Weekend reading links

1. Paul Krugman highlights that Trump tariffs are in practice, lower than the official rates. Tariffs on paper are the average tariff rate one would predict if we apply the announced tariff rates to what we were importing before the tariffs. The tariff rate in practice is the actual amount collected in tariff revenue divided by the value of imports. 

One illustration.

Imports from Canada are a case in point. Even under the Trump tariffs, most goods from Canada can enter duty-free if they’re “USMCA compliant” — that is, they qualified for zero tariffs under the free-trade agreement formerly known as NAFTA, rebranded but barely changed in practice during Trump’s first term. In 2024, only 38 percent of U.S. imports from Canada entered under the USMCA. That’s surprisingly low, but the main reason was probably paperwork: certifying that a good complies with the free trade rules requires a lot of documentation. For smaller exporters, in particular, that paperwork often wasn’t worth doing, because tariffs were low even for goods not certified as USMCA compliant. Now the tariffs are much higher, and there has been a rush to do the extra paperwork. In June 2025, 81 percent of imports from Canada entered duty free. Not incidentally, this points to a hidden cost of the tariffs: Companies are incurring significant administrative costs to deal with a vastly more complex tariff system.

2. Important point about Zohran Mamdani's victory in NYC.

More than 2mn New Yorkers cast ballots in the largest turnout in a mayoral race since 1969.

To put this in perspective, 1.1 million voters voted four years back! 

The Times has a very good account of this remarkable victory.

A backbench assemblyman who had immigrated to New York City at age 7, he had almost no citywide profile. Even fellow socialists thought his views on policing and Israel would put a hard ceiling on his support... Mr. Mamdani’s political rise may be remembered for what came first: the buoyant, flamboyant, rule-breaking primary run that united a new coalition of Brooklyn gentrifiers and Queens cabbies around the city’s growing affordability crisis and the birth of a megawatt talent... The arc of his success is nothing short of staggering. At the start of the year, Mr. Mamdani was polling at 1 percent, tied, as he likes to say, with the candidate known as “someone else.” Few New Yorkers recognized his name, and his own political team put the odds of winning as low as 3 percent. Now, at age 34, he will be New York City’s youngest leader in more than a century, amid a pile of historic firsts: the first Muslim mayor, the first South Asian and arguably the most influential democratic socialist in the country.

3. Nothing captures the essence of the first ten months of President Trump more than tariffs. The FT has a good graphic. 

The point to be noted is the difference between the notional tariff and the actual tariff.

4. European defence spending is on the rise, and is expected to be an important driver of economic growth and innovation. 

5. Japan's famed convenience stores, konbinis, are facing the consequences of the country's demographic problems.

FamilyMart, 7-Eleven and Lawson all rely on a franchise business model to operate stores, taking a cut of sales or gross profit as a royalty in return for store owners using their brand, products and supply chains. In 7-Eleven’s case, typically between 40 per cent to 70 per cent of gross profit — sales minus cost of goods sold — is paid to the company. 7-Eleven Japan does not recognise the Convenience Store Union because franchisees are not its employees... store owners were under pressure because they were struggling to hire more staff. They had little leeway to raise wages unless the companies share more of the profits... Japan’s big three convenience store chains are trying to introduce technology such as self-service tills, artificial intelligence-assisted ordering systems and cleaning robots to reduce the volume of work. If those efforts fall short, the companies could be forced to introduce new franchise contract terms in order to account for higher wages, said analysts. Or, if new franchisees cannot be found, they will have to close stores.

6. Venture capital fund returns

For many years, long-run venture capital returns reported by Cambridge Associates reflected the huge profits from the dotcom boom of the late 1990s, a time when the average VC fund returned more than 20 per cent a year. Last year, though, those funds finally faded into history. Cambridge’s 25-year view now only catches funds raised — and invested — as the 90s boom turned into a bubble. These showed an annualised return of only 8 per cent. For every other period measured by Cambridge since then, VC returns fall below returns from investing in companies trading on Nasdaq. These are averages, and the profits in VC have always been heavily skewed to a handful of successful firms, making it essential to get exposure to the right funds.

And the top VCs benefit from a Mathew Effect,

Startups struggling for attention are drawn to the investors with the best track records: winning the right financial backers acts as a strong signal for young companies with little else to validate their claims of future greatness. That means the most successful VC firms usually get first option on the smartest founders and the best deals.

7.  FT visual article on perhaps the grandest follies of our times, the Saudi Arabian futuristic city of Neom and its 170 km long 500 m tall mirror glass structure, The Line, conceived by Prince Mohammed Bin Salman.

The budget for The Line was $1.6tn, Neom executives were told in late 2021. But an updated internal estimate the following spring put the cost at around $4.5tn, according to a person familiar with the estimates. That is roughly the size of Germany’s annual economic output. Teams then began tackling the unprecedented design and engineering challenges raised: imagining what life would be like inside a 500 metre-high, 170km-long wall; sourcing the steel and cement that would consume much of global supply; and making water circulate in a manmade deepwater port with no current... Its staggering requirements for materials were enough to overwhelm both the capacity of its local infrastructure, and its pricing power... to make the concrete for the first 20 modules, the contractors would need a supply of cement every year that would be greater than France’s annual output. Each 800-metre module required, by design, about 3.5mn tonnes of structural steel, 5.5mn cubic metres of concrete and 3.5mn tonnes of reinforcement steel — the narrow steel bars twisted into cage forms to strengthen the reinforced concrete. “We were going to take something like 60 per cent of the global production of green steel [per year], which causes the price to go up,” said a senior design manager.

8. Ed Luce writes that peak Trump is over. He writes that the Democratic Party election victories owed significantly to their focus on rising prices, and that the deal with China postponing tariffs for one year may have won Trump some reprieve on the inflation front. 

Trump now has a strong incentive to declare similar wins on other trade wars. In that regard, Tuesday night was also a good one for Brazil, India, Canada and other targets of Trump’s ire. By a quirk of timing, the US Supreme Court on Wednesday held hearings on the legality of his tariff war. Was it coincidence that conservative justices sounded unusually bold in querying that? They too might possibly help Trump by striking the tariffs down.

9. John Burn-Murdoch points out that culture conflicts (and not economic differences) have been the drivers of political polarisation in the US.

In their pioneering paper The Business of the Culture War, published earlier this month, MIT and Harvard economists Shakked Noy and Aakaash Rao use second-by-second TV viewing data to show how the commercial incentives of cable news channels helped to sow discord not only among their viewers but across America more broadly.

Their key insights are that content relating to crime, immigration, race, gender and criticism of elites reliably increases viewing figures (while economics and healthcare cause people to switch away). This means there is a resulting shift in coverage towards more culture war issues and fewer socio-economic stories, which leads voters to rate these issues as more important. Politicians then respond by campaigning more on cultural hot button topics. All told, they estimate that the emergence and growth of cable news can account for fully one-third of the increase in US cultural conflict since 2000.

10. State capacity fact of the day, Competition Commission of India. 

It has exactly one active office. In New Delhi... CCI has no presence in Bengaluru, one small outpost in Navi Mumbai, and a “touch-and-go” office in Kolkata that lawyers say is barely functional. Markets regulator Sebi, by comparison, has 22 offices. The aviation regulator, DGCA, has around 20. When it conducts raids, it flies 25–30 officers to Mumbai. Every investigation means teams of lawyers and informants shuttling to Delhi for two years. “In India, such a large country, there is only one big agency for 28 states,” said Kumar. “Look at the US. There are competition agencies in all the states.” The costs add up. Filing a case itself can set a company back Rs 50,000 to Rs 6 lakh. Add multiple Delhi trips—three or four by the informant, three by lawyers, over a 2–2.5-year period—and justice becomes a luxury good... The Commission is still operating with roughly the same headcount it had in 2009. The Director-General’s office, sanctioned for around 20 officers, has seven. The merger-control team has six. Case disposals that once took three months now take six to eight—on a good day.

11. FT reports that the US has added "poison pill" termination clauses to recent trade deals with countries like Malaysia and Cambodia, which threaten to end the deals if either signs a rival pact that jeopardises "essential US interests" or "poses a material threat" to US security. This is a form of "loyalty test" for trade partners. 

Simon Evenett, professor of geopolitics and strategy at IMD business school in Lausanne, Switzerland, said the clauses were so broad that they handed the US unilateral powers to terminate the agreements, giving Washington fresh leverage across the region. The agreement with Malaysia also includes a provision requiring it to align with US sanctions and other economic restrictions. “Ultimately, poison pill provisions transform trade agreements from purely commercial instruments into tools for managing partner countries’ broader foreign economic policy orientation,” Evenett wrote in a paper this week. Although there is a partial legal precedent for poison pills in the 2020 US-Mexico-Canada Agreement, Evenett said the USMCA clause had legally defined triggers, in contrast to the broad conditions in the Malaysia and Cambodia pacts.

12. The rise and rise of US Government debt. 

Infrastructure project delivery and state capability

An important misplaced belief that has become entrenched in infrastructure project delivery is that of substituting public system capabilities with outsourced project management consultants (PMCs) and independent engineers (IEs). 

In India, commentators misleadingly attribute the successes of NHAI or DMRC or the few other successful projects to private participation in general and particularly the adoption of private sector management practices and outsourcing of services to consultants. They overlook the critical importance of the role played by the engineers, planners, and bureaucrats in these organisations, the processes followed, and the autonomy enjoyed by these project entities. 

Echoing these important requirements, Alon Levy at Pedestrian Observations has a very good post on infrastructure project delivery practices, where he makes the distinction between the models of modern management theories-based delivery (followed in US and UK) and the traditional public sector-driven delivery (followed in continental Europe). 

The takeaway is that effective project delivery “requires an active public sector that can supervise consultants and contractors, learn within its own institutions, and assume risk”. Even when project delivery is largely done by private consultants, they are done “under public-sector supervision, with institutional knowledge retained in government agencies even in an environment of privatization”. 

If there’s a common theme to the various elements of Southern European (and largely also French and German) urban rail procurement norms, it’s that they require an expert civil service. Teams of engineers, planners, architects, procurement experts, and public-sector project managers are required to manage such a system, and they need to be empowered to make decisions. This empowerment contrasts with American public-sector norms, in which to a small extent in law and to a very large extent in political culture, civil servants are constantly told that they are dregs and cannot make any decisions. Instead, they are bound by red tape requirements that can only be waived if a political appointee wants to take the risk… 

The idea of listening to engineers and planners is denigrated as siloing, whereas generalist managers with little knowledge are elevated to near-godhood… In contrast, it is less important how many civil servants are hired to supervise contracts than that they have the authority to make judgment calls and that they do not have to answer to an overclass of generalist managers. Italy and France use very large bureaucracies of planners and engineers at Metropolitana Milanese and RATP respectively… Once the civil servants can make decisions and supervise contractors, they can look at bids and score them technically, or delve through itemized lists, or oversee changes and make quick yes-or-no decisions as the builders are forced to vary from the design… making this the most significant single intervention in reducing infrastructure construction costs.

Levy lists out some of the good practices followed by Southern European countries, which have a track record of delivering large projects on time and within budget. While he discusses in the context of metro rail systems, these principles apply to infrastructure projects in general. 

• Technical scoring: infrastructure contracts must be awarded primarily on the technical score of the proposal (50-80% of the weight of the contract) and not on the cost (maximum 50%, ideally about 30%)

• Itemized costs: contracts must have a bill of items, priced based on transparent lists produced by the state, with change orders using the same itemized list to reduce conflict

• Separation of design and construction into two contracts (design-bid-build), rather than bundling into design-build contracts

• Public-sector planning, with the decisions on the type of project and technology made before any designers are contracted

• Flexibility for the builders to vary from the design, so that in practice the design only covers 60-80% of the design, as 100% design is impossible underground until one starts digging

• Moderate-size contracts (tens of millions of dollars or euros to very low hundreds), to allow more contractors to compete

• Limited use of consultants, or, if consultants are used, regular public-sector supervision

The orthodoxy on infrastructure project management today is characterised by certain core principles drawn from management theories - efficiency maximisation (bundling of design and construction), life-cycle cost approach (bundling of construction and O&M), private sector efficiencies (PPPs and long-term concessions), outsourcing services to professional experts (PMCs, IEs), etc. Levy attributes this dominance of modern management theories to the soft power of “English-speaking multinational consultants with extensive experience in megaprojects” and the belief that they knew better than the continental European state. 

As I have blogged on numerous occasions (and written in detail here), contrary to conventional wisdom, it’s technically prudent to separate design and construction in most cases, though with some significant design flexibility during the construction phase; it is financially prudent to separate construction and O&M, so that the O&M contractor does not bear any construction risk; it is cheaper to construct with public finance and then do concessions; and leverage and PPPs must be used only where there are private sector efficiencies to be had and never merely as a means to address fiscal constraintsand avoid large upfront costs. 

A very important, and under-appreciated, aspect is that of effective contract management by the government entity. It’s not uncommon for the consultants employed for the project, including the IE or the third-party quality audit firm, to be captured by the project developer. Given the financial stakes involved, the political economy of infrastructure construction, and the tightly knit ecosystem involving the project developers, consultants, IEs, and other service suppliers, the incentives are strongly aligned to collude at the margins. Strict internal supervision and monitoring become essential to address this problem.

Fortunately, the use of IT applications makes it possible to significantly increase the quality of oversight and remote monitoring of large projects. However, this must go beyond mere videography, biometric attendance, location tracking, GIS mapping, data acquisition systems, and so on, and involve deep data analytics of the data so captured to identify outliers and trends of systematic manipulation. Getting this done and effectively using it to enforce contract and execution discipline is deeply dependent on internal capabilities. 

An important takeaway here is the capabilities of the internal project team and the autonomy given to them. Perhaps the most important requirement for the success of any large project delivery is ensuring that the project team is adequately staffed with engineers, planners, and leaders who are competent and have high integrity. Any relaxation on this, especially in important positions, is a recipe for certain failure. Nothing is more important than this requirement. Unfortunately, this is often the area where governments tend to compromise the most.

Weekend reading links

1. The Swiss Central Bank has lowered interest rates to zero in its sixth consecutive rate cut, after consumer prices fell 0.1% in May from a year earlier. Switzerland has had negative rates from 2015-22, with the lowest being minus 0.75%.

2. Hybrids are making a comeback.

In the first three months of this year, hybrids — including cars that can and cannot be plugged in — made up about 14 percent of all light vehicles sold in the United States, according to the Department of Energy. That was around twice the market share of fully electric vehicles in that period. Republican legislation working its way through Congress could further lift sales of hybrids. In May, the House passed a policy bill backed by President Trump that would eliminate a $7,500 tax credit available to people who bought or leased electric vehicles. That legislation would also impose an annual tax of $250 on electric cars and $100 on hybrids to finance road projects. The Senate version of the bill introduced this week would do away with the tax credit, too, but does not include the annual tax.

A few large automakers dominate the sale of hybrids. Nearly half the cars and trucks that Toyota and its luxury brand, Lexus, sold in the first five months of the year were hybrids — and sales of those vehicles were up about 40 percent from a year earlier. Ford Motor’s hybrid sales rose 31 percent in the same period. Honda is on track this year for its highest hybrid sales ever, and the hybrid versions of its Accord sedan and CR-V sport utility vehicle now outsell the gasoline-only models. Hybrids are typically powered by a small gasoline engine that is paired with an electric motor driven by a battery that is much smaller and, thus, less expensive than the batteries in fully electric vehicles. These batteries are charged primarily by regenerative brakes and gasoline engines. Plug-in hybrids, which account for a small share of hybrids, have bigger batteries than regular hybrids and can also be charged from power outlets at home or at charging stations. Some plug-ins can go around 50 miles on battery power alone before the gas engine kicks in.

3. The changing nature of business lines and revenues of Reliance Industries.

Rahul Malhotra, director at Bernstein, calculates that Reliance now generates more than half its annual earnings before interest, taxes, depreciation and amortisation from consumer-facing businesses, compared with less than 10 per cent a decade ago.

4. Smartphone assembly has been the PLI's standout success.

5. Trends with India's FDI.

Manufacturing's share of FDI has continued to decline.

6. Why Chinese consumers took to EVs?

XPeng's Mona Max, which has just gone on sale in China for around $20,000. For this price you get self-driving capability, voice activation, lie-flat beds, film and music streaming. Young Chinese graduates, we're told, see all these as standard features for a first car purchase... a huge amount of government spending goes towards making EVs financially attractive, according to the CSIS study. Members of the public receive subsidies for trading in their non-electric car for an EV as well as tax exemptions and subsidised rates at public charging stations. These perks drove Mr Lu to go electric two years ago. He used to pay 200 yuan ($27.84; £20.72) to fill up his car for 400km (248 miles) of driving. It now costs him a quarter of that. People in China also normally pay thousands for their vehicle registration plate - sometimes more than the cost of the car itself - as part of government efforts to limit congestion and pollution. Mr Lu now gets his green one for free... Another proud EV owner in Shanghai... says that rather than charge her vehicle at a station, she changes her car's battery at one of the city's many automated swapping stations provided by EV maker Nio. In under three minutes, machines replace her flat battery with a fully charged one. It's state of the art technology for less than the price of a tank of fuel.

7. Some statistics on government spending on public sector units.

The government’s total receipts from disinvestment and dividend from PSUs over this period of 10 years fell from 0.45 per cent to 0.25 per cent of GDP... In contrast, the government has been increasing its capital allocations for PSUs through equity and loans in the last 10 years, from about 0.54 per cent in 2014-15 to about 1.66 per cent of GDP in 2024-25... In 2014-15, total equity and loans to PSUs were estimated at ₹67,512 crore, accounting for just about 34 per cent of the Modi government’s total capex of ₹1.96 trillion. By the end of 2024-25, that share rose to 54 per cent, as PSU equity and loans were estimated at ₹5.48 trillion, out of a total capex of ₹10.2 trillion.

8. State capability, airline industry graphic of the day.

9. Brazilian Supreme Court rules that social media platforms can be held legally responsible for users' posts, forcing them to proactively demove material like hate speech, incitement to violence, etc., even without a prior judicial takedown order. This follows rising concerns in Brazil about harmful digital content, especially on children and youth. 

10. The balance sheet of AI spending and benefits is not looking good.

On the cost side, the effects of AI mania are all too apparent. The four tech companies leading the charge — Alphabet, Amazon, Meta and Microsoft — increased their capital spending by nearly two-thirds, or $95bn, in 2024. As this year got under way, they were planning to boost capex by another $75bn... Bank of America Securities predicts that for the tech industry as a whole, spending on data centres will jump from $333bn last year to about $1tn in 2030. By the end of the period, 83 per cent of the money will go into AI-related investments. 

On the revenue side of the equation, meanwhile, some of the AI leaders are starting to notch up big percentage increases in business — but the extra revenue is counted in the tens of billions rather than the hundreds. Early this year, Microsoft said its annualised revenue rate from AI had climbed 175 per cent to reach $13bn. That is still only about 5 per cent of the total revenue it is expected to produce this year. OpenAI’s revenue run-rate from subscriptions, its main source of income, just topped $10bn, doubling from the end of last year. The rates of increase are notable, but the absolute figures still pale in comparison to the capex.

Insights from development - WB takeaways

Some time back, the World Bank published a compilation of useful insights that have emerged from its development work over the decades.

Berk Ozler on conditional and unconditional cash transfers, 

A systematic review of CCT and UCT programs finds that the effect sizes on school participation increase as the conditions are made more explicit, monitored, and enforced... while CCT programs may be more effective than UCTs in obtaining the desired behavior change, they can also undermine the social protection dimension of cash transfer programs... While there are few long‐term studies of unconditional cash transfers, the available evidence suggests that their short‐term effects are not sustained.

Deon Filmer and Adam Wagstaff draw attention to the importance of service delivery quality,

In both education and health, poor quality of service delivery is the key reason why service coverage does not necessarily translate into better outcomes... One study found that going from having a teacher in the bottom quality decile to one in the top is equivalent to a full additional business‐as‐usual year of learning for students. Another study compared mortality in high‐income countries and mortality in low‐ and middle‐income countries (LMICs), and concluded that of the 8.6 million excess deaths in LMICs that were amenable to medical care, the bulk (5.0 million) were due to receipt of poor‐quality care rather than non‐receipt of care.

They also discuss the pros and cons of the three approaches of paying for public service delivery - fee-for-service, capitation (according to the number of characteristics of people served), and budget-salary. They argue in favour of some combination, depending on the sector and context, with a pay-for-performance element.

In this context, I recently came across a J-PAL meta-study of 17 preventive health products, including mosquito nets, deworming pills, and water-purifying chlorine tablets, which found that "offering them for free makes it far more likely that people actually get and use them, benefiting themselves and others."

Roberto Fattal, Hiau Looi Kee, and Sergio Schmukler points to the constraints faced by small firms and business formation in general.

The overall functioning of financial markets is important, the allocation of credit across firms matters for economy‐wide growth. Small firms as well as young that create novel products and technologies but that lack the financing to scale up tend to be harmed the most by misallocation of credit. In countries where credit is expensive and hard to access, firms typically are small, leading to a misallocation of credit. Large firms that are relatively less productive end up producing a significant share of the output, while smaller more productive firms are unable to grow and to contribute as much as they could.... just developing financial markets might not be enough to generate growth – ensuring that credit flows to the firms that have growth potential is as important... The regulation of entry, for instance, should consider the incentives for low‐scale entrepreneurship to become informal. Similarly tax policy should anticipate distortions to firm growth that happen when firms of different sizes face differential enforcement.

Norman Loayza and Michael Woolcock draw attention to the importance of complementary measures and state capability.

Policy implementation can fail for two broad reasons: (1) the absence of complementary measures needed to make the chosen policy effective; and (2) the inadequate capability of prevailing institutions and administrative systems... without a supporting institutional framework and capable public sector organizations to implement them, even technically sound policies and programs are likely to fail... Children do not learn if they are hungry, so educational and nutritional policies should go hand in hand. Parents do not vaccinate their children if they are struggling to survive, so immunization campaigns should target the poor and provide pecuniary benefits to families that participate. Farmers do not adopt new crops and technologies that are potentially more profitable but also riskier, so introducing new farming practices should be accompanied by improved insurance mechanisms and access to markets... Trade openness cannot promote competitiveness if domestic industries are burdened with excessive regulations, so international openness should be accompanied by streamlining regulations and improving public infrastructure.

Vijayendra Rao and Michael Woolcock write about the role of local accountability.

There is an increasing realization that better development outcomes are delivered within institutional systems where citizens and communities matter... Elections are one mechanism of accountability, but they are not enough because they are held infrequently and can be captured by elites. Elections need to be complemented by citizen bodies – institutions for collective and deliberative decision‐making where the voices of citizens can be heard and where they are able to monitor the performance of governments.

They also dwell on the importance of process legitimacy.

How difficult and contentious social outcomes (such as elections, judicial rulings, or even the extent of inequality) are reached has enormous bearing on their legitimacy and the extent to which they are accepted, especially by those who would have strongly preferred a different outcome. Political parties that lose close elections can accept this outcome if they believe that votes were cast and tallied impartially; citizens tolerate higher levels of inequality to the extent the wealthy are perceived as having gained their riches by diligence, innovation and prudence (not theft, deception or corruption)... Securing and sustaining legitimacy is likely to be deeply context‐specific, varying considerably between and within countries. Even professional ‘best practices’ (fiscal rules, meritocratic hiring) and scientifically verified ‘solutions’ (immunizations, fertilizers) must earn local legitimacy and credibility before they will be embraced, at scale. Creating public spaces within which such practices and solutions can be identified, adapted to the local context, and/or be improved is a key way in which legitimacy is acquired.

Robert Cull and David McKenzie write about the challenge of scaling programs,

Even when pilots and local development interventions have proven very successful, they have often been difficult to scale up in a cost‐effective way to achieve development impact on a large scale. Conversely, several development interventions that have managed to achieve impressive scales at relatively low costs are increasingly under scrutiny for their lack of transformative impacts on the lives of the poor... A recent meta‐analysis of more than 600 research papers covering 20 different types of development interventions found that the larger the study, the smaller the size of the effect, and that programs implemented by governments tend to have smaller effect sizes than academic or NGO‐implemented programs.

They list out a few reasons - small‐scale pilots may concentrate efforts on those who benefit most; implementation and political economy issues can arise as programs grow; general equilibrium effects can further reduce some impacts; cost issues can make scaling prohibitive.

Sergio Schmukler, Michael Toman, and Adam Wagstaff use examples from early childhood education, financial crises, and environmental degradation to highlight the cost-effectiveness of early policy interventions at scale. 

Education and health interventions in early childhood have large returns... The period over which returns accrue is therefore very long. By contrast, the costs of early childhood interventions occur over just a few years. But even after discounting to present values, the benefit‐cost ratio is large... preschool interventions... make these later investments more productive. Empirical work supports this idea that early investments enhance the productivity of (i.e., are complementary to) later investments... Recognizing that financial crises are costly, governments around the world have moved to implement measures to act early in order to prevent them... Preventive measures include financial regulation and supervision, macroprudential policies, and even capital controls. By minimizing currency and maturity mismatches, obtaining high capitalization and liquidity buffers, adopting flexible exchange rate regimes, and introducing sand‐in‐the‐wheel types of measures, the financial system can be less prone to boom‐and‐bust scenarios.

Finally, Bob Rijkers and Erhan Artuc write about international trade.

The negative distributional impacts of international trade are large, localized, and long‐lived... Workers who are adversely affected by trade liberalization face high moving costs and are often not able to leave to find better jobs in other regions. The adverse effects of trade liberalization are consequently concentrated in particular regions, while the benefits are widespread throughout the whole economy. These negative localised effects persist in the long run and the affected regions take a long time to recover, if at all.

The compilation is also a good example of how a body of knowledge can be built through long-drawn and institutionally guided research efforts. It can play an important role in changing narratives and may be a bigger and more important legacy of the World Bank than the various development programs it has financed. 

Tax assessments and arrear recoveries

I blogged here arguing, among other things, that collecting tax and non-tax arrears is a very challenging endeavour. Central and state tax agencies have large amounts locked up in such arrears, including litigation. Only a tiny proportion of these amounts is ever realised. 

Arrears refer to any amount due from the taxpayer due to confirmation of demands due to original orders, appeals, and tribunal/court orders. They are in turn classified as recoverable and irrecoverable (those where there are court stay orders). Let’s take a look at the magnitude of these arrears of the central government’s direct and indirect tax departments. 

The FT has a good graphic that informs that disputed tax arrears amount to $186 bn, rising a staggering 1140% from $15 bn in 2010 to $186 bn in 2024. 

This is the story of the $1.4 bn tax demand raised on Volkswagen in September 2024 on what appears to be a case of legitimate tax minimisation to skirt around a clear loophole in the tax structure. 

The CAG’s compliance audit report on GST for 2022 reveals some interesting insights on service and excise tax under the Central Excise Act 1944. The Table shows limited progress in recovery of arrears.

Realisation from closed units is negligible.

The age-wise break-up of pending arrears is in the table.

The two graphics below show the percentage of detections and recoveries in GST…

… and Excise and Service Tax.

On the direct taxes side, the CAG’s compliance audit on the outstanding demand on income tax assessees for FY22 reveals the following table (HT: The Wire).

An analysis of ‘total outstanding demand’ and demand classified by the ITD as ‘difficult to recover’ vis-à-vis the ‘total direct tax collection’ for the financial years 2016-17, 2017-18, 2018-19 and 2019-20 showed that total outstanding demand had exceeded direct tax collections consistently. The demand classified by the ITD as 'difficult to recover' was more than 97 per cent of the total outstanding demand in all these years. 

The Table captures the different reasons for the demand difficult to recover. 

The amounts locked up in litigation range from 59% to 77%. 

The figure of outstanding demand against the ‘assessees not traceable’ more than doubled in 2019-20 and tripled from 2017-18, despite linking PAN with Aadhaar being mandatory since July 2017. 

All compliance audit reports of CAG can be found here. 

A few observations.

1. Arrear collections are a dissipative endeavour. For a new officer or government, notwithstanding its persistence over the years, the large arrear pending provides an alluring attraction. A disproportionate amount of effort is expended on arrears with limited results. On a pure cost-benefit analysis, the realisations are often offset by the manpower costs involved, much less the opportunity costs from displaced efforts. 

2. There’s an iron law of arrears - the difficulty of collection increases exponentially with its age. The best time to collect an arrear is in the first year. Once it exceeds the first year, it becomes extremely difficult to recover. Tax authorities should, therefore, focus efforts on collecting dues pending for less than a year. 

3. Once a case goes into litigation, it’s inevitable that the assessee will litigate till the final court of appeal. This also means several years for which the amounts are locked in litigation. Finally, only a tiny share of those cases result in actual realisations. The amounts realised after the completion of litigation are likely to be rounding errors. 

4. It’s not out of place here to say that the courts also play their role in the accumulation of cases in litigation. While inordinate delays are the common culprit, a less-discussed contributor is the propensity in many courts to admit cases at various stages of investigation, adjudication, and appeal. The taxpayers tend to prefer this route since it allows them to pay a small amount and delay the due process before the tax authorities. Collusion among all stakeholders ensures that the case gets delayed interminably. 

In this context, I had blogged here with several actionable suggestions to address such excessive demands. 

Apart from procedural reforms, there’s also the need for some form of performance management of officers in tax departments. Specifically, there should be a mechanism to rigorously monitor the quality of their assessment and enforcement work. 

As a framework, allocation of cases for investigations should be based on signatures of high likelihood of evasion (also ideally high-value evasion for audits and inspections). Investigations should avoid false positives that harass innocent taxpayers with notices and procedural pain. Similarly, the quality of investigation and adjudication should strive to target deviations in the least invasive manner and should result in realisations that are close to the initial demand.

Accordingly, any investigation can be reduced to four stages - assignment of the case and issue of notice, detection of deviation and raising of preliminary demand, adjudication and issue of final demand, and collection. The detection rate (detected cases/total cases identified for issue of notice) is a measure of the quality of assignment or allocation. The ratio of final demand to initial demand is a measure of the quality of the investigation. The ratio of collection to the final demand raised is a measure of the quality of adjudication (and collection). Finally, there’s the average realisation per case, which is a measure of the combined quality of the tax enforcement work (this last metric will also ensure that officials don’t game the system by raising several small tax demands). 

These metrics can be customised based on the specific sequence of processes associated with each tax agency. 

Taken together, at a steady state and over the tenure of an officer, these four ratios should give a reliable assessment of the quality of the assignment, investigation, adjudication, and collection. It might, therefore, be useful for the tax authorities to devise benchmarks for each stage and have all tax officials performing these roles assessed for the duration of their tenures on these metrics. These performance metrics should inform the postings of officers and the assignment of cases. 

In fact, if historical data on these metrics can be assessed for each senior officer (along the lines discussed here), then it might be a good basis for identifying officers who have the propensity for aggressive demand-raising. The CBDT and CBIC could invite academic researchers and offer them access to their databases and have them analyse and generate the reports as required (while also allowing them to publish on the headline findings).  

Weekend reading links

1.  Ruchir Sharma points to the attractions of investing in China.

China now has more than 250 companies with a market cap of over $1bn and a free cash-flow yield of more than 10 per cent; the US has fewer than 150. Of those 250-odd China stocks, all but about 20 are in sectors other than tech, led by industrial and consumer discretionary businesses, so the opportunities are not just in the internet and AI... But by some measures, capitalism with Chinese characteristics is more competitive than its US rival. Large caps account for a smaller share of listed companies in China, leaving more room for newcomers. Among the 11 leading sectors, seven are less concentrated in China than in the US, meaning the top five businesses constitute a smaller share of each sector’s market cap. China’s tech sector is much less concentrated, which means a private upstart such as DeepSeek could rise in an environment less dominated by giants.

2. Interesting that amidst all talks of green transition in the US under Biden, the country continued to increase oil and gas extraction at an increased pace since 2016.

3. Good description of the bear and bull case for US equity markets with associated numbers.

4. Microsoft announces a breakthrough in quantum computing by unveiling Majorana 1, the world's first quantum chip powered by a topological core architecture. 

Microsoft’s ability to exploit a new kind of matter to create a new type of qubit (or quantum bit) promises to accelerate the development of reliable large-scale quantum computing... It’s kind of a generational technology like moving from vacuum tubes to a semiconductor. The advantages of Microsoft’s topological qubits are that they are fast and digitally controlled. That should enable them to scale more reliably to the 1mn qubit threshold that researchers consider necessary for sophisticated quantum computation. But it will still take years of experimental engineering before the company can deploy its quantum processing units (QPUs) in data centres alongside the classical graphics processing units (GPUs) that are currently powering the AI revolution. Nevertheless, the company still hopes to build a utility-scale quantum computer by the end of the decade configured to tackle a set of problems that no classical computer can address. By exploiting the special properties of a quantum computer, Zander reckons researchers will be able to develop new catalysts to break down microplastics, enhance the fertility of soils or develop new forms of self-healing concrete, for example.

A summary of the latest on quantum computing chip development - Google's Willow, IBM's Heron, Microsoft's Majorana 1, Amazon's Ocelot, and others. It's estimated that we are 15-30 years from any commercial chip deployment. 

5. In a paradigm breaking shift from its more than two decades of fiscal conservatism, Germany looks set to amend its 'debt brake'

Chancellor-in-waiting Friedrich Merz late on Tuesday agreed with the rival Social Democrats (SPD) to exempt defence spending above 1 per cent of GDP from Germany’s strict constitutional borrowing limit, set up a €500bn off-balance sheet vehicle for debt-funded infrastructure investment and loosen debt rules for states. Deutsche Bank economists described the deal as “one of the most historic paradigm shifts in German postwar history”, adding that both the “speed at which this is happening and the magnitude of the prospective fiscal expansion is reminiscent of German reunification”.

The plan is expected to open €1tn of additional borrowing over the next decade, more than a fifth of the country's GDP, for defence and infrastructure spending. Given its far lower debt to GDP ratio of 63%, Germany fortunately has enough fiscal space to accommodate such spending which is expected to rise to 84% over the decade. It has precedents in so far as similar spending spike happened in the aftermath of the reunification and boosted economic growth in the nineties. 

At the core of the problem has been a “debt brake”, written into Germany’s constitution in 2009 at the peak of the global financial crisis, that limited the government’s capacity to take on new debt to 0.35 per cent of GDP — one of the most stringent anti-borrowing laws in history. Much of the fiscal space that did exist was spent on the welfare state and social benefits. Merz’s plans bypass the debt brake by enabling the exclusion of everything over 1 per cent of GDP spent on defence. Goldman Sachs anticipates that the plan will drive German defence spending to as much as 3.5 per cent of GDP by 2027 — up from 2.1 per cent in 2024 and a mere 1.5 per cent in earlier years... Even with a debt-to-GDP ratio of around 84 per cent, German public leverage would be “still pretty favourable” compared with most peers, said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, pointing to ratios of 115 per cent in France and 124 per cent in the US.

The markets reacted in all the positive ways to the announcement.

Markets are applauding. As a Kiel Institute policy brief notes, the increase in German borrowing costs after the announcement was accompanied by rising stock prices, an appreciating euro, a steeper yield curve and stable default insurance — all pointing to improved growth expectations.

6. It's a measure of the unprecedented global power wielded by Donald Trump that his tirade against Chinese ownership of Panama Canal has led to the Hong Kong based CK Hutchison has decided to sell its ownership of two ports at either end of the Panama Canal to BlackRock. The deal involves the takeover of 43 ports, including the two, by a consortium headed by BlackRock and includes Global Infrastructure Partners (the private infrastructure investment company purchased by BlackRock last year), port operator Terminal Investment Ltd (TIL), and the world's biggest container shipping line, Mediterranean Shipping Company (MSC).

7. Good primer on the effects of tariff increases. Interesting that it confines to short-term costs and does not talk about the gains and the long-term impacts.

8. Efficiency maximisation, Amazon edition.

Amazon’s fulfilment centre in Shreveport, Louisiana — its most technologically advanced warehouse — has demonstrated the type of savings it can achieve with automation. The 3mn sq ft facility, which opened in September, uses robots at every stage of fulfilment and has achieved a 25 per cent cut in costs, according to Amazon, following a tenfold increase in robotics compared with its previous generation of warehouses... Shreveport features a range of mobile drive units, which are used to carry items across the warehouse, and advanced robotic arms that pick and sort items, cutting down on the number of human workers in the warehouse. The tech giant is also investing in robotics talent as part of a wider push to deploy AI large language models in its warehouse robots... 

While its retail business continues to be profitable, Amazon has forecast more modest growth across the group in the first quarter of this year, with a strong dollar knocking revenues. The US ecommerce group is pushing to lower delivery times, particularly for users of its Prime subscription service. This includes separating its logistics network into specific regions to ensure inventory is in place for same day deliveries... The group has deployed more than 750,000 mobile drive units since it acquired robotic start-up Kiva Systems in 2012. In recent years it has introduced Proteus, a fully autonomous lift vehicle that navigates sites independently using a set of sensors having been trained using AI. The company has also partnered with chipmaker Nvidia to develop “digital twins” of its warehouses to enable it to run thousands of simulated situations before deploying an autonomous robot.

9. Bjorn Lomborg interview in FT. He appears to have 12 hanging fruits, drawn from deep research evidence, that would cost $35 bn to add $1.1 trillion to developing world output and save 4.2 million lives a year. 

His favoured educational reform, for example, is to improve outcomes in countries such as Malawi by teaching children according to their level, not their age. Many children, crammed into massive classes, fall hopelessly behind. Lomborg’s solution is to teach for one hour a day using tablets with adaptive software, giving children the benefit of a good curriculum delivered at their own pace. Implementing it, according to his think-tank, would cost $9.8bn and deliver a $604bn boost to income through better-educated children. “This is spinach for the world. I want people to know about it.”

Ahem!

10. Donald Trump, Elon Musk, neo-colonialism, and corruption.

Foreign companies operating in South Africa have to navigate Broad-Based Black Economic Empowerment (B-BBEE) regulations set by the Department of Trade, Industry and Competition, and in the case of certain multinationals, such as auto manufacturers, where ownership quotas can’t be applied, “equity-equivalent” programs require investments that drive Black participation in supply chains to meet empowerment targets. This doesn’t apply in the case of communications companies, though, which need to be 30% owned by “previously disadvantaged” people to qualify for a license.

Musk wants to launch his Starlink satellite-communications service in South Africa, but that requires him finding an equity partner for a South African operation to qualify for a license. “Change the laws,” Musk is said to have repeatedly told Ramaphosa during a Feb. 3 meeting. On Feb. 5, Musk’s SpaceX (representing Starlink) withdrew from the Independent Communications Authority of South Africa’s hearings into a proposed licensing framework for satellite services. Trump’s executive order blasting South Africa came two days later... Donald Trump’s Feb. 7 executive order decried the “egregious actions of the Republic of South Africa,” claiming its 2024 Expropriation Act, which allows the state to seize land without compensation in certain scenarios, has been used to dispossess White people of their property.

11. The best illustration that America is now a country of rule by law, where law is that decided by the President and his cronies, comes from the decision to cull USAID programs. 

In Afghanistan, women’s education programmes shut down. Health services were suspended for refugees from Myanmar taking shelter in camps in Thailand. In Colombia, anti-narcotrafficking helicopters were suddenly idle. But African countries were hit particularly hard. In Uganda, medical trials were halted. Life-saving medicines are gathering dust in warehouses in Malawi, where more than half of healthcare spending is dependent on US and foreign aid. Perhaps greatest of all has been the impact on the decades-long battle to end the Aids pandemic... The President’s Emergency Plan for Aids Relief, known as Pepfar, screeched to a halt. Launched by George W Bush in 2003, a year in which Aids killed more than three million people, the multibillion-dollar health initiative is based on a simple premise that everybody deserves access to antiretrovirals that suppress the spread of HIV... The initiative changed the trajectory of the Aids pandemic. To date, Pepfar has saved more than 26 million lives and prevented roughly 1,000 babies a day from being born with the HIV virus. Pregnant women can avoid passing on the virus to their babies by taking medications that either suppress their own viral load to undetectable levels, or pass through the placenta to the baby’s body... 

Mitchell Warren, the executive director of the Aids Vaccine Advocacy Coalition (Avac), a New York-based campaigning group, called Pepfar “inarguably the best investment ever in global health and development”. “We took 20 years to build up what has taken less than four weeks to dismantle,” he said, reflecting on the chaos caused by Trump’s move... Within days, the 340,000 global healthcare workers whose salaries depend on the Pepfar programme — doctors, nurses, lab assistants and community outreach workers — received “stop-work orders”. More than 20 million HIV-positive people like Samkelo no longer knew when their next dose of antiretrovirals would come. Already, since January 24, at least 15,000 premature deaths have occurred because of the funding gap, according to a Pepfar tracker set up to monitor the impact.

The surest sign of the phasing out of Rule of Law and phasing in of Rule by Law comes when one hears news like this.

Congressional Republicans, egged on by Elon Musk and other top allies of President Trump, are escalating calls to remove federal judges who stand in the way of administration efforts to overhaul the government. The outcry is threatening yet another assault on the constitutional guardrails that constrain the executive branch... “The only way to restore rule of the people in America is to impeach judges,” Mr. Musk wrote this week on X, his social media platform, in one of multiple posts demanding that uncooperative federal judges be ousted from their lifetime seats on the bench.

12. Two maps that convey the striking reversal of global trade leadership between the US and China.

13. Xiaomi does what Apple could not.

After nearly a decade of trying, Apple finally gave up its effort to produce an electric car last year, canceling a project that soaked up $10 billion. But last year in China, the electronics maker Xiaomi launched its first electric car after just three years of development and delivered 135,000 vehicles. It has vowed to double that number in 2025. Xiaomi’s ability to succeed where Apple could not shows how thoroughly China has come to dominate the supply chain for electric vehicles. Chinese companies have mastered electric vehicle manufacturing. By tapping that infrastructure, Xiaomi was able to get components quickly and cheaply. More Chinese electric vehicle companies — including Leapmotor, Li Auto and Seres Group — are starting to turn a profit after burning cash for years in their intense competition for the world’s largest auto market... The telecommunications giant Huawei, which the U.S. government has targeted with sanctions and legal action for years, is making autonomous driving software. Huawei has teamed up with multiple Chinese automakers, including Seres Group and the state-owned firms SAIC Motor, BAIC and Chery.

14. Two striking graphics about the masculinisation of the US society. First on gender roles.

The second on society becoming too feminine.

15. Javier Blas introduces a dose of realism to the debate on the critical minerals squeeze due to Chinese restrictions.

Beijing has targeted five metals: tungsten, tellurium, bismuth, molybdenum and indium. China is the biggest producer of all of them...My calculations suggest the US spends about $300 million importing tungsten; roughly $30 million on bismuth; about $90 million on indium; and less than $1 million on tellurium. The total annual cost for all four comes to less than $500 million... it’s the same trend as the one observed in the much-hyped rare earth elements sector. Fears abound, but the cost of importing the 17 metals that form that category is tiny. The US Geological Survey calculated rare earth imports at less than $200 million in 2023... 

The import bill of minor metals could increase by five, 10, 20, even 50 times, and not amount to more than a rounding error for the US economy. Prices, however, are lower today than they were a decade ago. Did you notice when they were high? Nope; for a reason. Indium, for example, traded as high as $800 per kilogram in 2011; it’s now at $345. The cost of the most common compound of tungsten, one of the much-hyped critical minerals, is trading 25% below its 2011 peak. Even if prices rise because of Chinese restrictions, recycling will increase, American engineers will work to reduce their use and alternatives will be found. High prices cure high prices.

This is a good primer on rare earth minerals and their refining (where, in particular, China has a 30 year headstart advantage). 

16. Some facts on employment increase in the Government of India, which rose 4% from 3.17 mn to 3.3 mn from March 2022 to March 2024. 

But what contributed to the rise in the civilian staff strength in the last three years? Note that over 86 per cent of the total civilian staff is accounted for by just four heads — Indian Railways, posts, central police forces, and tax departments... And even as the overall civilian staff strength has risen by over 489,000 in the last three years, the Indian Railways has seen a small increase during the same periods—about 3,000 employees. Of the four heads, the postal department and the police saw the largest increase by over 179,000 and 143,000, respectively, in the last three years. The two tax departments (overseeing direct and indirect taxes) have seen an increase in their staff strength by over 71,000, bringing their total strength to over 172,000.

17. As defence spending rises globally, it may be end of the peace dividend.