Monday, December 11, 2017

Eco-system as a constraint on outcomes-based policies

I have blogged earlier here about the under-appreciated difficulties with targeting outcomes. Apart from the three challenges raised in that post, there is another equally important challenge. This concerns ecosystem constraints.

It is commonly assumed that the existing ecosystem can be disciplined to achieve the desired outcomes through efficiency improvements, by getting human and physical capital to work more and better. What if this is not at all true?

This post gives three examples of how outputs or outcomes-focused technology or process interventions disrupted entrenched equilibriums and raised difficult administrative challenges. 

Consider school education. We have no clear idea of how much of learning outcomes realisation is a function of early childhood education, classroom instruction, remedial support in classroom, peer-engagement, off-school hours engagement at home, and the grade-appropriate competency levels themselves. What are their relative weights? How do those vary across socio-cultural contexts?  What if the competency standards are too ambitious? Or what if home engagement is critical?

Consider primary health care. This study found that doctors spend limited time and asked very few questions (as against what the medical protocol dictates) when treating patients. And it is pervasive across developing world, though nowhere as bad as in India. While unambiguously accepting the larger point about apathy and incompetence, it is also important to highlight the plumbing reality - the Out Patient load, when doctor is available, in PHCs can be far higher than what any systems can deal. Once this becomes the norm, a newly recruited doctor, over a few years, deeply internalise the challenge and forms a response that instead of treating the patient only tries to get done with the long-que of patients before lunch! Just imagine a GP in UK dealing with 30 patients turning up over a two-hour window with just one nurse for assistance. 

Nowhere is this more relevant than with state capacity. It is unrealistic to expect public systems as they exist now to deliver sectoral outcomes in scale and anywhere close to the defined benchmarks. Right now, these systems are entrapped in a low-level equilibrium of low human and physical resource allocations, unfavourable socio-economic conditions, and tolerance for and expectations of sub-par outcomes. Even the most incentive compatible financing strategy cannot be expected to have anything other than marginal effect on the system.  

Fundamentally, this should have been simple. Development is hard. The resolution of complex problems demand multi-dimensional policies that directly and proactively address deep structural failings, and persistent effort in their implementation. So to expect outcomes-targeting to magically deliver the result is plain naive.

But that we still fall prey to the lure of such apparently neat and simple solutions can be blamed on our psychological urges. We want to do something quickly about these complex problems. We find the logic of outcomes-based policies irresistible. So we seek refuge in them.

But they will not work!

Monday, December 4, 2017

The alternative assets universe and India

The latest quarterly update of infrastructure funds from Preqin shows that the total dry powder held by unlisted infrastructure funds has reached a record high of $154bn as at September 2017. Most of this is routed to N America and Europe, with just $20 bn earmarked for all of Asia, including China and Japan. 
As regards India, the total dry powder currently available aimed at investing in India is just $3 bn. The vast majority of this comes from overseas funds, rather than domestic fund raising. In fact, India forms just 7% of the $65 bn unlisted infrastructure assets in the Asia-Pacific region. 
As to the entire alternative investment funds industry - private equity, venture capital, real estate, infrastructure, private debt etc - the total assets under management (AUM) as of December 2016 was $598 bn. India's share was $42 bn, of which $13.5 bn was the dry powder.
The major share of the AUM in India went into PE/VC funds. The PE sector has been boosted by the pick-up in exits, $10 bn in each of 2015 and 2016, and $7 bn to date this year.
While $7 bn of the $23.6 bn in the PE/VC sector is dry-powder available for deployment, a very small proportion of this is currently earmarked for buyouts. This allocation is contrast to elsewhere, including in Asia, where buyouts form the dominant share. 
Two observations

1. The government has planned infrastructure investments in the range of $700-1000 bn over the coming five years. It is estimated that a significant share of the investments will come from foreign investors. But, as these numbers show, we would be happy if even 10% of these investments come from abroad. Therefore, expectations of the National Infrastructure Investment Fund (NIIF) being able to leverage its $3bn corpus ten-fold etc are simply unrealistic.

One approach to attracting more infrastructure funds is by selling commissioned assets where revenue streams are predictable. Entities like NTPC and NHAI should consider divesting certain existing assets both attract infrastructure funds as well as mobilise resources to finance newer projects.

2. The new Bankruptcy Code and the resultant wave of distressed assets sales promises to flood the Indian market with massive buyout opportunities. The domestic market may not be deep enough to absorb anything beyond the first few sales. Foreign buyout funds would be essential for the fair price discovery required to make these sales sustainable, both commercially (for banks) and politically. 

While the currently earmarked amounts India-focused buyout funds is negligible, this distressed asset sales present a great opportunity to attract a big volume of such funds and deepen India's alternative assets market. This may require more strategic approaches to some of these sales, including bundling assets into groups so as to make it large enough to be commercially attractive.

As to the distressed assets sales themselves, two articles in Mint point to the challenges that are likely to be faced going ahead. One concerns the 26 GW of thermal power assets without any power purchase agreements, which makes them risky even after write-downs and restructuring. In these cases, as I have argued earlier, it may have to fall on NTPC to become a buyer of last resort.

The other one relates to steel sector, where the problems are worse still and massive haircuts may be necessary. And, unlike with power assets, it may be very bad idea of have an inefficient SAIL buy them up. In this case, strategic sales by bundling assets assume relevance.   

Tuesday, November 28, 2017

The year of bubbles in a snapshot

As one more year of monetary accommodation draws to a close, John Mauldin has these bubble facts
  • A painting (which may be fake) sold for $450 million.
  • Bitcoin (which may be worthless) soared nearly 700% from $952 to ~$8000.
  • The Bank of Japan and the European Central Bank bought $2 trillion of assets.
  • Global debt rose above $225 trillion to more than 324% of global GDP.
  • US corporations sold a record $1.75 trillion in bonds.
  • European high-yield bonds traded at a yield under 2%.
  • Argentina, a serial defaulter, sold 100-year bonds in an oversubscribed offer.
  • Illinois, hopelessly insolvent, sold 3.75% bonds to bondholders fighting for allocations.
  • Global stock market capitalization skyrocketed by $15 trillion to over $85 trillion and a record 113% of global GDP.
  • The market cap of the FANGs increased by more than $1 trillion.
  • S&P 500 volatility dropped to 50-year lows and Treasury volatility to 30-year lows.
  • Money-losing Tesla Inc. sold 5% bonds with no covenants as it burned $4+ billion in cash and produced very few cars.
If all this is not enough to take the punch-bowl away, then we can be rest assured that real-world monetary policy will always be asymmetric - loosen when faced with economic weakness to ease conditions and stoke demand, and refrain from tightening when overheating for fear of bringing the house down. Prefix it with Greenspan or not, one cannot but not walk away with the feeling that central bank actions in recent years have released a moral hazard named Central Bank Put!

Friday, November 24, 2017

Managing organisations - the importance of trust and delegation

I have a simple hypothesis about managing organisations. There are several complex dynamics at play, but there is one non-negotiable attribute - trust and delegation. A good leader is one who has the instinct to trust the right people, the confidence to delegate, and the restraint to step in only when required. 

Consider the example of a District Collector in an Indian district. He is responsible for the administration of all development and regulatory activities in the jurisdiction. Take the example of  sanctioning and stage-wise approval of the release of payments for engineering works - school/hospital buildings, roads, irrigation structures and so on. In all these cases, the Collector has to exercise some judgement to make decisions. 

How does he know that all the 125 school buildings or 12 roads or 245 irrigation structures to be sanctioned this calendar year are the most appropriate ones? How can he be sure that the first instalment for the school building is being released only after the foundation stone has been completed? How can he be assured that the building or the road has been completed with good quality before sanctioning the release of the final payment? 

For sure, there is administrative guidance by way of formal delegation of powers, which though can be changed by following the due process, that define the sanctioning and payment release powers of officials at each level. But most often than not, even these are a very narrow and conservative delegation, more appropriate for a time when government was limited - there were limited number of such schools to be sanctioned and limited scope and sectors of administration. The modern administration and its scope demands further delegation. 

How do different Collectors respond? Some go by the official playbook. This leaves them with the dilemma of approving something which they have not physically seen, but based on what is on record. And given that what is on record can be aggregates, incomplete, irrelevant, misleading, or even plain incorrect, as is most often the case, the Collector has to exercise judgement calls. And the numbers of such files are huge in most districts. 

Faced with this dilemma, some, known as query masters, raise questions and insist on clarifications, which in turn cascades into more questions and so on. Some others, inspection masters, demand personal inspections, which can never be completed for even one round of approvals given the sheer volume of work. And even when they inspect, they are unlikely to be satisfied, since the contractors are likely smarter and the Collector likely does not have the professional competence to make conclusive assessments of malafide and fraud. The approval gets delayed and the work drags on. Cost escalates and contractors abscond, forcing re-tenders which come with multiples of the original cost. 

Then there are the corrupt, who approve everything as it comes, since the transaction has already materialised as planned before the file reaches their table. And they rationalise, and rightly so, with the argument that they are only sanctioning some thing as per the formal delegation of authority and they cannot be held accountable if the facts are contrary. 

There are also a few who decide to revisit the delegation of powers and either directly or indirectly delegate their own approval powers. The extent of delegation varies from context to context, and is made on the person's best judgement of what is the most appropriate level - a trade-off of perfection and efficiency. They manage to get the right people in some of the more important places, trust them, and delegate authority. They struggle hard initially to put in place appropriate safeguards to mitigate the associated risks. They create monitoring mechanisms that rely on credible and easily collectible direct or proxy indicators and open alternative channels of feedback that helps them keep abreast of the field situation. They also put in place independent quality assurance mechanisms. 

The very significant amount of time saved by way of delegation helps them focus on maintaining the fidelity and rigour of these feedback and monitoring channels. It gives them more personal time. By ensuring that 100 of the 125 buildings are completed on time, even at the risk of poor quality in 25 schools, the fiscal gains too are very large. 

The benefits go way beyond such personal or financial gains. Such delegation, and the attendant signal of trust, empowers the next line of command. Those being trusted are now likely to feel morally inclined to not let down their leader. They assume greater responsibility. Within a reasonable period of time, a spirit of collective ownership can infuse the entire organisation. 

For sure, the last category of Collectors run the risk of the occasional blow-ups - the road that develops pot-holes a month after its inauguration, the sunk flooring of the new building, the irrigation canal gate that develops leaks in the first week, and so on. And such risks materialise in a few cases. It does not help that the vested interests gang up to show-up and amplify the smallest omissions. The challenge is not to eliminate such risks. No matter what anyone does, the corrupt and mischievous will always find their way to retain some rent-seeking channels. The challenge is to minimise such eventualities by deterring them through very good feedback systems, practical but credible monitoring systems, and by making deviance very costly. 

This framework of analysis is equally applicable to every organisation - big and small, general and specialised, public and private - and all levels of decision-making. 

We all like to be in control of things. We prefer full information and logical neatness when taking decisions. We hate ambiguity and prefer certainty while making decisions. This is the human in all of us. 

I will argue that this ability to trust and delegate has little to do with being logical or smart. It is almost completely a behavioural attribute, though one which can be inculcated through conscious but painstaking practice. Giving up anything, much less power, is not something we are likely to be comfortable with. All of us start this way. But the realisation of this very insight and training ourselves to internalise it can be the epiphany for those few who manage to break away. It also helps to be confident of your own abilities. Confidence helps trust people and the trust, in turn, enables delegation. 

Slice and dice, analyse and dissect any organisation which ever way you want, there are decisions to be made. Such decisions involve judgement calls that demand a trade-off between exactitude, with all its attendant delays and other perils, and efficiency, with all its potential for blow-ups. 

Deregulation in governments is the most classic example of these dynamics at play. It ranges from the Collector's proclivity to demand more information and inspections before approving payment releases to the Goods and Services Tax (GST) Council's insistence for voucher reconciliation before tax credits are reimbursed to the reluctance of the University Grants Commission (UGC) or the Medical Council of India (MCI) to adopt more light-touch regulations. In some ways, it is also lazy administration or management, since it avoids the need to be wiser and to work hard to manage complex environments. 

Daniel Kahneman talks about decision making involving System I or System II. The former is instinctive and the latter is reflective. 

Over a life-time as we gather experience, we need to train the System I to drive the vast majority of decision-making. For sure, we can train our instincts using heuristics like what some District  Collectors do. We can make the System I internalise the insights of System II, but leave the decision making with System I. A good tennis player's ground strokes are System I at work. 

There are always some of the complex decisions, those with stakes which are higher, where System II may have to dominate. The same good tennis player uses System II to strategise a Plan B when faced with being two sets behind or when the opponent is blazing all guns and hitting the lines consistently. 

We need to make judgement calls over what demands the attention of System I and what System II. 

The Collector, or any other decision-maker, should train him(her)self that all bar critical administrative decisions respond to System I impulses. This requires trusting and delegation. This is, most often, the difference between getting stuff done and not. But it is, at a deep enough level, our choice to use the System I or System II as our default decision-making strategy.

Wednesday, November 22, 2017

More thoughts on Indian agriculture

I had written sometime back about the corrosive effects of loan waivers arguing that such "assault on incentives" are far more pernicious than giving electoral freebies. 

India has witnessed and explosion of farm loan waivers in the last year or so as part of electoral politics in states which held assembly elections. And with the next election season on, the trend continues unabated

But this issue cannot be seen in isolation. It has to be seen as part of the entire agriculture eco-system in India. 

Actually agriculture is a pretty complex system and conventional market solutions have been shown to not work. Gluts and shortages are inevitable - bad weather is a risk; good prices lead to excess cultivation next year and resultant drops, and vice-versa; global supply shocks and resultant price fluctuations are always round the corner; poor storage and other forward linkages make farm sales the only option etc. Pain and suffering follows.

Developed countries, over decades, have sought to address this problem through less distorting approaches - mainly crop insurance and/or direct payments. It helped that they have good irrigation systems, farms are bigger, forward linkages are better, credit access simple, and markets are functional.

We have none of the positive conditions, and crop insurance and direct payments are both very expensive and run into problems of effective administration.

But we have this smorgasbord of inefficient and distorting things - subsidised crop loans and their recurrent waivers; procurement and MSP (which feeds into the PDS); fertiliser subsidy; free farm power; agriculture IT exemption; minor irrigation programs like PMKSY etc. Worse still, each one has generated its set of powerful entrenched interests, which reflexively gang up as a vocal electoral constituency whenever they are threatened. Making matters complex, it cannot also be denied that each one of these, in their very sub-optimal ways, contributes to mitigating, even if partially, the fundamental problem, and the resultant pain and suffering.

So we have a very bad self-reinforcing and perpetuating equilibrium. A chakravyuha, from which exits appear very daunting.

I have not come across anything satisfactory as a path out of this. Except the gradual process of development - build irrigation systems, transition people out of agriculture, consolidate farms, let linkages and markets develop etc - and the gradual introduction of things like crop insurance. In this dismal environment, doubling farm incomes may well be the government's most over-optimistic promise yet.

There may be just a few avenues to manoeuvre. Given that the crop insurance scheme is one of the government's bigger initiatives, and one of the most progressive (as well as efficient), I think it should actually spend more energies and resources on it. As experience from across the world shows, premium support will always entail big subsidies and this may be worth paying. Can the government also think of phasing out some of these other subsidies and phasing in more of crop-insurance support? For example, it could encourage states which are willing to do farm power metering and a low agricultural tariff (to start with), to be provided a much higher premium support subsidy.

But alternatively, there is some merit in reframing both the MSP and crop-insurance. Instead of government procurement (except, and only to the extent required, for wheat and paddy), the MSP should be announced and farmers should be given the differential between the MSP and the market price, as is being tried out now in Madhya Pradesh for onions.

Similarly, there is a compelling case to dispensing with crop insurance, with all its transaction costs and reimbursement delays, and making direct payments when the crop fails. After all, if the identification of farmers affected has to be done even with insurance and a major share of the premium will have to be subsidised to make the insurance payouts meaningful enough, then the supposed advantages of an insurance model compared to direct payments looks questionable. 

Sunday, November 19, 2017

A primer on the rise of populism and a way forward

There are several narratives surrounding the rise of populism and events like the election of Trump and Brexit. I have written about it here, here, and here. This is an attempt at articulating the narrative based on news stories from the week.  

1. What is happening? The remarkable post-war economic, social, and political stability across developed societies, especially in the US, was built on an underlying consensus on certain values. This consensus revolved around the commitment to the values of free-market capitalism, liberal social order, and democracy. Political positions converged to reflect this consensus. 

But as the fascinating graphic below shows, this consensus has been breaking down and the median liberal and conservative positions in the US has diverged significantly over the past decade. 
2. Why is it happening? But this consensus was accompanied by a less benign bipartisan elite convergence (more of it latter) which effectively ended up capturing the economic and political establishment. 

The rapid and fairly inclusive economic progress achieved in the period helped underpin this consensus and paper over fissures that were developing due to forces like trade liberalisation, globalisation, de-unionisation, and skill-biased technological changes. But once growth started slowing, for a variety of factors, these fissures started to show up.

But mainstream political parties, captives as they had become of elite interests, failed to see the breakdown in social consensus. The liberal elites too became caught up in their rhetoric.    

Nothing has been more emblematic of this isolation of elites from the electorate than the staggering levels of economic inequality, which has been widening at a rapid pace since the millennium. As the graphic below shows, in the US, the share of national income going to the top 1% has nearly doubled from 11% in 1980 to 20% in 2014. 
While trade, technology, de-unionisation, immigration, business concentration etc played a role, Jonathan Rothwell argues, 
Almost all of the growth in top American earners has come from just three economic sectors: professional services, finance and insurance, and health care, groups that tend to benefit from regulatory barriers that shelter them from competition. The groups that have contributed the most people to the 1 percent since 1980 are: physicians; executives, managers, sales supervisors, and analysts working in the financial sectors; and professional and legal service industry executives, managers, lawyers, consultants and sales representatives. Without changes in these largely domestic services industries — finance, health care, the law — the United States would look like Canada or Germany in terms of its top income shares.
He also points to how the elite capture of institutions that sets the rules of the game have contributed to an elite premium and rapid widening of inequality,
The United States also stands out in terms of how much money its elite professionals earn relative to the median worker. Workers at the 90th percentile of the income distribution for professionals make 3.5 times the earnings of the typical (median) worker in all occupations in the United States. Only Mexico and Israel, which have very high inequality, compensate professionals so disproportionately. In Switzerland, the Netherlands, Finland and Denmark, the ratio is about 2 to 1. This ratio, the elite professions premium, is very highly correlated with income inequality across countries.
Others are noticing these trends. A new book, “The Captured Economy” by Brink Lindsey and Steven Teles, argues that regressive regulations — laws that benefit the rich — are a primary cause of the extraordinary income gains among elite professionals and financial managers in the United States and of a reduction in growth. This year, the Brookings Institution’s Richard Reeves wrote a book about how people in the upper middle class have shaped both legal and cultural norms to their advantage. From different perspectives, Joseph Stiglitz, Robert Reich and Luigi Zingales have also written extensively about how the political power of elites has undermined markets.
Problems cited by these analysts include subsidies for the financial sector’s risk-taking; overprotection of software and pharmaceutical patents; the escalation of land-use controls that drive up rents in desirable metropolitan areas; favoritism toward market incumbents via state occupational licensing regulations (for example, associations representing lawyers, doctors and dentists that block efforts allowing paraprofessionals to provide routine services at a lower price without their supervision).
Economic geography too has played a role. Richard Florida has documented the increasing trend of concentration of poverty, both across cities and within them. Defining concentrated poverty as neighbourhoods where 40% or more residents are below the US poverty line, he writes,
The number of people living in concentrated poverty has grown staggeringly since 2000, nearly doubling from 7.2 million in 2000 to 13.8 million people by 2013—the highest figure ever recorded. This is a troubling reversal of previous trends, particularly of the previous decade of 1990 to 2000, where Jargowsky’s own research found that concentrated poverty declined. Concentrated poverty also overlaps with race in deeply distressing ways. One in four black Americans and one in six Hispanic Americans live in high-poverty neighborhoods, compared to just one in thirteen of their white counterparts.
Similar concentrations can also explain Brexit. Sarah O' Connor has this fantastic essay on the declining fortunes of the once popular English seaside tourist resort town of Blackpool. The article shows how Blackpool has become "a net importer of ill health, unemployment, and precarious labour and a net exporter of good health and skilled labour". It talks about the "Shit Life Syndrome" that has contributed to a self-fulfilling downward spiral of despair and misery.
And this manifests in social problems that affect the current generation...
... and the future generation too.
See this commentary on the article by Ananth. The opioid epidemic that is sweeping large parts of the US mirrors Blackpool's problems across the Atlantic. And it affects all the similar groups of people.

3. So what can be done? The always incisive Dani Rodrik describes the political situation as a pooling equilibrium, recounts its consequences, and points to a solution to wean the electorate away from populist demagogues,
Conventional and reformist politicians look alike and hence elicit the same response from much of the electorate. They lose votes to the populists and demagogues whose promises to shake up the system are more credible... A pooling equilibrium can be disrupted if reformist politicians can “signal” to voters his or her “true type"... It means engaging in costly behavior that is sufficiently extreme that a conventional politician would never want to emulate it, yet not so extreme that it would turn the reformer into a populist and defeat the purpose. For someone like Hillary Clinton, assuming her conversion was real, it could have meant announcing she would no longer take a dime from Wall Street or would not sign another trade agreement if elected.

In other words, centrist politicians who want to steal the demagogues’ thunder have to tread a very narrow path. If fashioning such a path sounds difficult, it is indicative of the magnitude of the challenge these politicians face. Meeting it will likely require new faces and younger politicians, not tainted with the globalist, market fundamentalist views of their predecessors. It will also require forthright acknowledgement that pursuing the national interest is what politicians are elected to do. And this implies a willingness to attack many of the establishment’s sacred cows – particularly the free rein given to financial institutions, the bias toward austerity policies, the jaundiced view of government’s role in the economy, the unhindered movement of capital around the world, and the fetishization of international trade.
In other words, the most promising solution may be to let the house burn down completely!

Wednesday, November 15, 2017

Graphical summary of India's power sector

A graphical summary of India power sector

1. Among major developing economies, despite its much higher economic growth rates, India has had the weakest growth in net capacity addition in recent years.
2. Interestingly growth in net power consumption has remained more or less steady since 2000, even during the high-growth periods of 2003-08. In contrast, economies like Vietnam and China have had much higher net power consumption rates in their high growth years. 
3. This is even more surprising since India's very low percapita consumption ought to have a given a low base thrust. Note that, like with Indonesia, India's percapita consumption has barely inched forward over the past decade-and-half.
4. The relatively lower demand is also reflected in the remarkably stable growth in Plant Load Factor (PLF), even in the thermal sector, despite the significant increases in capacity addition in recent years.   One would have thought that with the recent increases in capacity addition, the PLF should have risen.
5. The Achilles Heel though remains the very high transmission and distribution (T&D) losses, whose decline, worryingly enough, has plateaued off this decade. Come to think of this, the two phases of accelerated power restructuring programs appear to have had limited effect on loss reduction.
This blogger has consistently held the view that India's power surplus is deceptive. It conceals the suppressed demand arising from a combination of factors - fiscally enfeebled discoms preferring load reliefs to buying power whose cost of service is not recovered in the tariffs, deficient transmission infrastructure preventing evacuation of all available power, and displaced (to diesel generators etc) and suppressed economic activity due to poor quality of supply eroding business competitiveness.