile, the BHS pension fund fell from a surplus of £17m in 2002 to a potential deficit of £571m today, a sum strikingly similar to the profit taken out of the company by the Greens. BHS has not made a profit since 2008... By paying bigger dividends than would have been possible without, among other steps, underfunding the pension fund and in effect paying dividends out of borrowed money, the Greens were able to withdraw large sums from the business. Without the necessary investment, and saddled with debt, the company has simply not been able to compete in a highly competitive sector...  
the buyer of BHS, Retail Acquisitions... has failed. Why did the directors permit a serious business, with significant pension liabilities, to be acquired by a group that had no chance of turning it around? Of course, this has not stopped the new owners from taking more than £25m out of BHS for just over a year’s work, albeit including more than £11m for legal and professional fees.
The asset stripping happened this way,
Over the 13 years from 2001, and despite a brief surge between 2006-08, capital expenditure totalled just £349m. That was far below BHS’s £438m cumulative depreciation charge, suggesting the shops were becoming more worn out... For the first few years, tough cost control allowed profits at BHS to recover. This helped the company to pay £423m in dividends between 2002 and 2004, allowing Sir Philip not only to recoup the purchase price, but more than twice that amount just a few years after taking control... a large chunk of them — some £290m — was paid when the pension fund was already in deficit... Another issue is that the dividends not only far exceeded the profits made in the years they were paid, they dwarfed the total cash profits of £223m made by BHS over the entire period of Sir Philip’s tenure... other tactics that may have further reduced financial flexibility... included selling a number of freehold stores to a company controlled by Lady Green, which then proceeded to levy rents on them. BHS was also charged nearly £600m for management services, which far exceeded the amounts charged by Storehouse and escalated even as the business shrank.
The FT article is spot on with its assessment,
This is the dark side of capitalism: in­creased borrowing and payment of ever bigger dividends; risk transferred from the private to the public when the business fails; the low paid and the taxpayer left to pick up the bill. It is all worryingly reminiscent of the 2008 banking crash... The BHS story is a case study in many unpopular aspects of modern capitalism: exploitation of limited liability, loophole-ridden tax law and intricate accountancy.
In this context, the news that Indian corporates have been making generous dividend payouts despite anemic profits growth deserves closer scrutiny. The dividend paid by a sample of the country's top 144 listed companies more than tripled over the past five years whereas profits increased by 50%,
These companies will pay Rs 61,087 crore in equity dividends to their shareholders for FY16, an increase of 19.2 per cent year-on-year compared to Rs 51,262 crore in FY15. In comparison, their combined net profit is up only 5.7 per cent year-on-year in FY16... In FY16, companies in the sample will share 43 per cent of their net profit as dividend, up from 38 per cent in the previous year and 19.3 per cent in FY11. In FY15, BSE 500 companies had together paid equity dividend of Rs 1.45 lakh crore. The combined dividend payment by these 144 companies has clocked a compounded annual growth rate (CAGR) of 26.7 per cent during the past five years, which is more than thrice the underlying growth in earnings. The combined net profit for the sample grew at a CAGR of 8 per cent during the period.
A similar trend is visible in the historical data for the S&P BSE Sensex 30 companies, though less pronounced. In the last five years, the underlying dividend pay-out by the index companies has grown at a CAGR of 13 per cent, against 7.5 per cent CAGR growth in their underlying earnings per share during the period. Sensex companies now pay around 30 per cent of their net profit as dividends up from around 22 per cent in April 2011.
This trend raises concern, especially given the country's none so stellar record on corporate governance and regulatory oversight. A 40% dividend payout ratio is par for the course in developed markets with mature businesses. But in a growing market, businesses are more likely to invest in expanding their businesses than returning capital. In fact, a combination of steeply rising dividend payout when the profits are flat, coupled with stagnant corporate investments, increases the likelihood that businesses are dipping into their reserves to satisfy their shareholders. 

This too may be alright, at least legal. Unless there is some asset stripping going on. Many Indian firms are thinly capitalized and labor regulations poorly enforced. What if there are Philip Greens and BHS's who are stripping assets even as their EPF or private pension funds are being starved? It  would not be one bit surprising. Maybe an opportunity for greater regulatory scrutiny. 

On the same theme, there is a fascinating article in New Yorker on the SEC investigations against Goldman Sachs for its Abacus investment deal made on behalf of hedge fund John Paulson & Company. The deal involved the sale of risky mortgage bonds to Goldman's clients, whose counterparty was John Paulson & Company. In the article, James Kidney, the SEC lawyer who was part of the investigations, bemoans the "capture" of SEC and narrates how the regulator chose to refrain from pressing criminal charges against senior Goldman executives in return for monetary fine and indictment of a low-level trader. 

In fact, Mr. Kidney describes the SEC as "an agency that polices the broken windows on the street level and rarely goes to the penthouse floors". The article describes Kidney's assessment of the reasons for this attitude of the regulators like SEC,
The oft-cited explanations—campaign contributions and the allure of private-sector jobs to low-paid government lawyers—have certainly played a role. But to Kidney, the driving force was something subtler. Over the course of three decades, the concept of the government as an active player had been tarnished in the minds of the public and the civil servants working inside the agency. In his view, regulatory capture is a psychological process in which officials become increasingly gun shy in the face of criticism from their bosses, Congress, and the industry the agency is supposed to oversee. Leads aren’t pursued. Cases are never opened. Wall Street executives are not forced to explain their actions.
Such egregious excesses and jaw-dropping brazenness, and the failure of gatekeepers to regulate them is, unfortunately, an increasingly commonplace feature of economies across the world. At a time of widening inequality and alarming concentration of incomes at the very top of the income ladder, it chips away at capitalism's credibility. 

Sunday, May 1, 2016

India tax base facts of the day

More definitive data released by the Department of Revenue that validate the narrow nature of India's direct taxation base.

In the period from 2002-03 to 2007-08 tax revenues and tax-to-GDP ratio rose impressively and revenues exhibited very high buoyancy. Unfortunately, since then trends have been disappointing. 
Interestingly, the 2002-08 period was accompanied by a significant broadening of the income tax base, which would have contributed to the high tax buoyancy. 

The disaggregated picture of income tax assessees for 2012-13 - a total of 31.19 million taxpayers with a net tax payable of Rs 3.896 trillion - reveals a disturbing concentration at the top of the income ladder. Just 0.001% of the taxpayers who had more than a billion in income contributed 37.62% of the total taxes. A very high 55.63% of tax assessees did not pay any tax and those with income below Rs 5 lakh formed just 14.62% of the tax revenues.  
In absolute numbers, 21,879 taxpayers paid tax more than Rs 10 million, just 2532 above Rs 100 million, 315 above a billion, and a mere 63 above Rs 5 bn! Like with corporate tax, exemptions hurt. In 2012-13, a total of Rs 15.56 trillion was returned, four times the total tax payable itself! Business income tax assessees were the biggest beneficiaries. Just 198 taxpayers claimed exemptions worth Rs 4.29 trillion!

As is more widely known, the story is much the same with corporate tax data for the country, available in the excellent MCA database.
Just 1945 companies had paid capital more than Rs 1 bn and 85% of them had PUC below Rs 5 million. In terms of taxation, for 2012-13, just 1044 firms had more than a billion in profits before tax.

In terms of specific challenges, arguably the two biggest obstacles to the country's sustainable growth are the very narrow corporate and income tax bases and creation of the massive numbers of jobs required to manage the transition from agricultural to a modern economy.

Saturday, April 30, 2016

Weekend reading links

1. The story that Africa, with its burgeoning middle-class and a new dawn of democracy, would be the new East Asia was always questionable. Now "over-exuberance has given way to uber-pessimism",
In its semi-annual report, the World Bank forecast growth in Sub-Saharan Africa of just 3.3 per cent this year, less than half the average of 6.8 per cent recorded between 2003 and 2008. Because of their growing populations, most African states need nearly 3 per cent growth just to stand still in per capita terms.
The biggest challenge for the African economies is their lack or slow pace of productive structural transformation, a problem not amenable to easy solutions,
Perhaps the biggest flaw in the middle class story is that, with a few exceptions, Africa hardly makes anything. For too many countries, the economic model continues to be to dig stuff out of the ground and sell it to foreign companies... Unless governments can build sustainable growth models less dependent on commodities and based more on adding value domestically, the ‘Africa Rising’ story will be just that: a story.
2. This snapshot of the reversal of commodity prices since January 2014 says it all,

3. Gavyn Davies points to the relative exchange rate movements since 2010, which marks out renminbi as being the biggest loser, in terms of currency appreciation.
The scale of renminbi's appreciation makes it a ripe candidate for an one-way bet, something which Beijing would go out of the way to dispel.

4. FT points to China's spectacular debt accumulation, rising from 148% at end-2007 to $25 trillion (163 trillion RMB) or 237% at March 2016., far higher than the emerging markets debt to GDP ratio of 175 at the end of Q3 2015. New borrowing rose by 6.2 trillion RMB in Q1 2016, the biggest three-month surge on record. As the graphic below shows, the country today has the largest corporate debt ratio among all major economies.
However, the article's reference to the concern of Michael Pettis and others about a Japan-style balance sheet recession in China may be overblown. For a start, there is a compelling argument that demographics has been the driving force behind the Japanese problems. More importantly, in terms of the space for responding, unlike Japan, the government and households in China are among the least indebted. The big worry with China would be the impact of large-scale corporate defaults and its impact on a largely public banking system, which gets amplified as the government struggles to increase consumption spending by consumers.

5. Bloomberg reports that $7.8 trillion of sovereign bonds are currently yielding negative rates, as against just $3 trillion yielding more than 2%!

To put the distortions in perspective,
Ireland’s 100 million euros ($113 million) of bonds due in 2116 were issued to yield 2.35 percent -- similar to yields that benchmark 10-year German bunds offered as recently as 2011.
And FT has country-wise break-up of negative yield debt,

Half a century ago, harvesting California’s 2.2 million tons of tomatoes for ketchup required as many as 45,000 workers... by the year 2000, only 5,000 harvest workers were employed in California to pick and sort what was by then a 12-million-ton crop of tomatoes.
7. FT has a longform on China's robot revolution, which will make it the largest operator of industrial robots in the world by the end of the year. Even as it is automating its factories with robots, its entrepreneurs have been moving very rapidly up the robot production chain. Backed by government support, Chinese robot manufacturers have been rising fast. In 2014, President Xi Jinping called for a 'robot revolution' to address labor shortages and improve Chinese manufacturing quality, and exhorted,
Our country will be the biggest market for robots, but can our technology and manufacturing capacity cope with the competition? Not only do we need to upgrade our robots, we also need to capture markets in many places.
Driving the rapid adoption of robots in China is its economics - the payback period of robots fell from 5.3 years to 1.7 years in the 2010-15 period and is expected to fall to 1.3 years by 2017. 

8. Corporates in the US may be flush with cash surpluses. But the market expectations of long-term corporate health may have rarely been as bleak as now,
Three decades ago, the club of triple A-rated American corporate borrowers was a busy place. About 60 big companies, ranging from Pfizer to General Motors, were deemed so “safe” that they held this coveted tag from the credit rating agencies. No longer. Standard & Poor’s has just stripped the mighty ExxonMobil of its triple-A rank because of understandable concerns about falling oil prices and mounting energy sector debt... This leaves just two — yes, two — American companies still in that triple-A club: the unlikely duo of Microsoft and healthcare giant Johnson & Johnson.
This further shrinks the global space of "safe assets", thereby amplifying the flight in "search of yield". In this context, Gillian Tett also points out the parched global landscape for "safe assets",
Ricardo Caballero and Emmanuel Farhi calculate, using data from Barclays, that between 2007 and 2011, the value of safe assets fell from $20.5tn to $12.2tn, equivalent to a drop from 36.9 per cent of global gross domestic product to a mere 18.1 per cent... Prof Caballero and Prof Farhi argue the imbalance is so severe that the problem confronting the world today is not a “liquidity” trap but a “safety trap”: the shortage is creating a self-reinforcing, panicky cycle that is contributing to stagnant growth.
More stringent post-GFC financial market regulatory provisioning norms, QE purchases by central banks, growing global sovereign indebtedness, and now the shrinking space of AAA rated corporate debt, have all contributed to the scarcity of "safe assets".

Thursday, April 28, 2016

Geng Yanbo and the transformation of Datong

NYT has this brilliant documentary made by Qi Zhao and Hao Zhou that captures the tenure and life of Mayor Geng Yanbo of Datong municipality, who transformed the city over a five-year period by relocating nearly half million people and overseeing the redevelopment of the city's ancient quarter.
The script is strikingly similar with at least a handful of municipal commissioners and corporations in India - intense and committed, rough and abrasive, impatient with ambitious timelines, slow-moving bureaucracies, endless inspections and reviews, haul up slacking contractors, threats to bring around defiant property owners, petitioners and endorsements, heavily overworked with early mornings and late nights, tough on families, and finally transfers, protests, and successor syndromes. Not to speak of the paraphernalia and accompanying staff. The difference is that the squatters would have a court order, the defiant citizens not so meek and have the support of some political party or other, the telephonic instructions to get work done not anywhere as effective, the instant decision making to change a pipe size impossible, the contractors still be unable to hasten beyond a point, the threats to fire or shift officials blunt, and the tenures limited to 2-3 years (so fly-overs or road widenings are more likely than relocations). More often than not such leadership goes hand in hand with controversies, which in turn increases the likelihood of faster transfers and even shorter tenures!

The outcomes are reflected in the state of Chinese and Indian cities! Whatever the enabling policy frameworks, it is the dynamics of field level implementation that makes the difference. And it is in getting stuff done that the Indian state, for whatever reasons, pales in comparison.

Tuesday, April 26, 2016

Selling stressed bank loans

Livemint reports that Stanchart's efforts to off-load $1.5 bn in stressed loans has found few takers, even with attractive haircuts. The only interested buyer, SSG Capital, is apparently offering to buy the stressed loans with a haircut of only 30%. This, as per the World Bank's latest Doing Business Survey, would be far higher than the country's average haircut of 74.3% and comparable to the OECD's average of 28.1%.
But, despite the very attractive valuation, Stanchart is apparently in no hurry to sell the asset. Livemint quotes an insider, 
The current process is aimed at arriving at a valuation. Depending on the valuation they receive, they will assess whether they can recover more internally. The bank has already taken full provisions on these loans. They are not in a hurry to get rid of these.
There have been several news reports in recent days of intense activity in the buyout market with the arrival of major global LBO firms. But there have been very few actual transactions. In 2015-16, just 15% of the total of Rs 1.1 trillion assets put for sale were actually sold. It is widely accepted that public sector banks are naturally averse to taking haircuts for fear of subsequent vigilance and other proceedings. But the apparent reluctance of the likes of Stanchart to sell their bad assets, even at very attractive valuations, may point to deeper challenges in off-loading bad assets. 

One possible reason could be that banks, public and private, are encouraged by the prevailing incentive structures to retain the loans as long as possible in the hope of recovering as much as possible or even in the belief that the asset would repair with time. Consider the pervasive practice of banks floating Asset Reconstruction Companies (ARCs) and selling their bad assets to these entities in what has been described as "right-pocket, left-pocket" transactions. Similarly, the provisioning rules too may be encouraging banks to hold out for as long as possible. 

The Government have, including in the Union Budget 2016-17, taken several steps to allow majority foreign ownership of ARCs, even 100% ownership by sponsoring entity, 100% FDI on automatic route, complete pass-through of income tax on securitization trusts to their investors, and permit non-institutional investors to invest in securitization receipts (SRs). But they may not be enough to overcome more deep-rooted structural factors. 

While the RBI has been constantly taking action to mitigate the incentive distortions from such practices, it has refrained from imposing a clean break between the bank and ARC, if at least for certain categories of loans. Unfortunately, such incrementalism is unlikely to yield the desired results. Neither do the sponsoring banks, and their subsidiary ARCs, have the competence to effectively restore the asset, nor will the ownership structure allow their respective managements to take the hard decisions necessary to achieve the objective. More disturbingly, this may also be discouraging genuine sales of assets and the emergence of a vibrant market in stressed assets. 

In fact, we may only be kicking the can down the road, with the attendant risk of having to pay a much higher cost when the sale eventually materializes, as it must in most cases. In the circumstances, a prudent strategy may be to limit such conflicts of interest and cut the umbilical cord between the asset selling banks and asset purchasing ARCs, at least for certain categories of bad assets, and allowing for structured transactions which claw back a share of windfall gains, in any, in the future.

Sunday, April 24, 2016

Weekend reading links

1. MR points to Ruchir Sharma's very bleak assessment of the Brazilian economy. He paints the picture of an economy intimately tied to the global commodity cycle and dynamism smothered by a massive bureaucracy and public spending,
Brazil’s GDP growth rate has fallen from 7.5% in 2010 to minus 3.5% last year. This decline followed the collapse in commodity prices that began in 2011... Today the average Brazilian income is about 16% of the U.S. average, with basically no gain for 100 years... Even more striking, since the mid-1980s Brazil has seen its GDP growth rate track commodity prices more closely than any other nation in the world. Brazil’s fortunes are so closely tied to the global commodity cycle in part because so little works inside the country. The private economy does produce some internationally competitive companies in auto parts, aerospace and other industries, but they thrive by dodging a growing bureaucracy that smothers the rest...
The country appears to be a classic example of a country entrapped in commodities and an over-generous welfare state, 
Spending by local, regional and national governments amounts to 41% of Brazil’s GDP, the largest for any country in its middle-income class, and a scale close to those of much richer European welfare states such as Germany and Norway. Brazilians face the heaviest tax burden of any emerging country, with collections amounting to 35% of GDP... The budget is very rigid, most of it going to salaries and legally mandated social entitlements, which are growing. Over the past 15 years, public pensions have increased from 3% to 7% of GDP. Brazilian men typically retire at age 54 and women at 52, earlier than in any major European country, drawn into the golden years by generous benefits. On average Brazil pays pensioners 90% of their final salary, compared with an average of 60% in developed countries.
The basic issue for Brazil is that heavy state spending tends to push up interest rates and borrowing costs, depress private investment and defer any shift away from commodities. Under Lula and Ms. Rousseff, Brazil has grown more reliant on soybeans, with commodities now accounting for 67% of exports, up from 46% in 2000. Brazil’s manufacturing industries remain anemic, representing only 11% of the economy, near the bottom of emerging-economy rankings.
2. Ed Morse, the head of Citi's commodities research, talks of a new oil order, where the rise of US has rendered OPEC "irrelevant",
The US is now arguably the world’s largest oil liquids producer in the world, if you take into account crude oil production and other supply like liquefied petroleum gases (LPGs), biofuels output and the incremental volumetric gains from having the largest refining system in the world. On paper the US might produce 9.3m barrels a day against Russia’s 11.1m b/d and Saudi Arabia’s 10.3m b/d. Add everything that looks and smells and is used as oil and the US is the biggest of the lot, producing 14.8m b/d versus the kingdom’s 11.7m b/d, versus. Russia’s 11.5m b/d.
And the basis for his conclusion,
US has production based on competitive decisions of hundreds of independent producers, which now, unshackled, can sell oil at home or abroad. That makes an enormous difference, especially when considering the nature of marginal production in the US, which comes from shale resources. These rocks are not only superabundant, but they can be exploited at a relatively low cost. Just compare an offshore well at $170m with a vertical shale well that costs under $5m, with a five-year payout for a successful deepwater well versus a mere five-month payout for a shale play. And multiply a single, individual shale well by hundreds of wells and hundreds of decisions and you get a new world order.
Shale, for sure, has changed the global oil market dynamics. But I am not sure that it is wise to draw too sweeping conclusions from events of recent memory. If any analyst says that an incremental 5-6 mbd in a 95-96 mbd global market has rendered OPEC "irrelevant", then I would be inclined to discount that source of research.

3. WSJ has interesting news on India's pharmaceutical companies, which are aggressively pursuing niche treatment areas, apart from generics,
Close to a third of all FDA applications in the nine months through September were by India’s multibillion-dollar pharmaceutical industry, which accounts for 40% of generic drugs sold in the U.S. That figure, the latest tally available, is up from 19% during the same period a year earlier.
For all the bad press that the pharma industry gets from US FDA actions, it ranks on par with IT as corporate India's most remarkable world-class achievements.

4. FT has a report which appears to indicate that Sun Edison's woes are likely to affect its Indian operations. The report talks of a cash transfer from the account of one of the company's yieldco TerraForm Global into its own account to pay off a margin loan in November 2015, which is now part of a lawsuit filed against the company,
It approved an $150m advance against some unfinished solar plants in India that TerraForm was planning to buy from SunEdison at a future date. The money pinged from TerraForm Global’s bank account to SunEdison’s to pay off the margin loan “mere minutes before the 3pm payment deadline”, according to the lawsuit.
In any case, given the close links between Sun Edison and its yieldcos, it is unlikely that the latter will be able to avoid being dragged into the bankruptcy process by creditors.

5. Livemint points to the newly released data from the Global Consumption and Income Project (GCIP), which suggests that the official figures may be understating the true extent of poverty in India. The poverty rate for 2011-12, at Rs 38 per day (or $2.5 per day on PPP terms), would be 47% against the 22% Planning Commission figures (for Rs 27 and Rs 33 per day in rural and urban areas respectively).
Other than the high rate, the other disturbing fact is the slow pace of decline.

6. The New York mayor has an ambitious affordable housing goal, the development or preservation of 200,000 units over the next ten years. The City Council kickstarted it in 190 blocks of Brooklyn, the first of 15 neighborhoods across the city,
The city’s tools are powerful: a new mandatory inclusionary housing law that requires developers in rezoned areas to set aside up to 30 percent of units in new buildings for lower-rent apartments. That’s a minimum — the administration also plans to use subsidies and tax breaks to extract even deeper levels of affordability from new construction. In East New York, it promises to break ground in the next two years on 1,200 “deeply affordable” apartments. Forty percent of them will be rented by families earning $38,850 or less. Ten percent will be rented by families making $23,350 or less.
India's metropolitan cities, where land valuations are astronomical, similar aggressive mandates should be associated with all land use conversions.

7. Nice article in Times on the market for the super-rich, the top 1%, where businesses are focussing an increasing share of their innovation and resources to provide premium services. To get a sense of the top 1%,
Emmanuel Saez, a professor of economics at the University of California, Berkeley, estimates that the top 1 percent of American households now controls 42 percent of the nation’s wealth, up from less than 30 percent two decades ago. The top 0.1 percent accounts for 22 percent, nearly double the 1995 proportion... From 2010 to 2014, the number of American households with at least $1 million in financial assets jumped by nearly one-third, to just under seven million, according to a study by the Boston Consulting Group. For the $1 million-plus cohort, estimated wealth grew by 7.2 percent annually from 2010 to 2014, eight times the pace of gains for families with less than $1 million... Spending by the top 5 percent of earners rose nearly 35 percent from 2003 to 2012 after adjusting for inflation, according to a study by Mr. Fazzari and Barry Z. Cynamon of the Federal Reserve Bank of St. Louis. For everyone else, spending grew less than 10 percent.
From jumping ques to exclusive zones and timings, the richest are able to purchase their convenience.

8. And staying with inequality, and its impact on life expectancy, new research by Raj Chetty and Co find a 15 year difference in life expectancy among American males at the top and bottom 1 per cent.
It is difficult to establish contributors and causal factors. Apart from wealth buying better health care, wealthier people also lead healthier lifestyles. Further, the cause and effect may go in both directions - healthier people can work more and productively and increase their incomes. And one of the implications of this life expectancy gap is that the richer people benefit more from various social security programs.

9. As the wheels are coming off the emerging markets story, with minus four per cent growth in Brazil and Russia in 2015, Dani Rodrik questions the merits of the original story itself,
Scratch the surface and you found high growth rates driven not by productive transformation but by domestic demand, in turn fueled by temporary commodity booms and unsustainable levels of public or, more often, private borrowing.
The article has this about the India story,
In a sense, all of the major emerging markets – with the revealing exception of India, where economic growth is not dependent on commodity exports – are reliving the lesson of the 2008 global financial crisis. As Warren Buffett famously summed it up: “Only when the tide goes out do you discover who’s been swimming naked.” For much of the last generation, buoyant commodity prices served as a fig leaf for emerging markets’ profound governance failures. Now the fig leaf has been stripped away, and their leaders must face the beach.
It is true that India benefits from not being a commodity exporter and having a fairly diversified economy. But the problem is that it, like all others, has not done enough on the productive transformation front, thereby raising questions about the sustainability of economic growth, especially at high rates.

10. Business Standard refers to a paper by KC Zachariah and Irudaya Rajan which puts in perspective the importance of remittances to the Kerala economy,
(Kerala) receives 40 per cent of remittances that come to India... Remittances finance as many as 20 per cent Kerala households, or 2.4 million families. Assuming a family size of three, remittances directly affect 7.2 million of 35 million Keralites... Remittances, at Rs 70,000 crore, accounted for 36.3 per cent of the net state domestic product (NSDP) in 2014. Remittances constitute a fourth - Rs 22,689 of Rs 86,180-of the per capita income of Kerala in 2014. Remittances were 1.2 times the revenue generated by the Kerala government in 2014... The number of Keralites working abroad had jumped to 2.4 million by 2014... a majority, 86 per cent , work in the Gulf countries.

Friday, April 22, 2016

Secular stagnation, corporate surpluses, industry concentration, and declining business dynamism

The widening inequality, especially driven by the out-sized compensation in the financial sector and the rising pile of corporate profits, and reflected in the stagnant median labor incomes, must count as the arguably the most disturbing social and political theme of our times.

Now Larry Summers has argued that monopoly profits, extracted by the growing concentration of market power across sectors among the top firms, is responsible for the increasing returns to capital despite the persistently low real interest rates. Profits, free-cash flows, and returns on capital are at historic highs among US corporates.
A spate of mergers and aggressive cost-cutting have boosted profitability from both supply and production sides. The persistence of high profitability and the likelihood of the same firms being the beneficiaries over time points to prohibitive entry barriers. Pointing to high levels of entry barriers, the Kauffman index of startup activity is at its lowest since the 1970s.

The Economist examined US firms in 893 industries, grouped into broad sectors, and found that two-thirds of them became more concentrated between 1997 and 2012 and the weighted average share of the top four firms in each sector rose from 26% to 32%.
The concentration is especially pronounced in sectors like Finance, Retail, and Wholesale.
In this context, MR points to the findings of a recent study by Grullon, Larkin, and Michaelly which finds an alarming decline in publicly traded US firms and attendant concentration of economic activity,
There has been a systematic decline in the number of publicly-traded firms over the last two decades. Half of the U.S. industries lost over 50% of their publicly traded peers [from 6,797 in 1997 to 3,485 in 2013, AT].... This decline has been so dramatic, that the number of firms these days is lower than it has been in the early 1970s, when the real gross domestic product in the U.S. was one third of what it is today. This phenomenon has been a general pattern that has affected over 90% of U.S. industries... The decline has increased industry concentration, as the void left by public firms has not been filled by an increase in the number of private businesses or by greater presence of foreign firms. Firms in industries with the largest decline in the number of firms have generated higher profit margins and abnormal stock returns, and enjoyed better investment opportunities through M&A deals. Overall, our findings suggest that the nature of US product markets has undergone a structural shift that has potentially weakened competition.
This US CEA study finds a significant increase in the concentration of economic activity in many industries recent decades, a reflected in record levels of mergers and acquisitions. It also finds declining new firm entry and returns that are greatly in excess of historical standards. The share of US workers requiring some form of State occupational licensing grew five-fold over the last half of the 20th century to about a quarter of all US workers in 2008. 

Nowhere is the concentration more pronounced than in the financial sector. Noted investor, Henry Kaufman, has cautioned that such concentration undermines the operation of market forces,
The number of FDIC-insured institutions fell from more than 15,000 in 1990 to a mere 6,300 today, and the ten largest U.S. financial institutions currently control some 80 percent of all financial assets... financial concentration increases the spreads for securities, drives up financing costs, increases price volatility, reduces traditional sources of liquidity, and requires greater government supervision of credit markets... Debt has been shifting tectonically as well... U.S. government debt... now equals – GDP; in 2000 it was only half of GDP. In the 1990s, corporate equity increased $131 billion while debt soared an astonishing $1.8 trillion. And the quality of corporate debt has been deteriorating... In the mid-1980s, the number of non-financial corporations rated AAA was 61; today it is 4.
The returns on capital invested, excluding goodwill, among the American publicly traded non-financial companies have become increasingly concentrated in a small segment at the 90th percentile and above, whose returns are more than five times those of the median. 
Another recent paper by Ryan Decker et al points to declining entrepreneurship, job creation and destruction, and economic dynamism in the US. It finds increased reallocation of jobs towards the more productive and more profitable sectors, which invariably require ever declining shares of workers. This has to be taken with evidence of declining workers internal mobility across occupational categories.
The opinion is divided on what are the factors driving these secular structural trends. But these trends assume significance for even developing countries which are already buffeted by adverse headwinds of premature de-industrialization and stagnation in global trade. If declining business dynamism (entry and exit), lower entrepreneurship, increased industry concentration, internal workers mobility are driven by factors that are more secular, independent of nature of economies, then they may prove insurmountable barriers to economic growth in these economies.