economics – Page 17 – Pertinent Observations

What Should Mexico Do?

If Mexico and Uruguay draw their last league game, then both of them go through to the second round irrespective of what France and South Africa do. However, on account of a better goal difference, Uruguay will qualify as group winners and face the second-placed team from Group B, while Mexico will qualify second and meet the Group B winners, likely to be Argentina.

Uruguay’s option is clear. Play for a draw. If Mexico go for a win, Uruguay should just sit back and try hit back on the counterattack (and in terms of players and style, they are very well equipped for that). Simple case of getting men behind the ball and putting gaaji.

Mexico’s strategy is not so straightforward. The “greedy” thing to do would be to play for a draw, in which case they will most likely end up facing Argentina in the second round (if you remember, Mexico went out last World Cup by losing to Argentina at the same stage). On the other hand, if Mexico beat Uruguay, they will top Group A and meet a potentially inferior team (Korea or Greece) in the second round.

As mentioned earlier, if Mexico go for a win, Uruguay will simply defend and play a counterattacking game which they are good at, so I don’t know if they are going to go for it.

Thinking about it, it comes down to Mexico’s payoff function. I’m sure their payoff is an increasing function of how far they progress in the tournament. However, we should be able to identify one particular “jump” in payoff – some kind of a discontinuity, where the payoff increases considerably for one additional round of progress in the tournament.

If this “jump” is for the second round, Mexico can afford to put Ranatunga Principle, get a peaceful draw against Uruguay and claim their “jump reward”.

If the “jump” is for the quarter-finals, however, then Mexico will want to take the risk at this round in order to get themselves easier opponents in the round of 16 (I’m assuming here that Mexico consider Korea or Greece as much easier opponents than Argentina).

If the “jump” occurs further down in the tournament, I think there is way too much randomness about their potential quarterfinal opponents (especially given the fuzzy results in Groups C and D) and opponents as hard as (or harder than ) Argentina cannot be ruled out. Nevertheless, they would rather face one tough opponent than two (and I’m assuming here that no team is significantly “harder” for Mexico than Argentina) and so they should put fight to avoid Argentina and thus go for a win.

Considering that they have reached the Round of 16 with reasonable regularity in the last few World Cups, I presume that their “payoff jump” will occur later in the tournament. And based on the above reasoning that means they should go for a win against Uruguay, so that they can try avoid Argentina.

And it is on this thin thread that the French are hanging their hopes (though first they need to thulp South Africa, no easy task).

Relationship Stimulus

This post doesn’t necessarily restrict its scope to romantic relationships, though I will probably use an example like that in order to illustrate the concept. The concept that I’m going to talk about any kind of bilateral relationship, be it romantic or non-romantic, or between any two people or between man and beast or between two nations.

Let us suppose Alice’s liking for Bob is a continuous variable between 0 and 1. However, Alice never directly states to Bob how much she likes him. Instead, Bob will have to infer this based on Alice’s actions. Based on a current state of the relationship (also defined as a continuous variable between 0 and 1) and on Alice’s latest action, Bob infers how much Alice likes him. There are a variety of reasons why Bob might want to use this information, but let us not go into that now. I’m sure you can come up with quite a few yourself.

Now, my hypothesis is that the relationship state (which takes into account all past information regarding Alice’s and Bob’s actions towards each other) can be modelled as an exponentially-smoothed variable of the time series of Alice’s historical liking for Bob. To restate in English, consider the last few occasions when Alice and Bob have interacted, and consider the data of how much Alice actually liked Bob during each of these rounds. What I say is that the “current level” that I defined in the earlier paragraph can be estimated using this data on how much Alice liked Bob in the last few interactions. By exponentially smoothed, I mean that the last interaction has greater weight than the one prior to that which has more weight than the interaction three steps back, and so on.

So essentially Alice’s liking for Bob cannot be determined by her latest action alone. You use the latest action in conjunction with her last few actions in order to determine how much she likes Bob. If you think of inter-personal romantic relationships, I suppose you can appreciate this better.

Now that you’ve taken a moment to think about how my above hypotheses work in the context of human romantic relationships, and having convinced yourself that this is the right model, we can move on. To simplify all that I’ve said so far, the same action by Alice towards Bob can indicate several different things about how much she now likes him. For example, Alice putting her arm around Bob’s waist when they hardly knew each other meant a completely different thing from her putting her arm around his waist now that they have been married for six months. I suppose you get the drift.

So what I’m trying to imply here is that if you are going through a rough patch, you will need to try harder and send stronger signals. When the last few interactions haven’t gone well, the “state function of the relationship” (defined a few paragraphs above) will be at a generally low level, and the other party will have a tendency to under-guess your liking for them based on your greatest actions. What might normally be seen as a statement of immense love might be seen as an apology of an apology when things aren’t so good.

It is just like an economy in depression. If the government sits back claiming business-as-usual it is likely that the economy might just get worse. What the economy needs in terms of depression is a strong Keynesian stimulus. It is similar with bilateral relationships. When the value function is low, and the relationship is effectively going through a depression, you need to give it a strong stimulus. When Alice and Bob’s state function is low, Alice will have to do something really really extraordinary to Bob in order to send out a message that she really likes him.

And just one round of Keynesian stimulus is unlikely to save the economy. There is a danger that given the low state function, the economy might fall back into depression. Similarly when you are trying to get a relationship out of a “depressed” state, you will need to do something awesome in the next few rounds of interaction in order to make an impact. If you, like Little Bo Peep, decide that “leave ’em alone, they will come home”, you are in danger of becoming like Japan in the 90s when absolute stagnation happened.

Keeping Transaction Costs Low

The Bruhat Bangalore Mahanagara Palike’s coffers aren’t Bruhat, it seems. For the up-coming road widening project, for which considerable amounts of land need to be acquired, it seems like the BBMP can’t afford to pay in cash. Hence, it has been proposed that compensation will be paid in terms of Transferable Development Rights (TDRs). The basic funda is that when your land gets acquired, you get rights to construct more in some other existing site, or on the remaining part of your site, or some such.

Quoting

According to a BBMP official, TDR is an instrument through which the Palike facilitates landlosers to construct additional floor or building in the remaining portion of the property or anywhere in the City.

…

The BBMP would issue a Development Rights Certificate (DRC), which can be either be utilised for personal need or can be sold to anyone who wants to construct an extra floor. The owner gets the right to construct a built up area 1.5 times over and above of that the property acquired for development. For instance, if 600 sq ft built-up area is given up to the BBMP, the property owner will receive a DRC for 900 sq ft built-up area.

This is interesting on several counts. Firstly, do you realize that what the BBMP is paying for the land is effectively an option? A TDR is nothing but an OPTION to construct more than what would normally have been permitted. The valuation of this option hinges upon the fact that current building laws are highly restrictive (in terms of the built up area as a proportion of the site area) and so the option of constructing more will actually be valuable.

It would be interesting to see how these options get valued. You can trust that there will be a lot of litigation concerning this since you can expect most people to have problem with the valuation. First of all valuation of financial options is itself so tough, you can imagine how hard valuing these TDRs can be.

Then, there is the whole supply aspect. The whole model of these TDRs will hinge upon the unwritten promise that more such rights will not be given away any time in the near future, since that will cause the value of existing TDRs to drop sharply. Given that there is one single agency (the BBMP) that controls the supply of such rights, and that the potential supply of such rights is infinite, there is a chance that valuation of these rights might be depressed.

One important thing the BBMP needs to take into account while issuing these rights is to make sure there are no transaction costs for trading these rights. The “transferable” bit needs to be emphasized in order for the value of these rights to be truly unlocked. I can see a large number of individuals who will be compensated with these rights who will want to trade them away, since they are unlikely to possess another site to utilize them. And given the number of big buildings coming up on small sites, I can foresee there being a decent demand for it.

I do hope that investment banks (or their equivalent) come forward in order to make markets in these rights. I’m sure banks won’t miss opportunity to step in here, but the important thing is for regulation that will enable such intermediation. It is in the interests of the BBMP to keep these transaction costs low, since that is going to have a positive impact on the valuation of these rights, and eventually less such rights can be given.

Postscript: It would be interesting to study the impact of these rights on bribery rates of BBMP officials. I’m sure that currently a lot of money is made in illegally granting rights for buildings that don’t conform to regulations. Since there will now be a legal way of getting similar favours (I’m told that the Akrama-Sakrama scheme has similar intentions) it would be useful to see if bribes do drop.

The Value of Fatwas

With random ulemas here, there, everywhere (and maybe nowhere) issuing fatwas left, right and centre, I wonder if the value of the fatwa hasn’t gone down.

The thing with religion is anyone who is mildly religious will try to follow as much of the traditions and customs are possible. However, if one puts way too many restrictions, there is the chance that the follower might “do a ramanamurthy” * and just snap and decide to not any of the customs. AS long as you keep things reasonable, though, there is a good chance that the follower will continue to follow.

Now that the context has been set, I reiterate my question as to whether there isn’t a law of diminishing returns for fatwas. Things I suppose were fine when the fatwa was a rare entity. For example, twenty years ago when someone issued a fatwa to kill Salman Rushdie, it was a rare event (the fatwa) and hence got taken seriously and Rushdie has to go into hiding.

But look at the kind of fatwas that are being issued nowadays and I would be really surprised if these are getting taken seroiusly. For example, read this article (HT: Nitin Pai). There is a fatwa against buying insurance. There is a fatwa against working in banks. There is a fatwa against families accepting income earned by female members. And so forth.

Don’t the ulema understand that there exists a law of diminishing returns, and so people are not likely to take fatwas seriously if too many of them are put in place? Ok I suppose they don’t teach economics in Madrassas. Or is it that Islamic society is still in the part of the curve where slope is significantly positive ? (imagine a curve with the total “degree of acceptance” on the y axis and “number of religious restrictions” on the X axis. You would expect that the curve initially rises and then flattens out, and if you stretch things too far maybe even bend downwards).

All religions and all sects of all religions have their share of loonies. People who come up with random fundaes and then claim it’s part of the teaching of that particular religion and everyone should follow it. But I suppose that most other religions are decentralized enough that loonies are treated as just that, and people go on leading their lives without taking cognizance of the loonies.

PS: Check out this hilarious essay from The Dawn about this bunch of guys who tried to take along a Maulvi to Afghanistan to fight Russians.

Tax Breaks

One thing that has struck me recently is about charitable organizations that try to attract donations by claiming “100% tax break under section 80G” or a similar 50% tax break or some such thing. Given how often organizations use this technique to get funds, I’m sure this works. That people do choose where to donate their money depending upon the amount of tax break they get.

I’m just trying to illustrate this concept from another angle. Let’s say you donate Rs. 10000 to a charity that has gives a “100% tax free” receipt. So effectively your taxable income goes down by Rs. 10000. And considering a 10% marginal tax rate (ignoring cess, surcharges, etc.) your tax payable comes down by Rs. 3000. So effectively, you have donated ONLY Rs. 7000 to this charity and forced the government to pay the balance Rs. 3000.

Do you see the catch in this tax-break scheme? Essentially the government is forced to pay money to charity at the behest of a single citizen! By granting this “tax free status” to a charitable organization, the government is making itself liable to commit unlimited funds to this particular charity (of course I suppose that it isn’t easy to get such breaks for your organization, and considerable greasing of palms is involved. But considering that a small charity run by my extended family gets 50% tax break it may not be very hard after all).

So yeah, I’m sure the numbers will be available somewhere but i’m too lazy to find it. But I’m interested in finding out the aggregate deduction sought by all taxpayers put together under this section 80G (the one where you get tax exemption for donations). And then see where the government’s forced charity is headed!

Road Widening is NOT the solution

The other day, walking down Dr. Rajkumar Road in Rajajinagar, I saw several signboards on the road, on shopfronts, on buildings, etc. protesting against plans for widening the road. Apparently they want to widen the road and thus want to demolish shops, parts of houses, etc. Looking outside my own apartment building the other day, I saw some numbers written on the compound wall. Digging deeper, I figured that they want to widen the road I live on and hence want to claim part of the apartment land.

Now, the logic behind road widening is not hard to understand – due to increase in traffic, we need more capacity on the roads and hence increasing their width results in increased capacity in terms of vehicles per unit time and so it is a good thing . However, before going headlong into road widening and land acquisition for the purpose, road architecture in the city needs to be studied carefully.

There are two primary reasons why trafffic bottlenecks happen. The more common reason at least in western nations is road capacity. Roads just don’t have the capacity to take more than a certain number of cars per hour and so when more cars want to go that way, it results in pile-ups. The other problem, which I think is more common in India is intersections.

It is going to be a tough problem to model but we should split up roads into segments – one segment for each intersection it is part of, and one segment for each segment between intersections (ok it sounds complicated but I hope you get it). And then, analyzing capacities for these different segments, my hypothesis is that on an average, “capacity” of each intersection is lower than the capacity of road segments between intersections.

Now how does one calculate capacity of intersections? Assume an intersection with traffc coming from all four directions. Suppose traffic approaching the intersection from north sees green light for fifteen seconds a minute. And in each fifteen second interval, 25 cars manage to make it past the intersection. So the capacity of this intersection in this direction becomes 25 cars per minute. I hope you get the drift.

I’m sure there will be some transportation engineers who will have done surveys for this but I don’t have data but I strongly believe that the bigger bottleneck in terms of urban transport infrastructure is intersections rather than road width. Hence widening a road will be of no use unless flyovers/underpasses are built across ALL intersections it goes through (and also through judicious use of road divider). However, looking at the density of our cities, it is likely to prove extremely expensive to get land for the widened roads, flyovers etc.

I don’t see private vehicle transportation as a viable solution for most Indian cities. Existing road space per square kilometer is way too small, and occupation way too dense for it to be profitable to keep widening roads. The faster we invest in rapid public transport systems, the better! I’m sure the costs borne in that direction will be significantly lower than to provide infrastructure to citizens to use their own vehicles.

Women’s Reservation and Roving Bandits

There are two kinds of bandits – stationary and roving. Roving bandits (eg. Mahmud of Ghazni) attack an area, plunder it to the fullest and then abandon it and move on to another area to rape and pillage. They seldom attack the same area twice, at least not in quick succession, because of which they don’t really care about the medium-term consequences of their actions. Similarly you have shifting agriculture.

Stationary bandits, on the other hand are interested in plundering an area over a longer time period (eg. British in India). They too pillage, but given that they know that they will stick on for a reasonable amount of time, they make sure that they don’t kill the goose that lays the golden egg. And it is a possibility that they will feed the goose well, take steps to increase production of eggs and so on. In other words, they do contribute to general development of the area (though they tend to take away a large portion of the benefits), build institutions, etc. This is more like settled agriculture.

Now, it is clear that given a choice, it is in the interest of the region for it to be attacked by stationary bandits rather than by roving bandits. Yeah, the stationary bandits do stick on for longer and pain you for longer periods of time, but the damage inflicted by roving bandits is usually so severe that it will take a longer time to recover from this.

In democracies like the UK or India, what keeps the legislators honest is the possibility of re-election. It is the possibility of re-election which incentivizes the incumbent to do good for his constituents, rather than just plundering away the region’s funds (in whatever ways possible). In other words, legislators do try to act like stationary bandits, because of which some good does happen for the region.

Now, with the new women’s reservation law in the process of coming into force, what will happen is that once in three elections, constituencies will get reserved for women by rotation. The implications of this are severe. In two out of every three parliaments, the incumbent knows that there is zero chance of him/her retaining the seat in the following election (yeah, women can still continue to get elected from their constituencies when it becomes general by rotation but I’m sure parties won’t allow that). With the possibility of re-election being taken away, this will play havoc with the incentives.

There will be more incentve now for legislators to maximize their benefits in the one term they get rather than to try and put gaaji on the constituency and take benefits off it for the rest of their lifetime. This, I think will lead to overall poorer performance by legislators, irrespective of gender of the legislator and whether the constituency is reserved or not.

This is unfortunate.

Orange Juice and Petrol

So I was reading this article by Ajay Shah about administered pricing for petroleum. He does an excellent (though it gets a bit technical in terms of statistics) analysis about what could go wrong if the government were to free pricing of petroleum products. He mostly argues in favour of deregulation, and that is a view that I completely endorse.

One of the big fears about deregulation that he mentions is the fear that volatility in retail prices of petroleum products might increase, and he argues that this is a good thing and is much better than the government artificially hiding the prices and subjecting the junata to major price shocks once in a while. While I agree with him on this, I don’t think prices will change frequently in the first place.

While I was reading this article, I started thinking about the neighbourhood Sri Ganesh Fruit Juice (yeah there are a dozen of those in every neighbourhood in Bangalore) center. About how the guy keeps the price of orange juice constant throughout the year, despite the price and availability of oranges themselves fluctuating wildly across seasons. Yeah he might do minor adjustments such as changing the proportion of water but he can’t do too much of it since he needs to maintain quality.

The basic funda here is that customers want certainty. Every time they go to the shop for their fix of orange juice, they want certainty in the prices. Even if you are on an average cheaper, you will lose customers if your price is more volatile than your competitor’s. Of course there are occasions when you can’t help it and are forced to change your price – and on these occasions your competitors are also likely to do the same. But as far as possible, you try your best to decouple the price of orange juice from the price of orange which is pretty volatile.

Now I don’t know if the volatility in crude oil prices is more than the volatility in orange prices (it’s likely to be) but considering that oil companies are supposed to be more sophisticated than your neighbourhood juice shop guy, I would expect similar behaviour from them – of keeping retail prices of petroleum products as stable as they can. Of course they are likely to follow long-term trends but they are surely not going to pass on the short-time noise in prices to the customers.

So this fear of increase in volatility of retail prices is unfounded, assuming of course that the oil marketing companies are good businesspeople!

Compensating Teachers

This is yet another of those things which I’ve been thinking about and have been intending to write about for a long time but have never gotten down to it. Pinky wrote this excellent post on the topic today and that has got me thinking. To quote her,

A bad teacher makes a bad student. A teacher who looks at teaching as just another job is doing no good to anyone. She neither grows in her life nor contributes to the positive growth of a kid.There have been a few teachers in my life who i have tremendous respect for, not because they taught me effectively enough to pass in their subjects but because they taught me to listen, think and speak!

I don’t have any solutions yet but I thought I should just put some bullet points here, just to try and give a structure to the problem. Let me know your thoughts

If we consider a person’s salary as Society’s recognition of his/her worth, school teachers are not recognized enough
Abysmal salaries drive away a large number of potential school teachers away from the profession
Love for teaching is important, but if teaching pays as abysmally as it currently does, the opportunity cost of doing what you love is way too high for some people, and so they end up in other professions
We have a market failure in teaching – how do we run a school profitably while paying teachers competently while on the other hand keeping fees reasonable, and not resorting to any subsidies?
India suffers from what I call the “official’s wife bug”. In the 60s and 70s, the teaching profession got flooded by women who weren’t really looking to make much money, but more to just pass some time and use their bachelor’s degrees rather than being housewives. This has fostered a culture of low schoolteachers’ salaries in India. People who weren’t looking to make money out of teaching crowded out those who found the opportunity cost of the low salaries in teaching too high.
McKinsey interview level arithmetic: assume a school having classes 1 to 12, 4 sections per class, 40 students per section. 8 periods a day 5 days a week gives a total of 12 * 4 * 8 * 5 = 1920 periods per week. Assuming each teacher can take 5 classes a day (or 25 a week) we will need 77 (round it off to 80) teachers. Number of students is 12 * 4 * 40 = 1920, so essentially 25 students have to pay for one teacher’s salary, and this is apart from expenses towards school building, maintenance, overheads, etc. McKinsey level handwaving. 10 students have to pay for one teacher’s salary. Doesn’t sound feasible
Primary and secondary education is simply way too important to be left in the hands of unmotivated disinterested people, but that seems like the situation we are in (I dont’ mean to say all teachers are unmotivated or disinterested; just that the situation doesn’t incentivize talented motivated people to enter the profession).
Universities attract talent by allowing faculty to make money by other means such as consulting and organizing for-profit courses. Will something like that work for schools? And no, I’m not talking about private tuitinos as the other source of income. Is there something else?
Government intervention is not a solution. In a place like India it will only end up messing up things further and draining more money from the system.
In the pre-IT era, teaching salaries were more competitive (with respect to competing jobs) than they are now, so they could attract better talent
I wonder if it is only in India that such a large proportion of school teachers are women. This is just a general pertinent observation, and has nothing to do with the rest of the post
The officer’s wife model was good when it started off – some motivated people came into the system because fo that. Just that the system is not sustainable and we’re facing the problems of that now and because a lot of school managements fail to take into account that the model isn’t sustainable

Any thoughts on this? Any possible solutions? Of course it’s not possible to implement any macro-level solution. All I’m looking at is a school-level solution. How do you plan to run one school (of size I mentioned in my bullets) sustainably while ensuring teachers are paid adequately enough to not scare away interested people?

Urban living and restaurants and liquidity

Last night I had dinner at Alfanoose, a small Mediterranean joint off Broadway. I had hummus and salad with pita bread, and had also brought along a falafel sandwich which is now sitting in my fridge and is likely to get consumed today for breakfast. Excellent stuff. Absolutely brilliant. And not expensive at all – ten bucks for the hummus and salad, and six for the sandwich. Considering that USD = 10 INR according to the Idli index, this is extremely reasonable, insane value for money.

I have been intending to write this post for ages, about how one of the best positive externalities of urban living is restaurants. When you are living in a desolate area, with not too many people around, there is no option but to cook your own food. Even if you live in a village ora small town, the number of people who are willing to eat out will be small, which means it makes little business sense for someone to open a restaurant there. You are likely to find a handful of them, but the lack of competition will mean that you can’t really trust quality.

There is a network effect in restaurants. Some people don’t eat anywhere but at home, and some don’t cook at home at all. However, there is the large middle ground of people whose consumption of restaurant food varies directly with quality and liquidity. And these two concepts are inter-related – the bigger the town is, the greater the required supply of restaurants which means more competition and thus higher quality. And higher quality leads to higher demand (more fence-sitters converted) and the virtuous cycle goes on (of course, population and the fact that some people don’t like to eat out limits the boundaries of the cycle).

Another thing is that the larger a town gets, the greater the liquidity of the food market in there, there is more variety. If you remember Bangalore in the 1980s, when I was growing up, there was one standard type of restaurant. Where you would get cheap idli and dosa and a few other standard snacks, and a few “north indian” items at meal times, and every time you wanted to eat out you had to go with one of these. And you would have noticed how with the growth in the restaurant market in the 90s you got more variety.

What makes cities such as London and New York such foodie havens is their size, and also that culturally people here are more inclined towards eating out than in other places such as India. This leads to insane liquidity in the market, and as I explained above that leads to more variety, and so you get more niche food. And when you have cities as large as New York or London, what you get is full-fledged liquid markets in cuisines that are everywhere else considered niche!

So because of liquidity in otherwise niche markets, in each cuisine you will find various kinds of restaurants. Like yesterday I had awesome hummus at this self-service place! While in a place like Bangalore to get any kind of hummus you’ll have to go to a fine dining place and spend a bomb.

Another thing I realized is that when liquidity is thin it usually occupies the top end – like how in Bangalore you get non-Indian stuff only in high end fine dining places. But I suppose I’ll write about that in detail some other day