Monday, August 29, 2016

The nuanced case for policies to improve productivity

The conventional wisdom on productivity is tied up with capital formation. As businesses make capital investments, it increases worker productivity. 

I have three problems with this line of reasoning, especially for developing countries grappling with the challenge of providing jobs for the new workforce entrants as well as those moving out of agriculture. For these countries, productivity improvement is just a means to achieve increased incomes for their workers as well as to create new jobs. But it can be so that while headline productivity numbers improve, increases in worker incomes may be disproportionately lower. 

To start with, productivity enhancements can come from investments in either physical technologies or human skills or both. Improvements in physical infrastructure - plant and machinery, information and communication technologies etc - increases the productivity even with minimal incremental human capital formation. A semi-automation of factory floor in a low technology manufacturing also increases output considerably without much worker capacity augmentation. Returns from such investments are disproportionately likely to be captured by the owners of physical capital. 

The second concerns the capital investment focused definition of productivity. What about productivity that is driven by increases in human capital formation – education, skill acquisition, etc? The less developed countries are characterized by poor levels of primary school learning outcomes, abysmal rate of employability among professional graduates, very low penetration of skill trainings, and limited use of apprentice system. Or the use of better management tools by the millions of small enterprises that dot the economic landscape of countries like India. Given their massive antecedent lags, there is a huge potential for large productivity gains from improvements in any of them. In fact, in terms of bang for the buck, investments in these areas are likely to be far superior in resource-constrained countries. Alternatively, the returns from every unit invested in human capital formation far exceed that invested in physical capital formation. 

It is, of course, true that co-ordination problems and externalities come in the way of the practical realization of gains from human capital investments. Why should the private sector invest in human capital formation if it cannot appropriate the full benefits from such investments? How can public financed skill training and apprentice promotion schemes be closely integrated with industry requirements? But these are matters of getting the enabling policy and implementation design right than policy design failings.  

My last problem with capital investment focused productivity improvement strategy comes from its adverse impact on jobs. There is a very rich body of evidence that robots and automation have been destroying or displacing jobs. It has even been estimated that a majority of today's jobs are at risk of being replaced by automation.  

Productivity enhancement which comes at the expense of jobs imposes prohibitive welfare costs. This is more so for developing countries, where social safety nets are grossly inadequate. Here, the rate of job destruction far exceeds that of job creation. 

Public policy in developing countries seeks an unqualified increase in productivity improvement through increases in physical capital formation. This is reflected in the large subsidies and fiscal concessions provided to encourage capital investments. In fact, industrial policy in these countries is largely about fiscal concessions. In contrast, initiatives that enhance human capital investment is largely forgotten and, therefore, marginalized. Public support for physical capital investments are orders of magnitude more than that for human capital investments. This should constitute arguably the least discussed and among the most important resource misallocation problems in the context of poor human capacity constrained developing economies.

The policy implication of this argument is that the unambiguous focus on productivity improvements through physical capital formation need to be more nuanced. We need to acknowledge that, while very important, it may not be an unalloyed good. For poor developing countries with weak human resource development, the pursuit of productivity enhancement should involve encouraging both human and physical capital formation.

Saturday, August 27, 2016

The problem with unfettered free trade

An unequivocal acceptance of free trade has been a central theme of mainstream macroeconomics for decades. It is argued that factor markets adjust over time to generate superior outcomes. Among all the tenets of the Washington Consensus, this alone continues largely intact. 

But in recent years, as the dynamics unleashed by the emergence of China has played itself out, some influential voices, including those from the right, have started questioning the conventional wisdom. In fact, David Autor, David Dorn, and Gordon Hanson have even claimed that import growth from China caused 2.4 million jobs in the US over a dozen years. 

At a conceptual level, for the world as a whole, there is no doubt that free trade leads to better outcomes. But there are at least two problems with this line of reasoning. 

1. The world is politically organized as countries and regions. The world as a whole matters little in political terms, and is largely an academic construct. When seen in terms of individual countries or even more so among regions, there is very little evidence to suggest that free trade leads to superior outcomes - increased output and more jobs - even in the aggregate. Labor market adjustments take time and a large share of those displaced end up with inferior jobs and lower lifetime incomes. And there is nothing to suggest that comparative advantage in certain sectors offsets the loss in output and jobs due to lower competitiveness in other tradeables.

2. Then there is the fairness argument. Even the most ardent free traders accept its adverse distributional consequences. But they rationalize this by saying that governments can enact policies to mitigate this by facilitating labor market adjustments (re-trainings and re-skilling etc) and through transfers by appropriating from the winners and giving to the losers. But here too, there is scarce evidence of such hopes materializing. In fact, given the reality of the political economy in developed or developing countries, especially in the present times, the winners are far more likely to resist and prevail over any attempts to appropriate a share of their gains. To paraphrase Machiavelli, the greed of the influential few is most certain to overcome the requirements of the powerless many! In other words, not only is there little evidence of re-training and transfers, political economy militates against its realization. 

Given this, all arguments for unfettered free trade are essentially faith-based arguments. This assumes significance since India is in the process of negotiating free-trade agreements with many countries. Yes, we need to embrace free trade. But we should be aware of its consequences and negotiate hard to obtain adequate safeguards for those sectors most likely to be vulnerable to trade-induced disruptions. This has to be complemented with a re-skilling programs and robust enough social safety net that rehabilitates and cushions the losers. 

Tuesday, August 23, 2016

The costs of formality in land titling

I have blogged earlier about the high, often prohibitive, costs associated with formality in manufacturing, labor market, and real estate. In simple terms, in the absence of any reduction in complementary costs, formality introduces layers of compliance costs which the demand side in these markets cannot support. All sides to transactions in these sectors, therefore, prefer to keep them informal.

The MR folks point to a paper by Sebastian Galiani and Ernesto Schargrodsky, who studied a natural experiment involving allocation of land titles to very poor families in the suburbs of Buenos Aires, and found similar costs associated with formal land titling,
Although previous studies on this experiment have found important effects of titling on investment, household structure, educational achievement, and child health, in this article we document that a large fraction of households that went through a situation at which formalization was challenged (death, divorce, sale/purchase), ended up being de-regularized. The legal costs of remaining formal seem too high relative to the value of these parcels and the income of their inhabitants... The cost of processing the inheritance of an asset valued at US$ 11,700 is about US$ 2,300... When property rights are transferred to very poor people, preserving legal tenure will likely entail onerous expenses in the form of attorney and public notary fees, and courts costs. In addition, these charges are higher in relative terms in very unequal societies where the gap between the poor and the relatively well-off is wider.
These low-level informality equilibriums are rarely ever broken with regulatory changes. They require economy-wide changes whose benefits by way of lowering the cost of transactions offsets the increased cost associated with going formal. 

Sunday, August 21, 2016

India banking sector - a long road ahead

Livemint has this assessment of the Strategic Debt Restructuring (SDR) scheme initiated by the Reserve Bank of India (RBI) last year to address the issue of bad bank loans,
In the 14 months since it has been introduced, banks have invoked the provisions of SDR in at least 21 cases... they have converted debt to equity in only four cases... Of these, they have closed out only two. Difficulties in finding buyers, disagreement over valuations and even the choice of merchant bankers used in the SDR process seem to be impeding closure... some of the probable buyers that came on board eventually exited due to creditors’ concerns around their genuineness and source of funding, among others... In most of these deals, the banks are required to take a serious haircut, which is something that they are not interested in.
The SDR entailed converting debt to equity, taking over management, and finding a buyer in 18 months, failing which the asset became classified as a Non-Performing Asset (NPA) with all requisite provisioning requirements. As if acknowledging its failure, in June, the RBI introduced another scheme, the Scheme for Sustainable Structuring of Stressed Assets (S4A), which allowed banks to convert up to 50% of debt into equity without the need to find buyers immediately.

This problem does not have any immediate and easy solutions. Given the size of the NPAs, Rs 6.3 trillion as of end-June, and more likely to be much higher, there are at least two binding constraints on both supply and demand sides. On the supply-side, as mentioned, the banks are clearly unwilling for various reasons, the vigilance enquiry concerns being primary, to take anything close to the reasonable haircuts required to make such assets attractive to buyers. Given the persistent global economic weakness and related uncertainties, as well as the risks associated with restructuring such assets, it is not surprising that investors demand very high haircuts. In any case, the valuations of many of these assets are far below their liabilities. On the demand-side, the market is too narrow, in fact by orders of magnitude, to absorb these assets. Apart from the finances, the human resource and corporate capital available to manage and restore the health of bad assets too is acutely scarce. And neither of these can be addressed soon.

Apart from this, there are several other operational challenges - incentive compatibility problems with Asset Reconstruction Companies (ARCs) and the Security Receipts (SRs) issuance processes; continuing linkages between banks and the assets sold to ARCs; practical difficulties associated with consolidation of fragmented debt; and problems with taking over management control and bankruptcy resolution. Complicating matters, the considerable risk of corrupt practices in transactions, engendered by the poor corporate governance standards and lack of market competition, forces the RBI into more tougher regulations, which in turn limits the sale prospects further.

In the circumstances, the best that can be done is a mix of different options. One, continue the ARC and leveraged buyout fund routes. Two, encourage purchases by private (infrastructure funds) and public (like NIIF, IIFCL etc) funds which could either securitize some assets or establish SPVs and manage these assets till they become profitable. Three, strategic acquisitions of some of the infrastructure assets, especially in power, by the better governed public sector units. Four, strategic auction of certain other assets, especially in steel and metals, to reputed private buyers. In at least some of these cases, provisions like back-ended clawback of some share of windfall gains by potential buyers may ease the resistance and apprehensions associated with such sales. 

In order to facilitate this process, to start with, it would be useful to classify the NPA loans into different categories based on the nature of loans and the types of buyers who are likely to be interested. For example, retail loans like mortgages, credit card, and other small enterprise and personal loans can be classified into one category, which can be sold off in plain vanilla auctions. The infrastructure loans can be classified into completed cash-flow generating projects (strategic sales), incomplete public goods (strategic acquisitions with public leverage), and incomplete private projects like steel plants (restructured disposal). It may also be useful to make available to potential investors the portfolio of such assets so as kindle the interest of the biggest global asset managers and pension and insurance funds. Or even bundle similar assets so as to make them attractive to buyers with deep pockets and patient capital. 

None of these are simple and are certain to throw up challenges and uncertainties. It is, therefore, essential that the restructuring embraces at least three principles. One, it will be necessary to let enabling regulations emerge as the process unfolds. Two, there will have to be a high level of tolerance for omissions and oversights (which are likely to become egregious with the benefit of hindsight) and failures. Finally, avoid the attractions of quick-fix solutions and prepare for the long haul. A mix of restructuring and restoration by economic growth, played out over a period of time, may be the most prudent strategy. 

Friday, August 19, 2016

The excesses of QE - Japan Edition

There are public sector companies and then there are public sector companies. In the former, as in the erstwhile Communist and Socialist countries, governments physically established and owned businesses. The latter is a neat twist to ownership, where private sector establishes companies, float them in the capital market, and then government becomes the majority share-holder in those companies! Thanks to the never-ending adaptations of quantitative easing, Japan has become the progenitor of this new economic model!

The Bank of Japan (BoJ) had embarked on a massive quantitative easing program, including purchases of Exchange Traded Funds (ETFs). As of June 2016, the Bank of Japan (BoJ) owned 60% of the country's ETF market and is now a top-five owner of stocks in 81 out of the 225 companies that make up the Nikkei Stock Index. Last month, it increased the annual ETF purchase target to 6 trillion yen. It is now estimated that the ETF purchases will make the BoJ the largest shareholder in 55 of the 225 Nikkei stocks and top 10 holder in 99% of its companies by December 2017!
The BoJ's ETF purchases are rapidly depleting the free-float of shares (or those available for trading). As the free-float is expected to rise above 50% in many companies, market liquidity will be squeezed with increased volatility.

The apparent logic of all this is that ETF purchases will boost economic activity, enhance risk appetite, and thereby raise inflation above two per cent. There is a hollow ring to this, given the disproportionately low returns from years of expansionary fiscal and monetary policies. Instead of such hugely risky experiments, Japan, as I blogged earlier, should get down to more fundamental labor market reforms on migration and women workers to address its massive demographic challenge. 

Tuesday, August 16, 2016

Limits to rapid growth - Higher Education Edition

A recent ASSOCHAM study found out that just 7% of the pass-outs from business schools in India, excluding the top 20 schools, are employable and are able to get a job immediately after completing their course, 
India has at least 5,500 B-schools in operation now, but including unapproved institutes could take that number much higher... Low education quality coupled with the economic slowdown, from 2014 to 2016, campus recruitments have gone down by a whopping 45 per cent. There are more seats than the takers in the B-schools... In the last five years, the number of B-school seats has tripled. In 2015-16, these schools offered a total of 5,20,000 seats in MBA courses, compared to 3,60,000 in 2011-12. Lack of quality control and infrastructure, low-paying jobs through campus placement and poor faculty are the major reasons for India’s unfolding B-school disaster...
While on an average each student spent nearly Rs 3 to Rs 5 lakh on a two-year MBA programme, their current monthly salary is a measly Rs 8,000 to Rs 10,000... Of the 15 lakh engineering graduates India produces every year, 20-30% of them do not find jobs and many other get jobs well below their technical qualification. There is clearly a rush towards engineering, that which is engineered largely by parents and the society... There is a large mismatch in the aspirations of graduating engineers and their job readiness. 97% engineers aspire for a job in IT and core engineering. However, only 18.43% employable in IT; 7.49% in core engineering, adds the paper.
This is a teachable moment. The tripling of business school seats, like with similar explosion in engineering colleges in the 2006-11 period, came with a prohibitive cost in terms of quality. The provision of good quality professional education requires competent faculty, adequate infrastructure, and good students. And finally, there should be enough jobs going around to absorb those passing out. These are not achieved easily at the speed and scale expected, given our antecedent human and physical capital quality deficiencies. And in any case, colleges take time to develop good quality and establish credibility. They cannot be manufactured on a production line in a routine manner.

This is equally true of the spurt in IITs, IIMs, AIIMS, and other institutions of national excellence. After failing to build on the success of these brands by gradually increasing their numbers over the years, there has been a swing to the other extreme in recent years in terms of sanctioning of a slew of such institutions. It is only to be expected that the supply-side in terms of quality of faculty and students fail to keep up with the growth in such institutions.

This is true not just of higher education, but any sector. There are limits to how quickly any sector can grow in a country with a very narrow base in industry, human resource, agriculture, financial capital, state capacity, and so on. India needs economy-wide human and physical capital accumulation for a long period of time to build up the platform necessary for sustainable growth. Without this foundation, high growth can only happen in short episodes of over-heating followed by cleaning up balance sheets, as is happening now. 

Monday, August 15, 2016

Japan Housing Fact of the Day!

This is a truly stunning graphic! Especially, that of the Minato ward of Tokyo.
As are these statistics,
In 2014 there were 142,417 housing starts in the city of Tokyo (population 13.3m, no empty land), more than the 83,657 housing permits issued in the state of California (population 38.7m), or the 137,010 houses started in the entire country of England (population 54.3m)... Japan has experienced the same “return to the city” wave as other nations. In Minato ward — a desirable 20 sq km slice of central Tokyo — the population is up 66 per cent over the past 20 years, from 145,000 to 241,000, an increase of about 100,000 residents. In the 121 sq km of San Francisco, the population grew by about the same number over 20 years, from 746,000 to 865,000 — a rise of 16 per cent. Yet whereas the price of a home in San Francisco and London has increased 231 per cent and 441 per cent respectively, Minato ward has absorbed its population boom with price rises of just 45 per cent, much of which came after the Bank of Japan launched its big monetary stimulus in 2013.
In the aftermath of the property bubble of 1990s, Japan, which has a single set of nation-wide development control norms, ushered in a new set of dramatically liberal development rules as part of the Urban Renaissance Law of 2002. It made rezoning and vertical redevelopment simpler. The result - increased demand was offset by increased supply, muting price increases. Tokyo has the highest Floor Area Ratio among all major global cities, and dwarfs Indian cities.