Wednesday, March 31, 2010

Earth Hour and environmental awareness creation?

As part of the annual World Wildlife Fund (WWF) sponsored global Earth Hour, lights and electrical appliances were turned off in many parts of the world between 8.30 and 9.30 PM on March 27th by households and businesses in an effort to raise awareness towards the need to take action on climate change. The WWF claims that the one hour saved India 1000 MW last year.

However, for all its high-profile, apart from the feel-good factor engendered by flaunting the pro-environment credentials of those switching off their lights, I am not convinced that it has achieved anything substantial. I have three observations on this

1. Ironically, by switching off their lights, the environment conscious denizens of our cities may actually have not contributed anything to reducing carbon emissions. In fact, the Earth Hour may be one of the biggest environmental mis-information campaigns, non-events, atleast in India! Here is why.

No power plant anywhere in India switched off their generators in response to the reduced demand. So where did power saved by way of voluntarily reducing consumption go? Very few people may be aware that the severe peak power deficits (and 8.30 to 9.30 PM is indeed peak time) in India, amounting to over 15%, is controlled by load shedding (or load reliefs) to certain categories of consumers. Typically, industries and residential consumers in rural areas and small towns face the brunt of these power cuts. During the Earth Hour, the reduced off-take by the town feeders meant that the loads were, for a change, merely diverted to the rural and industrial feeders.

In fact, more than lowering carbon emissions, the Earth Hour may have only give many villages an unexpected load shedding free night! In other words, it could well have been advertised as an attempt to bridge the rural-urban divide in electricity supply!

2. If the organizers of such events are really serious about their intentions, they should be looking at more meaningful initiatives like organizing a "no-car" day when all private car owners will be encouraged to keep their private vehicles at home and use public transport or car pools. Or they should organize a campaign to discourage (or even boycott!) conventional light bulbs and incentivize energy efficient light bulbs like CFLs.

Such interventions will contribute significantly towards curbing greenhouse gas emissions and addressing the problem of climate change.

3. In electricity itself, a more meaningful way to create awareness, signal environmental credentials and reduce the carbon footprint (and even achieve equity in electricity distribution!) would be to discourage the use of air conditioners and other electrical appliances, watering of lawns and washing of vehicles during peak demand times so as to permanently keep down cosnumption during such times.

Coincidentally, a pilot study in California that incentivized (with flat monthly cash credits and usage measured with smart water meters) water users to shift their watering of lawns to off-peak times found encouraging positive response. It found that at peak times, participating homeowners used less than half the amount of water as those in the control group and the homeowners’ total use also ended up being 17% lower than the control group’s. Given the energy needed to pump it, water accounts for an astonishing 19% of the electricity use in California, water utilities save considerable money by minimizing their peak time electricity utilization.

Update 1 (1/4/2010)
See also this from Mint.

Monday, March 29, 2010

The challenges facing fertilizer subsidy reforms

I have blogged a few days back about how the Government of India proposes to reform the fertilizer subsidy regime by immediately migrating to a nutrient-based subsidy regime and then gradually moving to direct cash transfers into the farmer's UID-linked bank account.

Despite its apparent conceptual simplicity, especially given the possibility of a UID-linked beneficiary account in the coming months, there are several important challenges that will need to be addressed before such direct cash transfers and price decontrol can be successfully implemented. Here are a three problems that are certain to come in the way of any attempt to dispense off with the dual pricing system and transfer subsidies as direct cash support.

1. Beneficiary targeting - The fundamental requirement in delivering fertilizer subsidies as direct cash transfers is the accurate identification of its target group. In the Indian context, there is the important distinction to be made between farm land owners (mostly absentee) and actual cultivators (or tenants). However, since tenancy has been abolished across most parts of India, existing land regulations and records recognize only the land owner and does not acknowledge the rights of the tenant.

In the absence of any legally certified record that establishes the identity of the actual cultivator, it becomes impossible to administer a cash transfer scheme for fertilizer subsidies. It is for this reason that the largest beneficiaries of the recent loan waiver scheme were the absentee landlords (crop loans are given based on the existing land records which acknowledge only the landlords).

Further, even assuming the cultivator status is established, means-tested targeting would require identification of beneficiary farmers based on some objective farming-related parameter - say, the extent of land ownership or cultivation. However, given the abysmal shape of our land records, the veracity of any such identification will remain questionable.

In view of the problems in identification based on cultivation status, the most effective proxy for targeting farmers will be their income levels, established based on some relatively accurate database, like the PDS card issued. It can be mandated that only the Below Poverty Line (BPL) farmers will be eligible for fertilizer subsidies. The cash subsidy can then be delivered to their UID-linked account.

Another option to deliver the subsidy would be to use time-dated (so that it would not be used after the season) and UID-linked bar-coded vouchers. The vouchers could be issued to eligible farmers who would then pay the market price and get the subsidy redeemed to their UID-linked bank account when the bar-code is swiped. With appropriate controls to restrict the amounts that can be transferred to any UID-linked account, the extent of subsidy delivered to any one farmer can be restricted.

Though the accurate identification of the beneficiary farmers to be given the vouchers in the first place will remain a problem, any leakages arising from too liberal a coverage (of beneficiaries) can be substantially limited with the subsequent aforementioned controls.

2. Ensuring availability - As this Businessline story documents, the success or otherwise of the fully decontrolled regime will critically depend on curbing speculative tendencies in the market and thereby ensuring adequate availability of stocks. I have blogged about the strong incentives to game the market in the case of a similar strategy to deliver PDS through private shops by abolishing the dual-price system.

This is more so in the case of DAP and MoP, the two most consumed fertilizers after urea, due to their use-pattern and import dependency. Fertilizers prices are especially vulnerable to market manipulation given the limited number of manufacturers, large share of imports, and narrow consumption window. For example unlike urea which is applied throughout the crop cycle, DAP is a nutrient required for root establishment and which farmers apply primarily as a basal dressing just before sowing (for wheat DAP is to be applied only during planting in November-December). Given this, there is the strong possibility of demand spikes and price rises unless adequate and timely availability is ensured during such times. It also means that the bulk of Indian imports should be concentrated in October-December, when the demand in other major users/importers is low due to severe winter.

Further, while three-fourths of urea consumed is produced domestically, domestic output meets only 30-40% of demand of DAP and the entire annual consumption of 44-45 lt of MoP is imported. Further, underlining the sensitivity of global market prices to India's imports, India formed 40% of global DAP imports in 2009, 58% of phosphoric acid, and 31% of rock phosphate.

Even under the proposed NBS scheme, distribution and movement controls (not price controls) under the Essential Commodities Act, 1955 would remain on up to 20% of the production and imports of these products so as to ensure adequate supplies in under-served areas. The government should use this 20% quota available to ensure adequate availability of these fertilizers, especially during the planting seasons. This should be complemented with very firm efforts to crackdown on hoarding and other activities that cause scarcity.

3. Cushioning against price volatility - Decontrolled prices mean that the domestic farm-gate fertilizer prices will now be substantially determined by international markets, especially since many of these fertilizers are predominantly imported, one way or the other. Given the widespread political opposition to decontrolling the similarly global market dependent petroleum prices, the Union Government will face strong pressures to intervene especially during periods of oil price spikes.

Further, despite the generous subsidies to placate the powerful fertilizer companies and also discourage them from raising their MRP, the incentives to indulge in price gouging will continue to be strong.

However, in due course of time, a more closely integrated pan-national market for such products, as against the highly fragmented and localized existing markets, coupled with more easy access to market information for farmers, will limit/contain the possibilities for such price manipulation.

In order to off-set any volatility in global market prices, there have been calls to maintain a strategic reserve of DAP and MoP. While this may be politically attractive, it poses numerous problems of incentive distortions and administration challenges that bedevil existing programs like the PDS.

An effective alternative would be to help farmers access the forwards and futures market for fertilizer products and hedge for such volatility. This could be done either at the individual farmer level or more effectively at the level of farmers groups or co-operatives. Customized and user friendly financial market products, which are readily accessible, can dramatically expand the use of such hedging instruments.

By clearly defining the unit subsidies on each element for the full year, the proposed NBS regime removes all regulatory uncertainties for the producers and leaves them to address only the market risks. It is therefore important that they too hedge for input price volatility risks with futures and forwards contracts.

In any case, given the pervasive market failures, especially in markets with strong legacy of political interference and regulatory controls, all such perverse tendencies will continue to surface at some time or other at all levels. In order to deter such practices, governments, especially at the state level, will have to show the commitment to immediately crackdown on such practices with firmness.

Incidentally all the same problems will remain with the NBS regime too.

Sunday, March 28, 2010

Wave and tidal power






How large is USA?

American states mapped to countries with nations with same GDP.

At the same population density as Brooklyn, all of America could be fitted into the size of its fifth smallest state New Hampshire!

(HT: Strangemaps via MR)

China Vs US - mirror images?

Sometime back, I had blogged about how China's rise over the last two decades more or less mirrored Japan's decline.

Now Economix points to a comparison of the changes in the shares of China and US GDP's relative to the world GDP. Similar pattern is evident, atleast in the rise in the share of China's GDP since the nineties.

Interestingly, the decline of Europe's share of world GDP is even more precipitious and continuous since the sixties. Since the nineties, India's share of the world GDP has been inching upwards. Taking cue from China's growth, India today looks like being at where China was at the beginning of the nineties.

Friday, March 26, 2010

Lesson in poverty eradication humility

Micheal Clemens has a nice post that seeks to make out a case for long-term evaluation (comparison of the villages that get the intervention to villages that do not get it, in such a way that which villages do and don’t get the intervention are randomly picked from an initial group) of development interventions since short-term effects and long-term effects can be completely different from one another.

But he points to a massive experiment, the World Bank financed Southwest Poverty Reduction Project in China, a multi-sectoral village-level development package intervention in 1,800 rural villages, whose failure is an object lesson in bringing some humility to poverty eradication experts.

It was implemented in the autonomous region of Guangxi and the provinces of Guizhou and Yunnan, and covered 600,000 households in 35 of China’s poorest counties, and ultimately assisted 2.8 million people. The World Bank provided $247.5 million for the project, and Beijing matched that amount.

The Project targeted the poorest villages, lasted about five years (1995-2000), cost hundreds of thousands of dollars per village, and sought to permanently reverse the fortunes of those villages with a broad-based and community participation-based package including roads, piped water, power lines, upgrading schools and clinics, training of teachers and health-care workers, microcredit, and initiatives for raising crop yields, animal husbandry, and horticulture.

Evaluations of the Project five years after it started, by Shaohua Chen, Ren Mu, and Martin Ravallion (also here), showed that income in those villages grew by 20% more during the project than in similar villages in the same area that had not received the intervention, and savings grew by 100% more. However, once the the intervention ended, all those effects on income and savings disappeared. Stunningly, ten years after the five-year project began, average income and savings in the villages that got that massive package of interventions were indistinguishable from income and savings in villages that did not.

A double-difference estimator of the program's impact (on top of pre-existing governmental programs) reveals sizeable short-term income gains that were mostly saved. Only modest gains to mean consumption emerged in the longer term - in rough accord with the gain to permanent income. Certain types of households gained more than others. The educated poor were under-covered by the community-based selection process - greatly reducing overall impact.

From hindsight and subsequent analysis, incomes in both the treated and untreated Chinese villages in the Southwest Project area increased greatly during the span of the project (1995-2000) and for years thereafter since the period coincided with the dramatic transformation of the Chinese economy. The impact, if any, of the massive village-level package development interventions, was marginal.

Btw, about the Clemens post itself, I could not but agree with Chris Blattman on RCTs, albeit in the context of a different project - the equally ambitious Millennium Villages Project.

The sub-prime crisis and stimulus in historic perspective

Interesting post by William Easterly who while not underplaying the short run pain caused by financial crises, including the current one, argues that despite such recurrent crises capitalism has survived and gone on to produce unprecedented prosperity. For good measure, he rephrases Keynes’ "in the long run, we are all dead" with "In the long run, we are all better off because our dead ancestors stuck with capitalism".

The graph below shows episodic waves of defaults (involving a high number of countries in each wave) on their external debt (one possible dimension of a financial crisis) by a number of of countries over the last two centuries.

Average per capita income in the world (a shaky estimate, but probably right order of magnitude) increased by a multiple of 12 over 1800-2008, and in the US it shows a steady upward trend from 1870 to the present, despite repeated banking crises (using those identified by Reinhart and Rogoff), with usually little effect of each crisis on output relative to trend (except for the Great Depression)

Mark Thoma makes the important inference from the relative stability of the linear growth trend of US per capita income from 1870 – 2008 that aggressive interventions (which help substantially in the short-run in expediting the recovery) to stimulate the economy is not likely to cause long-run problems. He therefore feels that we should not panic and start reducing stimulus measures too soon, or be too timid with stimulative policies, out of fear it might harm long-run growth.

Thursday, March 25, 2010

Managing the recovery in developed economies

It cannot be denied that government interventions - monetary expansion (conventional and unconventional) and fiscal stimulus spending - in the aftermath of the sub-prime crisis played a major role in both preventing economies from slipping into a deeper recession, even a depression, and speeding and easing the recovery path. However, developed economies continue to face large unemployment rates, depressed consumer demand, and weak investment environment. Household and business balance sheets remain in bad shape and require considerable restructuring.

With things "getting worse slowly" or some form of recovery on, governments and central banks have to decide on the further course of fiscal and monetary policy actions. Supporters of continuing the aggressive government interventions point to the persistently high output gap, large unemployment rates and weak aggregate demand and advocate keeping monetary policy loose and another round of fiscal stimulus. Opponents point to the growing deficits and accumulating public debt burdens, credit markets awash with liquidity (albeit without many takers) and the resultant inflationary expectations, and demand that government scale back their interventions immediately.

In an excellent article, Prof Micheal Spence provides a sense of perspective to this debate and cautions that whatever governments do, the process of healing will take time and cannot be accelerated "beyond fairly strict limits". It may also not be desirable to do so, since that would inevitably lead to more asset bubbles that artificially boost the balance sheets, with all the resultant adverse consequences. He favors "an orderly healing process in which balance sheets are restored mostly without government intervention". He writes,

"The benefits associated with deficit-financed boosts to household income are now being diminished by the propensity to save and rebuild net worth. On the business side, investment and employment follows demand once the inventory cycle has run its course. Until demand returns, business will remain in a cost-cutting mode.

The bottom line is that deficit spending is now fighting a losing battle with an economy that is deleveraging and restructuring its balance sheets, its exports, and its microeconomic composition – in short, its future growth potential. That restructuring will occur, deficit spending or no deficit spending. So policy needs to acknowledge the fact that there are limits to how fast this restructuring can be accomplished.

Attempting to exceed these speed limits not only risks damaging the fiscal balance and the dollar’s stability and resilience, but also may leave the economy and government finances highly vulnerable to future shocks that outweigh the quite modest short-term benefits of accelerated investment and employment. Demand will revive, but only slowly.

True, asset prices have recovered enough to help balance sheets, but probably not enough to help consumption. The impact on consumption will largely have to wait until balance sheets, for both households and businesses, are more fully repaired. Higher foreign demand from today’s trade-surplus countries (China, Germany, and Japan, among others) could help restore some of the missing demand. But that involves structural change in those economies as well, and thus will take time."

Apart from these immediate issues, there is a need for more fundamental structural changes in both domestic and global economies. The much-discussed global macroeconomic imbalances and rebalancing of demand will surely have to be addressed before we can be assured of any sustainable recovery. Emerging economies, especially China, will have to consume more, and by corollary, consumers in developed economies have to save more.

The financial markets in the emerging economies will have to develop greater depth and breadth so as to accomodate a much greater share of their surpluses. They could take a leaf out of the Japanese financial markets which house the major share of domestic savings, despite the ultra-low interest rates (a de-facto government guarantee on deposits made at Japan Post have attracted huge funds - about ¥300 trillion, or more than the annual GDP of France). And finally, the macro-prudential regulation of the global financial markets will have to become more counter-cyclical and strongly enforced. All these will take time and governments can do little to expedite them in the short term.

Prof Spence also argues that best use of deficits and government debt, especially in an extended balance-sheet recession, is to focus on distributional issues, particularly the unemployed, both actual and potential. Unemployment being structural rather than the result of any perverse incentives, unemployment benefits should be expanded and extended for a limited, discretionary period and should revert back to old norms after the structural barriers fall and jobless rates decline. Given the limited fiscal space available in all these economies, it may now be more appropriate to focus more on direct employment creation policies.

Despite the well documented adverse consequences of a more aggressive interest rate policy - reduce asset prices, increase debt-service burdens, and trigger additional balance-sheet distress - he cautions against continuing the present cheap credit policy on the grounds that it will produce asset bubbles, sectoral misallocations, and keep the dollar cheap. The last will incentivize emerging economies to indulge in forex management operations to retain export competitiveness and facilitate the dollar carry-trade induced capital flight to emerging economy equity markets, and thereby postpone the inevitable rebalancing of global macroeconomic imbalances.

Unlike the easier decision on fiscal policy, the monetary policy decision is much more difficult, especially from amore systemic perspective. The balance sheets of the majority of financial institutions continue to remain in the red, and they (and the market itself) have been kept afloat by access to cheap capital and the artificially depressed debt burdens due to the ultra-low interest rates. The loose monetary policy has played a life-support role in buying time for these institutions to repair their battered balance sheets (both through firm-specific restructuring and deleveraging and the spectacular recovery in equity markets). It remains a matter of considerable uncertainty as to whether the balance sheets have recovered adequately enough for the markets to take the monetary exit without too may hiccups.

Wednesday, March 24, 2010

More on Euroland crisis

I have blogged earlier about how Greece has become the symbol of what ails the 16 nation European Monetary Union (EMU).

The experiences of many of the periphery economies of Euroland have mirrored the real estate bubble and post-bubble banking crisis that characterized US and UK. However, unlike both these countries (and others facing similar problems), who undertook unconventional monetary policy actions to loosen monetary policy and unprecedented fiscal stimulus spending to boost aggregate demand, recession fighting policies in the Euroland countries has been on a divergent trend.

As a consequence of the original sin with the rigid conditions imposed under the Growth and Stability Pact and the absence of any political union, these economies start with the considerable disadvantage of fighting the deep recession and financial crisis without the freedom to make the full use of the conventional fiscal or monetary policy tools. Adding to their discomfiture is the reluctance of stronger economies of Germany and France to assist them with any form of bailouts.

In fact, far from supporting them with liquidity injections, Germany has reiterated its traditional preference for fiscal austerity measures and have backtracked from any support for Greece. These calls for fiscal contraction during such a deep recession and financial market crisis threatens to tip Greece into a deflationary spiral and raise unemployment to politically unacceptable levels.

Simon Johnson and Peter Boone point to an IMF assessment that by the end of 2011 Greece’s public debt will be around 150% of its GDP, of which about 80% is foreign-owned. The major share of the foreign holdings are by investors from Germany and France, who flocked into the debt offerings of countries like Greece, Spain and Portugal in the later half of the last decade.

While other countries have in history managed their economies with much higher debt-to-GDP ratios, Greece suffers from a major credibility problem and economic weakness in addition to the lack of conventional macroeconomic stabilization tools. Paul Krugman points to a recent working paper examining public debt and banking crisis by Carmen Reinhart, and argues that some developed countries have managed their economies with relatively less disruption even when they had public debts in excess of 250% because they had stronger economies. He argues that "it’s not so much that bad things happen to growth when debt is high, it’s that bad things happen to debt when growth is low".

Given its precarious public finances (fiscal deficit of 12.7% of GDP) and stuttering economy, it is inevitable that Greece will need to repeatedly reschedule repayment of debt coming due for the immediate and foreseeable future (nearly half of Greek debt will roll over within three years). However, this would require offering attractive interest rates to get investors to buy Greek bonds. The spreads on Greek debt have widened since the crisis erupted.

Boone and Johnson estimate that for every 1 percentage point rise in interest rates, Greece will need to send an additional 1.2% of GDP abroad to its foreign bondholders. At a realistic interest rate of 10%, Greece would need to send at total of 12% of GDP abroad per year, once it rolls over the existing stock of debt to these new rates. As both they and Paul Krugman writes, this is simply unsustainable for Greece.

Therefore, even with the stringent austerity programs, it becomes almost a fait accompli that Greece can avoid a sovereign default - with its disastrous consequences for European (and global) financial markets (remember the massive share of European investors in Greek bonds) - only with massive capital infusions from the major European powers. Boone and Johnson estimates this capital requirement to be around 180 billion euros for the next few years. They advocate granting of long-term, subsidized loans that ultimately would cover a large part of the liabilities coming due in the next 3-5 years as the only solution to retrenching Greece's debt at an affordable level. And, even on such generous terms, Greece would probably need a daunting 10%-of-GDP fiscal adjustment just to return to a more stable debt path.

WSJ has a good article on how Ireland, another country which experienced the excesses of the property bubble and slipped into massive debt and public deficit (fiscal deficit of 12% last year), has been taking some steps towards recovery. The Irish GDP declined 7.3% in the third quarter of 2009 compared with the third quarter of 2008; exports were down 9% year on year in December 2009; and house prices havce fallen by more than 50% since 2008 and continues to fall.

The Irish government announced and implemented a massive fiscal austerity program which cut down on government expenditures, including social security spending and wage cuts (public sector salaries cut by 20% since 2008), that have been received positively by the financial markets, as reflected in the narrowing spreads on Irish debt. However, the spending freezes have adversely affected consumption, which forms nearly half the GDP, and is contributing towards keeping the economy weak.

Being in the Euroland means that Ireland cannot rely on the conventional tools - cutting interest rates and devalusing currency - to stimulate its economy. The only way for export dependent Ireland to retain its competitiveness is to cut wages, which had risen sharply during the real-estate and economic boom of the last decade. This will only add to the pressures on economic growth.

As Peter Boone and Simon Johnson point out in another article, Ireland's fall from grace from being the poster child of liberalization in Europe offers important lessons. With its massive investments in education (especially higher education), aggressive courting of investments in knowledge-based industries, ultra-low corporate tax rates (at 12.5%, the marginal corporate tax rates are amongst the lowest in the world), and fiscal prudence (the public debt to GDP ratio of 25% was one of the lowest among developed economies), Ireland was amongst the fastest growing economies in the Western Hemisphere.

However, like the US, Ireland experienced a spectacular property bubble financed by cheap credit from its major banks. Its three main banks built up 2.5 times the country’s GDP in loans and investments by 2008. But when the crash came in the fall of 2008, property prices fell over 50% and people started defaulting on loans, the Irish government bailed them out. The government injected cash into these banks and purchased their worthless assets for government bonds. As Boone and Johnson write, "one way or another, the government will have converted the liabilities of private banks into debts of the sovereign (i.e., Irish taxpayers)... It could have avoided taking on private bank debts by forcing the creditors of these banks to share the burden". Thanks to this largesse, the public debt to GDP ratio of Ireland is estimated to cross 100% by end of 2011.

Peter Boone and Simon Johnson also argue that any sustainable solution to the debt crisis in the periphery countries will have to include some form of restructuring involving the creditors taking "haircuts" on their capital. In the event of such defaults, forced or otherwise, by these countries, those most affected would be creditors in Germany and France. It would be a just penalty for those reckless creditors who threw caution to the winds in lending to the "Banking Real Estate Complex" in Ireland and financing the Greek government's irrepsonsible spending on its bloated (and unionized) public sector over the last decade.

In light of the aforementioned experiences, a centralized fiscal and monetary stabilization authority may be a necessary pre-requisite for successful monetary union. I have already posted on the proposal gaining wide currency about a centralized European Monetary/Fiscal Council, which would help struggling members with their exchange rate crises, macroeconomic imbalances or debt problems. It will help such countries implement counter-cyclical fiscal and monetary policies to provide all the required traction to flagging economies during down-turns.

In a Vox article, Micheal Burda calls for the setting up of a European Monetary Fund (EMF), with the same type of prudent, independent governance as the European Central Bank as the logical next step along the path of political integration. See also Daniel Gros and Thomas Mayer making a more detailed presentation in Vox of their EMF proposal.

WSJ has an excellent interactive graphic, prepared by RBC Capital Markets, which offers an assessment of the relative strengths/weakness of many developed economies with respect to fiscal deficits, debt loans, growth rates and inflation. It then uses a 'sovereign risk' index to capture the riskiness of the country.

Update 1 (25/3/2010)
In an announcement that would be welcomed by banks and other lenders with exposure to Greece, the European Central Bank (ECB) will hold off tightening lending rules until 2011 and would also keep the credit ratings for the collateral that its accepts from banks, in return for short-term loans, at an exceptionally low level (it had been lowered as an extraordinary measure to help banks in the euro area weather the global credit crunch) for longer than planned.

This re-assurance comes in the aftermath of Germany's refusal to support any financial commitments to Greece, except as a "last resort", when the country can no longer borrow on financial markets.

Update 2 (30/3/2010)
Greece finally managed to raise $6.7 billion by issuing seven-year bonds priced to yield 6%. This rate is a princely 3.34 percentage points above what Germany, considered the European benchmark, pays to borrow at a similar maturity. It was also well above the rates paid by the governments of Portugal, Spain, Ireland and Italy, other countries where indebtedness has caused concern.

Last week, the European leaders had announced that, as the last resort, EMU member nations would offer Greece coordinated bilateral loans "as part of a package involving substantial International Monetary Fund financing", in exchange for which Greece offered a package of painful austerity measures this month for a population accustomed to more than a decade of rising wages.

Update 3 (7/4/2010)
With an additional 11.6 billion euros ($15.5 billion) of debt coming due before May, so as to cover its gaping deficit and refinance old debt, bond spreads on Greek debt has surged indicating low investor interest and risk aversion. It needs to raise more than $40 billion before the end of the year, so an additional 1 percent in interest would cost the Greek treasury an extra $400 million annually.

The yield on Greek debt climbed past 7% as investors sold Greek bonds. At the last Greek bond auction on March 29, when the country raised $6.7 billion, yields stood at 5.9%.

See also this superb interactive graphic of European debts and deficits as share of GDP.

Update 4 (16/4/2010)
Next on line to follow Greece looks to be Portugal. Sample this from Simon Johnson and Peter Boone

"Just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012. With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment. The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess."

The US Health Care Reform Bill Passed

Culminating President Obama's year-long, mostly acrimonious and divisive, push to reform health care in the US, the House of Representatives approved the historic Patient Protection and Affordable Care Act 2010 (which was passed by the Senate on Christmas Eve) and sent it to the President for signing into law. The legislation, which faced opposition from within sections of Democrats and looked dead at one time, was passed without a single Repblican vote in both Senate and House (the first such instance of a major legislation being passed thus), after a compromise package that federal money provided by the bill could not be used for abortions, was tailored to secure the support of wavering Democrats.

The Bill would require most Americans to have health insurance, would add 16 million people to the Medicaid rolls and would subsidize private coverage for low- and middle-income people, at a cost to the government of $938 billion (CBO estimates) over 10 years. CBO also estimates that it would provide coverage to 32 million uninsured people (who were denied coverage either because insurers deemed them too sick or because they could not afford ever-rising insurance premiums), but still leave 23 million uninsured in 2019, of whom one-third would be illegal immigrants.

Households covered under Medicaid with income up to 133% of the federal poverty level, or about $29,327 for a family of four, would be eligible for the subsidies. People with incomes of between 133-400% of the poverty level (that’s $29,327 to $88,200 for a family of four) would be eligible for premium subsidies through the exchanges. Premiums would also be capped at a percentage of income, ranging from 3% of income to as much as 9.5%.

Further, health insurers will no longer be able to deny coverage to children with medical problems or suddenly drop coverage for people who become ill, and must allow children to stay on their parents’ policies until they turn 26. It would require many employers, those with 50 or more workers, to offer coverage to employees or pay a federal fine beginning 2014. Each state would set up a marketplace, or insurance exchange, where consumers without such coverage could shop for insurance meeting federal standards. Small businesses could obtain tax credits to help them buy insurance.

Further, starting in 2014, Americans with employer-based insurance who lose their job and have to buy their own policy, cannot be denied coverage or charged high rates because of pre-existing conditions. Before then, the chronically ill could gain temporary coverage from enhanced high-risk pools and chronically ill children are guaranteed coverage.

In order to address concerns (maninly from the insurers) that young and healthy people will not enroll because the new requirements will make their premiums higher to help subsidize the older and sicker, the Bill contains a provision that requires most Americans to have insurance or pay a federal penalty. Though there still remains apprehension that the penalties will be too small and may be weakly enforced.

The mandatory requirement to cover even people with potentially costly pre-existing conditions and the strict limits on how much more an insurer could vary premiums among the people taking out the same policy, largely to factor in age differences, means that the current practice of insurers protecting profits by trying to enroll only the healthiest individuals, while also charging enough to recoup the expense of covering sick people will become history.

It will also eventually close (eliminate by 2020) the gap in Medicare drug coverage, known as the doughnut hole, in which elderly patients must pay for prescription drugs rather than having them covered by the government. Many chose to stop taking their medicine or switched to lower-price generics.

The bill does not quite reach full universality, but by 2019, fully 94 to 95% of American citizens and legal residents below Medicare age will have coverage. The bill achieves that by requiring most Americans to obtain health insurance, providing subsidies to help the middle classes buy policies on new competitive exchanges, and expanding Medicaid coverage of the poor to include childless adults and others not currently eligible.

CBO has also said that the new costs would be more than offset by savings in Medicare and by new taxes and fees, including a tax on high-cost employer-sponsored health plans and a tax on the investment income of the most affluent Americans. Beginning 2013, affluent families with annual income above $250,000 would be required to pay an additional 3.8% tax on their investment income, while contributing more to the Medicare program from their payroll taxes. Starting in 2018, employers that offer workers pricier plans — or those with total premiums of $10,200 or more for singles and $27,500 for families — would be subject to a 40% tax on the excess premium. It also proposes savings by way of lower payments for hospitals and doctors and lower drug prices. All these reforms are expected to reduce federal budget deficits by $143 billion in the next 10 years.

However, the Bill does not contain the important public-option plan - a health plan that would compete with the private insurers and make them lower costs and become more competitive. This omission had also earned the Bill the support of hospitals and drug makers, who would be clear beneficiaries as nearly 32 million new customers enter the market to purchase health care.

Insurers, whose main trade group, America’s Health Insurance Plans, vehemently opposed the legislation, will face pressures to become more cost-effective and competitive in a strikingly different business environment, with drastic changes in the way insurance is sold to individuals and small businesses, besides much heavier regulation. However, they will stand to gain from the about 16 million of the newly insured who are expected to enroll in private plans.

The creation of state-supervised marketplace, called exchanges, in which insurers would be required to sell their policies for individuals and small businesses, will involve much greater regulatory oversight than insurers now typically face and will force them to alter their business models drastically.

Greg Mankiw has a superb post putting the health care reform debate in perspective - the Bill offers "more equality (expanded insurance, more redistribution) and less efficiency (higher marginal tax rates)" and "more community (all Americans get health insurance, regulated by a centralized authority) and less liberty (insurance mandates, higher taxes)". He opposes it on the grounds that it would place unsustainable fiscal burdens.

See also this timeline on health care reforms in the US over the past century and this summary of the changes in the Bill during its passage through Senate and House. This interactive graphic informs how the Bill owuld affect insurance consumers. See this consumer guide Q&A on health care reform. See this comprehensive linkfest on health care reforms.

The Economist approves the Plan. Links from Healthcare Economist here. Robert Reich's comments here. Paul Krugman here. See the CBO's latest estimate of the final version of the Bill. Mark Thoma has this nice analysis of the numbers who benefit from the Bill. Ezra Klein explains who will be left uninsured. David Leonhardt shows how the Bill attacks health care inequality. See Uwe Reinhardt here.

See the final version of companion the Bill, the H.R. 4872 — the Health Care and Education Affordability Reconciliation Act of 2010, and its summary. See also this health care reforms discussion document for summary of the research on the health care in the US.

Tuesday, March 23, 2010

An IPL bonanza - what for the cities?

The biggest endorsement of the commercial success of cricket's Indian Premier League (IPL) was the big auction for two cities (Pune and Kochi) which netted a staggering $ 703.33 mn, a value in excess of the original eight franchises combined. Apart from the organizers, I am inclined to argue that the IPL bonanza offers unclaimed money on the table for each of the cities which are franchised out. In fact, every commercial consideration dictates that it is a marvellous opportunity for these cash-strapped cities to pocket a much-needed windfall.

In a world of brands and logos, patents and copyright protections, city and country names are the ultimate brands, especially powerful in their respective markets. The IPL franchises have mounted their bids by leveraging the brand name of each city, so much so that the USP of each franchise is the respective city's brand name.

Econ 101 tells us that since city brands are critical factor inputs underpinning the IPL enterprise, the brand should be appropriately compensated, like other factor inputs are. The brand name of a city is a public good and not a private property that can be appropriated for private gains. It is therefore natural to levy a "brand-use rent" on those using the brand that should accrue to the legal custodians of the city, the local Municipal Corporation. If IPL organizers can free-ride on using the city name for their private gain, what prevents businesses from directly using city brand names to peddle their products.

Further, the IPL matches clearly places strains on the local administration in many other ways. The shifting of IPL to South Africa last year on grounds of security and the controversies and debates surrounding security of players in the lead-up to this year's IPL underlines the critical role of security in the organization of such events. The district administration of the host city is therefore clearly stretched out to ensure the successful completion of a purely commercial event, often to the exclusion of other more important public issues. Since state governments regularly charge the organizers of private entertainment events for providing security for the event, the IPL too should be levied an appropriate user charge.

None of this is to deny that cities do not gain from IPL matches, but is only a arguement for giving cities their due share. There cannot be any crowding out effect here - if cities charge for the brand, the franchises will simply move out. Franchises base themselves in the big cities to leverage the massive audience and markets of these cities which can support the highly priced tickets and other memrobilia, apart from the reality that such events need the infrastructure that only these cities have.

Only the ignorant or duplicitous will persist with the claim that IPL is more about cricket than commerce. Without being judgemental about anything, cricket has become the platform for a massive commercial push. The IPL organizers may say that they pay their corporate taxes and therefore have a right to expect the government to provide all assistance in organizing the event. Lest they forget, corporate taxes are levied on the profits made by a commercial enterprise and is not a substitute for user charges or rent.

Tailpiece: I am convinced that the Pune and Kochi auctions will turn out to be classic examples of "winner's curse". The real winners from this auction are the existing eight franchises, who can now leverage the latest price discovery to exit when the IPL bubble is peaking. Let us re-visit the balance sheets three years down the line and I will be really surpised if it turned out any different!

Deferred consumption tax as stimulus?

The touchstone for any effective fiscal stimulus measure is its ability to get people to spend money immediately and thereby boost aggregate demand. In other words, it has to stimulate people to either indulge in additional spending or pre-pone their consumption decisions.

Accordingly, Robert Mundell had advocated that the US Government issue $500 bn of dated Spending Vouchers (to expire in 3 months) to increase effective demand with retailers using the executed vouchers as tax credits. He estimated that this would amount to stimulus in one quarter that would represent a potential 12.5% increase in spending in the quarter's income.

Along the same lines, Prof Robert Frank makes the case for a deferred progressive national consumption sur tax that would not only stimulate demand (by bringing forward consumption) but also raise revenues to bridge the deficit.

Prof Frank proposes a consumption sur tax on on families earning more than $1 million and with consumption beyond $500,000 annually, to be enacted right away, but not take effect until unemployment again fell below 6%. Since it would be enacted right away but not take effect until later, it will also produce immediate, off-budget economic stimulus by giving wealthy families powerful incentives to accelerate future spending. He points to a study by University of Delaware economists Larry Seidman and Ken Lewis who estimate that a progressive consumption tax could generate $50 billion or more in additional revenue annually.

He also proposes calculating consumption as the difference between reported (to the IRS in the annual statements) income and savings, and once consumption topped $500,000, the families would be subject to the surtax. Rates would start low but rise as consumption grew. He also argues that such a tax would not distort any incentives - beyond a certain point, additional consumption serves needs that are almost completely socially determined and more than 99% of households would be exempt from this tax.

Among other details, "loan repayments would be added to the savings total, thereby reducing potential tax liability. New borrowing, meanwhile, would be subtracted from savings, increasing the potential tax. For homeowners, annual housing consumption would be counted as the implicit rental value of their house, so a $500,000 purchase would not set off the tax."

See also Prof Frank's original arguement advocating replacement of the income tax with a progressive consumption tax. Mark Thoma prefers a more general discretionary automatic stabilizing fiscal policy to fight a recession, one that allows income taxes, payroll taxes, etc. to vary procyclically - these taxes would be lower in bad times and higher when things improve, and implemented through an automatic moving average type of rule that produces the same revenue as some target constant tax rate (e.g. existing rates).

Monday, March 22, 2010

Nutrient-based fertilizer subsidy regime

In the Union Budget 2010-11, the Government signalled its desire to shrink subsidies to 1.5% of GDP in 2011-12, and to 1.3% in 2012-13, from 2.1% of GDP (Rs 1.31 trillion) in 2009-10 and Rs 1.16 Cr estimated for 2010-11. The 13th Finance Commission had recommended that the level of food, fertilizer and petroleum subsidies, which together account for at least 90% of the government’s subsidy bill, be brought down to a combined 0.88% of GDP by 2014-15.

Fertilizer subsidies are arguably the most politically sensitive and form the second largest share of subsidies after food. It is also entrapped in the most powerful vested interests of farmers and fertilizer industry lobby. Any meaningful revamp of the existing product-based fertilizer subsidy regime will always be a touchstone for the commitment of any Central Government in India towards genuine fiscal reforms.

In a landmark move aimed at reforming the fertilizer subsidy regime, the Union Budget 2010-11 had announced the decision to move away from product-based towards a nutrient-based subsidy (NBS) regime for fertilizers (especially phosphatic and potassic fertilisers) from April, 1, 2010. It was also decided to mark-up the maximum retail prices (MRPs) of urea by 10% (from Rs 4,830 per tonne to Rs 5,310 starting 1 April) and decontrol the prices of non-urea fertilizers.

However, distribution and movement controls (not price controls) under the Essential Commodities Act, 1955 would remain on up to 20% of the production and import of these products to ensure adequate supplies in under-served areas. While the Centre would be able to direct companies where and how much to sell in respect of this 20%, the remaining 80% can be freely sold by the industry anywhere at market prices determined based on the demand-supply forces.

The proposed NBS regime would be directly applicable only to 18 non-urea fertilisers already covered with product-based subsidy - di-ammonium phosphate (DAP), mono ammonium phosphate, triple super phosphate, single super phosphate (SSP), muriate of potash (MoP), ammonium sulphate and 12 grades of complex fertilisers. In these 18 fertilisers, the subsidy would be given based on their respective Nitrogen (N), Phosphorus (P), Potassium (K), and Sulphur (S) contents and the unit subsidy for them would be decided on an annual basis by the Department of Fertilisers as per the recommendations of an Inter-Ministerial Committee consisting of the Secretary (Fertilisers) and representatives from the Department of Agriculture & Cooperation, Department of Agricultural Research and Education, Department of Expenditure and Planning Commission. Further, any variant of the above fertilisers containing secondary and micro nutrients such as calcium, zinc, boron or molybdenum will attract a separate per tonne subsidy to encourage their application along with the primary nutrients.

The fertilizers would be sold to farmers at its decontrolled MRP (minus the sbubsidy) and the subsidy amount paid separately to the fertilizer companies. The payment of subsidy to the manufacturers/importers of the 18 fertilisers (barring SSP) shall be based on the receipt of fertilisers in the districts of the States, while being based on sale in the States in case of SSP. The customised fertilisers and the fertiliser mixture industry will be able to receive the subsidised fertilisers from the manufacturers/importers after its receipt in the districts as inputs for manufacturing customised fertilisers/fertiliser mixture.

Accordingly, the government have announced that the subsidy on N would be fixed at Rs 23.22 a kg, for P at Rs 26.27, for K at Rs 24.48, and for S at Rs 1.78 from April, 1, 2010. Therefore the subsidy on DAP (containing 18% N and 46% P) would stand at Rs 16,263.8 a tonne, on MoP (containing 60% K) would be Rs 14,688 a tonne. The current controlled retail price of DAP is Rs 9,350 a tonne, while it is Rs 4,455 a tonne for MoP. The unit subsidies fixed for the four nutrients would be applicable for the whole of 2010-11 and have been arrived at by benchmarking to international prices that were taken at $500 a tonne for DAP, $370 a tonne for MoP, $310 a tonne for urea and $190 a tonne for sulphur.

These subsidies have been fixed keeping in mind the prevailing market prices, medium-term expectations, reasonable returns for producers, and small inevitable price increases (Rs 500-600 per tonne for DAP) during the crop season. The current controlled MRP of DAP is Rs 9,350 a tonne and the landed cost of imported DAP is now around $515 a tonne or Rs 23,432 a tonne at current exchange rates. If the subsidy element is added, the industry could realise Rs 25,613.8 a tonne without increasing the MRP. Similarly, the current controlled MRP of MoP is Rs 4,455 a tonne and the landed cost of imported MoP (from Canada) is $370 a tonne. With this, the realisation to the industry after adding subsidy to the existing controlled MRP would be a comfortable Rs 19,143 a tonne or $420 a tonne. Except unforeseen increases in global fuel prices, any possible volatility in fertilizer prices therefore appears remote.

The move is expected to facilitate balanced fertilisation through new fortified products and promote extension services by the fertiliser industry, besides increasing productivity and returns for the farmer. Further, once a nutrient-based subsidy is in place, makers of phosphatic and complex fertiliser may gain at least limited flexibility in pricing products based on individual cost structures. Producers can now introduce many more variants of fertilizers, and will no longer need to stick to DAP or other specific complex fertilisers, due to the product-subsidy element on each. Though the normal ratio for N:P:K in the soil is 4:2:1, this has been greatly skewed due to the distortions in the old subsidy regime. Urea contributes at least 50% of fertilizer consumption of around 50 million tonnes in the country.

The diversity in product mix will also enable greater differentiation between producers and they could customise products to crops and regions without jostling each other within the same commoditised markets. Further, while subsidy per tonne of nutrient may be uniform across producers and based on input costs, a few may be able to price their products lower if they enjoy lower overheads.

The Government will keep the nutrient-based fertiliser prices for transition year 2010-11 at around the (MRPs) currently prevailing and disburse the subsidy to the fertilizer firms directly. It hopes to dispense off with the dual pricing and move over to a system of direct transfer to the farmers bank account from next year.

Interestingly, the Economic Survey has favored coupons over cash transfers on the grounds that the subsidy would get channelised to the intended use instead of being frittered away on wasteful expenditures (like liquor and gambling). It also advocates structuring these coupons to favour particular nutrients keeping in view soil fertility and health considerations and having different coupons for different nutrients, with the underlying subsidy being varied accordingly.

Update 1 (27/3/2010)
If the new rates of subsidy applicable on different fertilizers from the coming fiscal are compared with their existing levels, in most products, the subsidy payable to fertilizer companies will actually go up.

For DAP, manufacturers and importers who are currently given a concession of Rs 10,245 a tonne in return for selling at a controlled MRP of Rs 9,350 a tonne, will now get a subsidy of Rs 16,268 a tonne (and increase of 59%). The subsidy on MAP has been raised by 104% and on TSP by 38.5%.

Quantitative easing in US and Japan

John Taylor has two nice graphs comparing the monetary base expansions in Japan and US as part of the quantitative easing (QE) programs of the respective central banks, Bank of Japan and the Fed.

The BoJ's QE during the 2001-06 period increased the monetary base from about 65 trillion yen to 110 trillion yen, or by about 70%. The exit was swift and went without any volatility in the markets. Though the post-2008 QE was small compared to the 2001-06 QE, the persisting deflation makes any exit from monetary expansion difficult.

In contrast, the monetary base in the United States (to finance its purchase of mortgage backed securities, bailouts of AIG and Bear Stearns and other loans and securities purchases) increased by twice as much in percentage terms (140%) and much more quickly (especially in the last few months of 2008) in the aftermath of the sub-prime mortgage bubble bursting. While the Fed entered into QE when the interest rate target was 2%, the BOJ started QE when the interest rate was already essentially zero at 0.1%.

Prof. Taylor feels that the BoJ's quick and relatively problem-free exit from QE suggests that a quicker exit for the Fed might notcause too many problems.

However, I feel that he may be asking the wrong question here. The debate now should not be about the problems with managing an exit, but whether it is time yet (given the weak economy, business investment and consumer demand, and continuing threat of deflation) to roll back the monetary expansion.

Sunday, March 21, 2010

An "economic genocide" in progress and "tunnels" to the rescue?

Why does the strangulating economic blockade of the 1.5 million residents of Gaza Strip not attract any international indignation and outrage? By all accounts the suffocating economic blockade and systematic destruction of the economy of Gaza is a grave human rights violation and a classic example of "economic genocide". Rex Brynen of McGill University describes the situation nicely,

"Today, what is or is not allowed into Gaza is never entirely clear and can change from month to month. Broomsticks and chamomile have recently been permitted; toys, music, books, and shampoo with conditioner have been prohibited; and the importation of pasta required the direct intervention of US Secretary of State Hillary Clinton. Almost all of the materials needed for reconstruction after Operation Cast Lead last year have been blocked, although some imports of glass have finally been permitted after months of extended negotiation. As a result of this, there is little productive enterprise within Gaza today. It is only recently that Israel has started to permit limited exports of cut flowers and strawberries, for example, after seven months of blockage. The number of employees in the industrial and construction sectors has fallen from over 53,000 in 2007 to fewer than 3,000 today. According to the most recent report from the World Bank and PalTrade, 70 percent of industrial establishments are closed, 20 percent are operating at 10 percent capacity, and only 10 percent are working at 20-50 percent capacity."

Even such extreme repression cannot break the enterprise of human beings subjected to it. The most impressive manifestation of the survival instincts of Gazans is the proliferation of the so-called "tunnel trade" across the border with the Egyptian municipality of Rafah, which has even created a "new class of wealthier smugglers and merchants". The hundreds of active tunnels - which bring in shoes, clothing, chocolate bars, utensils, appliances, livestock, automobiles, etc - stretching from two hundred meters to a kilometre or more under the border, and costing an average of $100,000 to build and operated by traders and smugglers, have become "Gaza's essential lifeline to the outside world".

The economic embargo was imposed by Isreal in the aftermath of Hamas' victory in the 2006 Palestinian local elections, with the specific objective of shutting out Gaza Strip from the outside world and thereby punishing Palestinians for electing Hamas and hopefully discrediting Hamas before the residents of Gaza Strip. However, expectedly (to any impartial observer of such situations), the embargo has only strengthened the Hamas which has belligerently taken on the embargo (with no small help of the tunnels) and are seen as standing up to protect the Palestinian cause. The conspicuous silence of the Palestinian Authority and the remaining Arab countries appear to have only reinforced the credibility of Hamas.

Update 1 (6/6/2010)
Here is an explanation of the components of the economic blockade of Gza by Isreal.

Age of the "attention economy"

Fascinating article (via Marginal Revolution) by Michael Erard about how in the information age, cultural producers (designers, filmmakers, theater types, musicians, artists, advertisers etc) face both a shortage of attention (among their audience) and the challenge of "allocating that attention efficiently among the overabundance of information sources that might consume it".

He gives the exmaple of giving "free" and making things brief as allocation strategies to capture immediate attention. However, on the flip-side, pricing things free does not come free, and is unsustainable. And, being brief is underpriced. He writes

"I imagine attention festivals: week-long multimedia, cross-industry carnivals of readings, installations, and performances, where you go from a tent with 30-second films, guitar solos, 10-minute video games, and haiku to the tent with only Andy Warhol movies, to a myriad of venues with other media forms and activities requiring other attention lengths. In the Nano Tent, you can hear ringtones and read tweets. A festival organized not by the forms of the commodities themselves but of the experience of interacting with them. Not organized by time elapsed, but by cognitive investment: a pop song, which goes by quickly, can resonate for days; a poem, which can go by more quickly, sticks through a season. A festival in which you can see images of your brain on knitting and on Twitter.

I imagine a retail sector for cultural products that's organized around the attention span: not around "books" or "music" but around short stories and pop songs in one aisle, poems and arias in the other. In the long store: 5,000 piece jigsaw puzzles, big novels, beer brewing equipment, DVDs of The Wire. Clerks could suggest and build attentional menus. We would develop attentional connoisseurship: the right pairings of the short and long. We would understand, and promote, attentional health.

I imagine attention-based pricing, in which prices of information commodities are inversely adjusted to the cognitive investment of consuming them. All the candy for the human brain — haiku, ringtones, bumper stickers — would be priced like the luxuries that they are. Things requiring longer attention spans would be cheaper — they might even be free, and the higher fixed costs of producing them would be covered by the higher sales of the short attention span products. Single TV episodes would be more expensive to purchase than whole seasons, in the same way that a six-pack of Oreos at the gas station is more expensive, per cookie, than a whole tray at the grocery store.

I imagine an attention tax that aspiring cultural producers must pay. A barrier to entry. If you want people to read your book, then you have to read books; if you want people to buy your book, then you buy books. Give your attention to the industry of your choice. Like indie musicians have done for decades, conceive of the scene as an attention economy, in which those who pay in (e.g., I go to your shows) get to take out (e.g., come to my show). It would also mitigate one oft-claimed peril of the rise of the amateur, which is that they don't know from quality: consuming many other examples from a variety of sources, even amateur producers would generate a sense of what's good and what's bad: in other words, in their community they'd evolve a set of standards. This might frustrate the elitists, who want to impose their standards. But standards would, given enough time, emerge...


All this sounds very appropriate in the context of the intense debate surrounding the future (and even the utility) of test and one-day cricket matches in light of the spectacular manner in which Twenty-twenty cricket has caught hold of the imagination of cricket fans (and even those who never watched the game) across the world.

Saturday, March 20, 2010

India's sovereign debt history in perpective

Carmen Reinhart has a comprehensive Chartbook which provides a pictorial history, on a country-by-country basis, of public debt and economic crises of various forms. The Chartbook is a timeline of a country’s creditworthiness and financial turmoil and complements the thematic analysis with individual country histories, and provides the grounds for a systematic analysis of the temporal patterns of debt cycles, banking and sovereign debt crises, hyperinflation, and, for the post World War II period, the reliance on IMF programs. Here is India's chartbook history for the past 175 years

The yellow shaded region indicates the years in default or restructuring external debt, while those in green indicates near default.

As can be seen from the graph, despite its large public (domestic plus external) debt, India's debt to exports ratio is close to its lowest in more than 75 years. And more importantly, it has been declining.

Friday, March 19, 2010

Nudging on tax compliance - evidence from an RCT

A fascinating recent NBER working paper by Henrik J. Kleven, Martin B. Knudsen, Claus T. Kreiner, Søren Pedersen, and Emmanuel Saez explains the results of a randomized tax enforcement experiment conducted in Denmark for a stratified and representative sample of over 40,000 individual income tax filers. The study has interesting findings on increasing tax compliance.

In the first stage (year), taxpayers were randomly selected for unannounced comprehensive (both third-party reported and self-reported incomes) tax audits of tax returns filed in 2007, and any detected misreporting was corrected and penalized as appropriate according to Danish law. For the second half of taxpayers not selected for these audits, tax returns were not examined under any circumstances. In the second stage, employees in both the audit and no-audit groups were randomly selected for pre-announced tax audits of tax returns filed in 2008. One group of taxpayers received a letter telling them that their return would certainly be audited, another group received a letter telling them that half of everyone in their group would be audited, while a third group received no letter.

Their model predicts that evasion will be low for third-party reported income items, but substantial for self-reported income items and that the effects of tax enforcement (audits, penalties) and tax policy (marginal tax rates) on evasion will be larger for self-reported income than for third-party reported income. They have four main findings

"First, we find that the tax evasion rate is very small (0.3%) for income subject to third-party reporting, but substantial (37%) for self-reported income... Second, using bunching evidence around large and salient kink points of the nonlinear income tax schedule, we find that marginal tax rates have a positive impact on tax evasion, but that this effect is small in comparison to avoidance responses. This suggests that rigorous tax enforcement is a much more effective tool to combat tax evasion than lowering marginal tax rates. Third, we find that prior audits substantially increase self-reported income, implying that individuals update their beliefs about detection probability based on experiencing an audit. Fourth, threat-of-audit letters also have a significant effect on self-reported income, and the size of this effect depends positively on the audit probability expressed in the letter."

This is a classic example of how the behavioural aspects of tax payment decision making plays a critical role in determining compliance rates. In the aforementioned example, both prior audits and even the mere threat of an audit substantially raised compliance rates. Tax authorities in India would do well to embrace atleast the idea of sending "threat of audit" letters randomly to a targetted group of potential tax evaders (and follow it up with actual audits and enforcement action), so as to nudge them into minimizing their income under-reporting.

And this also carries a strong message to those consistently advocating lowering the marginal tax rates on the grounds that it will improve compliance. Contrary to conventional wisdom - expemlified by the now infamous Laffer curve of the Reagan era tax cuts in the US - that highlights the positive impact of lowering marginal tax rates to increase compliance, the aforementioned study finds that the marginal tax rates have only modest effects on tax evasion and are dwarfed by the third-party reporting effects. In any case, advocates of cutting marginal tax rates have always ignored the fact that the Laffer curve itself has an upward sloping first half!

Note : Third-party information reporting refers to the institutions such as employers, banks, investment funds, and pension funds directly reporting taxable income earned by individuals (employees or clients) to the government. Under this system, the overall tax evasion is low not because taxpayers are unwilling to cheat, but because they are unable to cheat successfully due to the widespread use of third-party reporting.

Thursday, March 18, 2010

More on food inflation story

As I have blogged earlier, the inflation story may be far more complex than issues of government failing to mount aggressive buffer-stock operations in time and in required quantities or increase imports. There are clearly important sub-plots within the larger inflation story.

The WPI-based headline inflation rate for February stood at 9.89%, with food inflation at 17.8%. And worryingly, inflation rate, especially, food inflation rate has been on a steeply rising trend.

In a highly informative article, Business Standard (15/3/2010) points to another dimension by highlighting the crucial role played by horticulture and animal husbandry perishables (milk, eggs, meat, fruits, and vegetables) in keeping food inflation high.

The average inflation trends for both 2008 and 2009 shows that perishables have risen faster than foodgrains. While the overall inflation rate was 9.09% and 2.12% in 2008 and 2009 repsectively, it was 6.62% and 12.43% for food articles. Even as the inflation rates were 6.36% and 14.27% respectivley for foodgrains (cereals and pulses), it was 7.9% and 9.03% for milk, 3.78% and 14.57% for meat, eggs, and fish, and 5.91% and 11.96% for fruits and vegetables for 2008 and 2009 respectively. And interestingly, perishables constitute 10% of the overall WPI-inflation index to 7.4% for foodgrains. In fact, the average inflation rates for milk, fruits, vegetables, eggs, and meat have been consistently high since 2003.

Given the high economic growth trajectory of the past decade, it is natural to presume that the demand for the high-quality perishable food products rose faster than their supply (the average growth in horticulture p[roduction has been 4-4.5% in the past three years whereas demand has been growing at a rate of 7%), putting upward pressure on their prices. Given the abysmally low gross capital formation in agricultural investments (especially the downstream storage linkages required for producing and marketing such perishables) and the marginal increases in productivity, these supply side constraints are no surprise. Unlike the non-perishables, without any buffer stock activity, governments have little control over their prices.

US foreign aid recipients

Pie Chart of US foreign aid by recipient in the 2004-08 period

(HT: Chris Blattman)

Wednesday, March 17, 2010

Multi-tier accounts for the poor

I have blogged and written about the possibility of drawing on financial innovations to help the poor manage their incomes, savings and consumption needs more optimally. One of the most fundamental innovations could involve the use of multi-tier accounts that leverage inflows from wages and other household income with the various government welfare schemes to achieve the aforementioned objectives. Here is how a super-set of such multi-tiered account will look like (the tiers are shown in the boxes)

(please click on the figure to enlarge)

Every poor person will have a single UID-linked bank account which would have multiple functionally (or use-directed) determined tiers. All his transfers from government - wages, pensions, farm loans, Minimum Support Price (MSP) payments, housing subsidies, self-employment loans/subsidies etc - would by default flow into the respective heads within the account. He can also choose to transfer his private wages and other income into the same account, as possible default (or pre-defined) escrows into specific heads.

The member would contribute a specific sum every month to an educational annuity or insurance product which could be matched with a government share. The periodic (monthly/quarterly) contribution can be transferred by default from her savings bank account. The contributions could even be increased with some periodicity, in small increments, as a default option.

The tiers within the account could even be leveraged to access capital from the private market to purchase various consumer durables by EMI-based payments or even raise small business loans and house construction loans. Some of the subsidies and government loans (say for housing or self-employment or health insurance) can even be topped-up with regular financing from banks by dove-tailing repayments from a specific savings tier (within the individual's account).

Here are just two examples. First, a self-employment subsidy of Rs 10,000 and a Rs 25000 margin money loan at a concessional 5% provided under say, the National Scheduled Tribes Development Corporation (NSTFDC), can be leveraged by a credit-worthy individual (who has been using the multi-tier savings account and has an acceptably regular savings patterns) with a private bank to raise another Rs 25000 loan to start a small pickle making unit. A "pickle plant" tier with first charge (default transfer of wage/income inflows) of any income of the borrower can funnel repyments. The details of such accounts are important and should be carefully worked out.

Second, consider a government run pension/health insurance scheme where the government contributes a sum of Rs 20 per month and the beneficiary puts in a matching Rs 20. Now, the beneficiary could choose to increase his contribution to Rs 50 every month and avail of a higher pension or expanded health care benefits. The scheme, run by say LIC, could be very easily administered through a pension/health insurance tier within the beneficiary's account.