The Crane-Mongoose Theory of Public Policy

I have several favourite stories from the Panchatantra (which perhaps explains my lack of appreciation of modern children’s fiction). One of them involves a crane and a mongoose. And I think it is a good lesson on when and where to call for regulation, and government or legal intervention.

So the story goes like this. A snake lives at the bottom of the tree where a crane has built its nest. Each time the crane lays eggs, the snake slithers up the tree and devours them. And the crane doesn’t know what to do. Ultimately it receives some “brilliant advice”.

There is a mongoose living somewhere nearby, and the crane lays out a Hansel-and-Gretel like path of fish from the mongoose’s house to the snake’s house. The mongoose duly follows the trail of fish and finishes off the snake. The next day, the mongoose is hungry again, and it climbs up the tree and devours the crane’s eggs.

It is common political discourse nowadays to call for the government’s or court’s intervention to solve what seems to be private problems. The governments and courts are of course happy to oblige – any new source for intervention and rent-seeking are good news for the people involved. And then you get a solution that temporarily solves the problem (slaughtering the snake). And then in the long term, what you get is a bigger problem (mongoose eating the crane’s eggs). The only difference is that in real life it is not just the crane that gets negatively affected – the regulations hurt everyone.

The examples that come to my mind at this point in time are all “local”. Some residents in Indiranagar in Bangalore weren’t happy about the noise from nearby pubs. They asked the government to “do something”. And the government “did something” – it banned the playing of live music in restaurants, killing off what was then a budding industry in Bangalore.

Some other residents somewhere else in Bangalore were unhappy that their neighbours had dogs that barked. They asked the government to do something. The government did something – coming up with an elaborate document to regulate dogs that people can own.

And there are more involved (and dangerous) examples of this as well.

Don’t be like the crane.

Murray Gell-Mann Amnesia and the Vodnoy Paradox

I’ve written about the Murray Gell-Mann amnesia here before. The idea there is that you trust whatever is printed in the newspaper, except for the section which is your domain of expertise. And despite the newspaper falling short in this section, you read the rest of the newspaper as if everything there is “correct”.

Yesterday I came across a similar idea when it comes to big government – what University of Nebraska economist Arthur M Diamond calls as a “Vodnoy Paradox” after his optomerist – it’s basically about big government advocates who advocate big government in all fields except for the one they’re expert in.

Government regulations sound plausible in areas where we know little and have thought less. But usually those who know an area well can tell us of the unexpected harmful consequences of seemingly plausible and well-intentioned regulations. As a result, the same person often advocates government regulations in areas in which they are ignorant and opposes them in areas where they have knowledge. I call this the “Vodnoy Paradox.” 

In the field they’re expert in they know that regulation doesn’t work, or is misguided, yet they support regulation in all other fields. Isn’t this just Murray Gell-Mann Amnesia in a different context? (quote via David Henderson of Econlog)

A Dying Complex

During a walk through Jayanagar Fourth Block last evening, I happened to walk through the shopping complex. Now, this isn’t something I do normally – while my usual Jayanagar walking route goes along one side of the complex, I seldom cut across it.

As it happened, my wife had asked me to buy coffee powder from a specific shop (from where I’d last bought coffee powder twenty years ago), and the easiest way to get to it after I had remembered to buy coffee was to cut across the Shopping Complex.

And it was dead. In my childhood, I spent most evenings “putting beat” around Jayanagar 4th Block with my parents, and we would invariably go to the shopping complex. The complex was then full of respectable stores, including a HMV outlet, a fairly high end tailoring outlet (called Khanate) and the shop where I bought my first ten pairs of spectacles. It was then natural that a shopping trip to 4th block included a visit to the shopping complex.

Not any more, for the shopping complex is dying, if not dead already. The walls look the same, the shop structures are the same, but most respectable businesses seem to have made their exit from the shopping complex. In their place you have stores selling cheap footwear, cheap clothes, possibly counterfeit goods and suchlike. There aren’t too many “respectable shoppers” in the complex as well.

On the other hand, the area immediately around the now-dying shopping complex has emerged as a brilliant retail destination. You can find large-ish outlets of most major brands, a wide selection of restaurants and stalls, fresh vegetables, hardware stores and yes – shops selling coffee powder! Just that the shopping complex has pretty much died, and faded into insignificance.

Quickly walking through the shopping complex last evening (it didn’t appear that safe), I mulled over why it had died, while the surrounding area had flourished. I have one hypothesis.

Basically the shopping complex is owned by the government, and the rents in the complex didn’t rise along with the market. This meant that businesses that were not exactly flourishing (or sustainable) continued to do business in the complex (low rents meant businesses could afford to be there even when they weren’t doing well). This reduced footfalls, and reduced business for the relatively healthy businesses. Which again didn’t move out because they could still make the rent.

And so the shopping complex went through a downward spiral until the point when businesses that had chosen to remain got crowded out by less respectable ones, and figured it was time to move out even if the rent wasn’t much. And so you have some of the prime real estate in Jayanagar being squatted upon by sellers of cheap footwear and cheap clothes and electronics of suspect make.

Probability of accidental death

So I’ve received two separate SMSs from my bankers over the last few days. One of them asks me to sign up for the Pradhan Mantri Suraksha Bima Yojana at Rs. 12 per annum for an insurance against accidental worth Rs. 2 lakhs. The other SMS asks me to sign up for a more general life insurance scheme (the Pradhan Mantri Jeevan Jyoti Yojana) by paying a premium of Rs. 330 per annum. Here is a poster that describes the two schemes:

Considering that you can insure yourself against all kinds of death for a premium of Rs. 330 per annum, and you can insure yourself against accidental death alone for a premium of Rs. 12 per annum, what this implies is that the probability of death by accident given death is 12/330 or 3.6%. Which seems rather low considering that it’s mostly the younger population that is covered by these insurance schemes!

That aside, it’s a good move by the government to increase insurance penetration. I don’t know about accidental death, but the rate on the life insurance is pretty good, and there is a reasonable cut for the banks too for distributing this instrument. And going by the principle that you should be insured for about 5-7 years’ of annual income, Rs. 2 lakhs is a decent amount (India’s mean income is USD 1500 (~INR 90,000) per head. But the median income is likely to be much lower ).

Moreover, the implementation of these schemes is rather simple, since the premium directly goes from your bank account and you can sign up with a SMS, and there are no medical tests. Hopefully this scheme will take off and the insurance penetration in India will increase significantly.

As an aside, I wonder what impact this will have on the life insurance industry which thrives in selling plans that are a combination of insurance and investment. Now that this scheme shows off the real cost of insurance (Rs. 330 for a Rs. 2 lakh insurance), customers might become more discerning about these combo plans and see through the margins the insurers are making, and this may not be all that good for the insurers. Though this might be offset by these insurers themselves becoming underwriters to the government plan itself.

Disclosure: I’ve worked as a consultant with a leading Indian life insurance firm.

 

The problem with Indian agriculture, and government

The problem with the Indian agriculture sector is that the government takes a very “cash view” of the sector while what is required is a “derivative view”. 

So Congress VP Rahul Gandhi railed on in a rally about how the current Narendra Modi government is anti-farmer, and pointed out at the land acquisition amendment bill and the lack of raising of “minimum support price” as key points of failure. Gandhi was joined at the rally by a large number of farmers, who reports say were primarily very pissed off about the failure of their rabi crops thanks to unseasonal rains in the last month and a bit.

If the government were to take Gandhi’s criticism seriously, what are they expected to do? Not amend the land acquisition act, or amend it in a different way? Perhaps, and we will not address that in this post, since it is “out of syllabus”. Increase the Minimum Support Price (MSP)? They might do that, but it will do nothing to solve the problem.

As I had pointed out in this post written after a field trip to a farm, what policymakers need understand is that farming is fundamentally a business, and like any other business, there is risk. In fact, given the number of sources of uncertainty that exist, it can be argued that farming is a much riskier business than a lot of other “conventional” businesses.

So there is the risk of high prices of inputs, there is risk of bad weather, there is risk of a glut in supply that leads to low prices, there is a risk that the crop wasn’t harvested at the right time, there is a risk that elephants trampled the field, or there is a risk that there might be a new strain of bugs that might destroy the crops. And so forth. And given that most farmers in India are “small”, with limited land holdings, it needs to be kept in mind that they don’t have diversification as a (otherwise rather straightforward) tool to mitigate their risks.

And when the farmers face so many risks, what does the government do? Help them mitigate at max one or two of it. One of them is the “minimum support price” which is basically a put option written by the government, for free, in favour of the farmers. All it entails is that the farmer  is assured of a minimum price for his wares if market prices are too low at the time of harvest. In other words, it helps the farmer hedge against price risk.

What other interventions do Indian governments do in farming? There are straightforward subsidies, all of the input variety. So farmers get subsidised seeds, subsidised fertilisers, subsidised (or in several cases, free) electricity, occasional subsidies in irrigation, subsidised loans (“priority sector lending” rules), and occasionally, when shit hits the fan, a loan waiver.

Barring the last one, it is easy to see that the rest are all essentially input subsidies, making it cheaper for the farmer to produce his produce (I’m proud of that figure of speech here, and I don’t know what it’s called in English). Even loan waivers, while they happen when market conditions are really bad, are usually arbitrary political decisions, and never targeted, meaning that there are always significant errors, of both omission and commission.

So if you ask the question of whether the government, through all these interventions, make the business of farming easier, it should be clear that an answer is no, for while it makes inputs cheaper and helps farmers hedge against price risk, it doesn’t help at all in mitigation of any other risks. Instead, what the government is essentially doing is by paying the farmers a premium (subsidised inputs, free options) and expecting them to take care of the risks by themselves. In other words, small “poor” farmers, who are least capable of handling and managing risk, are the ones who are handling the risk, and at best the government is just providing them a premium!

The current government has done well so far in terms of recognising risk management as a tool for overall wellbeing. For example, the Jan Dhan Yojana accounts (low-cost bank accounts for the hitherto unbanked) come inbuilt with a (albeit small) life insurance cover. In his budget speech earlier this year, the Finance Minister mentioned a plan to introduce universal insurance against accidental death. Now it is time the government recognises the merits of this policy, and extends it to other sectors, notably agriculture.

What we need is a move away from “one delta” cash subsidies and a move towards better risk management. The current agricultural policies of successive governments basically ensure that the farmer makes more when times are good (lower inputs costs, free put options (MSP) with high strike price), and makes nothing when times are bad. Rudimentary utility theory teaches us that the value of a rupee when times are good is much lower than the value of a rupee when times are bad. And for the government, it doesn’t really matter as to when it spends this money, since its economic cycle is largely uncorrelated with farmers’ economic cycles. So why waste money by spending it at a time of low marginal utility as opposed to spending it at a time of high marginal utility?

In other words, the government should move towards an institutionalised system of comprehensive crop insurance. Given the small landholdings, transaction costs of such insurance is going to be high, and the government should help develop this market by providing subsidies. And this subsidy can be easily funded – remember that the government is already paying some sort of a premium to farmers so that they manage their own risk, and part of this can go towards helping farmers manage their risk better.

It is not going to be politically simple, for the opposition (like Rahul Gandhi) will rail that the government is taking money away from farmers. But with the right kind of messaging, and subsidies for insurance, it can be done.

Eroding Trust in the Indian National Government

The latest issue of The Economist carries an article which talks about the “eroding trust in national governments”. This article is based on a poll conducted by Gallup in 2007 and again in 2012 with one simple question “do you trust your national government?”. World over, the proportion of people answering “yes” to this question has dipped significantly between the two years.

Source: The Economist, Nov 16th 2013

 

Now, this graph has been sorted by the orange dots (2012 data) so India is lost somewhere in the middle. What if, however, this graph were sorted by the 2007 numbers (white dots)? Notice that the white dot for India is very close to the 90% mark – the highest ever achieved among all countries surveyed in this poll!

This just goes to show the kind of confidence the Indian National Government (UPA-1) enjoyed back in 2007, perhaps a result of the populist schemes it had launched such as the NREGA. This was before any of the scams hit, and this goodwill might have resulted in the government getting voted back into power in 2009. The interesting thing, though, is that the number for India is still higher than that of a large number of OECD countries.

PS: I would have drawn this graph differently. Rather than using a scatter-plot like this, I would have rather used a slope-graph, which would have shown the relative standings in both years and also the way the ratings have moved.

 

Arbit Raj

Email alarm made government close arbitrage window“, screams the headline in this morning’s Business Standard. Upon reading further, you will find that the said “arbitrage” opportunity in question consists of remitting rupees abroad now and then bringing it back as remittances once the rupee has depreciated further. There are so many things wrong with this approach that I can hardly get started.

1. Technically speaking, arbitrage refers to a situation where through a set of trades one can make riskless profit. The riskless point is important here. If I were to convert my rupees to dollars today and then convert the dollars back to rupees later, it would be arbitrage if and only if the price at which I would sell the dollars is guaranteed (as of today) to be higher than the price at which I buy dollars. If I buy dollars today in the hope that the rupee will depreciate, it is NOT arbitrage.

2. By calling this process “arbitrage” the government is admitting that the rupee is expected to drop further, and significantly in the coming months (the extent of capital controls being imposed now suggests this). This is bad signaling

3. Regulating arbitrageurs is futile, and can be counterproductive. Arbitrageurs are quick to spot any price inconsistencies in the market and ruthlessly exploit them by means of their trades. Thus, if it is expected that (say) the USDINR will trade at 65 tomorrow, it is arbitrageurs who make sure that this expectation is reflected in today’s price (through a set of spot-future currency trades). By trying to curtail the operations of arbitrageurs, the government is missing out on valuable price signals. In other words, they are beheading the messenger (a la the Khwarizmian Shah, and everyone knows what happened to his empire once he did that).

The measures the government has been taking in recent times to help prevent further depreciation of the rupee are so ad hoc and badly thought out that it would make eminent sense to call the current dispensation an “arbit raj”.