Weekend reading links

1. Ruchir Sharma makes an important point about the norm in the financial markets and central banking today.

If you remember a couple of weeks ago, there was a big stock market correction around the world, and it was incredible to see what the reaction was. Everybody was going on television saying ‘the Fed needs to cut interest rates’. Now the market has been going up for such a long period, it falls for just one day, and all of a sudden it’s like ‘monetary policy is too tight! We need to cut interest rates! Let’s rush out the cavalry!’. That just tells you about what the thought process has become. And I think one of the unfortunate things which has developed is this asymmetry which has crept up in markets, which is that on the upside we have capitalism, but on the downside it’s socialism. The moment there’s too much of a downside, there’s rising clamour for a rescue... easy money is a suite of government habits, and it’s not just about central banks. The habits include the tendency to bail out private sector companies at the slightest hint of trouble, the zealousness to micromanage business cycles, etc... the analogy I use in the book is of pain management in America, which is that for the slightest hint of trouble, you give people opiates, and so the whole system becomes addicted to opiates...

One of the fundamental concepts of capitalism in the market is mean reversion, which is that eventually excess profits should get competed away and you should keep getting churn, which is that new winners emerge and the old players keep dying. But this whole concept has been undermined now because of this extensive government involvement, whether it’s too easy money, bailouts or regulations which benefit the big businesses enormously. I think that’s what’s become a real problem today, that the concept of mean reversion has been distorted.

2. Vivek Kaul points to how a generation of young Indian stock market investors have piled on to create the ongoing stock market boom in the country.

The number of individuals carrying out intraday trading has jumped from 1.5 million in 2018-19 to 6.9 million in 2022-23, with these figures being limited to the top ten stock brokers...On average, 71 out of 100 intraday traders in stocks lose money. It stood at 65 out of 100 in 2018-19... Also, a bulk of those carrying out intraday trading are youngsters. In fact, in 2018-19, only 18% of those carrying out intraday trading were under 30 years of age. In 2022-23, this had jumped to 48%. Which means that a bulk of the newer intraday traders are under 30 years of age... In fact, data released by the National Stock Exchange in early August tells us that in March 2018, the unique registered investors under the age of 30 formed around 22.9% of the total unique registered investors. In July 2024, it stood at 39.9%, implying that nearly two in every five investors in the stock market are under thirty years of age. In fact, the share of those in the 30-39 age group has remained stable, whereas the share of those over 40 has come down.

3. US public debt fact of the day

The US debt to gross domestic product ratio is heading far above 100 per cent, debt servicing costs are already 12 per cent of total government outlays and a third ($9tn) of government bonds must be refinanced in the next year alone.

4. The Government of President Patrice Talon in Benin is following in the footsteps of Paul Kagame in Rwanda and is trying to transform the country's economy by establishing manufacturing facilities.

Benin, a nation of 13mn people, is trying to achieve what few African countries have managed: systematically transform raw materials — not just cotton, but also raw cashew nuts, soya, shea and even human hair for wigs — into finished goods. Until now, like many poor countries, Benin has been trapped in a trading pattern in which it sells cheap raw commodities and imports expensive finished goods... Virtually its entire cotton crop, of about 300,000 tonnes of lint cotton, is exported raw, mostly to Bangladesh, where it is transformed into clothing for the world’s $1.5tn fast-fashion industry. In selling raw cotton, Benin, Africa’s biggest producer, is missing out on more than 90 per cent of the value, according to industry experts... In the Glo-Djigbé industrial park north of Cotonou, Benin’s commercial capital, where 12,000 workers are already employed, the vast air-conditioned integrated textile factory — at 160,000 sq metres equivalent to about 22 football pitches — is filled with rows of whirring machines from Switzerland, Germany and Japan. More than a thousand new recruits are cutting and sewing fabric that is being produced at the rate of 50,000 kilos a day...

According to the World Bank, the percentage of manufacturing value added in GDP for sub-Saharan African states, excluding high-income countries, has fallen from 18 per cent in 1981 to 11 per cent in 2023. Benin, with a GDP per capita of about $1,400 at market prices, is only at 10 per cent... The textile and apparel factory north of Cotonou, which will also produce bed linen, towels and garments such as polo shirts and leggings, is part of a national industrialisation strategy intended to quintuple the country’s manufacturing capacity by 2030. The finance ministry estimates that manufacturing contributes 9.8 per cent to GDP, but says that more than two-thirds of this is artisanal manufacturing. The formal industrial sector, restricted to a few activities such as cotton ginning, contributes only 3 per cent to GDP. If the entire cotton crop were processed into apparel, it would at a stroke add $12bn to Benin’s $17bn economy, say industry experts... To meet Benin’s goal of manufacturing its entire cotton crop at home would mean attracting investments in around 25 new factories... In just 18 months, five factories have been built to transform the country’s entire crop of cashew nuts into packaged goods. Previously they were all sent to Vietnam for processing and packaging, but this change increases their value to Benin’s economy 10-fold, he says.

5. This is such an important but hardly discussed fact amidst the debates on climate change - the main perpetrators of the stock and flow of carbon emissions are those economically well-off, both among nations and people, and unless they dramatically mend their ways there's no meaningful path to address the problem.

Amidst the controversy over Starbucks, a self-declared ESG leader, recruiting a CEO who'll travel to work daily over a 1600 km flight, this report raises some important points.

The richest 1 per cent of humanity is responsible for more carbon emissions than the poorest 66 per cent, according to a 2023 joint investigation by The Guardian, Oxfam, the Stockholm Environment Institute and other experts. “[T]his elite group, made up of 77 million people including billionaires, millionaires and those paid more than $140,000 (£112,500) a year, accounted for 16 per cent of all CO2 emissions in 2019 — enough to cause more than a million excess deaths due to heat,” the investigation revealed.

6. Important point about aid transfers

In the two and a half years since the Russian invasion, Ukraine has received more aid and debt relief than any African country in the past few decades. Unlike most other aid flows, this money has made history. It has allowed Ukraine to fight Russia to a standstill while stabilising its war-battered economy. In the “global south” it rankles that bloodier conflicts in Ethiopia and Sudan barely register in western commentary. European and US support for Ukraine shows in stark relief what is missing with regard to the “global south”: the sense of shared destiny and common purpose, necessary to unlock aid on a world-changing scale.

7. The paddy production costs and externalities

Paddy requires a minimum of 20-25 irrigations compared to less than four irrigations for pulses, oilseeds and millets. A 2023 study by the Central Ground Water Board on water tables reveals that 87 per cent of Punjab’s 153 blocks are categorised as over-exploited, critical, or semi-critical. With GHG emissions of 5 tonnes CO2 eq per hectare, paddy cultivation here is also driving climate change. Rice stubble burning is a major contributor to pollution. The successful implementation of this scheme will have a positive impact on the agriculture sustainability of the states, and the country at large.

8. Fascinating long read about Prospera Inc., a charter city incorporated in Delaware and located in  Roatan Island of Honduras in 2017. 

In 2021, Xiomara Castro, the wife of the ousted President Zelaya, made repealing the ZEDEs a central promise of her election campaign. The zones became associated with the corruption of Juan Orlando Hernández, the president at the time, whom many Hondurans now revile. Castro won with a clear majority. In 2022, Honduras’s Congress unanimously repealed the law and passed a constitutional reform that would abolish the three existing ZEDEs... There was one problem, however: Congress, mired in competing legislative priorities, failed to ratify the reform. Furthermore, the original ZEDE law guaranteed the companies 50 years of legal stability — no matter what changes were made after a zone was founded. The net result is that Próspera is in a state of legal limbo... 

But in seeking to sidestep politics, Próspera instead ran straight into them. The endemic corruption in Honduras, the sort of thing Próspera was supposed to combat, was also what enabled its creation and has plagued its pursuit of legitimacy. For Hondurans, the prospect of American capitalists promising prosperity may instead resurrect fears of exploitation and dispossession. Despite Próspera’s fantasy of exit, it uses roads, hospitals and ports built by the municipal government, and it shares an economy and ecosystem with its neighbors in Crawfish Rock. The national government that granted its right to exist, meanwhile, may still take it away. 

In 2022, the government began stripping Próspera of some of the special privileges it was granted under its predecessors. It halted the company’s tax-exempt customs service, allowing the zone to continue to import goods only if it paid the same duties as the rest of Honduras. Colindres said that the National Banking and Insurance Commission also pressured Honduran banks to shut down accounts of Próspera businesses and bar lenders from financing its projects... At the end of 2022, Honduras Próspera Inc. and its affiliates filed an astronomical $10.775 billion lawsuit against the state in a World Bank tribunal called the International Center for Settlement of Investment Disputes (ICSID). Próspera is thought to have a good chance of prevailing in part, critics say, because the court is biased toward corporations, which can bring suit against nation-states but cannot be sued by them.

9. Another rare earth mineral where China dominates, antimony.

Antimony’s flame and heat resistant properties make it crucial in the production of batteries, especially lead-acid storage batteries and those used in cars. It is also used to make other car parts including brake pads. In recent years, the global shift to green energy has created new demand for antimony. The material is able to improve transparency for the cover glass on solar cells. This super-clear glass helps the performance of solar cells and is also used in the screens of smartphones. More crucially, a long-term shortage of antimony could pose a security risk. It is a critical material in the defence supply chain, and is used in everything from nuclear weapons production to making night vision goggles, ammunition and infrared sensors. The export restrictions have yet to go into effect. But antimony prices have already hit a record high. Spot prices in Europe and China have surpassed $25,000 per tonne, more than double prices at the end of last year.

10. Malaysia is a success story in diversification away from commodities to manufacturing.

Rana Faroohar links to commodities price speculation being a contributor to price increases. 

As a recent Unctad report laid out, it is “unregulated activity within the commodities sector” that was responsible for the bulk of “speculative price increases and market instability” since the pandemic.

11. Peak-tourism in Europe?

Île-de-Bréhat, a French island off the coast of Brittany with just 400 residents, recently imposed a limit of 4,700 visitors per day... Last year, the ancient site of Acropolis introduced a ticketing system to manage visitor numbers, with a cap of 20,000 per day... Santorini, famous for its whitewashed buildings and sunsets, was one of the most overtouristed destinations in Europe last year, drawing nearly 3.5 million visitors to an island of 15,500. Cruise ships — 800 vessels brought in 1.3 million visitors — were a major source of foot traffic... the mayor, Nikolaos Zorzos, said the island would reinstate a cap of 8,000 passengers per day, down from what would have been 17,000 starting in 2025... The Barcelona city government said it would eliminate short-term rentals by the end of 2028 and announced a tourism tax increase that will go into effect in October... In April, Venice, a city of 50,000 that received 20 million travelers last year, introduced a 5 euro entrance fee (about $5.60) aimed at dissuading daytrippers from visiting at peak times... Last month, the Lisbon City Council announced that it would limit the number of licenses and parking spaces issued to tuk-tuk drivers to help ease congestion... After the pandemic, Amsterdam introduced a series of stringent measures, including a 20 million cap on annual visitors. Over the past year, tourism taxes have been raised; the number of cruise ships, which are now barred from docking in the city center, has been limited; new hotel construction has been outlawed; and vacation rentals have been restricted.

12. Russian crude exports to India surges post the Ukraine-war.

13. Important facts about government wages in India.

In India, the ratio of the average wage of a general government employee to per capita gross domestic product (GDP) is around 4—among the highest in the world. In most of Asia, that ratio lies between 1 (Vietnam, China) and 2.5 (Indonesia, Sri Lanka, the Philippines). Even South Korea, Thailand and Malaysia have a ratio of general government wage to per capita GDP of around 3-4. In the Arab world and Türkiye, that ratio is around 2-3. India’s government, contrary to popular belief, is small relative to its needs but extremely expensive relative to its income. It is also highly interventionist without the personnel or the capability to deliver effectively... The 7th Pay Commission identified the compression ratio as 3.12 for entry-level employees at Grade A compared to Grade C, and 3.74 for the highest paid at Grade A compared to Grade C. The upper end of the civil service has seen its real wages fall well below that of the private sector, whereas at the lower end, salaries (including benefits) can be more secure and are even higher than in the private sector. This has meant that the pay, and as a result the quality, of the inductees at the higher end, with discretionary decision-making authority, has declined, whereas those at the lower end, who make up more than 90 per cent of the government labour force, end up earning a much higher wage than in the private sector. No wonder many people want a government job.

14. Two graphics on India's poor sporting record. One, on Olympic medals.

The second is on the country's non-sporting culture.

15. The Economist has a good summary of why Thailand is the poster child for healthcare.

The average Thai can expect to live to 80, much longer than their regional counterpart... Last year a whopping 99.5% of the population of 72m was covered by health insurance. Remarkably, Thailand has achieved this as a developing country: its income per person was roughly $7,000 in 2023... in the 1970s, Thai policymakers focused on rural development. Public health became a priority, so a wave of spending was unleashed on infrastructure. By 1990 all 928 districts had a hospital. Investment in people also helped. In 1972 the government launched a programme that required medical graduates to spend the first three years of their careers in villages. This led to a “golden generation” of doctors, says Eduardo Banzon of the Asian Development Bank.

Subsequent Thai governments made health care more affordable. The first big initiative was an insurance scheme targeting the poor. This was followed by state-sponsored schemes for those working in the informal and private sectors. But the big boost came in 2002 when the government rolled out a universal health-coverage programme, which offered free health care to the poor and a nominal 30-baht ($1) fee for others... its coverage has expanded. Today it covers treatments for conditions ranging from hiv to kidney diseases. But an equally important feature of the programme is the focus on preventive health care, says Piya Hanvoravongchai of the National Health Foundation, a non-profit. A network of grassroots workers helps provide health advice.

Particularly striking is the fact that universal health coverage is not only affordable for beneficiaries, but also for the government. The programme is funded through tax revenues, but spending is controlled. Every year district hospitals are provided with a fixed amount of money per patient in their catchment area, regardless of the treatment they get. This “capitation” model ensures efficiency and predictability in funding. Thailand’s spending on health had remained largely steady at around 3-4% of gdp until the pandemic, even as its programmes expanded.

16. Finally, on the beneficial effects of sleep.

One study found that in America an extra hour of sleep a week raised average earnings by 5 per cent, which the authors said was about as much as half an extra year of education. Another found that in Germany half an hour more sleep each week was associated with around 2 per cent higher earnings among full-time workers, with the largest effects for mothers.

Alain Bertaud on Building new cities

An excellent Alain Bertaud interview where he discusses the idea of creating new cities. 

He does not in general agree with creation of new cities,

New city projects often start by highlighting their nice infrastructure, like Neom in Saudi Arabia. But nobody will move to a city with a good sewer system but no jobs. Historically, infrastructure follows the market, not the other way around. This is why, for example, the Greeks founded my home city of Marseilles: It exported local wine and cork and imported olive oil. During Roman times it became a portal for shipping grain from North Africa to Gaul. Then there’s the issue of cash flow. When you build a new city, you have negative cash flow for a long time. Essential early infrastructure like roads and airports aren’t cheap, and it takes time for land sales and tax revenue to start coming in. This might work for new capital cities like Canberra or Chandigarh, which had the financial backing of millions of taxpayers, but it won’t work for most new cities.

On successful examples of new city formation,

True new cities start with something that attracts a lot of people and go from there. This is the story of Orlando, one of the fastest-growing cities in the U.S. Disney created a lot of jobs there in the 1970s, and thanks to tourism, you quickly get a major international airport. Before you know it, you have a diversified city... Often, new international trade routes are the draw. For example, expect to see new cities emerge in Central Asia as China’s Belt and Road initiative creates a lot of new hubs. This is the story of Atlanta, by the way: It built an economy around being a rail junction. Or we might see new cities in the Arctic, as climate change opens up new Arctic shipping lanes. This is the story of Vancouver — a connection to the Pacific Ocean.

On what he thinks is necessary requirements if we are to establish new cities - the need to marry planning with bottom-up market-based evolution,

The first thing you need to do is clearly demarcate the public and private realms... These are design problems that need to be done all at once and in a top-down way before a healthy city can start to grow. Second, you need to set up some way to finance infrastructure... If you set it up correctly, new development should incrementally pay for itself... Beyond these two considerations, don’t overthink it. The key is to lay the groundwork for a land market that will reveal the right way to allocate land uses and densities. This is partly what went wrong with Brasília — planners thought they could plan out every little detail about the city, right down to how many shops each neighborhood should have, and the results have been less than ideal. Compare Brasília to Hong Kong, arguably one of the most successful new cities in modern history. Instead of micromanaging everything, the government focused on stewarding the public realm and providing quality public services. Otherwise, they mostly let markets design the built form of the city in a spontaneous and evolutionary way.

This nuance is missing in the likes of Paul Romer's Charter Cities.  

I am not convinced by the idea of building new cities, especially in developing countries. They are too grandiose as projects to be structured to a reasonable degree of satisfaction through planning and enabling regulations in the messy political economy and weak state capacity environments. However, what's possible is that once new communities start to emerge from housing developments, governments can step in with enabling regulations and investments to support their growth as future small towns. 

Konza and the fad of greenfield cities

A friend shared this article about the unfortunate consequences of smart city developments in Africa. The article uses the 13-year history of Kenya's pioneering Konza greenfield smart city and Konza Technopolis Development Authority (KoTDA) to highlight how ill-founded and self-serving advise by consultants like McKinsey have led to large and wasteful misallocation of acutely scarce resources. 

Konza was the forerunner to other African smart city experiments - Eko Atlantic City in Nigeria, HOPE City in Ghana, an Ethiopian city styled as the “real Wakanda” after the film Black Panther, Kigali Innovation City in Rwanda, and Senegal’s Akon City. 

Sample this about Konza,

Hundreds of multinational tech companies would have outposts in Konza, and a world-class fiber-optic network would run through its commercial center and financial district. There would be 37,000 homes in well-planned residential estates, large-scale shopping malls, and Kenyan and foreign university hubs. A new highway and railway line would link the city to Nairobi, 60 kilometers away, and light manufacturing industries were being courted to set up factories. The city would revolve around data. Roads, buildings, and other parts of the urban environment would be equipped with sensors to gather information about traffic, weather, water, and energy consumption. This data would then be made available to residents and used to improve public services.

From the start, Konza was intended to be globally oriented. Its desired partners were big Western and Asian technology firms. The idea was that the Kenyan government would provide the basic urban infrastructure — roads, electricity, commuter railway lines, water and sewage facilities — and step aside. Private investors would then take over and build the rest. In return, they’d get generous tax exemptions and tax holidays, hitch their fortunes to a regional IT hub, and be exempted from a law stipulating that Kenya-based companies have to have locals make up at least 20 percent of their shareholders. (As an added bonus, expatriates working in the city would not have to pay income or withholding tax.) By Ndemo’s count, around 150 companies took an early interest in the project. Among them were the Kenyan telecommunications company Safaricom, the University of Nairobi, the Jomo Kenyatta University of Agriculture and Technology, India’s Shapoorji Pallonji Group, Samsung, Research In Motion, Google, Craft Silicon, and the Telemax Technology Corporation.

Much the same could be written about countless other similar attempts across developing countries, with all having the same failed fates.  

If the history of global experiments with greenfield city developments is any evidence, it's abundantly clear that, unless you are China, one should eschew such endeavours. The idea is that government would provide the basic infrastructure and a new set of legacy-free rules and then step aside to allow the private sector and markets to play their magic to create world-class townships/cities and economic growth centres.

These endeavours are motivated by a bad confluence of convergent desires. Political leaders entertain notions of leapfrogging and creating cities which are comparable to those in developed countries. The rich and well-off see these as enclaves to escape from the messiness and poverty of their current habitations. The large corporates see them as areas where they can escape from the general difficulties of running a business elsewhere in the country. Investors see it as a legacy-free and new-rules based opportunity to make good returns. Suppliers and contractors see huge business opportunities from the contracts awarded in the construction of the city. Arm chair commentators and academic researchers find the neatness of logic, especially in a world of urban failings, and its simplicity irresistible. And, as mentioned earlier, consultants see them as easy money opportunities by peddling irrelevant advice. In short, it's in everybody's interest to prop up such concepts like smart cities. 

Instead the objective should be to facilitate the development and growth of existing small towns. Create the conditions, by using levers of urban planning and investing in basic urban infrastructure, to facilitate planned development of these towns. As I have blogged here and here, this demands no rocket science and the services of consultants. 

Unlike a greenfield development, which offers vast opportunities for consultants and suppliers to peddle grand theories and fleece governments, brownfield development and growth is about getting the simple areas of urban planning, good governance, and infrastructure creation right. This is painstaking work of doing the basics right and does not require much involvement and advice from consultants. 

This, alongside several other examples, raises the question of whether consultancies like those mentioned in the article do more harm than good with their self-imposed "thought leadership" on many areas in development! In a rational world, influential commentators and opinion makers should come forward and stigmatise the idea of grandiose nonsense like vision documents, which "outsources the task of dreaming about the future" to expensive and smooth-talking consultants. 

In a fair world, if these consultants are held to account for the value for money from their such advice to governments, then it will most likely figure among the greatest value destruction ideas in the history of development. In this deeply imperfect world, killing off bad ideas is often more valuable than adopting good ideas!

Weekend reading Links

1. Business Standard reports a series of incentives offered by the Government of Maharashtra to attract Foxconn to establish manufacturing facilities in the state at an investment of $5 bn. They include 100% and unlimited subsidy on fixed capital investment, 20% capital subsidy over and above central government subsidies, 100% exemption on stamp duty during investment period, 100% exemption from local body taxes (property tax, land conversion tax, and entry tax), 100% VAT exemption on local purchases, 100% retention from VAT and CST payable, electricity at Rs 2 per unit, and exemption from payment of energy and water duties for 15 years.

These are staggering commitments made with little public debate and most likely, limited understanding. There has been little discussion of its magnitude, in terms of transfers and revenues foregone, or its costs and benefits. This is sure to rekindle another round of race to the bottom among states in attracting trophy investors. It also raises questions about the central thrust of the 'Make in India' campaign. 

In the context of special investment zones like Charter Cities, NYU economist Paul Romer has the following smell test, which carries relevance to this debate,

This smell test is in sync with the 'Make in India' campaign, whose objective is to boost the country's manufacturing sector by competing on improved ease of doing business environment and not by a race to the bottom with irresponsible and unsustainable fiscal transfers. 

2. Indian states are not the only ones in the race to the bottom with fiscal incentives. Ireland, which already has one of the lowest corporate tax rates, has opened a new front in the global race to the bottom with taxation rates. It recently announced a new 6.25% rate category, a "knowledge development box", on revenues and royalties derived from patents and other forms of intellectual property. Countries like Britain, Luxembourg, and Netherlands have created similar tax categories for intellectual property, but with far higher rates. It has been argued that the royalties and other payments on IP no not reliably reflect where the inventions were made or where the innovations generate the most revenue.

The move comes on the face of a ruling by the European Union Competition Commissioner Margaret Vesteger last month that the sweet-heart tax deals given by Luxembourg to Fiat and Netherlands to Starbucks were illegal. Both the firms have been asked to pay €30m on the grounds that the payments constitute illegal state aid. Both firms, and many others, are alleged to have received "selective" tax benefits, comfort letters, unavailable to their competitors, which allowed them to transfer large slices of their profits calculated at non-market prices (even as market pricing comparables exist) from one part of the firm (located in the host country) to another (located in another country) and classify them as royalty to avoid payment of taxes. In case of Starbucks, its Dutch subsidiary under-reported its profits and transferred them to a subsidiary in UK, a low IP tax country, for coffee-roasting services.

The OECD, which conservatively estimates global tax avoidance to be about $240 bn or 10% of global corporate tax revenues, too has initiated moves to crack down on tax avoidance strategies by multinationals. America's largest 500 firms hold more than $2 trillion in profits overseas, and this has been growing rapidly.

Unless the "independent entity" principle which underpins corporate taxation policies, whereby subsidiaries are treated as separate legal entities, is changed and the entire corporation is taken as a single firm, transfer pricing strategies can never be satisfactorily resolved.

3. As the graphic below shows, debt raising by frontier markets, a group of 18 EM economies, have surged in the last couple of years, touching a record $23 bn in 2014. 

Driven by a world awash with cheap credit from quantitative easing and search for yield by asset managers, many of these debt issuances have been at attractively low rates. But early this year, in a sign that the reversal of the commodity super-cycle and slowdown in China was taking its toll on these economies, Ghana had to pay 10.75 per cent to borrow over 15 years, one of the highest borrowing rates for any country in the past two decades. Underlining the perils of foreign currency borrowing, the FT writes,

Countries rarely borrow for the first time with the intention of repaying their debt at maturity. They borrow under the assumption that they will refinance the debt and keep on borrowing... A little over a year ago, Ivory Coast was able to borrow for 10 years at a rate of 5.63 per cent while Vietnam secured a rate of just 4.8 per cent, illustrating the abrupt shift in sentiment towards frontier debt.

The problem now is that having already borrowed, most of these countries have no choice but to borrow again to refinance their loans as it matures. And that comes at an ever higher cost, thereby pushing them down the slippery slope. 

4. A Coasean bargain appears to be playing itself out in the global asset management industry. FT writes, 

Global asset managers are facing a double hit to their fees, as sovereign wealth funds withdraw billions to support their oil-dependent economies — and switch to a cheaper in-house investment approach... Azerbaijan’s oil fund, which oversees $37bn of assets, has said in its annual report that it intends to bring the management of all of its assets in-house... Similarly, the Abu Dhabi Investment Authority — the second-largest sovereign fund globally with $773bn of assets — has also grown its in-house teams. It reduced its allocations to investment managers from 75 per cent to 65 per cent last year — in effect, a $77bn outflow from external fund houses... According to a new report from Moody’s, the rating agency... sovereign wealth funds taking money in-house represents a long-term trend — and, those that still use external managers are “being more aggressive about negotiating prices”.

This was to be expected given the persistently high fees on these services despite the low returns on these investments. It is also following the pattern of large endowments like those of universities which already are primarily managed by in-house teams. 

5. Italy is the latest to join the negative interest rate club. It joined Germany, Switzerland, and France in being able to sell €1.75bn of two-year debt at a yield of minus 0.023%. That "investors are paying to lend to a country which has one of the highest debt-to-GDP ratios in the world and has long been a byword for fiscal profligacy" and whose short-dated borrowing rate had it 8.12% at the height of the eurozone debt crisis, turns conventional wisdom on its head. 

This follows the recent announcement by the European Central Bank president Mario Draghi that it is not averse expanding on its current €1.1 trillion monetary easing involving monthly purchases of €60 bn worth of mostly government bonds. Andrew Milligan, head of global strategy at Standard Life Investments reflects the underlying sentiments,

This is an Alice in Wonderland situation. Negative rates are highly strange. What is underpinning them is not so much a desire to own a particular country’s debt but the broader issue of slow global growth and what central banks are going to do to address it.

6. The remarkable story of blood-testing start-up Theranos, its rise and disgrace, is emblematic of this age of instant celebrity-dom. The firm says its technology can run a wide range of lab tests from a tiny sample of blood from a finger prick, collected on nanotainers, thereby eliminating the need for intravenous blood draws and making blood-testing more accessible. 

As the Times writes, Ms Elizabeth Holmes, who dropped out of Stanford and started Theranos at the age of 19, raised $400 m in venture capital, got prominent people like Henry Kissinger, Larry Ellison, and Cleveland Clinic to embrace the firm, and reached a valuation of $9 bn, fitted in the classic mould of the start-up entrepreneur with a great story,  

It all fit together perfectly: the college dropout, the fear of needles, the humanitarian mission. She checked all the boxes. Indeed, Ms. Holmes seems to have perfectly executed the current Silicon Valley playbook: Drop out of a prestigious college to pursue an entrepreneurial vision (like Bill Gates, Steve Jobs, and Mark Zuckerberg); adopt an iconic uniform (black turtlenecks like Steve Jobs); embrace an extreme diet; and champion a humanitarian mission, preferably one that can be summed up in one catchy phrase... Ms. Holmes envisions “a world in which no one ever has to say goodbye too soon,” brought about through improved health care. Theranos also has a slogan: “One tiny drop changes everything.” She stays relentlessly on message, as a review of her numerous conference and TV appearances make clear, while at the same time saying little of scientific substance.

All went well till WSJ ran this investigative story which questioned the company's technology and its processes, showing that it does not even use the technology that it promotes and doubting the intent behind its refusal to subject its technology to peer review. 

7. Global steel industry looks set for a long period of turmoil on the back of massive over-capacity and falling demand which has rendered producers in many parts of the world uncompetitive.

As the FT writes, this has left the door open for Chinese producers to aggressively export away their excess capacity,

Since 2000, China's annual production has expanded nearly sevenfold, reaching 858m tonnes in 2014 — around half of the worldwide total... However, while China’s output used to be for domestic consumption, its appetite for steel shrank for the first time last year — resulting in its producers pushing their output into other markets. Exports are expected to surpass 100m tonnes this year, after jumping by more than 50 per cent to 93m tonnes in 2014... By undercutting European costs, Chinese imports are finding buyers around the world... 

For steelmakers, the level of capacity being utilised becomes important, as high fixed costs mean that if they are running at less than 80 per cent capacity, plants use raw materials less efficiently and producers lose pricing power.High quality global journalism requires investment. This requires the permanent shutdown of excess global capacity, which is expected to widen to around 645m tonnes above demand this year and was identified by the OECD as one of the main challenges facing the sector.

8. Gavyn Davies points to this stunning productivity trend graphic of advanced economies since 1960.

The persistence of the secular downward trend echoes the 'average is over' hypothesis that economists like Tyler Cowen have been making.

9. Times points to the latest in customized political campaigning, neuropolitics. It involves capturing facial coding, biofeedback, and brain imaging, which reveal the true nature of voter's feelings and preferences,

In the lobby of a Mexico City office building, people scurrying to and fro gazed briefly at the digital billboard backing a candidate for Congress in June. They probably did not know that the sign was reading them, too. Inside the ad, a camera captured their facial expressions and fed them through an algorithm, reading emotional reactions like happiness, surprise, anger, disgust, fear and sadness. With all the unwitting feedback, the campaign could then tweak the message — the images, sounds or words — to come up with a version that voters might like better.

10. Times has an excellent investigation, here and here, of more than 25000 arbitrations in the 2010-14 period across the US,

From birth to death, the use of arbitration has crept into nearly every corner of Americans’ lives, encompassing moments like having a baby, going to school, getting a job, buying a car, building a house and placing a parent in a nursing home... But arbitration often bears little resemblance to court. Over the last 10 years, thousands of businesses across the country — from big corporations to storefront shops — have used arbitration to create an alternate system of justice. There, rules tend to favor businesses, and judges and juries have been replaced by arbitrators who commonly consider the companies their clients... This amounts to the whole-scale privatization of the justice system... All it took was adding simple arbitration clauses to contracts that most employees and consumers do not even read. Yet at stake are claims of medical malpractice, sexual harassment, hate crimes, discrimination, theft, fraud, elder abuse and wrongful death, records and interviews show....

Little is known about arbitration because the proceedings are confidential and the federal government does not require cases to be reported. The secretive nature of the process makes it difficult to ascertain how fairly the proceedings are conducted... And unlike the outcomes in civil court, arbitrators’ rulings are nearly impossible to appeal. When plaintiffs have asked the courts to intervene, court records show, they have almost always lost... Unfettered by strict judicial rules against conflicts of interest, companies can steer cases to friendly arbitrators. In turn, interviews and records show, some arbitrators cultivate close ties with companies to get business...

Arbitration records obtained by The Times showed that 41 arbitrators each handled 10 or more cases for one company between 2010 and 2014. Anthony Kline, a California appeals court judge, said, "Private judging is an oxymoron. This is a business and arbitrators have an economic reason to decide in favor of the repeat players"... Victoria Pynchon, an arbitrator in Los Angeles, said plaintiffs had an inherent disadvantage. “Why would an arbitrator cater to a person they will never again see again?”.

This should be seen as the latest example of how private delivery of essential public services can end up seriously distorting the markets and failing to deliver on its objectives. It also, at a very broad level, reflects the concerns about widening inequality and how it enables political capture that leads to the disenfranchisement of citizens and the evolution of political and public institutions.  

Charter Cities and Economic Zones

Paul Romer makes the distinction between economic zones and charter cities, with a smell test (which can be applied to pretty much all reforms),

Charter City should be a Reform Zone, not a Concession Zone. Most zones are created to offer concessions to firms, not to implement reforms. The goal of a Charter City is reform, not giving out concessions, so in this sense, the motivation for a Charter City is totally different from the motivation behind most special zones. 

Here are my two tests for whether a policy is a reform or a concession: Would you be happy if this policy lasts forever? Would you be happy if this policy spread to the entire country? If the answer to both questions is yes, it is a reform. If not, it is almost surely a concession, a gift to some special interest. A reform zone is a zone that implements one or more fundamental reforms.

The Special Economic Zones (SEZs) promoted in countries like India are essentially concession zones, which crowd-in investment from elsewhere in the neighborhood. To this extent, they are a form of beggar-thy-neighbor policy. As to how much real economic activity they create on their own, as against being displaced from elsewhere, very little analysis has been made. But information available from the CAG's Performance Audit of SEZs, especially with respect to the predominance of IT/ITES, appears to lend credence to the economic activity displacement hypothesis. 

Charter Cities project gets a rude wakeup call

So Paul Romer has officially ruled himself out of the first Charter City project in Honduras. Prof Romer had originally joined hands with the government of Honduras to pursue his dream project of establishing a  RED (Region Especial de Dessarrollo) on public private partnership basis to develop a model city. He was appointed a member of the five-member Transparency Commission and made to believe that it would have sweeping powers in ensuring the effective implementation of his new rules-based RED. 

It appears that all that was mere posturing and the Honduras government has been taking the professor and his colleagues for a ride. The Honduras government has entered into an agreement with a private party, without apparently any of the required due diligence, and have even refused to share a copy of the agreement with Prof Romer. 

Now there is nothing surprising about this turn of events. In fact, the Honduras establishment clearly saw the Charter Cities project as a very convenient alibi to push through a public private partnership agenda which had cronyism and corruption written all over it. There is no need of the wisdom of hindsight to have perceived the preferences of the Honduras government. For this would have been the case with the overwhelming majority of governments who volunteered for such projects. One can think of many state governments in India not being averse to accepting an offer from a reputed professor which would provide the fig leaf for them to pursue massive rent-seeking resource theft. 

In fact, one could say that there is an adverse selection problem with government motivations. Given the practically far-fetched nature of the project (and why that is impractical is another debate, partially covered here), governments which would agree to embrace such projects are more likely than not be motivated by desires other than national economic development. The stakes are simply too high and incentives too misaligned for the final outcome to be anything different. 

Consider this parable. A group of robbers pass up the opportunity for their biggest ever heist as a treasure is being moved from one place to another. Furthermore, they also take the trouble of guarding the treasure from being looted and also ensuring that it reaches its final destination. Inconceivable?

Charter cities for rural India

A version of Paul Romer's charter cities may offer interesting possibilities for the development of rural India. The proposal outlined is in its first draft and should undergo considerable fine-tuning before implementation. Sceptics are advised to step back and reflect on the broader idea before unsheathing their knives.

The proposal is to lease out large tracts of government lands in rural India, at very cheap rates or even free of cost, in return for development along broadly defined lines. The defined objective could be to set up a large enough manufacturing facility, which employs a number of people (not necessarily locals) and generates more than a quantified amount of economic activity. In other words, charter out parcels of land in remote locations, in the hope of creating substantially large enough non-farm economic activity.

The only pre-requisite would be that a failure to set up the manufacturing facility within the specified time will entail restoration of the allotted land. If only a partial extent of land is developed, then the remaining extent will be resumed. The bids can be evaluated and allotted based on the attractiveness of the commercial proposal - in terms of its potential impact on the local economy. While, this does raise genuine concerns about unhealthy practices, greater clarity on the terms of reference, phasing, and condition for restoration can considerably mitigate them. In any case, if the desired project is established on ground, its benefits would more than off-set any losses incurred by doling massive land parcels to favorites.

The underlying logic is that any private investment (and presumably, any private investor putting his money on the block would channel investments to those sectors that would enable him leverage the strengths of the area), especially in virgin locations like these remote areas, will have a dramatic impact on the local economy. Apart from providing jobs, mostly indirect, it will boost economic activity and form the threshold for further development. No government action can realistically be a substitute for one big-ticket private investment.

The private investments and its multiplier on the local economy (direct and indirect jobs, and the substantial other economic opportunities) have the potential to serve as the anchor for a broader set of other economic activities. This approach works on the assumption that the only sustainable way in which these remote geographic areas can move into the next growth trajectory is through manufacturing or services-led economic growth.

The proposed lands should be in remote enough locations (and there is no scarcity of such areas), which are deficient in both infrastructure and any off-farm economic activity, and which would otherwise not have developed on its own or even with government support in the foreseeable future. Further, in order to ensure that such efforts do not get cannibalized into small-time land grabs, it should be mandatory that the allotments be of large enough tracts.

A credible enough threat of taking back unused extents of land should serve as an adequate incentive for businesses to fully implement their investment proposals. Though current concession and other contract agreements provide for penalty clauses, including resumption of the allotted lands, the provisions are often drowned in impenetrable legalesse. This effectively nullifies the force of these provisions and emboldens the private developer to deviate from contractual provisions and hoard land.

In the circumstances, it would be required to explicitly link development (along pre-defined lines and within schedule) of the area to the threat of resumption or dispossession. In simple terms, development along the pre-defined lines within the specified time should be the only scope of work (or terms of reference) for the private developer.

In order to discourage developers from sitting on undeveloped land, contracts or concession agreement many be explicitly structured (while this provision is present in present-day contracts, they are most often qualified to the extent of dilution) to resume government possession of those extents which have not been developed within the scheduled time.

I would call such land transfers Pareto improvement decisions for the following reasons

1. It is difficult to achieve success with government-led economic growth interventions in remote locations. Private business investments go to either already established industrial locations or areas surrounding urban centers. Without government support, to the extent of it being perceived as overtly generous, business investments are not likely to materialize even in the long-term in such remote locations. This proposal would be an example of benign industrial policy, which while guiding investments into certain specific locations, does not micro-manage by defining the type of business activity.

2. Government-directed capital investments are a very remote possibility. And prospects of government investments - in the scale and comprehensive nature - required to improve local physical infrastructure too are bleak. In any case, the number of such locations are far too large for government investments, even assuming it to be in scale and comprehensive, to make any meaningful dent on the overall requirements.

3. The spill-over effect or positive externalities on the locality due to the private investments, especially in areas untouched by any economic activity, are likely to be substantial. Even if the investment is limited, it can provide an anchor to catalyze further economic activity. For example, a business investment in a remote location will suddenly bring in a large number of people into one location and involve transportation of inputs and products into and from the area. These activities will invariably generate linkages with the local economy by creation of jobs, newer business opportunities, and awareness about the potential/opportunities for human improvement (that comes with the introduction of such types of growth activities into virtually time-warped societies).

4. The private entrepreneur has the incentive of capitalizing on a potential first-mover advantage into such virgin territories/markets. This is especially true if the entrepreneur views his investment in such locations with a longer time horizon. The potential benefits from a successful intervention are huge and provides him a head-start, over all other later entrants, in establishing all linkages and making use of the local strengths. The cheap or virtually free availability of land and cheap unskilled labor (for all non-critical activities) will contribute towards keeping production costs low, especially since land values are an increasingly large share of investment cost.

5. Private business investment is the best bet for bringing in basic infrastructure investments, either through government (to incentivize these investments) or by the private investor(s), into these remote areas. Some level of basic investments on connecting roads, electricity, and telecommunications will inevitably follow, either from the government or the private developer himself. In fact, given the dynamics of the prevailing political system, more than the local political representatives, a big enough private developer stands a better chance of bringing in even government investments into public infrastructure in such areas.

6. Most often, such areas, apart from being economically backward, are also socially regressive (with caste and feudal social attributes). These external investments bring in outsiders and modern ideas to these villages. These coupled with the social empowerment dimension of access to newer (different from the cultural strait-jacketing types of livelihoods) and more remunerative business opportunities unsettles established orders and become a powerful source of social change for the better.

So how about this advertisement!

"The Government of Backwardland (GoB) invites Expression of Interest (EoI) from reputed manufacturing firms who are willing to invest in any manufacturing activity in its remote Timbuktu area. The GoB will provide 1000 acres land free of cost in the area. The developer would be required to develop the entire area with manufacturing related activity within three years from handing over possession, failing which the unused land will be immediately resumed back to the government."

Update 1 (9/12/2011)

The Economist reports on Paul Romer's proposal to set up a charter city in the northern coast of Honduras. The city will have its own government, write its own laws, manage its own currency and, eventually, hold its own elections. The proposal has found favor in Honduras and some constitutional changes too have been carried out.

Why charter cities may not take-off?

For sometime now, former Stanford Professor and pioneer of the New Growth theory, Paul Romer has been advocating the setting up of Charter Cities - a new city set up in an unoccupied piece of land, with population, material and financial resources imported from elsewhere, and whose deployment is governed by a set of rules or a charter. One government provides land and one or more governments grant the charter and stand ready to enforce it.

He has proposed three examples of possible charter cities - US handing over the part of Cuban terriroty adjoining Guantanamo Bay to Canadian government which undertakes to develop it along the lines of Hong Kong; Australia could set aside a part of its territory to be populated by Indonesian immigrants and administered by Australia in consultation with the Indonesian government; and development of a special zone with a charter of the Government in India, to be developed by one state government after a competitive bidding process among all states.

In a recent article (via Mark Thoma), Prof Romer clarifies on the tradeoff between faster growth and higher risk that charter cities would face. He draws the distinction between rules (or rule set) which emerges and gets refined through "an evolutionary dynamic based on small, incremental changes or through a new-system dynamic in which an entirely new rule set enters and competes with an existing one", and catch-up growth (based on copying existing ideas) and frontier growth (involves the discovery and implementation of new ideas).

Catch-up growth with an evolutionary dynamic, while being the least risky (in so far as there is least uncertainty about its trajectory and outcomes), is more likely to be very slow and not effective. However, in catch-up growth, the new-system dynamic can be used to copy existing rule sets, thereby allowing for faster growth without the additional risk that comes from using the new-system dynamic at the frontier (which are innovative and hence risky). Therefore, charter cities embrace catch-up growth with a new-system dynamic, and "adopt a new rule set made up of rules that are known to work well... (and) accelerate catch-up growth with little of the risk associated with the development of new systems at the frontier".

Presumably, the main objective of the Charter Cities would be to bring about a faster pace of development (by more effective administration with a set rules outlined in a charter) to areas within or adjoining developing countries by leveraging resources from across the world and the administrative efficiency of certain neighbouring national governments with a creditable track record for delivering on economic and social development.

It would be less of an attraction for many of the developed countries, since their governments already have a competence in effective administration. Further, their private sectors can be incentivized to leverage the local resource strengths and deliver of even frontier growth with a new-system dynamic.

This effectively means that Charter cities are a collaborative experiment between one or more developed and developing countries, which seeks to incentivize developed country governments to participate in a joint development effort (with a developing country) with the attraction of the profit opportunities that exist in such co-operation. I am not willing to countenance any arguement that would bring in attributes like altruism and internationalism into the motivations as driving national governments.

In view of the aforementioned, let me play the devils advocate on charter cities with the following observations.

1. Charter cities lay great faith in the ability and commitment of national governments to formulate charters and enforce them. However, there is little evidence nor sufficient enough economic or political rationale for reposing such huge faith in governments, especially foreign governments to administer and enforce a charter that also benefits another country and its citizens.

Further, there exists the real possibility that the foreign administrators could end up skimming off the cream and a disproportionate share of the benefits of development. No charter, however comprehensively framed to pre-empt all such possibilities, can prevent such an eventuality, should the government of the administering country (or the establishment that controls it) so wish. The possibility of Colonialism 2.0 becomes very real.

2. There is the very strong possibility that charter cities set up beside the poorer countries would end up cherry-picking the skilled human resources and investible capital away from the mainland (of the developing country). It is natural that the skilled professionals - doctors, scientists, teachers, engineers etc - and investors would gravitate towards these new areas, further impoverishing the poor country.

This would be something similar to the new townships (or "gated communities") or satellite towns that are proliferating in the suburbs of many of the metropolitan cities in countries like India, which act as a magnet in attracting the rich and skilled and the major share of investments in institutions relating to education, health care and other services.

Alternatively, the proximity to the under-developed and poorer areas can also have the effect of keeping away private investors, wary of the political repurcussions of events in the mainland and the possibility of spill-over or contagion from disturbances there.

3. The examples of the numerous world-class Chinese cities that have developed in the last two decades is misleading. They are more closer to being examples of catch-up growth cities with an evolutionary dynamic, albeit a break-neck pace of evolution during recent years, than catch-up growth following a new-system dynamic as suggested by Prof Romer. None of these cities emerged from thin air, but were the result of focussed government policies and driven by specific growth engines that catapulted the originally existing small to middling cities into a much higher growth trajectory. To that extent, they are more evolutionary than new-systemic.

4. There is something disconcerting about the fact that charter cities would need more than economic incentives to ensure its success. As mentioned earlier, it is unrealistic and not borne out by historical evidence to place such faith in a foreign government's commitment to the charter and its outcomes. A more practical model would be a partnership with private investors.

In recent years, there have been a growing number of cities similar to the aforementioned charter cities, most notable being the spectacular Palm Islands in Dubai and the grandiose New Songdo City in South Korea. However, both these, and other similar developments, have been done by private investors with enabling policies set in place by governments. There is nothing mis-aligned about incentives in the development of such cities. Private developers who sense a profit opportunity leverage investments from investors looking for attractive long term returns, and governments benefit by the economic development and tax revenues (and also the rents by way of contracts).

The Special Economic Zones, Technology Parks and so on, that are part of economic development promotion policies in many countries, seek to build on precisely such partnerships with private investors and developers to develop and promote economic growth and development.

5. And finally, there is the issue of political acceptability that will come in the way of charter cities even if all the aforementioned challenges are surmounted. For example, a charter city in India administered by one state government will surely come up against local politics, in its various dimensions (for simplicity assume a city located in one state and being administered by another, with both states belonging to two opposing political parties). The possible incentive distortions that can derail such projects are manifold.