The Art of Letting Go

It shouldn’t be a surprise that Air India, one of the most beloved public enterprises, is not finding any buyers. The government owned enterprise has been a cause for major concern for the union government with the size of its losses increasing over the past few years. Although, the proposal to sell the government owned airline has been put into action, it is evident that the appropriate desire has not followed.

The airline had opened up the offers for two months and did not see a single buyer concert. As per the reports,

“While the Rs 33,000-crore debt that was to be bundled with the airline was initially seen to be a major hurdle, industry analysts believe it was the government’s decision to retain 24% stake that ultimately proved to be the big deterrent.”

This is not the first time the proposal to sell the government enterprise has been brought to notice. Twice before, in 1996 and again in 2000, much more feasible plans to sell the airline, then in much better health than now, were scuttled. The problem is much deeper than this non-viable auction. The problem lies at the core strategy towards divestment.

Government with all its units and resources is still a limited body that has various responsibilities to fulfil with scare resources. Keeping this in mind, it is important to consider the sectors or firms in which the government invests, in order to ensure that the resources are being put to the best use. On of the first litmus test for this would be to see if the good or service being provided can be provided more viably by a private body. If yes, there is no reason for the government to enter the sector as the player. If not, government can either regulate it to make it feasible or provide the good or service itself to ensure their provision. This simple test helps limiting the number resources being directed to ineffective causes.

If we put Air India into this consideration, it is evident that in the current set-up there are enough players in the sector to ensure competition and air travel is increasingly becoming viable. Hence, there is no role for a government enterprise to exist in this space. Knowing this, it would be best for the government to sell all its ownership claims towards the loss making government unit. Government needs to instead invest more in strategic sectors such as defence, healthcare and education.

Even though the argument for strategic divestment have been made in previous occasions, it is quite clear that the lack of focus has made it difficult for the union government to let go of the age old air line.

India’s Economic Growth Rate is Overstated

In a brilliant article in Mint, Rajeswari Sengupta, Assistant Professor at IGIDR, has shown that India’s real GVA growth rate is around 5% and not 7.1% as the CSO claims. The reason is the use of deflator in converting the nominal GVA to Real GVA.

In nominal terms, GVA increased by 7.9% in the third quarter (October-December) of the fiscal year 2015-16, below its usual level of 10-15%. This increase translated into a 7.1% real growth, because the deflator reportedly increased by only 0.7%.

Could India’s inflation be so low? In effect, the CSO is saying that despite India’s booming economy, producer inflation is lower than that of the recession-wracked economies of the West, or even that of Japan, which has been wrestling with deflation since the 1990s. This is not plausible.

It does seem extremely fishy that an emerging economy, growing at 7% (5%?) can have an inflation of 0.7%. The article then goes on to explain why this might be the case. In the absence of a credible deflator figures for all sectors, the CSO approximates it by using Wholesale Price Inflation as a proxy. This can be extremely problematic as the WPI has been on a downward trend in India and there is also significant divergence between the WPI on one hand and the deflator and CPI on the other. This divergence has been occurring since 2014 at least and I had written about it earlier.

If we were to use better proxies for the deflator instead of the WPI, like the CPI in services and IIP for manufacturing, we get a real GVA growth rate for the third quarter at 5% instead of 7.1%. The figure of 5% seems a bit more in tandem with reality.

Elections and Rupee Volatility

The rupee has tumbled to the lowest point in the last 18 months, when it crossed the Rs68/$ mark this week. Analysts have posited multiple reasons for this occurrence – India’s sluggish export growth and an increasing import bill due to rising oil prices, the dollar strengthening, rising US interest rates, and the inflation differential between India and its main trading partners. However, one other reason could be elections – both the just concluded Karnataka election and the upcoming 2019 Lok Sabha elections.

A chart from 2013 that shows strong correlation between elections and rupee depreciation. Source: The Economist

There has been a historical relationship between elections and the exchange rate. Election time is usually associated with greater volatility of the rupee. Investors generally fret about populist schemes leading up to the elections. They are also afraid of policy uncertainty if a new government is elected. Chances of policy reversals or abandonment of certain policies can create jitters.

Post liberalisation in 1992, the rupee had a bout of weakness in 1997, and then, just after the 2004 elections, again in 2009 before the elections, and the biggest one in recent memory was in 2013. These have coincided with the elections and also major global macroeconomic shocks. There was the Asian crisis in 1997, the global financial crisis in 2009, and the episode of the taper-tantrum in 2013. It is hard to isolate these factors and establish causality between elections and rupee weakness, but there seems to be a strong correlation.

Episodes in other emerging economies can give a clue. Mexican Peso and elections have followed a similar pattern. The Economist explains:

Between 1976 and 1994 the peso regularly suffered a massive slump roughly every six years, around presidential elections—even though the country was effectively a one-party state at the time. Mexico tried to create stability by pegging the peso to the dollar in 1988, but by 1994 suffered a full-blown crisis. The pattern of boom and bust was broken only when authorities reverted to a freely-floating exchange rate—but also, crucially, put in place sound monetary and fiscal policies. There is a lesson there for India.

Political Will To Solve Jobs Problem

The recent 12th grade results declared by the Central Board of Secondary Education were a pleasant surprise for the Delhi government where the government schools took a 9 per cent lead in performance over private institutions. Although it is comforting to see that appropriate steps are being taken to improve the education system at school levels, we are yet to look at the larger problem facing us in the next few years- the problem of jobs.

One of the key features for the change was the political will and upfront commitment to bring about the change. Rohan Joshi, who has a vast experience of working in Education and Skill Development sectors, attributed the success to systematic engagement with the external stakeholders. He also mentioned that the political will translating into driving bureaucracy to focus on education quality among other factors have led to the remarkable achievement of Delhi Government Schools. He did, however, flag that while celebrating the achievement, we must also continue tracking progress in the coming years. Typically, 3 years is too short a time to reform an entire education system of a state. Overall, Delhi government has certainly taken the steps in the right direction, the point now is to build further upon this great start.

It is this political will that is required to solve other pressing issues like the jobs problem. With 12 million new people joining the workforce every year in the country for next few years and 29 million labour lying redundant in rural areas, it is the evident that India needs to create around 20 million jobs annually for next few years to satisfy the demand. This problem currently faces two broad issues- lack of political will to create systematic solutions and limited attention given to the quality of the solutions.

The lack of political will can be seen in the redundant attempts being made to redefine the level of unemployment rather than having discussions on increasing the number of jobs. One of the key learnings from the success of the Delhi government is that external stakeholders can have huge impact, if they are given proper targets and feedback. Hence, if there are NGOs incentivised to skill the labour or reduce the labour employee mismanagement, it would go a long way. This, of course, does not take the burden away from the government to create policies that ease up the labour laws and helps promote large manufacturers.

The other problem lies in how little attention is being paid to a problem of such magnitude. The atmosphere created over the years by the Delhi government focused on quality rather than quantity. Hence, the solutions went beyond just throwing money at the issue. With respect to jobs problem, the conversation hasn’t come to a point where the quality of jobs are being discussed. For instance, Prime Minister Modi in his infamous remark claimed that jobs like that of street-food vendor should also be included in the employment numbers. The conversation went back and forth on this paradigm but there is yet to be a substantial remark on the quality of jobs that need to be created for a country with the poverty and demographic levels as ours.

We have to take the conversation beyond just jobs or occupations and talk about sustainable work environment and employment options in the country. For instance, the policymakers should look at creating incentives to increase jobs that provide sustainable wages and decent work environment.

It is evident that enough work needs to be put in to sustain outcomes that the Delhi government saw in this year’s exam results. This one successful attempt has enough learning on how a motivated policy move can show positive results.

The Cost of Privacy

It is becoming increasingly difficult to purchase any good or service without giving up your mobile phone number. Most of the stores that you go to now will ask for your phone number when the bill is made and they later spam you with promotions. There is always a look of incredulity in the cashier when I refuse to give out my phone number. At times, I have tried to explain that it is an invasion of my privacy and that I like to avoid spam notifications, but it is extremely difficult to get across that concept. It is far easier to either give a fake phone number or just state that one doesn’t have a phone.

The reason that the bill desk is genuinely surprised by the refusal to share one’s personal phone number is that not many people do it. I am in the minority. In exchange for your phone number, they promise to put you in a loyalty programme that promises discounts on future purchases. Most people are happy to make that trade-off: give up your privacy and data in exchange for discounts. I am definitely willing to forego any discounts or offers in order to retain my privacy. That foregone discount is the cost of privacy and peace of mind.

 

The Nipah Outbreak and Kerala’s Public Health Systems

On May 25, the Ministry for Health & Family Welfare announced that the Nipah outbreak in Kerala had been contained. This came as a relief as the highly contagious virus had already claimed 18 lives.

The Indian Express has a good report that applauds Kerala’s public health systems for containing the spread:

By the time the NiV virus was confirmed, the health infrastructure in the district had been promptly spruced up by setting up isolation wards at the Medical College and the local hospitals. In the days that followed, people who had been in direct contact with the infected were immediately transferred to the isolation wards as they began showing symptoms thus breaking any further chance of spread of infection. Family members of the infected were put on home quarantine, their samples taken and their daily health parameters routinely checked by local officials. “We didn’t allow the virus to proceed in its natural cycle. Otherwise, there would have been a lot more fatalities. We were able to intervene at the right time,” said Dr Arun Kumar. [The Indian Express, May 26]

While the report appreciates the co-ordinated response of the Kerala and Union governments in dealing with this outbreak, it fails to highlight another important point: the highly decentralised nature of Kerala’s public health systems. In fact, in a study we completed last year on Public Health Expenditure in India (2005 – 2015), Kerala stood out in devolution of implementation functions in healthcare to its urban and rural local governments.

The differentiating feature is:

Unlike most other states, Kerala also does not provide much by the way of specific purpose transfers to panchayats and Municipal Councils in health. Instead, Kerala gives large amounts of general purpose transfers to local bodies (nearly 25 percent of the plan expenditures), some of which can be used for health and other expenditures. The local governments then decide how these funds should be allocated. Kerala also has an “Information Knowledge Mission” dedicated to running a system of accounts and payments for all local bodies in Kerala. They maintain a database that can disaggregate local body expenditures in health, water & sanitation and other sectors [Public Expenditure on Health in India: 2005-06 to 2014-15, Pavan Srinath et al].

My hypothesis is that this well-settled decentralised form of health administration had a big role to play in containing the outbreak. The empowered local governments were able to move quickly, without having to wait for explicit directives from the higher levels of government.

This claim needs more investigation but it is worth studying because it can help shape the self-governance debate in India.

 

The Logistics of Cash

I was in Budapest recently for a conference on the relative importance and usage of cash and non-cash methods of payments. The primary message from the conference was that cash is reliable, secure, and accessible to people. It was organised by a non profit organisation that is an association of companies dealing with cash management. Before heading to the conference, it seemed strange that there would be multiple companies involved in cash management and logistics in a country. We largely tend to take cash for granted and do not think about the vast logistical network that exists behind the usage of cash.

Here’s a brief glimpse into the fascinating world of cash logistics and management:

First, you would need specialised paper to print the notes on, which is supplied by few companies in the world. The material on which the notes are printed differ from country to country. India uses a pulp made of cotton and balsam, whereas the US dollars are made of cotton and linen. Australia, and a few countries, have shifted to an innovative polymer (or plastics).

The ink used to print the notes are also highly specialised and secure ink that does not get worn out easily. The ink would be made from a special dye that is not available to anyone except the central bank. Then, comes the host of security features, such as the hologram, watermarks, security threads, serial numbers, anti-copy marks, magnetic ink and microprinting. Each of these would be manufactured and supplied by a set of private companies, according to the central banks’ specifications.

Then, for distribution, you would require armoured vehicles to move the cash from the vaults of the reserve banks to the commercial banks and finally to the ATMs. There are private companies that specifically design these armoured vehicles and provide security guards as well. You also need specialised large vaults in commercial banks to store the currency. There are also machines developed exclusive to count the currency notes.

There are companies that manufacture and distribute ATM machines and who maintain them. A separate company would take charge of managing the ATM machine and making sure that they have enough cash to distribute. On the retail side, you have companies that manufacture tills to hold temporary cash required at point of sale. Of course, the complexity of the business determines the level of sophistication required for the cash handling machines. A Casino will require a more customised and complex machine to handle and store cash, as against a corner retail store selling milk. There are also companies that manufacture paper rolls for till and ATM receipts.

This is just a sample of the number of companies involved in cash management in a country.

P.S: I am reproducing the steps involved in cash printing and distribution in India from this Business Standard article:

HOW MONEY TRAVELS: PRESS TO PURSE

* The Reserve Bank of India (RBI) chalks out the requirement for currency notes before the start of the financial year

* The requirement is then communicated to the government

* When the government gives permission to RBI, the central bank raises ‘indent’ or order for printing specific bank notes to four presses

* Papers for banknotes were earlier procured from overseas but now the material is supplied locally

* The security features are installed by the mills first and then sent to the printing presses

* The printed notes are sent to RBI’s 19 regional offices

* There are 4,000 currency chests where the notes are kept

* RBI then raises a voucher for the notes needed

* Banks raise their demand for cash with RBI’s regional offices

* RBI then sends money to banks

* Banks keep the money in their currency chests and engage cash management firms to fill the ATMs

* ATM service providers do a daily calculation of cash required at night for the next day, called indent

* Banks validate the indent and the cash is transferred to the bank branch linked to that ATM

* These bank branches generate their own cash and in case of shortage, they borrow from currency chest

* Cash management companies transfer cash from branches to ATMs

* The companies fill up the ATMs with four ‘cassettes’, which can hold up to 2,500 notes each

* The money is dispensed when customers use their card

“Easing” Cancellation Will Lead to Higher Air Fares

Mint reports that the Union Civil Aviation Ministry is seeking to “ease rules for air ticket cancellation” in a bid to make air travel more customer-friendly. According to the draft rules,

  • Passenger allowed Lock-in option for 24 hours(after booking ticket) in which the passenger can cancel or amend the ticket without any additional charges.

While at first sight this might look like a passenger friendly move, it is likely to result in an overall increase in air fares.

I have argued before in Pragati that a reservation to travel consists of two instruments – the travel itself and the option to travel on the said route on the said day and time. In other words, the cancellation fees can be looked at as an option premium paid by the customer to exercise an option to travel on the particular route on the particular day.

When a ticket gets cancelled, the customer is effectively choosing to not exercise her option to travel. So it is fair that they not pay the cost of travel itself, and be refunded that amount. The reason travel companies levy a cancellation charge is to compensate them for the cost of the option to travel (the price of an option doesn’t depend on whether the holder chooses to exercise it).

The proposed regulation by the Civil Aviation Ministry requires airlines to offer this option for free for a limited period of time (24 hours after booking). While 24 hours may not be a high number, it can still result in people taking advantage of the free option by making bookings that they may later cancel or reschedule. And the airlines will want to get compensated for the free option they are providing.

It is likely that they will achieve this compensation by adjusting prices elsewhere – such as the price of travel itself or the price of the options where there is no price cap. And this is likely to hurt passengers.

All the new regulations from the Civil Aviation Ministry will achieve is to redistribute from passengers with firm schedules (who are more likely to be “retail customers”, from the middle class, etc.) in favour of those who may want to keep their schedules open for a day (more likely to be premium, corporate customers).

Once again invoking Ravikiran Rao, #thatzwhy we need strong regulations.

Behold Turkeynomics

Turkey’s election is certainly one to watch. It’s got a host of colourful characters with dark pasts and interesting nicknames, from Gollum to She-Wolf. Especially interesting, though, are the fascinating new economic theories being bandied about.

Now, inflation is a problem that is usually left to central banks to deal with independently. Central banks raise interest rates to reduce money supply and rein in inflation, and lower interest rates to increase money supply. But apparently, Recep Tayyip Erdogan, incumbent President, has different ideas. Erdogan’s masterstroke to deal with money flow problems isn’t demonetization (phew) but it’s something equaly counterintuitive.

How do you reduce inflation? Reduce interest rates, says Erdogan. And give me more control over the central bank.

Concerned investors reacted with a truly heartening show of support, immediately panic-selling the Turkish lira and sending it into a spiral. Perhaps Erdogan thought that this would help him gain some political capital – after all, blaming foreign entities has proven to be a great tool to keep dictators in power. Unfortunately, Meral Aksener, one of the frontrunners for the upcoming June election, has a solution: comedy.

Here’s one of her zingers, paraphrased: “Everything Erdogan touches turns to dust. He once called (Syrian President) Bashar Al-Assad ‘Brother Assad’. Well, I hope he never calls me ‘Brother Meral’.”

Her reaction to Erdogan’s brilliant plans for the economy? “Our country’s situation is like a bus on the edge of a cliff. And unfortunately, in the driver’s seat of this bus, there is a tired driver. It is irresponsible for this driver to insist on sitting in that seat.”

Oh, snap!

That said, Aksener isn’t nearly the frontrunner for the race, despite all the attention she’s received from Western media outlets amazed by the fact that a woman is running for office in increasingly conservative Turkey. Aksener’s history of overseeing deep state atrocities has led to a split in opposition unity, with the Pro-Kurdish People’s Democratic Party, the second-largest party in the current Parliament, refusing to vote for her. The nationalist, anti-Erdogan alliance still has many obstacles to clear before it can get into the driver’s seat.

Do Coasian Solutions Work in Real Life?

One of my students from the Graduate Certificate in Public Policy – Satish Terala (@satisficed– wrote a rejoinder to my Pragati blog post on why I should get compensated by my neighbour who is building a house. While he is sympathetic to my cause, he believes that the trade will not actually takes place. His post follows:


Anupam Manur in his post “Dealing With Construction in Your Neighborhood” sets up an interesting problem – construction activity in his neighbourhood undertaken by his neighbour is disturbing the peace and tranquility of his life. Anupam then rightly concludes that his neighbour’s actions are imposing a negative externality on him (actually the entire neighbourhood) and then invokes the Coase Theorem to solve for it. The solution would involve the offending party (his neighbour) paying Anupam a certain amount. Anupam would then promptly buy a new pair of heavy duty earbuds, soundproofs his house and perhaps gets some extra cleaning help.

Sounds simple enough. But why did that not happen in this case. I would surmise that getting his neighbour to understand the economics of externalities and Coase theorem is still not going to help matters here. Why is it that then perfectly rational actors fail to trade even when there are gains to be had by doing so. The answer to this comes from another equally important but not as famous theorem called the Myerson-Satterthwaite theorem.

In presence of private information about the value of certain good (Anupam’s peace and tranquility) to the buyer and the seller, Myerson-Satterthwaite theorem says that no mechanism exists that guarantees that a trade will always happen. The problem here is that of information-asymmetry. In a Coasian world, all information about the externality is public and bargaining will ensure that an efficient outcome for both parties is reached.

In Myerson-Satterthwaite’s world, people’s valuation of the good are private i.e. the buyer only has a vague sense of the what the seller is willing to accept and similarly the seller only has a notion of what the buyer is willing to pay (for the math inclined: buyers view of sellers cost is uniformly distributed on the interval [0,1] and vice versa). This private information induces sellers to act as if the costs of their goods are higher than they actually are and similarly for the buyer to act as if good is of lesser value than their private valuation of it. The theorem then shows that the gains of trade are not sufficient enough for either of the players to honestly reveal their costs and values. This implies that no fool proof mechanism can be designed that guarantees a trade will happen even when there is a price that would be agreeable to both parties.

Turns out that worst case scenario is the case of a single buyer and a single seller. As the number of buyers and sellers increase, these informational problems disappear and markets become ‘efficient’.

So Anupam might then just be better off buying those heavy-duty earbuds himself; Coase is not going to help him much in this case.

Note: While I highlight only the applicability of M-S theorem in case bargaining does occur, there are many other reasons why bargaining might not even occur. Social norms, inability to assign the responsibility of the externality, hold out problems and other issues often have large transaction costs dissuading the participants from even bargaining in the first place.

Satish is a technology professional based out of Boston. He has degrees from UC Berkeley and University of Toronto in ‘doing marginally useful things’. He still hopes to finish his GCPP – some day.

Why do Women get Charged More for Haircuts? Some Explanations

There is nothing so mysterious as the commonplace, said Sherlock Holmes. I was surprised by one such ‘commonplace yet mysterious’ incident reported in this article. The author, drawing on her personal experience, has reported that hair salons charge more (well, almost double) for the hair cut from women compared to men. Why would a barber, more interested in earning profit than anything else, want to charge more than the cost of service, even at the cost of being competed out?

There are two plausible explanations.

Basic economics tells us that when firms exercise market power, actual price need not be based on the cost of service. In fact, it is a standard undergraduate exercise that profit markup will depend on the willingness to pay (aka demand elasticity). If women, for some reason, are more willing to pay for their personal care products, it makes economic sense to charge differentially. This practice, known as ‘price discrimination’, is ubiquitous; it is the reason why book vendors charge differently for the domestic and international editions of their books (which have almost similar content).

The second explanation could be related to switching cost. Switching costs refer to the costs that must be incurred by the consumer for changing their current service provider.

Assume that, on average, men have greater mobility. They use modes of transportation which are more flexible and personalized (bikes, cars). When presented with a bad deal, they can easily say no and walk away. Now assume women, on average, use less flexible modes of transportation (say taxis or autos). Once they are in the salon, it will be more costly, both in terms of money and convenience, to say no and walk away. Knowing this, a barber would offer less favorable price deal.

In fact, this ‘theory’ can be empirically tested. If a number of salons are located nearby, the switching cost will be low and prices will be driven down to their cost of service by competitive pressure.

Sherlock Holmes has also said that it is a capital mistake to theorize before one has data. It is possible that none of the explanations make sense and something else is going on. But certainly it is a mystery that needs to be examined more closely.

Dealing With Construction in Your Neighbourhood

Dealing with construction activity near your place is a real pain. There’s a house that is being constructed right opposite my place and it is alarming how much it has disrupted my life. My productivity and peace of mind has been severely affected. This is a perfect example of negative externality, where a third-person (me) is affected by a transaction of which he is not a part.

The construction noise, from digging the borewell to cement mixers, have made it impossible for me to work from home. I find it hard to think about regulating platform economies or give a webinar while a guy outside my place is hammering on iron. That adds a couple of hours of travel to work and back.  Then, there’s the problem of fine dust that is deposited in all corners of my house. I have to either pay extra to the domestic help or spend a couple of hours to clean it myself. Not to mention, the added health risk of inhaling the particulate matter. All of these presents a real cost to the neighbours of a house that’s newly constructed.

The externality presents a market failure. The price of a house (whether it is rent or the cost of production) does not include the damage/suffering caused to others who will not benefit from that house construction. How do you solve for this  externality?

Most people would silently go through the suffering with minor complaints made to the owner and a lot of internal whining. Very few would have the power to stop the construction or put significant hurdles in the way, so as to increase the project timelines. Neither of it is an efficient solution. The owner has a right to construct a house on a plot of land that he has purchased and the neighbours have a right to peace and quiet and a right to expect their house not to get inundated by cement dust.

The only solution seems to be a Coasian solution. The owner can pay an amount to compensate for the damage caused to the neighbours and carry on with the construction activities. The externality will be internalised this way. The receivers of the payment can use the money to hire cleaners, install an air purifier, or invest in sound proofing. The additional payment gets added to the cost of construction, which can be passed on to the eventual occupiers of the space. The rent can be slightly higher to reflect this charge or if the owners decide to stay there themselves, they will bear the cost over many years that they live there.

Now, I’m off to find the owner and give him a lesson on Coasian solutions to externality and try extract compensation payments.