India-Kerala oil swap

India is short crude oil, while Kerala is long the commodity. So it makes sense for the two entities (one of which is a subset of the other) to strike a long-term swap deal.

With oil prices being at a rather low level for the last couple of years (compared to the preceding decade or so), Kerala’s economy is in deep strife, as Mint reported. This is a consequence of a large amount of the Kerala economy being dependent on remittances from its expat workforce (35% of the state’s GDP, according to Mint), most of which is in the Gulf countries. With oil prices down, Gulf economies aren’t doing well, and being foreign workers, the expat Keralites, and consequently Kerala, is bearing the brunt of it.

With economic activity in the state reduced thanks to the withdrawal of legal tender of Rs. 500 and Rs. 1000 notes, the state is in deeper trouble, with doubts even cast on whether the state can pay salaries.

India on the whole, however, has benefited significantly from the fall in oil prices. With India a large net importer of crude oil, the drop in prices has resulted in significant easing of the pressure on the country’s current account deficit. The oil price drop has also helped in inflation dropping over the last couple of years, and since fuel is a transaction cost, has also helped in increasing economic activity.

After the oil prices dropped, experts advised the Union government to lock in the oil prices by signing long term forward agreements, in order to cushion the country’s economy against an oil price shock. The problem with striking this kind of a forward agreement is the need for a counterparty who faces the opposite risk. While investment banks can do such a deal, the margins can be high if a counterparty is not forthcoming.

With India benefiting from low oil prices and Kerala being hurt by them, the two entities should strike a long term oil swap. India can pay Kerala a fixed sum for the duration of the swap. Each month, Kerala will pay India an amount proportional to the extent by which the oil price (measured by indices such as Brent) exceeds a pre-agreed benchmark. In case oil remains below the benchmark, Kerala won’t need to pay India anything – the swap cash flows can be like an option.

This way, both parties will benefit. India will get hurt when prices increase but some of that will get compensated by the payments by Kerala. And while prices remain low, Kerala will get compensated for the loss in remittances by the payout by the government!

Wonder why no one’s thought of this so far!

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The velocity of scarce money

Ever since the Union government took Rs. 500 and Rs. 1000 notes out of circulation last week, my consumption patterns have changed. Rather, I still consume the same things but I’ve changed my habits in terms of purchase. Not having the patience to stand in line at a bank or ATM, my inflow of Rs. 100 notes is close to 0. And I’ve been trying to keep my outflow close to that number as well.

So rather than shopping at the local vegetable market, I’ve been buying online on BigBasket, where I can pay using credit card. My grocer always took credit cards, so I continue to buy from him. I take Uber instead of auto rickshaws, and pay for my fuel purchases using credit cards. I’ve told my cook and maid I’ll pay them this month by bank transfer (they have PMJDY accounts).

The point I’m trying to make is that I’m trying to conserve my scarce hard currency, and have changed my purchase patterns to do so. And I’d expect everyone else to do the same, including people who are more into the so-called “cash economy”.

Plenty has been written about how the decision to withdraw notes can be seen as a monetary shock. Read Ajay Shah’s excellent take on it here, though Ajit Ranade argues that in the context of broad money it cannot be classified as a monetary shock. In a cash economy, the short term reduction in the availability of cash can result in sharply lowered economic activity.

In monetary terms, economic activity can be described as the product of the “quantity of money” (there is no one good definition of it) and the “velocity of money” (the rate at which money changes hands by way of enabling economic activity). Lower economic activity can be a result of either low money supply, or due to low velocity of money (see my old piece in Mint on how the 2008 financial crisis was characterised by low velocity of money).

While much has been written about the decrease in quantity of money thanks to money withdrawal, the velocity of money following the withdrawal is also a key variable to take into account. On the one hand, thanks to reasons I described above (scarcity of currency notes), velocity of physical currency is likely to go down. People are going to use it only when absolutely necessary, and not for discretionary purchases.

On the other, the velocity of money in the form of bank deposits is also likely to go down. While those that are experienced in using the banking system might be using the system more for transactions nowadays, a large amount of the currency being deposited is going into accounts of people who are not used to transacting using the banking system. And this money is likely to sit quietly and not contribute to economic activity (unless banks use it to lower lending rates and expand credit), implying a drop in the velocity of money from the banking system.

So both monetary counts taken together, a drop in economic activity in the near future is likely. Hopefully banks will cut lending rates (in the last couple of years, cut in policy rate has hardly been passed on to ordinary customers) in the near future (once they have the bandwidth to do so) to get us out of this drop.

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How 2ab explains net neutrality

So Prime Minister Narendra Modi has set off this little storm on Twitter by talking about the relationship between India and Canada being similar to the “2ab term” in the expansion of (a+b)^2 .

Essentially, Modi was trying to communicate that the whole of the relationship between India and Canada is greater than the sum of parts, and it can be argued that the lack of a “cos \theta” term there implies that he thinks India and Canada’s interests are perfectly aligned (assuming a vector sum).

But that is for another day, for this post is about net neutrality. So how does 2ab explain net neutrality? The fundamental principle of the utility of the Internet is Metcalfe’s law which states that the value of a telecommunications network is proportional to the square of the number of entities in the network. In other words, if a network has n entities, the value of these n entities being connected is given by the formula k n^2 . We can choose the unit in which we express utility such that we can set k = 1, which means that the value of the network is n^2.

Now, the problem with not having net neutrality is that it can divide the internet into a set of “walled gardens”. If your internet service provider charges you differentially to access different sites, then you are likely to use more of the sites that are cheaper and less of the more expensive sites. Now, if different internet service providers will charge different websites and apps differently, then it is reasonable assume that the sites that customers of different internet services access are going to be different?

Let us take this to an extreme, and to the hypothetical case where there are two internet service providers, and they are not compatible with each other, in that the network that you can access through one of these providers is completely disjoint from the network that you can access through the other provider (this is a thought experiment and an extreme hypothetical case). Effectively, we can think of them as being two “separate internets” (since they don’t “talk to” each other at all).

Now, let us assume that there are a users on the first internet, and b users on the second (this is bad nomenclature according to mathematical convention, where a and b are not used for integer variables, but there is a specific purpose here, as we can see). What is the total value of the internet(s)?

Based on the formula described earlier in the post, given that these two internets are independent, the total value is a^2 + b^2. Now, if we were to tear down the walls, and combine the two internets into one, what will be the total value? Now that we have one network of (a+b) users, the value of the network is (a+b)^2 or a^2 + 2 ab + b^2 . So what is the additional benefit that we can get by imposing net neutrality, which means that we will have one internet? 2 ab, of course!

In other words, while allowing internet service providers to charge users based on specific services might lead to additional private benefits to both the providers (higher fees) and users (higher quality of service), it results in turning the internet into some kind of a walled garden, where the aggregate value of the internet itself is diminished, as explained above. Hence, while differential pricing (based on service) might be locally optimal (at the level of the individual user or internet service provider), it is suboptimal at the aggregate level, and has significant negative externalities.

#thatswhy we need net neutrality.

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Other airlines to bail out Spice Jet?

In a rather bizarre move, the Directorate General of Civil Aviation (DGCA) has directed airlines to not charge “exorbitant fares” for passengers stood up upon cancellation of Spice Jet flights. This is a rather bizarre idea and effectively amounts to asking other airlines to partially bail out Spice Jet.

Essentially when an airline is in trouble, passengers are loathe to book tickets on it, for they know that the chances of their flight getting cancelled is high. A cancelled flight usually means either cancelling the trip itself or rebooking on another airline (sometimes airlines have arrangements with each other for taking on passengers on cancelled flights, but currently no other airline in India will give credit to Spice Jet). Either ways, it is a costly affair for the passengers.

By directing airlines to not charge “exorbitant fares”, and assuming that such a directive will be followed (very likely that this directive is meaningless for this is the busy season and other airlines are likely to be booked out), the total cost of booking a ticket on Spice Jet actually comes down, for the charge a customer will have to incur for re booking on another airline for a cancelled Spice Jet flight is likely to be reduced. And thus passengers will not abandon Spice Jet at the rate at which they normally would. And since other airlines are taking a hit on the spot fares they could potentially charge (in the absence of this directive) they are effectively subsidising and “bailing out” Spice Jet!

The other problem is that in the absence of market mechanisms (which the price cap effectively curb), how will other airlines allocate their remaining capacity among all the passengers who have been stood up by Spice Jet? Some arbitrariness is likely to ensue and passengers are likely to be left more disappointed!

The government had started off by handling the Spice Jet case rather well, as Devika Kher has argued here. However, of late, the wheels of the DGCA seem to have come off in his aspect, and there seems to be a concerted attempt to let Spice Jet stay afloat against the wishes of the market. The Airports Authority of India and oil companies have been asked to extend credit for fifteen days.

It seems Devika spoke too soon!

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Uber, Meru and Service Taxes

The use of arbitrary barriers in regulation, like the Rs. 10 lakh limit on Service Taxes is counterproductive and can lead to a non-level playing field. More importantly such barriers encourage small-scale operations which can act against efficiency

A couple of months back, the Service Tax Department slapped a notice on Uber, demanding that the cab aggregation service pay service tax on its revenues. Cab services fall under the service tax net, and recently other cab service providers such as Meru and Mega have started adding a service tax component to their bills.

What queers the pitch in the case of Uber is who pays, and whether they pay at all. Uber claims to be an aggregation platform, bringing together cabbies and passengers, and says that it is the cabbies who are in charge of paying service tax on the revenues they make through the platform. From the Tax Department’s perspective though, going after thousands of cabbies demanding taxes is not very feasible, so they are trying to get Uber to pay the service tax.

More importantly, Service Tax becomes payable only if the annual revenues from the service cross Rs. 10 lakh and it is unlikely that too many of Uber’s cabbies will cross that threshold. So if we were to look at Uber strictly as an aggregator (which it actually is), it is unlikely that any service tax can be collected on its services!

What it also means that this gives platforms like Uber an unfair advantage over companies such as Meru which own their taxis – the latter’s revenue is much more than Rs. 10 lakh per annum and thus service tax has to be paid on the entire revenue! And this means that the playing field when it comes to taxi services is not level – for it is cheaper for an individual running a single taxi to offer service rather than a company offering a fleet.

This is similar to regulations in manufacturing that make it much more expensive (in terms of enhanced labour regulations and disclosures for companies beyond a certain size) for larger companies to operate vis-a-vis smaller ones. Even in the proposed relaxation of labour laws, a number of relaxations are to do with the minimum size of a company for doing the disclosures, and not with the easing of regulations themselves. All that it means is that just the threshold is raised – it becomes easier for companies to grow beyond their current levels of inefficiency, but they will soon hit a new level of inefficiency!

The problem for all this is the arbitrary fixing of slabs. An ostensible reason for fixing the minimum slab for service tax at Rs. 10 lakh is that enforcement for people earning less is going to be difficult. But as can be seen in the Uber case, this can lead to inefficient structures of industrial organisations, by keeping them small, and is hence not prudent. The government would do well to remove such arbitrary numbers from its regulation!

The other thing about service tax is that once your income crosses Rs. 10 lakh, you pay service tax on your entire income rather than the excess over 10 lakh, which is how income tax is structured. This is again inefficient, for someone who is making Rs. 9.8 lakh is now dissuaded from taking new business since it can literally subtract value! Another reason for arbitrary barriers to go.

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Batch size at IIMB

A few days back I had written about how the new IIMs with a sanctioned batch size of around 60 and a faculty strength of 20 are unviable and need to scale up quickly. My argument was that one of the big strengths of the older IIMs is its faculty size which leads to a large number of electives, which allows students to shape themselves the way they best feel. In this context it would be interesting to compare these IIMs to one or more of the older IIMs.

I recently received a mail by the IIMB Alumni Association asking me to reach out to batchmates who are not part of the association. This mail had been sent to all IIMB Alumni who are registered with the association, and the purpose was to increase membership and reach of the association (and no, there are no membership fees). And the mail came with a very interesting data set, and one of the fields was the size of each graduating batch at IIMB.

Source: IIMB Alumni Association

Source: IIMB Alumni Association

It can be seen that IIMB also started rather small, with about 50 students graduating in the first batch in 1976. By the end of the decade, the number was close to a 100, which is where it stayed through the 1980s. Around 1990 was when the batch size increased to about 150, and the number stayed within the 150-200 range for another decade and a half (the 2004 batch was bigger than the ones around it, possibly due to the IT slowdown in 2002 when this batch entered IIM).

And then after 2006 (when I graduated), the batch size increased. My batch had three sections as would have the 15 batches prior to that (based on this data; IIM sections normally consist of 60-70 students). In fact, the “quantum” nature of the increase in batch size at IIM can be put down to the concept of sections – so the increase from the 100 to 150 level was a function of addition of a third section, and so on. After 2006, though, the batch size has exploded, and the current batch (2013-15, who I’m teaching) has a strength of almost 400 students (divided into six sections).

A good addition to this dataset would be some data that could show the prominence or measure of success of IIMB Alumni who graduated in each  batch, which can then allow us to examine whether batch size has had anything to do with continued career success of the students. It would be interesting to examine how this additional data can be collected.

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Environmentalism and the Discount Rate

Alex Epstein, in his new book “The Moral Case for Fossil Fuels” has a fantastic quote (HT: Bryan Caplan). Epstein writes:

It is only thanks to cheap, plentiful, reliable energy that we live in an environment where the water we drink and the food we eat will not make us sick and where we can cope with the often hostile climate of Mother Nature. Energy is what we need to build sturdy homes, to purify water, to produce huge amounts of fresh food, to generate heat and air-conditioning, to irrigate deserts, to dry malaria-infested swamps, to build hospitals, and to manufacture pharmaceuticals, among many other things. And those of us who enjoy exploring the rest of nature should never forget that energy is what enables us to explore to our heart’s content, which preindustrial people didn’t have the time, wealth, energy, or technology to do.

Or, as Caplan puts it in his annotation,

Epstein’s second key claim is normative: Human well-being is the one fundamentally morally valuable thing.  Unspoiled nature is only great insofar as mankind enjoys it:

This allows us to characterise environmentalism and other conservationist movements through one simple factor – the Discount Rate. Let me explain.

Essentially, let us assume that we are optimising for aggregate human well-being. So we are optimising for the aggregate of the well-being of all humans today, all humans tomorrow, 10 years from now, 100 years from now and so forth. Now, if we try to optimise for short term well-being beyond a point (extracting too much oil, for example, or burning too much fossil fuel or cutting down too many trees), the well-being of future generations gets affected in a negative manner. If we are more conservative (and conservationist) now, future generations will get to enjoy greater well-being.

So, looking at the problem from the assumption that we want to “maximise aggregate human well-being”, the problem boils down to one “simple” tradeoff between well-being of human beings today and well-being of human beings at a later point in time. And it is precisely for answering questions on such inter-temporal tradeoffs that the world of economics and finance introduced the concept of a “discount rate”!

Finance assumes that rational human beings like to consume today compared to tomorrow, but only up to a point – you don’t want to consume so much today that there is nothing left to consume tomorrow. This leads us to indifference curves between today’s and tomorrow’s consumption, and if we add to this the resource constraint, we get the “discount rate” (the actual derivation is beyond the scope of this blog post).

The discount rate essentially gives us a tool to compare consumption today to consumption at a point of time in the future and make a decision on which one is more valuable. The higher the discount rate, the greater importance we give today’s consumption vis-a-vis tomorrow’s. A lower discount rate gives greater weight to tomorrow’s consumption compared to today’s.

So coming back to conservationism, the question finally boils down to “what is our discount rate”, or to track back one step “how do we value today’s well-being vis-a-vis well being at a point of time in the future”. If you assume a high discount rate, that means you give more importance to today’s well-being. A discount rate of zero gives equal importance of well-being today compared to well-being a few generations down the line. The discount rate in this case can even be negative – where you give greater importance to the well-being of humans of a future generation than to current well-being!

So the debate on fossil fuel consumption and carbon emissions and suchlike can be characterised by this one factor – what is our discount rate? And it is a disagreement on this that leads to most debates on this topic. Conservationists usually have a very low (or even negative discount rate), and they tend to play up the risks to well-being of future generation humans. The opposite side works with a much higher discount rate and argues that we should not ignore the well-being of current generations vis-a-vis the future. And the battle rages on.

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Targeting government transfers

Bryan Caplan, quoting from Greg Mankiw, puts out some very interesting numbers on government transfers to households in the United States.

Source: Econlog

As Caplan puts it, this table shows a pattern “neither liberals nor conservatives will expect”. Some points to be noted:

1. government transfers per household to the top quintile is much more than to the bottom quintile. While the former pay taxes and the latter don’t, this is simply bizarre and shows how ill-targeted transfers in the US are

2. The bottom 60% of households in the United States pays negative tax! The “middle quintile” pays taxes but gets transfers from the government of twice the amount.

3. The net taxes paid by the 4th quintile is negligible ($700 per household). So effectively in the US, only the top 20% pays tax.

I wonder if it is possible to get such data for India, and if we can, what it will look like. If we manage to tack on all subsidies to the “transfers” thing (food, fuel, etc.) it should present a very interesting picture. My guess is that the “effective tax base” in India will be much lower than that of the US.

Any data sources that can help us construct one such table for India?

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Uber and the narrative bias

Following the alleged rape of a Delhi woman by a cab driver who she’d engaged via the Uber app, the Delhi government has banned Uber. Union home minister rajnath Singh has issued a notification to other state governments to do the same though union transport minister Nitin Gadkari has rightly called it a silly idea.

Irrespective of whether the service gets banned, fewer people are likely to use it. A survey conducted by Mint newspaper has shown that nearly half the people surveyed will not use an Uber following the incident (the survey doesn’t mention how many of those surveyed are existing users of Uber).

About a year back, two buses of the Volvo make (one travelling from Bangalore to Hyderabad and the other from Bangalore to Pune) caught fire, resulting in passenger deaths. While the government of Karnataka mercifully didn’t ban Volvo buses (instead simply subjecting them to safety checks and insisting on emergency exits), there was a large backlash from the public who eschewed travel by Volvos in favour of travel by other means of transport.

In 2001, following the 9/11 attacks, Americans eschewed air travel in favour of driving. Gerd Gigerenzer, a specialist in risk, has estimated that 1595 additional people died in the year following 9/11 on account of driving rather than taking flights.

The question that arises is what those current users of Uber who don’t want to use the service any more are going to do – surely they must resort to alternate means of transport to commute? The question they need to ask themselves is If the new chosen means of transport is safer than Uber!

People abandoning Uber in droves following last weekend’s incident is due to what I can the “narrative bias”. Last weekend’s incident has introduced the narrative that Uber is not necessarily safe – at least it is not as safe as people assumed it to be prior to the incident. And this narrative is likely to lead to people reacting, and in a direction that is not necessarily better for them!

So if people abandon Uber, or if it gets banned (the proposal is to ban other app based cab services too ), what is the alternative, and is it safer than Uber? Extremely unlikely, If the answer is auto rickshaws for example. We might as well end up in a situation like what happened on the highways in the US after 9/11.

News by definition is spectacular and spectacular incidents are much more likely to be reported than unspectacular ones (a favourite example I use is – how many times do we see a headline that says ” Ashok Leyland bus catches fire. Passengers dead “? The fact that we seldom see such headlines doesn’t mean that Ashok Leyland buses never catch fire). This, however, doesn’t mean that policymaking, too, be based on spectacular events only.

Any regulation, and decisions by people, should be based on rational expectations and not be biased by narratives and the spectacular. There is always pressure on the policymaker to ” do something “. This however doesn’t mean that anything will do. Decisions need to be based on reason and not narratives!

PostScript: I’ve written this post sitting in the back of an Uber taxi in Bangalore

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Why app based taxi services should not be banned

The move towards banning Uber and other app-based taxi services is devoid of logic on several counts

Writing during the Takshashila Hudson conference on India’s growth I had argued that an easy way to increase the level of business activity in the country, and thus GDP was by means of reducing transaction costs. Transaction costs are costs borne by buyers of a good or Service which don’t accrue to the seller.

The thing with transaction costs is that they introduce friction in the market – the cost ends up reducing both the market clearing price (as it accrues to the seller) and the market clearing quantity. And transaction costs are usually to no ones gain and thus reducing them is a quick and pareto optimal method of boosting GDP.

In this regard, the government must encourage all means that result in reduction of transaction costs. For example better road and rail network significantly reduce the transaction cost of moving goods and people. Removal of interstate taxes on goods and services results in more optimal setups of warehouses and plants.

Similarly apps such as Uber play an important role in reducing transaction costs in the local taxi market. By reducing the distance and time to be traveled by the driver, and by reducing the amount of the the passenger has to wait for the cab, these services significantly reduce the cost of local transport and benefit drive and users alike.

Thus moves such as banning such services are utterly brainless and devoid of logic. Moreover such moves will dampen investor sentiment in India and kill off any positive vibes that have been generated ever since the current government came to power.

I hope better logic prevails and the government focuses on improving law and order (a public good that can further reduce transaction costs) rather than knee jerk actions like banning taxi services which seek to reduce transaction costs.

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