Tom Wright and Siobhan Gorman in the Wall Street Journal on new thinking by Pakistan's ISI about who is enemy #1.
Tamal Bandyopadhyay in the Mint on the campaign against C. B. Bhave. Also see Ashok Desai and Mahesh Vyas on these issues.
A. K. Bhattacharya in the Business Standard on the crisis of project management in government. This is what animates Nandan Nilekani's TAGUP group and I hope this induces fundamental change in Indian public administration. Also see.
Fascinating new research by Devesh Kapur, Chandra Bhan Prasad, Lant Pritchett and Shyam Babu, written by Ila Patnaik in the Financial Express.
Jayanth Varma is dismayed at RBI's lack of modern finance knowledge in thinking about CDS.
India on the FATF high table by K. P. Krishnan, in the Economic Times.
Neelasri Barman and Parnika Sokhi in DNA about the most important question in RBI reforms: that of HR practices. Roughly 30 years ago, RBI used to do direct recruitment at middle management levels. When the union became powerful and recruitment became restricted to the entry level, it had greatly damaging consequences on the organisation's capability. If the HR falls into place with really top quality people, then all the needed RBI reforms will rapidly get done.
William Dalrymple in the New York Times on Sufis.
Jeffrey Goldberg in the Atlantic magazine about the task of stopping Iran's nuclear capability.
Jeff Frankel says that we have a lot to learn from small countries.
Damon Darlin in the New York Times tells the story about how Netflix worked on video over the net even though this directly competed with its profitable DVD-by-post business.
Javier Blas and Greg Farrell in the Financial Times on the interesting role of agricultural commodity futures in the recent flareup of prices.
Wednesday, August 18, 2010
Sunday, August 15, 2010
Entry of private banks
RBI has a discussion paper on opening up banking for entry by private banks. See responses by Jayanth Varma in the Financial Express and by Ila Patnaik in the Indian Express. Also, a less coherent response from me on TV.
A nice feature of the above RBI URL is that it also links to the January 1993 guidelines on entry of new private banks and the January 2001 guidelines.
Striking a balance between avoiding crooks and theft, and ensuring competition, is hard. It's easy to go to either extreme, but the puzzle lies in finding the middle road. These are the political and governance challenges that India must now grapple with.
A nice feature of the above RBI URL is that it also links to the January 1993 guidelines on entry of new private banks and the January 2001 guidelines.
Striking a balance between avoiding crooks and theft, and ensuring competition, is hard. It's easy to go to either extreme, but the puzzle lies in finding the middle road. These are the political and governance challenges that India must now grapple with.
Saturday, August 14, 2010
Fault Lines, by Raghuram Rajan
by Viral Acharya.
Raghuram Rajan's book Fault Lines (Princeton University Press for the international edition, and Harper Collins for an Indian edition with a special chapter on India) is possibly the most thought-provoking contribution in the aftermath of the economic and financial crisis that has engulfed the West after 2007 with significant global repercussions.
The epilogue of the book summarizes its punch line:
The book presents two important government distortions in the global economy and their underlying causes. These are (i) the push for universal home ownership in the United States, and (ii) export-led growth in countries such as Germany and China. Together, these policies have led to massive "global imbalances", with some countries such as the United States, the United Kingdom and Spain persistently being in deficit, and borrowing from the surplus, exporting nations. While pursuit for home ownership affordability and growth do not necessarily have to be distortionary, the book makes the sharp observation that these have been occurring at the expense of something more important but subtle.
In the United States, there has been growing income inequality, which combined with a relatively feeble safety net for the poor and unemployed, has created pressure on politicians to find quick ways to bridge the inequality. Instead of improving the long-run competitiveness of labor force for a global market with a changing mix of industries and required skills, governments have adopted the short-run option "let them eat credit" (the title of Chapter One). The presence of government-sponsored financial firms in the United States (Fannie Mae and Freddie Mac, in particular) enabled exercising such an option readily through a push for priority lending to the low-income households (sub-prime mortgages).
In case of surplus countries, it has been the problem of exporting to grow (the title of Chapter Two). Their single-minded focus on exports has led governments to ignore the domestic sector, preventing sufficient redeployment of surplus for internal development, and somewhat perversely, even boosted domestic savings rates significantly due to lack of adequate safety nets (at least in case of China, if not in case of Germany). As someone mentioned in a recent dinner conversation: Each child in China is saving to fund post-retirement expenses not just of two parents but also of four grandparents. These savings have thus had no place to go but outside, giving rise to massive capital inflows that fueled the housing sector expansion in the US, the UK and Spain.
What is fascinating is that Fault Lines explains how these lop-sided government policies of two separate sets of countries have interacted with each other - and with the financial sector - in fueling the expansion to levels of unsustainable housing bubbles. The idea here is that the invisible hand operating through the price when the price is distorted can also lead to massive distortions in the allocation of capital. The financial sector in developed world is so sophisticated and amoral (a great choice of word by the author) that its dispassionate pursuit of profits leads it to direct capital to wherever there is a relative mis-pricing.
So if governments are subsidizing home ownership, efforts will be made to deploy all free capital of the world to the housing sector. If some governments are finding it cheap to borrow because savings are seeking them out, the financial sector will grow at a sufficient rate to absorb and support expansion of housing credit through these capital inflows.
Clearly there have been incentive-based distortions in the financial sector, especially due the short-term nature of accounting-based compensation that ignores true long-term risks. The book explains, however, that the bigger issue was something else: that the imbalance of capital flows and the ease of pushing sub-prime home ownership - both due to government distortions - meant the financial sector was essentially a conduit to making happen what the rest of the world was seeking to achieve. In the process, banks made a ton of bad loans (but the governments were happy with that till it all really blew up). And some parts of the financial sector pursued this role even more aggressively than one could have imagined due to the steady entrenchment of too-big-to-fail expectations -- large banks being repeatedly bailed out through government forbearance and enjoying central-bank monetary stimulus each time markets turned south.
Some may question the basis of this argument by saying - why did we see credit expansion across board and not just in low-income households? Here, Fault Lines focuses on a rather fascinating phenomenon that recoveries from recent recessions, especially in the United States, have remained "jobless" for extended periods of time. Perhaps as a subconscious response to this (or due to ideologies in other cases), central banks have tended to provide massive monetary stimulus to get the financial sector to push the household consumption and real sector investment harder and harder through greater lending and intermediation. Such stimulus, unfortunately, again serves to transfer rents from households to the financial sector (by keeping interest rates low) and produces mispriced risk. Thus, the economy moved "from bubble to bubble" (the title of Chapter Five), until the most recent bubble could not be mopped up by anyone, not even the most innovative Central Bank of all, despite its own best efforts.
In essence, Fault Lines connects the dots visible to all of us in a rather ingenious manner to provide an explanation of what brought about the perfect storm we have recently weathered.
While the book is worth it even just for its explanation of why we had a crisis now rather than at some other points of time, it goes the extra mile and proposes valuable reforms, focusing on all three issues: building a better safety net in the United States (see in particular, the suggestions to improve education access to all and extend a greater level of unemployment insurance), reducing the global imbalances, and improving the regulation of the financial sector so that it (and its financiers) pay for mopping up of bubbles it fueled, rather than governments and Central Banks passing on these costs to taxpayers.
The book also helps understand why export-based Chinese and German growth, and their effective vendor financing of consumption in the US and Euro-zone countries, may ultimately face limits as consumption slows. These countries are now being forced to become the stimulators of growth and run the risk of planting seeds of bubbles in their own economies. This is how hidden fractures still threaten the world economy, as the book's subtitle goes. It also leads one to reconsider that India's slower growth rate than China, while not entirely faultless, might however be more balanced given its lack of extreme export reliance.
Raghuram Rajan's writings are always cogent and based in sound set of facts. But this book is special in the sense that here he paints on a much larger canvas, covering bases from distributional issues within income strata of society, to the persistent capital imbalances across large countries of the world, and the ruthless profit-maximizing incentives of modern market-based financial sector.
There is a lot going on in the book. But it is written with great examples and cases - almost lyrical at times (even has a fascinating poem recounted in the chapter "The Fable of the Bees Replayed"), and should be accessible to one and all. It will certainly question some long-held biases about current state of economic conditions in Western countries. But it is hard to not take a deep breath and ponder once you have read it all. In many ways, it shows that when economic conditions so demand or induce, the developed world behaves much the same way as the developing world: they are both after all driven by choices of human beings and the book lays out some common patterns of global economic behavior - in households, markets and governments.
Raghuram Rajan's book Fault Lines (Princeton University Press for the international edition, and Harper Collins for an Indian edition with a special chapter on India) is possibly the most thought-provoking contribution in the aftermath of the economic and financial crisis that has engulfed the West after 2007 with significant global repercussions.
The epilogue of the book summarizes its punch line:
The crisis has resulted from a confusion about the appropriate roles of the government and the market. We need to find the right balance again, and I am hopeful we will.The key idea of Fault Lines is to focus on slow-moving tectonic plates in the global economy: consumption by borrowing in countries with fiscal deficits, excess savings in exporting countries that are fiscally in surplus, and growing sophistication of the financial sector. None of these movements might seem dangerous in itself, but when these plates come together and collide, the global economy can get badly shaken. To most players focused narrowly on their own positions, leave alone the movements of the plate they stand on, the earthquake - like this crisis - may seem an unfortunate happenstance. In the analytical framework of Fault Lines, the crisis was not a pure accident and that more severe crises could arise in future unless the root causes are addressed sufficiently soon.
The book presents two important government distortions in the global economy and their underlying causes. These are (i) the push for universal home ownership in the United States, and (ii) export-led growth in countries such as Germany and China. Together, these policies have led to massive "global imbalances", with some countries such as the United States, the United Kingdom and Spain persistently being in deficit, and borrowing from the surplus, exporting nations. While pursuit for home ownership affordability and growth do not necessarily have to be distortionary, the book makes the sharp observation that these have been occurring at the expense of something more important but subtle.
In the United States, there has been growing income inequality, which combined with a relatively feeble safety net for the poor and unemployed, has created pressure on politicians to find quick ways to bridge the inequality. Instead of improving the long-run competitiveness of labor force for a global market with a changing mix of industries and required skills, governments have adopted the short-run option "let them eat credit" (the title of Chapter One). The presence of government-sponsored financial firms in the United States (Fannie Mae and Freddie Mac, in particular) enabled exercising such an option readily through a push for priority lending to the low-income households (sub-prime mortgages).
In case of surplus countries, it has been the problem of exporting to grow (the title of Chapter Two). Their single-minded focus on exports has led governments to ignore the domestic sector, preventing sufficient redeployment of surplus for internal development, and somewhat perversely, even boosted domestic savings rates significantly due to lack of adequate safety nets (at least in case of China, if not in case of Germany). As someone mentioned in a recent dinner conversation: Each child in China is saving to fund post-retirement expenses not just of two parents but also of four grandparents. These savings have thus had no place to go but outside, giving rise to massive capital inflows that fueled the housing sector expansion in the US, the UK and Spain.
What is fascinating is that Fault Lines explains how these lop-sided government policies of two separate sets of countries have interacted with each other - and with the financial sector - in fueling the expansion to levels of unsustainable housing bubbles. The idea here is that the invisible hand operating through the price when the price is distorted can also lead to massive distortions in the allocation of capital. The financial sector in developed world is so sophisticated and amoral (a great choice of word by the author) that its dispassionate pursuit of profits leads it to direct capital to wherever there is a relative mis-pricing.
So if governments are subsidizing home ownership, efforts will be made to deploy all free capital of the world to the housing sector. If some governments are finding it cheap to borrow because savings are seeking them out, the financial sector will grow at a sufficient rate to absorb and support expansion of housing credit through these capital inflows.
Clearly there have been incentive-based distortions in the financial sector, especially due the short-term nature of accounting-based compensation that ignores true long-term risks. The book explains, however, that the bigger issue was something else: that the imbalance of capital flows and the ease of pushing sub-prime home ownership - both due to government distortions - meant the financial sector was essentially a conduit to making happen what the rest of the world was seeking to achieve. In the process, banks made a ton of bad loans (but the governments were happy with that till it all really blew up). And some parts of the financial sector pursued this role even more aggressively than one could have imagined due to the steady entrenchment of too-big-to-fail expectations -- large banks being repeatedly bailed out through government forbearance and enjoying central-bank monetary stimulus each time markets turned south.
Some may question the basis of this argument by saying - why did we see credit expansion across board and not just in low-income households? Here, Fault Lines focuses on a rather fascinating phenomenon that recoveries from recent recessions, especially in the United States, have remained "jobless" for extended periods of time. Perhaps as a subconscious response to this (or due to ideologies in other cases), central banks have tended to provide massive monetary stimulus to get the financial sector to push the household consumption and real sector investment harder and harder through greater lending and intermediation. Such stimulus, unfortunately, again serves to transfer rents from households to the financial sector (by keeping interest rates low) and produces mispriced risk. Thus, the economy moved "from bubble to bubble" (the title of Chapter Five), until the most recent bubble could not be mopped up by anyone, not even the most innovative Central Bank of all, despite its own best efforts.
In essence, Fault Lines connects the dots visible to all of us in a rather ingenious manner to provide an explanation of what brought about the perfect storm we have recently weathered.
While the book is worth it even just for its explanation of why we had a crisis now rather than at some other points of time, it goes the extra mile and proposes valuable reforms, focusing on all three issues: building a better safety net in the United States (see in particular, the suggestions to improve education access to all and extend a greater level of unemployment insurance), reducing the global imbalances, and improving the regulation of the financial sector so that it (and its financiers) pay for mopping up of bubbles it fueled, rather than governments and Central Banks passing on these costs to taxpayers.
The book also helps understand why export-based Chinese and German growth, and their effective vendor financing of consumption in the US and Euro-zone countries, may ultimately face limits as consumption slows. These countries are now being forced to become the stimulators of growth and run the risk of planting seeds of bubbles in their own economies. This is how hidden fractures still threaten the world economy, as the book's subtitle goes. It also leads one to reconsider that India's slower growth rate than China, while not entirely faultless, might however be more balanced given its lack of extreme export reliance.
Raghuram Rajan's writings are always cogent and based in sound set of facts. But this book is special in the sense that here he paints on a much larger canvas, covering bases from distributional issues within income strata of society, to the persistent capital imbalances across large countries of the world, and the ruthless profit-maximizing incentives of modern market-based financial sector.
There is a lot going on in the book. But it is written with great examples and cases - almost lyrical at times (even has a fascinating poem recounted in the chapter "The Fable of the Bees Replayed"), and should be accessible to one and all. It will certainly question some long-held biases about current state of economic conditions in Western countries. But it is hard to not take a deep breath and ponder once you have read it all. In many ways, it shows that when economic conditions so demand or induce, the developed world behaves much the same way as the developing world: they are both after all driven by choices of human beings and the book lays out some common patterns of global economic behavior - in households, markets and governments.
India's middle income trap
In the Financial Express today, I have a piece on India's middle income trap: Don't take growth for granted. Coincidentally, on the same day, T. N. Ninan in the Business Standard had a piece on a similar theme, and in the Indian Express, Shekhar Gupta ponders where UPA-II went astray.
My thinking about these questions in recent weeks has been prodded by questions about entry of private banks, and by the campaign against C. B. Bhave.
Friday, August 13, 2010
Don't like the SKS valuation? Compete, don't complain
by Bindu Ananth and Nachiket Mor.
Much has been said about the astronomical SKS valuations and the personal fortunes of the original investors. Speaking for ourselves personally, we are not at all disturbed by how much money was made by whom. On the contrary, we are very excited that an area that was once thought to be the exclusive turf of, as Monika Halan (http://bit.ly/SquidorDevta) puts it so graphically in Mint, `the nexus of political doles and the rural bank branch system rotting under the weight of corruption and dysfunction' thanks to pioneers like Vikram Akula, Padmaja Reddy and Udaya Kumar, has moved firmly into the domain of `mainstream commerce'.
People forget that we are a country of over 500 million very-very poor people, so very large amounts of equity capital are required in building an ecosystem of financial firms which will serve the poor of India. Now that the ball has been tossed up high in the air we are hoping that other people who also know how to build India sized businesses (Ratan Tata, Kumar Birla, Mukesh Ambani, Sunil Mittal, Azim Premji and several others) take notice of this ball and hit it with all the power that they can bring to it. Curiously, the fact that so much money was made and was seen to be made is good news because this kind of money even makes the big boys sit up and take notice. Preventing Vinod Khosla or Vikram Akula from making some money is not going to eradicate this poverty, but the power of their ideas taken to scale will.
Should we then not be concerned at all about how much money was made? For sure! Not because somebody got rich but because it calls into question the oft-stated MFI position that their high interest rates are only just about covering their high operating costs. A paper (http://bit.ly/Nvw6k) by Chaudhary and Rai shows that valuations are very sensitive to interest rates. They show that just a 1% decline in MFI interest rates leads to a Rs. 1.5 billion drop in valuation for an MFI with 500 branches. They also show that should the large MFIs choose to cut interest rates by as much as 10% (from the over 30% per annum that most of them currently charge, to under 20% per annum), they would still deliver a holding period return on equity of over 25% per annum. The focus on individuals making money distracts our attention from this very important fact.
And attempts that are intended to bring about `orderly conduct' (http://bit.ly/MFINCode) could have the consequence of preventing competitive forces from coming in and bringing these rates down there is a real need to make sure that this does not happen and to actively encourage intense competition amongst new and existing players. Experience, for example with housing finance in India, shows that this was the only reason why the rates fell and services standards improved without any dilution of credit quality. There is also an urgent need to bring in completely new models of financial services for low-income households (we are associated with one such attempt: www.bit.ly/LocalTouch). For example, the rapid scale-up of ATMs in India changed the entirely banking landscape by changing the very nature of the service models.
Bindu Ananth (bindu.ananth@ifmr.co.in) is the President of IFMR Trust (and the corresponding author). Nachiket Mor is the non-executive Chairman of the Governing Council of IFMR Trust and the President of ICICI Foundation for Inclusive Growth. Views are strictly personal.
Much has been said about the astronomical SKS valuations and the personal fortunes of the original investors. Speaking for ourselves personally, we are not at all disturbed by how much money was made by whom. On the contrary, we are very excited that an area that was once thought to be the exclusive turf of, as Monika Halan (http://bit.ly/SquidorDevta) puts it so graphically in Mint, `the nexus of political doles and the rural bank branch system rotting under the weight of corruption and dysfunction' thanks to pioneers like Vikram Akula, Padmaja Reddy and Udaya Kumar, has moved firmly into the domain of `mainstream commerce'.
People forget that we are a country of over 500 million very-very poor people, so very large amounts of equity capital are required in building an ecosystem of financial firms which will serve the poor of India. Now that the ball has been tossed up high in the air we are hoping that other people who also know how to build India sized businesses (Ratan Tata, Kumar Birla, Mukesh Ambani, Sunil Mittal, Azim Premji and several others) take notice of this ball and hit it with all the power that they can bring to it. Curiously, the fact that so much money was made and was seen to be made is good news because this kind of money even makes the big boys sit up and take notice. Preventing Vinod Khosla or Vikram Akula from making some money is not going to eradicate this poverty, but the power of their ideas taken to scale will.
Should we then not be concerned at all about how much money was made? For sure! Not because somebody got rich but because it calls into question the oft-stated MFI position that their high interest rates are only just about covering their high operating costs. A paper (http://bit.ly/Nvw6k) by Chaudhary and Rai shows that valuations are very sensitive to interest rates. They show that just a 1% decline in MFI interest rates leads to a Rs. 1.5 billion drop in valuation for an MFI with 500 branches. They also show that should the large MFIs choose to cut interest rates by as much as 10% (from the over 30% per annum that most of them currently charge, to under 20% per annum), they would still deliver a holding period return on equity of over 25% per annum. The focus on individuals making money distracts our attention from this very important fact.
And attempts that are intended to bring about `orderly conduct' (http://bit.ly/MFINCode) could have the consequence of preventing competitive forces from coming in and bringing these rates down there is a real need to make sure that this does not happen and to actively encourage intense competition amongst new and existing players. Experience, for example with housing finance in India, shows that this was the only reason why the rates fell and services standards improved without any dilution of credit quality. There is also an urgent need to bring in completely new models of financial services for low-income households (we are associated with one such attempt: www.bit.ly/LocalTouch). For example, the rapid scale-up of ATMs in India changed the entirely banking landscape by changing the very nature of the service models.
Bindu Ananth (bindu.ananth@ifmr.co.in) is the President of IFMR Trust (and the corresponding author). Nachiket Mor is the non-executive Chairman of the Governing Council of IFMR Trust and the President of ICICI Foundation for Inclusive Growth. Views are strictly personal.
Tuesday, August 10, 2010
Monetary economics is hard
On 5 August, the RBI Governor did a speech in Hyderabad. I was disappointed in reading this speech; it suggests little learning of monetary economics amongst RBI staff after the 1960s. See this response by Ila Patnaik.
A few recent papers look at these things very differently: John Taylor (June 2010), Takatoshi Ito (July 2010) and Asli Demirgüç-Kunt and Luis Servén (February 2010). We continue to be in a situation where RBI's thinking on monetary policy is quaint and out of touch with world class knowledge of economics.
A few recent papers look at these things very differently: John Taylor (June 2010), Takatoshi Ito (July 2010) and Asli Demirgüç-Kunt and Luis Servén (February 2010). We continue to be in a situation where RBI's thinking on monetary policy is quaint and out of touch with world class knowledge of economics.
Randomised field experiments
by Ajay Shah.
In recent years, many economists have been attracted by the possibility of obtaining better knowledge using randomised experiments, which are termed the `gold standard' for empirical analysis. I have long been skeptical about this approach, for three reasons:
- Reality is a complicated nonlinear relationship in many dimensions. Each randomised experiment illuminates the gradient vector in one small region. It's hard to generalise the results (i.e. low external validity).
- I am quite worried about the bang for the buck obtained through this strategy. A lot of money is spent, which could have other uses in funding dataset creation or research.
- Economics is a bad field in having low standards of replication. The journals don't publish replication, which is the foundation of science. Randomised experiments, too often, generate proprietary datasets which are controlled by the original authors. The scientific progress which comes about from multiple scholars working on common datasets does not come about easily.
Jim Manzi has a great article on the difficulties of obtaining knowledge about social science questions. He tells the story of a field -- Criminology -- which experienced the Randomised Experiment Revolution in the 1980s:
In 1981 and 1982, Lawrence Sherman, a respected criminology professor at the University of Cambridge, randomly assigned one of three responses to Minneapolis cops responding to misdemeanor domestic-violence incidents: they were required to arrest the assailant, to provide advice to both parties, or to send the assailant away for eight hours. The experiment showed a statistically significant lower rate of repeat calls for domestic violence for the mandatory-arrest group. The media and many politicians seized upon what seemed like a triumph for scientific knowledge, and mandatory arrest for domestic violence rapidly became a widespread practice in many large jurisdictions in the United States.
But sophisticated experimentalists understood that because of the issue's high causal density, there would be hidden conditionals to the simple rule that `mandatory-arrest policies will reduce domestic violence.' The only way to unearth these conditionals was to conduct replications of the original experiment under a variety of conditions. Indeed, Sherman's own analysis of the Minnesota study called for such replications. So researchers replicated the RFT six times in cities across the country. In three of those studies, the test groups exposed to the mandatory-arrest policy again experienced a lower rate of rearrest than the control groups did. But in the other three, the test groups had a higher rearrest rate.
...
Criminologists at the University of Cambridge have done the yeoman work of cataloging all 122 known criminology RFTs with at least 100 test subjects executed between 1957 and 2004. By my count, about 20 percent of these demonstrated positive results: that is, a statistically significant reduction in crime for the test group versus the control group. That may sound reasonably encouraging at first. But only four of the programs that showed encouraging results in the initial RFT were then formally replicated by independent research groups. All failed to show consistent positive results.
I am all for more quasi-experimental econometrics applied to large datasets, to tease out better knowledge by exploiting natural experiments. By using large panel datasets, with treatments spread across space and time, I feel we gain greater external validity. And, there is very high bang for the buck in putting resources into creating large datasets which are used by the entire research community, with a framework of replication and competition between multiple researchers working on the same dataset.
You might like to see a column in the Financial Express which I wrote a few months ago, with the story of an interesting randomised experiment. In this case, there were two difficulties which made me concerned. First, this was not randomised allocation to treatment/control: there was selectivity. Second, it struck me as very poor bang for the buck. Very large sums of money were spent, and I can think of myriad ways to spend that money on datasets or research in Indian economics which would yield more knowledge.
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