One Rank One Pension – some thoughts

There has been a lot of debate of late on whether veterans should be moved to a “one rank one pension” system. I won’t bother explaining the whole deal here, I’ll let you read this brilliant post by Ajay Shah about the numbers behind the move. Now that the quant has been outsourced, I can put forth my “qualitative” arguments.

I’m not a fan of this One Rank One Pension (OROP) move. I’m not against paying our soldiers, or veterans, well – I think it must definitely pay above market rates for the skills required for the job. Yet, I think OROP is a “one delta” solution to the problem (previous post here about government’s one delta thinking on agriculture), and can lead to massive unfunded liabilities.

The problem with any kind of pension scheme is that you create liabilities today that need to be funded later on. And at a later date these liabilities might become unserviceable. From this perspective, it is important to try and fund any future liabilities today, or at least have a handle on the precise magnitude of liabilities required. OROP, being “inflation indexed” (that’s Ajay Shah’s nice model to look at it), doesn’t allow for proper budgeting and long-term planning.

It is precisely due to this budgeting issue that the government moved most of its incoming employees to the New Pension Scheme (NPS) in 2004. NPS, unlike previous pension schemes, is a “defined contribution” scheme, where your pension is paid out of a corpus you create by your own saving. From an accounting perspective, it moves liabilities from tomorrow (pensions) to today (higher salary to fund the contributions), and is an excellent move. And there is no reason for it not to apply to the armed forces.

Most of the arguments being made in favour of OROP are emotional (“how can you deny our veterans money” etc.), and not well backed up by logical or economic reasoning. One of those is that lower-level military persons retire when they are 35, and hence need a “one rank one pension” (which I absolutely fail to understand). While I understand that the rigours of the role imply early retirement, I don’t see why defined contribution doesn’t solve the problem. It will have to be matched with higher salaries (to fund the contribution required for a long lifetime of retirement), but that implies liabilities are funded today, which is superior to pushing liabilities under the carpet for future  generations.

The thing with NPS is that it cannot be pushed retrospectively, and hence can apply at best to all forthcoming hires. We still need a solution for the existing employees and veterans, who are already on a defined benefit scheme. Yet, the important thing to consider is that the beneficiaries should be divided into three categories – current veterans, current servicemen and future servicemen, and we should find separate solutions for the three.

It might be argued that without defined benefit pensions, it might be hard to attract talent for a high-risk job like the military, and that is why we might need OROP. This is where the “derivative thinking” comes in. The thing about a job in the military is that there is a higher-than-civilian risk of losing life or limb. The solution to that is not blanket higher compensation – it is risk management.

What we need is generous death and disability insurance for our military, and this too should be purchased by the military from a professional Life Insurance firm. A generous insurance package can help mitigate the risks to life borne by military personnel, and should be sufficient to attract necessary talent. The purchase of such policies from professional insurers is important, for you don’t want the military to be doing an actuary’s job. More importantly, such a purchase will push liabilities to today rather than to tomorrow, and the last thing an army will want during the time of war is increased expenses on account of insurance.

The current debate about OROP has opened the door for a complete overhaul of military compensation. The government should jump at this, rather than simply get bullied by veterans’ groups. As Nitin Pai argues in this editorial in the Business Standard, compensation is an economic decision and should be made based on economic (and financial) reasoning, not based on emotion.

Vistara and Indigo

Earlier today the Air Traffic Controller of Bangalore tweeted that Air Vistara had a 100% on time performance in Bangalore.

My immediate reaction was that this was because Air Vistara is positioned as a premium service, and hence their schedule is more “sparse” and has greater “slack”. That, I mentioned, has a direct consequence on their on-time performance.

The Directorate General of Civil Aviation puts out monthly reports on the performance of airlines in India. The data they dispense is very interesting, but the format is horrible. It’s a PDF embedded into a 20th century web page. If you can parse the above link there are a number of insights to be gleaned.

Firstly, a full 63% of flight delays in India (for the month of June) have been classified as “reactionary” (not cutting and pasting the image here because I don’t want to desecrate this blog by putting a pie chart on it). This is what airport announcers term as “delay caused due to delay in incoming aircraft”.

In other words, what happens is that airlines try to over-optimise their schedules too much leaving little slack between two consecutive flights for a particular aircraft. And so any delay in any flight cascades through the length of the day for that particular aircraft. My hypothesis (haven’t found data to back this up) is that Vistara has a more relaxed schedule than other airlines and hence has better on-time performance.

It is also pertinent to mention that Vistara has a much lower passenger load factor compared to other airlines. The average Vistara flight in June was only about 60% full, comfortably putting it in last place. Perhaps the premium pricing hasn’t been attracting the kind of passengers as hoped for. Or they’re not marketing well to the right kind of people.

The other airline which merits mention here is Indigo, which seems to be literally running away with the market. Not only is it comfortably number 1 with a consistent 37% market share, it also has the lowest proportion of cancelled flights, a pretty high passenger load factor (86%) and better on-time performance than any of the other large airlines.

Airlines is an industry where there are significant positive feedbacks – if you are on time, not only do more people want to fly you but you can also have a more efficient schedule. And so forth. And there are definite economies of scale in maintenance and schedule density and so forth. Indigo is taking advantage of all of those.

It may not be a particularly profitable industry, but the airline industry is surely interesting to watch!

Revenue management in real estate

Despite there continuing to be large amounts of unsold inventory of real estate in India, prices refuse to drop. The story goes that the builders are hoping to hold on to the properties till the prices rebound again, rather than settling for a lower amount.

While it is true that a number of builders are stressed under bank loans since banks have pretty much stopped financing builders, this phenomenon of holding on to houses while waiting for prices to recover is actually a fair strategy, and a case of good revenue management. Let me illustrate using my building.

There are eight units in my building which was built as a joint venture between the erstwhile owner of the land on which the building stands and the builder, both receiving four units each. The builder, on his part, sold one unit from his share very soon after construction began.

Given the total costs of construction, the money raised from sale of that one apartment went a long way in funding the construction of the building. It wasn’t fully enough – the builder faced some cash flow issues thanks to which construction got delayed,  but since he managed to raise that cash, he didn’t need to sell any other units belonging to his share. He continues to own his other three units (and has rented out all of them).

The economics of real estate in India are such that the cost of land forms a significant part of the cost of an apartment. According to a lawyer I had spoken to during the purchase of my property (he also has interests in the construction industry), builders see a significant (>100%) profit margin (not accounting for cost of capital) in projects such as my building.

What this implies is that once the builder has taken care of the cost of land (by paying for it in terms of equity, for example, like in the case of my building), all he needs to do to fund the cost of construction is to sell a small fraction of the units. And once these are sold, there is absolutely no urgency to sell the rest.

Hence, as long as the builder expects prices to recover (when it comes to house prices, builders are usually an optimistic lot), he would rather wait it out (when he can realise a higher price) than sell it currently at depressed prices. Hence, downturns in housing markets are not characterised by an actual drop in prices (few builders are willing to drop prices) but by a drop in the volume of transactions.

While there might be a large number of housing units that remain unsold, it is unlikely that there are apartment complexes which are completely unsold – there will be a handful of bargain-hunting early buyers who would have bought and funded the construction of the complex. And given the low occupancy rates, these people are losers in the deal, for it will be hard for them to move in.

And it is also rational for the builder to invest in new projects even when they are currently holding on to significant inventory. All they need to do is to find a willing partner who can contribute the necessary real estate in the form of equity. And new projects will inevitably find the first set of early buyers looking for a bargain, irrespective of the builder’s track record.

And so the juggernaut rolls on..

Indian Americans and the Selection Bias

There is this one chart from the Economist that has been doing its rounds over the interwebs over the last few days:

Basically it shows that Indian Americans are much more accomplished academically and professionally compared to other immigrants. And there are many theories floating around as to why Indians are so successful.

The answer, however, is rather simple – selection bias. Migrating from India to the US was an extremely difficult task till the 1960s – there were some quotas that the US had for immigration under which the Indians had nothing. And when Indians did finally start migrating in the 1960s, it was mostly for education.

Most people who migrated from India to the US even in the 1960s and 70s did so to go to graduate school. And this meant that they already had 16 years of education in India, which either meant an engineering or medical degree, or a masters in one of the other fields. So basically most Indians migrating to the US were highly accomplished already.

And considering the kind of foreign exchange controls imposed by the Indian government, the only Indians who could afford to go to the US for an education were those that received a fellowship or support from their universities. Thus increasing the seelection bias! (Now that I’ve mentioned foreign exchange controls, you should listen to this song, which was apparently meant to parody such policies)

Yes, you had the odd Patel without much education who made it to open a “Potel” (Patel run Motel), but that is probably the reason that the Indian bubble in the above chart is not farther out!

So that Indians have done better than other migrating communities in the US is not about innate Indian intelligence, or innate Indian ability to work hard, or because the Americans took in the Indians much better than other nationality. It is simple selection bias, based on tight immigration controls and tight emigration controls and stupid foreign exchange policy on the part of Indian government (which, at one point of time, only allowed citizens to take out eight dollars from the country).

To illustrate this point, look at the country that is “second” (quotes since we are looking at two dimensions here, so second is subjective) in this list – Iran.

Irreversible policies

Some policies are so badly designed that they become irreversible. Take, for example, the “5/20” rules for airlines in India. For an airline registered in India to fly abroad, it needs to have been in operation for 5 years and have at least 20 aircraft. The rule is silly, and the government wants to change it. But established players say that changing the rule will be unfair to them, for they have sunk costs in order to comply with the rule and want newer competitors to go through the same.

Now, given that the airline industry is dynamic in terms of firms going in and out of business, there will always be new firms and old firms in the market. And given that the rule is fundamentally senseless, there will be proposals to change it at many points in time. Now, notice that the arguments that today’s established players are making can be made at all those points in time! In other words, if you were to postpone changing the rule because older airlines are going  to be unhappy, you are giving reason to postpone the rule change indefinitely!

When you design a policy, you should keep in mind that there is a chance that changed market environments might render it useless/absurd (as for the 5/20 rule, it was absurd from inception!). Hence, you need to consider how easy the rule is going to be to dismantle when it goes past its use-by date. If such a “poison pill clause” doesn’t exist in the rule, then it will be very difficult to undo and the absurdity will propagate into perpetuity, causing much more damage than necessary!

Then again, if the rule has been framed due to the influence of bootleggers (the 5/20 rule definitely has indications of that, and it is hard to identify any “baptists” who could have backed the rule), then the bootleggers are likely to prevent any such “poison pill clause” from being put in. Such are life.

How “non-vegetarian” is India?

Last week, after Master Chef India announced that the next season is going to be all-vegetarian, there was considerable outrage on social media. Most of the outrage contended that this was a result of the Hindu right dominating the narrative, and quoted studies that said that over 80% of India eats meat. It didn’t help that sponsors of Masterchef this season are Amul (the milk cooperative) and the Adani group, which is known to be close to the Prime Minister.

In this context, this chart from the Washington Post is quite instructive. The chart indicates the per capita per year consumption of various meats across different countries. It takes a lot of effort to find India in this chart, since it is almost non-existent. This chart shows how little meat per capita is actually consumed in India.

source: http://www.washingtonpost.com/blogs/wonkblog/wp/2014/07/14/the-coming-global-domination-of-chicken/

While it might be true that 80% of India’s population is not averse to eating meat, the actual fact on the ground is that very little meat is actually consumed. Which makes is okay to term India as a largely vegetarian country.

Whether that should necessitate a vegetarian-only cookery show on TV, though, is another matter and one that this blog has no opinion on.

Comparing Airline Pricing across countries

The WSJ reports, based on a survey, that airline prices are cheapest in India (HT: Nitin Pai). They evaluate the cost of flying in terms of cost per 100 km. The usual ridiculous comparisons that go with any such article are present in full here – they compare the per kilometer cost of flying to train and bus fares, and conclude that flying is cheapest (this reminds me of an equally ridiculous report in the Times of India which showed that the cost of India’s Mars mission was less than that of taking a bus in Mumbai).

A few thoughts on this report by the WSJ:

  • Per km is a wrong way at looking at air fares. In most markets (from my experience pricing air tickets and cargo), fares are set based on competition and to fill capacity. Notice that marginal cost of a passenger is really really low, so once a flight is in place airlines will do what they can to maximize their revenues from that.
  • Taking this forward air fares depend on the competition in a particular sector (btw, the way airlines price it, Bangalore-Barcelona is one sector, and the price of that doesn’t depend on the Bangalore-Frankfurt and Frankfurt-Barcelona prices. These are three independent markets and triangle inequality doesn’t necessarily hold. Just FYI). So going by the report, India has a lot more competition compared to other countries in most sectors.
  • Now think of other large countries (you need big area for flights to make sense) and think of their income levels compared to India. Only developed countries and other BRICS come to mind. All of them have a higher willingness to pay than India.
  • Airline prices are thus a function of simple (elastic) demand and (inelastic – flight schedules are announced by “season”) supply. So once in a season we have a lot of flights scheduled, competitive forces push prices down
  • Given that it’s demand and supply that determines airline prices and not costs, in my opinion the airline industry goes through cycles. You have lots of competing airlines. Prices are low and they lose money. In the course of time one or two go out of business or scale down, and that leads to increased prices. Airlines make money for a while, and then looking at the supernormal profits you have new entrants and so on. India right now is going through the phase where you aer getting more investors (Air Asia, Air Costa, Tata-SIA, etc.). That depresses prices. In a year or so I would think someone like SpiceJet will go out of business and that might push fares up for a while.
  • There’s also the seasonality factor – based on regular travel to Bombay over the last two years I’ve found that fares in the monsoon months are half of the fares at any other point in the year. It’s a function of demand, again (Indian seasons don’t exactly tally with international seasons according to which schedules are made, so this results in flawed matching)! Given the timing of the piece it is possible that Indian fares in the monsoon months have been sampled.