Friday, September 19, 2014

QE and Fed's verbosity!

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

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

Thursday, September 18, 2014

Metro rail fact of the day

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

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

Tuesday, September 16, 2014

Observations on the Reliance gas pricing issue

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

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

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

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

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

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

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

Sunday, September 14, 2014

India's biggest immediate public policy challenge

I am surprised why the problems facing our banking sector does not get the attention it deserves. It is arguably the biggest short to medium-term problem demanding the attention of the Government of India. Its resolution is central to realizing the massive infrastructure investments that are necessary to ease important supply side constraints and sustain a reasonable economic growth rate.

ET puts India's corporate debt restructuring challenge faced by its predominantly public sector banks in perspective,
The total of banking system's net owned funds is under Rs 7,10,000 crore as of March-end 2014. The stated non-performing loans (NPLs) are around Rs 3,00,000 crore and the estimated level of NPLs, including restructured assets, is around Rs 10,00,000 crore. 
It is no hyperbole to say that India's banking sector is in a crisis. This "negative equity" situation is compounded by the additional capital requirements placed due to the Basel III norms which are due for implementation by March 31, 2019. There is no substitute for massive capital infusions, either directly from budget resources or through divestment of government equity. The RBI appointed PJ Nayak Committee estimated an additional equity capital requirement of Rs 3.1 lakh Cr over the next four years for public sector banks to comply with Basel III norms, sustain a credit growth of 16%, and provision for 30% restructured assets turning bad.

It is abundantly clear that government does not have the fiscal resources for direct recapitalization. Raising this capital through divestment cannot happen without lowering government stakes below 51%. In any case, without additional capital infusion, the ambitious infrastructure investment plans will remain still-born.

There is no way we can wish away a problem of this magnitude or hope that economic recovery will generate the resources required to tide over. A sustainable economic recovery itself is contingent on supply of infrastructure resources or atleast an expectation of it.

Clearly, any solution has to embrace a mix of both options, coupled with strong commitment to recover impaired loans from corporate defaulters. But immediate action is required since kicking the can down the road will not only increase the cost but also postpone the green-shoots of sustainable economic recovery. 

Saturday, September 13, 2014

Larry Summers on US crude exports and disagreements in public policy

In a brilliant speech at the Brookings Institute Larry Summers makes out a very well-reasoned and cogent case for why the US should lift the four-decade long ban on crude oil exports. The speech itself is a great example of persuasive argumentation. But in particular, I found this philosophical conclusion profoundly insightful and relevant to many other areas of public policy (and other) debates,
With respect to most areas of public policy... I don't have any difficulty understanding why somebody might disagree with me and how they would understand the world which would cause them to disagree with me. I have certain views on financial regulation. I have no difficulty understanding why somebody else would have a view that was different from mine. They have a different understanding of how the world works or they have a different set of values. This issue (restrictions on export of crude oil from US) is quite extraordinary in my experience because I don't understand what are the values that you could have that I don't have that would cause you to want to maintain the restriction nor do I understand what your theory of how the world works is that would cause you to have a different view.
I have one more thing to add to this nugget of wisdom. In either case - different understanding of the world (mechanism conflict) or different set of values (values conflict) - convincing the other side is a massive challenge, though in case of the latter, I am inclined to believe that even getting their attention, leave along convincing them, may be beyond the powers of human reasoning. In such (latter) cases, the best approach may be to create the conditions (or let it emerge) for the other side to themselves realize, if at all, the deficiencies in their value system.

Therefore, I believe that the first step in public policy debates should be to clearly distinguish whether it is a mechanism or values conflict. This alone could go a long way towards creating the conditions for a dialogue that is sensitive to all shades of opinions. 

Thursday, September 11, 2014

Apple Pay and the future of shopping

Ten years down, historians may look at the launch of Apple Pay this week as a giant step in the direction of digital wallet. An iPhone equipped with Apple Pay software can potentially become a platform to undertake friction-less transactions using all kinds of virtual assets - money, loyalty and reward points, airline miles, cellphone minutes and so on. Times has this peek into the future of such exchange transactions,
Let’s say you want to buy an audiobook from Best Buy. It costs $16, or 1,000 My Best Buy points, or M.B.B.P.s. Your wallet contains several hundred dollars and 200 Best Buy points. The wallet software automatically determines that, at the current exchange rate between M.B.B.P.s and dollars, it is better to buy using the points. But then let’s say you only have 50 M.B.B.P.s. The wallet system searches its clients and finds someone - call her Hannah - with enough M.B.B.P.s for the transaction. It buys the audiobook with her points and sends it to you, and sends Hannah dollars from your account. Following Bitcoin’s protocol, the wallet software broadcasts these transactions to the network, and every wallet in the world updates the M.B.B.P.-to-dollar exchange rate. The idea is that you can buy anything, with anything. The wallet will find the best deal and execute it. In so doing, it will ignore the historical and cultural differences between dollars, points, coins and virtual property. 
Such transactions pose a big challenge to regulators. In particular, such seamless transactions, carried out without any intermediaries (like banks), leaves regulators with limited enforcement power. Who would be responsible for stopping a transaction? There are likely to be many other emergent problems that regulators will have to grapple with when mobile wallets take hold.

Another thing of interest will be its effect on consumer behavior. As Cass Sunstein highlights, Apple Pay could end up exploiting people's cognitive biases and leaving them poorer. There is enough evidence from research in behavioral psychology that credit card and other non-cash transactions, by reducing the cognitive salience of the transaction, nudge people into spending more than would have been the case with cash transactions. A highly versatile application like Apple Pay is a fertile ground for businesses to manipulate these cognitive biases and exacerbate the hidden social and economic costs associated with such less salient transactions. 

Wednesday, September 10, 2014

Changing international trade patterns

MR nudged me into reading the work on the changing nature of international trade. This paper by Pol Antras and Stephen Yeaple captures the change starkly,
In 2000, for instance, the top 1% U.S. exporters accounted for 81% of U.S. exports. The involvement of these large firms in the world economy goes well beyond the mere act of selling domestically produced goods to foreign consumers. According to 2009 data from the U.S. Bureau of Economic Analysis, the sales of domestically produced goods to foreign customers account for only 25% of the sales of large American firms.The remaining 75% (nearly U.S. $5 trillion) is accounted for by the sales of foreign affiliates of American multinationals. Furthermore, data from the U.S. Census Bureau indicates that roughly 90% of U.S. exports and imports flow through multinational firms, with close to one-half of U.S. imports transacted within the boundaries of multinational firms rather than across unaffiliated parties. 
The out-sized role of multi-national corporations in international trade is highlighted by the table. Foreign affiliates of multi-national firms take up a large share of the sales, R&D expenditures, and exports of the host country.
As Antras writes, these trends hold for the US too,
The first thing that one notices when using U.S. related party trade data is how pre-dominant intra-firm transactions are in US trade. In 2011, intra…-firm imports of goods totaled $1056.2 billion and constituted a remarkable 48.3 percent of total U.S. imports of goods ($2,186.9 billion)... On the export side, related-party exports are also pervasive, with their share in total US exports ranging from 28 to 31 percent in recent years... (in 2011) the share of intra-firm trade reached a record 89.6 percent for U.S. imports from Western Sahara... the share of intra-firm trade still varies significantly across countries, ranging from a mere 2.4 percent for Bangladesh to an astonishing 88.5 percent for Ireland.
Clearly, the case for placing MNCs at the center in any analysis of international trade is now compelling. If 92.3% of Ireland's exports come from MNCs, with a few firms constituting the dominant share, then it stands to reason that the Irish government be able to closely monitor their activities. In particular, the monitoring of transfer pricing, or the accounting allocation of firm profits across the different geographical jurisdictions where the firm operates, assumes great significance.

Consider the incentives. While notionally, the parent firm and its affiliates are supposed to conduct arms-length transactions, the tax accountants of the parent firm have the exclusive mandate of minimizing the entire corporate group's tax outflows. In other words, its job is allocate profits across the different entities, consistent with prevailing rules, in a manner than minimizes the tax liability in each jurisdiction. Typically, they end up working accounts to transfer profits from high tax jurisdictions to low tax ones. See this, this, and this.

In the absence of effective regulation, the acrimony and controversies that arise from practices like under-pricing of imports and under-pricing of exports, 'Double Irish and Dutch Sandwich', and 'tax inversion' are only likely to worsen. Even more importantly, it is estimated to cost developing countries around $160 bn in annual taxes evaded. India's sharply rising trade volumes means that its transfer pricing losses are likely to be substantial. For those in India campaigning to recover black money stashed abroad, plugging the far bigger annual leakage from transfer pricing may be a more effective and realistic objective.

Unfortunately, no country, on its own, including the US, is in a position to crackdown on such practices. Unilateral actions are unsustainable not only because such actions require international co-operation, but also because MNCs have the advantage of exiting such countries. But, in the prevailing international environment, the consensus required to achieve an agreement on this issue look remote. A more realistic campaign, one which a country like India could assume leadership, would be to increase transparency through greater disclosure of intra-firm pricing and profit allocation across jurisdictions.