STCMA- 5th February 2020

A long story in FT on how the Dutch have tried to protect themselves from flooding, after some major disasters in the 19th century. The contrast with the American approach (reliance on private and individual solutions) is interesting. The latter might not work for problems such as these. Collective approach might be needed.

John Cassidy writes about the need for ‘green growth’ or ‘degrowth’ (not for all countries) and the pros and cons of them.

As though on cue, some of the models that were used to forecast global warming have started giving us less time. Scientists hope that the answers are wrong!

European commercial bankers make the argument against negative rates. These are well-known. But, central bankers – especially the Swiss Natonal Bank – do not seem to be in a mood to listen. Surprising.

Douglas Irwin has a frustrating story (ht: Gulzar) on how Private Equity investors might have contributed to the bankruptcy of ‘Payless’ shoes. This is similar to the story (report, rather) by Joe Nocera on a New York grocery chain that filed for bankruptcy, after having paid a lot in terms of dividends to the PE investor.

Read this in conjunction with the remark in the story on Euroepan commercial bankers asking for reconsideration of negative rates:

David Solomon, chief executive of Goldman Sachs, cited the impact of negative rates in the eurozone and low rates in most other developed economies as a factor in the inflated, multibillion-dollar valuations that private companies such as WeWork have been able to attain. “In an environment where for a long, sustainable period of time interest rates have been zero, and money has basically been free, it pushes people out [along] the risk curve,” he said. “One of the consequences of that is people chase growth, and people start to overvalue growth.”

Last item on ‘Stuff that caught my attention’ edition of 5th February 2020 is the report in print.in on the new chief of IBM and his connection and that of IBM’s connection to IIT Kanpur.

Night lights and India and China growth estimates

Ran into this well-written, sober and reasonable note by Robert Barbera and Yingyao Hu at Johns Hopkins University on the luminosity based growth data and official GDP growth data estimates for China. The note is from December 2018. The good thing about the paper is that they don’t badmouth official GDP growth estimate for the sake of it. They explain how and why the discrepancy between the two estimates arises.

The original paper by Yao and Hu is here. Check out tables 11 and 12. The date of this paper is August 2019. India’s official GDP growth estimates too are overstated but not to the extent that China’s is. Also, the volatility of China’s official growth estimate is too low. We all know that it is ‘too smooth’.

RBI Occasional Paper (July 2019) offers a more granular look at GDP growth and other real-economy measures and how they stack up with luminosity data. It is a good paper too.

India did grow quite strongly between 2003 and 2012 punctuated in the middle briefly by the 2008 crisis but the sustainability of that growth model (or the lack thereof) is illustrated by the subsequent slowdown that is still ongoing. Luminosity data captures that well.

Economic and market cylinders

Jeroen Blokland’s twitter handle (@jsblokland) is a great resource. So, according to his recent charts, US housing starts are rising fast; US consumer comfort index is quite strong; US retail sales is growing. China’s leading index is turning up as is China’s money supply. Citi Economic Surprise Index for the US is back above zero. SPX (S&P 500) Price/Sales ratio is at its highest – more so than it was in the technology boom years of 1996-2000.

Under normal circumstances, central banks would be pre-emptively hawkish with such a confluence of economic data and developments. Not only is the Federal Reserve adding liquidity at record rates but it is expected to leave rates unchanged for 2020 with the next move as likely to be up as it is likely to be down.

Are any further comments required?

Unintended side effects of stress tests on American banks

Unintended side effects: stress tests, entrepreneurship, and innovation
 
BIS Working Papers  |  No 823  |  22 November 2019
by  Sebastian Doerr

Focus
Regulators have introduced stress tests for the largest banks with the aim of ensuring that they hold enough capital to withstand another crisis. Stress tests have effectively reduced systemic risk and improved risk management and capital planning at individual institutions. However, policymakers and academics worry about the potential negative effects on credit and the real economy. This paper investigates how regulatory stress tests may have affected entrepreneurship in the United States.

Contribution
Contributing to the literature that highlights some negative consequences of stress tests on credit supply to small businesses, this paper presents new evidence on the real effects of financial regulation. Regulatory stress tests for the largest banks might have an unintended side effect by curtailing credit to young businesses, which are especially dependent on external financing. The contraction in lending has the potential to stymie entrepreneurship and innovation. This novel channel, through which stress tests dampen economic dynamism, could help to explain the persistent decline in entrepreneurship since the crisis.

Findings
Stress-tested banks have sharply reduced home equity loans to small businesses, an important source of financing for entrepreneurs. The resulting contraction in loan supply has affected the real economy. By exploiting geographical variation in county exposure to stress-tested banks, the paper shows that counties with a higher exposure have experienced a relative decline in employment at young firms during the recovery, especially in industries that rely more on home equity financing.

Additional findings also suggest that counties with a higher exposure to stress-tested banks have seen a decline in patent applications by young firms, as well as a fall in labour productivity. The latter finding reflects the disproportionate contribution of young firms to innovation and growth. While the results do not imply that stress tests have reduced overall welfare, they highlight a possible trade-off between financial stability and economic dynamism.

Abstract
Post-crisis stress tests have helped to enhance financial stability and to reduce banks’ risk-taking. In order to quantify their overall impact, regulators have turned to evaluating the effects of stress tests on financing and the real economy. Using the U.S. as a laboratory, this paper shows that stress tests have had potentially unintended side effects on entrepreneurship and innovation at young firms. Banks subject to stress tests have strongly cut small business loans secured by home equity, an important source of financing for entrepreneurs. Lower credit supply has led to a relative decline in entrepreneurship during the recovery in counties with higher exposure to stress tested banks. The decline has been steeper in sectors with a higher share of young firms using home equity financing, i.e. where the reduction in credit hit hardest. Counties with higher exposure have also seen a decline in patent applications by young firms. I provide suggestive evidence that the decline in credit has negatively affected labor productivity, reflecting young firms’ disproportionate contribution to growth. My results do not imply that stress tests reduce welfare, but highlight a possible trade-off between financial stability and economic dynamism. The effects of stress tests on entrepreneurship should be taken into account when evaluating their effectiveness. [Link]

RCT related links

The first op.-ed., I wrote, after being appointed as a part-time member to the Economic Advisory Council to the Prime Minister (of India) on October 16 is this one.

Randomised Control Trials are not the panacea for development questions. But, they may be useful if they pose the right questions. The conclusions may still have to be tempered and tailored to suit different contexts.

Two well-written critiques of the RCT methodology to answer development questions are to be found here and here. (ht: Vijaya, my colleague at IFMR-GSB)

RCTs cannot reveal very much about causal processes since at their core they are designed to determine whether something has an effect, not how. The randomistas have attempted to deal with this charge by designing studies to interpret whether variations in the treatment have different effects, but this requires a prior conception of what the causal mechanisms are. The lack of understanding of causation can limit the value of any insights derived from RCTs in understanding economic life or in designing further policies and interventions. Ultimately, the randomistas tested what they thought was worth testing, and this revealed their own preoccupations and suppositions, contrary to the notion that they spent countless hours listening to and in close contact with the poor. It is not surprising that economists doing RCTs have therefore been centrally concerned with the effects of incentives on individual behavior—for instance, examining the idea that contract teachers who fear losing their jobs will be more effective than those with a guarantee of employment. [Link]

The long piece in opendemocracy.net has a wealth of links. These paragraphs are very good:

… the narrowness of the randomized trials is impractical for most forms of policies. While RCTs tend to test at most a couple of variations of a policy, in the real world of development, interventions are overlapping and synergistic. This reality recently led 15 leading economists to call to “evaluate whole public policies” rather than assess “short-term impacts of micro-projects,” given that what is needed is systems-level thinking to tackle the scale of overlapping crises. Furthermore, the value of experimentation in policy-making, rather than promoting pre-prescribed policies, should not be neglected.

The concept of “evidence-based policy” associated with the randomistas needs some unpacking. It is important to note that policies are informed by reflections on values and objectives, which economists are not necessarily well-suited to intervene in. Of course, evidence should be a part of a policy-making process, but the pursuit of ineffective policies is often driven by political priorities rather than lack of evidence…..

… While the Nobel Prize does leave those of us concerned with broader political economy challenges in the world anxious, not everything is doom and gloom. Firstly, the Nobel directs attention to the persistence of poverty in the world and the need to do something about it. What we as critical development economists now need to do is to challenge the fact that the Prize also legitimizes a prescriptive view of how to find solutions to global problems.

Secondly, the fact that a woman and a person of color were awarded a prize that is usually reserved for white men is a step forward for a more open and inclusive field. [Link]

Interesting that one of the links that Ingrid Harvold Kvangraven provides is an opinion-piece ‘written’ by fifteen economists last year. In that, they ‘anticipate’ the Swedish Riksbank Prize for RCT and ‘caution’ against it. Obviously, not directly.

Lastly, from Andrew Batson’s blog post on who should be awarded the Nobel Prize (Swedish Riksbank Prize) for Economic Development in China:

The contribution of randomized controlled trials to China’s poverty reduction has been, to a first approximation, zero. Yao Yang, the dean of the National School of Development at Peking University, wrote in an English-language op-ed that “Experiments might help policymakers improve existing welfare programs or lay the foundation for new ones, but they cannot tell a poor country how to achieve sustained growth.” In a similar vein, Harvard professor Dani Rodrik tweeted: “Remarkable how little today’s development economics has to say about the most impressive poverty reduction in history ever.” [Link]

My appointment to EAC-PM also reminded me of this column I wrote way back in May 2009: that op.-eds., did not bring change.

I was also reminded of this famous advice by Larry Summers to Yanis Varoufakis and quoted in his book, ‘Adults in the Room’:

‘There are two kinds of politicians,’ he said: ‘insiders and outsiders. The outsiders prioritize their freedom to speak their version of the truth. The price of their freedom is that they are ignored by the insiders, who make the important decisions. The insiders, for their part, follow a sacrosanct rule: never turn against other insiders and never talk to outsiders about what insiders say or do. Their reward? Access to inside information and a chance, though no guarantee, of influencing powerful people and outcomes.’ [Link]

Swedish Riksbank and poverty

The 2019 Swedish Riksbank prize for three economists who have done extensive work on poverty and how to deliver poor out of poverty has attracted a lot of attention, pride and noise in India because one of them is an Indian-American. One understands from newspaper reports that he is an American citizen.

This blog has never really commented on the annual prizes awarded to economists every year. It is not mandatory. The only time I had a strong feeling against the award was when Eugene Fama was given the prize in 2013 for his work on (financial) market efficiency.

These prizes are judgements of people in a committee. So, disagreements of outsiders with the committee’s judgement, on occasions, should not be a big surprise nor a source of disappointment or anger on the part of those who happen to agree with the Committee’s decisions.

Those who disagree have no reason, however, to conclude that the committee made incompetent decisions because the committee, arguably, pores over far greater information and spends a lot more time deliberating than those who take to twitter to vent their disagreement and even anger at the choices. That is unhelpful.

Much of the anger stems from the political stances taken by some of the recipients. But, the Riksbank Committee does not give them awards or deny them awards for their political views. So, questioning the decision because the recipients hold different political views is unreasonable. 

Some of the past awardees, on their part, have ‘monetised’ their award by espousing strong political views. The moment they enter the political boxing ring (or, the cesspool), then they should be willing to trade blows The discourse is not often civil in such spaces. But, they cannot complain because they chose to enter that arena.

As for the awardees this year, I have not followed their work that closely to make rigorous observations. Interested readers should refer to the ‘Urbanomics’ blog of my coauthor Gulzar Natarajan. You can sample this blog post of his. 

The quote attributed to Arvind Subramanian by Devesh Kapur (ht: Gulzar’s post above) in this article is worth recalling:

When asked how many of these expensive RCTs had moved the policy needle in India, Arvind Subramanian, Chief Economic Advisor, GOI, was hard pressed to find a single one that had been helpful to him in addressing the dozens of pressing policy questions that came across his table. By contrast, the compiling of just some key facts on learning outcomes by Indian NGO, Pratham, has had a big impact on policy discussions in education, because it is backed by a degree of specific knowledge and engagement that is more credible and persuasive. [Link]

On my part, I will simply use the occasion to highlight some other related issues which may or may not be directly relevant to their work.

At the core of the Randomised Controlled Trials (RCT) is the belief that, somehow, it is possible to make Economics a physical science by following the controlled experiments that are eminently doable in physical sciences. But, facts and behaviour in social science are embedded in contexts. They are inherently not falsifiable. Hence, not sure if RCT could capture all the nuances. Consequently, the reliability of the conclusions drawn from such experiments might be suspect.

The second point is that most economists do not keep in mind the asymmetric and non-linear nature of the relationships between economic variables and between causes and effects are asymmetric. That gives rise to the law of unintended consequences (=road to hell being paved with good intentions). For example, see this story on microlending in Sri Lanka gone awry. 

While the story of microlending in Sri Lanka need not be a case of the law of unintended consequences, it is a case of the gap that exists between goals/intentions and real-life outcomes.

It is useful to ask why economic relationships are asymmetric and non-linear? Because, humans are. Loss aversion is a classic example. We value what we don’t have and once we have it, its value goes down. That is asymmetry. This has implications for policymaking.

When folks tell surveyors that they value something and would be happy and better-off if provided, one can never be sure that they would value it as much if given and, hence,  the effect may not be what policymakers expected.

Reason why economic relationships are asymmetric and non-linear is that there are only few positive factors but several hygiene factors that influence human behaviour. Hygiene factors matter only in one direction. Positive factors do in both directions. But, hygiene factors far outnumber positive factors in our lives.

However, on balance, any research or methodology that challenges conventional wisdom on an important topic such as human impoverishment and raises fresh set of question must be deemed useful. The work of the three winners of the Swedish Riksbank prize for economics in 2019 passes that test.

Postscript: The World Bank published a report called ‘Voices of the Poor’ in 1999-2000 that simply listened to them. You can find it here.

The Yin and the Yang of ‘Make in India’

My friend Gulzar Natarajan shared this story with me. It is about India wanting to move from merely assembling mobile phones to phased manufacturing. It is an important and significant development. This is not hyperbole:

The formal notification of the phased manufacturing programme is a historic event in the Prime Minister’s path breaking Make in India and Digital India programs. With the consequent PMP – II which is in the works, in 3 years it is proposed that value addition will increase to 39 – 50 per cent,” said Pankaj Mohindroo, president of the Indian Cellular Association that represents all handset makers like Samsung, Apple, Micromax and others. [Link]

Contrast that news with this story. It smells from a distance. Train 18 which was named ‘Vande Bharat Express’ and launched by the Prime Minister will not be produced this fiscal and they will produce 40 more rakes up to 2022. The Railway Minister met manufacturers in July and assured them of ‘level playing field’. What level playing field? Who are these manufacturers? and why should they be offered a level playing field?

We need all engines firing and humming together. One engine cannot pull in another direction. If so, ‘Make in India’ and employment generation successes will be sporadic.