Trade my gasoline spill for your 'red mud' dump: A '(Vi)Pareto' Opportunity in Environmental Finance

Ganga Prasad Rao

http://myprofile.cos.com/gangar

Disclaimer: As with other columns and blogs in this series, the author makes no claims to factuality, or the outcomes therefrom. The author also explicitly rejects culpability for any financial, environmental, legal or other undefined impacts that might follow from adopting this proposal.

For decades, even the US, the nerve center of capitalism, evaded economics in its environmental policy-making despite evidence inefficient regulations were costly to the environment and the economy. Instead, it chose to persevere with medical risk benchmarks and technological innovation to guide its environmental programs and standards. Then came the pollution trading schemes in which firms and industries could trade their current and future emissions with each other and re-allocate production resources to jointly achieve economic and environmental goals. It was theoretically sound, practically feasible, and demonstrably a success. But, there has been little by way of a third means of achieving pollution control and remediation - the financial market itself.

Consider the case of Maritime Oil Spills versus Solid Waste Dumps (Maritime piracy, albeit an entirely genre of risk, could be clubbed with Oil spills for its unpredictability. Such aggregation favors a larger treatment of maritime risks and facilitates a flexible, if not an early resolution due access to multiple resource pots and the global reach of the financial markets). Superficially, the former is a multi-lateral 'Commons' problem that extends in to international maritime waters, and the latter a matter for the national, even regional/local administration. Whereas oil spills are an ongoing risk from a perennial activity that merely requires subscription either to a fixed annual group insurance fee (preferred by shippers with a long-term crude contract) or a 'pay as you ship' insurance (typically merchant tankers filling in incremental demand for crude and products), private solid waste dumps must be constructed in anticipation of the demand for garbage disposal, necessitating huge upfront investment toward land re-zoning, financial guarantees to obtain environmental clearances, as well as a financial cover until the dump achieves optimum operational scale years/decades down the road. Further, oil spills from maritime vessels occur in either the open seas, or in the importing/exporting nations. The rules that pin 'guilt' and financial accountability for spills are often confusing due vessel ownership/chartering issues, cargo ownership, route determination, insurance exclusions, and a host of other factors. On the other hand, solid waste, albeit generated within the consuming jurisdiction, may be traced back to imports from foreign, exporting nations. In fact, many in the US claim their backyard SW dumps were filled with hazardous substances found in cheap Chinese imported 'use and throw' stuff (and hence the 'NIMBY syndrome'. India too may worry about similar environmental impacts from its 'FDI in Retail' policy). The question of who ultimately bears financial responsibility for, on one hand, compensating oil spill damages in foreign/international waters, and on the other, for obtaining clearances, constructing, maintaining and closing solid waste dumps, as well as paying for environmental remediation and restoration has bedeviled policy makers. In fact, the lack of policy and legal consensus is evident in the prolonged nature of oil spill litigation and in the proliferation of solid waste that has literally spilled beyond  government-owned or -leased dump sites. Both issues have festered across decades and are ripe for a new approach.

In this context, it'd be opportune to consider a new paradigm for financing environmental remediation and control. In these days of globalization and free capital flows, trade in raw material, fuel, intermediates, and products brings about many unforeseen, even perverse environmental results. These negative environmental outcomes that often occur beyond the confines of the producing or consuming jurisdiction, are not resolved within the domain of conventional environmental theory limited to intra-jurisdictional optimization. Instead, one must look beyond for instruments that are valid globally and robust to different political and economic systems. When environmental policy-makers find themselves up the wall against extreme risk, uncertainty, extra-jurisdictional impacts, incompatible legal systems, and even unfriendly political regimes, financial markets offer instruments that may be strategically structured to serve as appropriate incentives or dis-incentives, or, in the case of uncertain/risky outcomes, provide effective hedges that pre-empt polar environmental outcomes. The globally integrated financial markets potentially offer an attractive 'via media' to resolve environmental issues that extend across, or, are common to multiple jurisdictions.

Toward such a resolution, let us consider a Group Insurance Policy for oil spill damages (with optional piracy cover) subscribed to by shippers of crude and petroleum products. Refining being a volume-intensive, continuous process, the shipping of crudes to refineries too is a quasi-continuous activity that is insured for contents and spill damages in long, multi-decade insurance contracts. The insurance premiums are thus a pseudo-perpetual source of income to the issuer of the policy who covers for the damages in the event of an oil spill. These premiums could alternatively be considered analogous to a perpetuity payout to the issuer of the Insurance policy, if in return for a lumpsum obligation, the obligation being the expected Future Value of claims from a hypothetical future oil spill. The aggregate of premia collected in any period would be the sum of 'variable', tonnage-based premia paid in by crude suppliers for delivery of incremental supply, and fixed annual premia negotiated by crude producers with long-term supply contracts irrespective of actual volume. Elsewhere, and in the context of multi-lateral competition in global trade, a nation may seek to promote its exports - a high priority for its potential to stimulate employment and growth - over competing nations, by offering a 'sweetener' in the form of a large, initial lumpsum.While that lumpsum could take various forms and be justified on just as many grounds, it is appropriate, given international trade exploits the commons and the environment of the importing/consuming nation, to offer it as an Environmental P-Note that compensates them for any and all (environmental) externalities that might result directly, or indirectly, from the import, storage, consumption and disposal of its products (thus avoiding the transactions costs from decades long legal quagmire). The EPN represents an arms-length, limited liability, transferable financial instrument toward upfront, potential compensation for undefined and uncertain future environmental damages in the importing nation from consumption of goods originating in the exporting nation. The exporting nation offers a sovereign guarantee for the face value of the EPN during the period of its validity. It permits the leveraging of the EPN in national and global financial markets during the normal term of the trade agreement, and for the gains thus obtained to be available toward environmental and related causes in the importing nation. However, with a transparent incentive to nurture the trade relationship, the EPN does not 'vest' with the importing nation until the natural and normal conclusion of the trade agreement. Clearly, the face value of the EPN is 'politically negotiated' a priori as part of the bilateral (or, multilateral) trade agreement thus lending a decidedly strategic, multi-term, political angle to the matter. However, given competition among exporter-and importer nations, EPN face values will generally reflect potential inter-temporal profits, if not the 'gains from trade', bargaining position and the morality of the political leadership negotiating the agreement. Should the trade agreement be abrogated or annulled mid-course by the importing nation, the EPN would be returnable to the issuer-nation.

Both, the Oil Spill Group Insurance Policy portfolio, OSGIP, and the EPN are denominated in the same currency, and are instruments sought for their 'shadow financial value' - the OSGIP for the certainty of income stream from policy premium receivables, and the EPN for its present collateral value, for its potential in underwriting a Bond issue, its hedge value in currency exchange markets, and for its pareto discounting and buyback opportunities. Unlike the EPN, which cannot be separated from its financial value, the OSGIP may conceptually be bifurcated in to a 'good' and a 'bad'. The 'good' is not unlike a 'perpetuity coupon' that entitles the 'owner/creditor' to a highly certain stream of insurance premiums. The 'bad' is the uncertain insurance obligation that the 'insurer/debtor' inherits toward damages from the insured risk. Thus bifurcated, the OSGIP turns amenable, on one hand, to trading, discounting, and buybacks in the financial markets, and on the other, to cross-sectoral, cost-reducing risk-aggregation in the insurance markets. While the 'good' is sought at a lumpsum price for its positive shadow value, the 'bad' must be sweetened with a lumpsum - a lumpsum that approximates the discounted PV of the certainty equivalent of the uncertain future payout - before it becomes attractive to buy in to. Consider a fictitious example: A 10-year group insurance subscribed to by 100 shippers and that covers $1 billion of oil spill damages at $10,000 per month per shipper may be separated in to a 'perpetuity' coupon of $1,000,000 per month (that is further discounted to a lumpsum of $50 million in the discount market), and an insurance obligation of a billion dollars amalgamated with a Risk Aggregator for a sum of $200 million. Obviously, the Risk Aggregator reduces expected inter-temporal costs by exploiting scale and scope economies inherent in the insuring of incremental risks: scale measured in both insurance volume and the insuring of incrementally smaller risks, and scope being a synonym for the cost reductions due risk diversification across sectors and causes (natural, anthropogenic random, anthropogenic non-random, natural-anthropogenic interaction). Thus bifurcated, the spill risk is now 'insured' by a larger, financially more secure entity, while the perpetuity coupon trades between financial entities who hold different positions and expectations in the money market. As interest rates change with the stage of the macro-economic cycle, these entities find themselves potentially benefited by trading the perpetuity coupon, thus bringing about repeated pareto trades in the perpetuity instrument (This result extends to the case in which the ad valorem insurance for value of shipped crude or products is combined, or issued jointly with spill insurance, with the caveat that the trades are now further influenced by trends and expectations of variations in product prices). Thus, the legal green light to bifurcate the OSGIP and permit insurance risk aggregation sets in motion various interests that are individually and group pareto. Designed with appropriate institutions, financial instruments and regulatory fiats, they yield profits that may be channeled to obtain integrated and simultaneous control of multimedia pollution externalities.

It is advantageous, given there exists a positive shadow value for profiting from these 'attributes' in the financial market, and an opportunity to reduce insurer-insuree costs by aggregating/diversifying risks, to design a financial-cum-insurance strategy that exploits the OSGIP and the EPN to the advantage of the environment. The key to the design of this novel environmental strategy is legally permitting the re-assignment of ownership, and the privileges (separate from) obligations tied to these instruments, so they could be traded separately, and repeatedly, to exploit risk and financial arbitrage opportunities that arise at different stages of the macro-economic cycle across different market participants in different nations, and to channel the returns so obtained to fund preventive, remedial and compensating environmental programs, both nationally, and in the global commons. Toward the design of the financial system, let us first recognize a pair each of national and international bodies: the Solid Waste Authority, SWA, and the Export Credit Bureau representing the former, the Oil Spill Fund Authority, OSFA, and the Merchant Shipping Association, MSA, the latter.

The OSFA is an international organization that coordinates spill insurance and responses across friendly and competing nations (A Maritime Risks Resolution Authority would bring piracy risks too under its fold). It has the authority to offer, or sponsor, an Oil Spill Group Insurance to shippers of crude and petrochemical liquids. The MSA, too, is a trans-national association meant to espouse the cause of Merchant Shippers. Since the fleet of ocean-going vessels owned by merchant shippers is a fixed asset that must be maintained regardless of business, or the lack of it, one of the primary tasks of the MSA is to seek freight rates and vessel lease rates that support the industry across macro-economic downturns. When the state of the global economy and the industry does not permit such rates, the MSA adopts other financial and business strategies that assure the industry will have a source of income to cover its operating cost when freight volumes and vessel-leasing activity shrink.

The SWA, on the other hand, is strictly a national organization. There are as many SWAs as there are participating nations. Entrusted with the EPN by the foreign exporting nation, for undefined environmental excesses caused by the transport, consumption and disposal of its products, each SWA regulates the solid waste landfill industry in its nation by issuing licenses to operate dumps and ensures their environmental obligations are discharged. In the licensing auction rounds conducted by the SWA, those who bid the lowest for operating a landfill, environmental costs excluded, win the license for each auctioned site. Since the lowest, winning bid is likely to have underestimated the 'income elasticity of volume growth', the licensees, operating with a fixed annual revenue (the winning bid amount) and a high cost elasticity of output, will find the waste generated and the cost of operations rise non-linearly when the economy heats up (Conversely, the income elasticity of volume growth would be minimal for a closed cycle economy). It is to cover this 'unanticipated' rise in private and environmental costs that the SWA seeks to discount its EPN and/or buy in to the OSGIP stream of spill policy income.

On the final front, the Export Credit Bureau, ECB, of the importing nation facilitates trade, particularly exports by issuing export credit lines and guarantees. The ECB, dealing in large foreign currency transactions, happens to move the exchange rate with its operations. To carry out its operations while maintaining stability in exchange rates, the ECB must seek a 'foreign currency counterweight' - a financial instrument with a large face value, and denominated in the foreign nation currency that acts as an 'opposite hedge' to stabilize the exchange rate despite the lop-sided transactions that might occur during a currency depreciation-induced, export-led, economic revival. The EPN, guaranteed to its face value in the currency of the foreign nation, is a heaven-sent to the ECB ; it serves various purposes - collateral, exchange rate stabilization, and the facilitation of the export (credits), for which reason it is actively sought by the ECB.

And so, the various interests and incentives converge in financial markets. Both, the OSFA and the ECB bid for the EPN, while the MSA and the SWA bid for the OSGIP. In the normal course of events, the OSFA would deposit its insurance policy premiums in low-risk assets such as the bond market, and the SWA its EPN with Banks for Collateral fee, or with Bond Issuers for an Underwriter's fee. But if the economy were responding to an interest rate stimulus, the SWA, anticipating a period of higher interest rates in a future characterized by larger trade in crude and products, would offer its EPN in the discount market while concomitantly bidding for the OSGIP. In discounting ahead of a rise in interest/discount rates, the SWA hopes to pre-empt competing SWAs and obtain a larger discounted lumpsum for its EPN. Similarly, in seeking the OSGIP, the SWA intends to profit from the expectation of rising stream of income from the variable, 'pay as you ship' policy premiums. Simultaneously, the OSFA, fearing a loss of bond value resulting from an anticipated hike in interest rates, finds the EPN an attractive 'FV Lumpsum' to discount and buy in to both for capital protection (and for the additional cover it offers in the event of an oil spill when the tanker industry is stretched to its capacity; the EPN is also additional protection against an 'un-obliging' Risk Aggregator. For this reason, it'd be appropriate to require the Insurance Aggregators to participate in the issue of the EPN). Toward this objective, the OSFA scans the SWAs of different nations for EPN discounting opportunities. The OSFA is also open to pre-empt the rise in interest rates by trading its OSGIP for a higher lumpsum at an earlier date, and either leverage that lumpsum to palm off the insurance obligation to an Insurance Aggregator, exploit the impending rise in money market yields, or, diversify its risk-return by investing the proceeds to charter and re-lease general merchandise vessels just as charter rates turn north on the cue of an expanding global economy. (Perhaps the OSFA would rein in charter rates if global economic activity were 'oil-intensive'?). On the third front, Merchant shippers, burdened with the fixed cost of holding a ready fleet of freight vessels, walk the fine line between raising charter rates that carry with it the risk of putting the brakes on global economic expansion, and letting the OSFA charter its vessels for a lumpsum that reins in rates and insures (energy-intensive) economic growth. When the global economy approaches its zenith, the Merchant Shippers up their bid for the OSGIP for the steady source of income that it represents and the financial insurance it provides should their fleet remain idle in the contractionary phase of the global macro cycle. On the final frontier, the Export Credit Bureau (of the importing nation) too evinces interest in the EPNs in the hope it may, during a period of increasing trade, leverage the EPN toward underwriting export credit and loans in foreign currency to the face value of the EPN. When the macro-cycle turns around, the ECB is caught with too much foreign currency exposure (the local currency appreciates when the economy is reined in with higher interest rates). Fortuitously, the SWA, which discounted the EPN ahead of rising interest rates is now all too willing to buy it back and book its 'EPN profits' before rates fall to accommodate the next growth cycle, and just in time to fund remediation of environmental excesses of the growth phase.

The OSFA's bid reflects its view of the bond market, in particular how it'd react to expected firming of interest rates. The ECB's bid, on the other hand, would reflect its assessment of export credit demand (a demand sensitive to exchange rates). The question then arises whether the rise in economic activity is driven or accompanied by currency depreciation. If GDP growth and exports are driven by artificial currency depreciation, then the Bond market is likely to tank when, following a surge in GDP growth, a hike in interest rates causes the currency to appreciate. When this is the case, the OSFA is likely to bid over the ECB for the EPN as a safe haven for its bond market holdings (The EPN could also cover oil spills that might occur from the volume-driven rise in exports). Fearing an artificial currency-depreciation induced export bubble, the ECB too backs off from extending too much credit to exporters. If however, the GDP growth were driven by fundamentals, (or, the Fed/Central Bank was expected to stimulate the economy with a drop in interest rates inducing currency depreciation) then the ECB would have its hands full with demand for export credit. It'd bid higher for the EPN which provides it the foreign currency cover necessary to issue export credit without destabilizing the exchange rate. The OSFA then moves its bond holdings to charter and re-lease merchant ships and profit from the sustainable growth in exports. In either case, the SWA obtains a large, if discounted lumpsum for trading its EPN over which it parks in money markets to exploit the anticipated rise in interest rates.

Similarly, both, the SWA and the Merchant Shippers seek the OSGIP, endowed as it is with the certainty of income stream embodied in the insurance premium receivables. The SWA would be the more aggressive of the two bidders at the start of an economic expansion, especially if the Insurance portfolio were weighted heavily toward the 'variable pay as you ship' tonnage-based insurance subscribers, because that would enrich it consequent the rise in crude volumes shipped in times of rising economic activity. The  income stream would be a 'just-in-time' for SWA licensees who must contend with larger volumes of solid waste. In that event, the Merchant shippers raise their charter rates. Toward the end of the economic expansion however, the Merchant shippers, seeking a cover for their fleet in idle times, bid higher for the OSGIP. They vary their bid in the fraction of the OSGIP portfolio comprised of long-term contracts with volume-invariant, fixed insurance premiums. The larger that fraction, the lower the MSA pegs its freight and charter rates to tide over the downturn in economic activity. When the Merchant shippers outbid the SWA, the SWA takes its cue, and promptly buysback the EPN before discount rates drop with falling interest rates and force a higher lumpsum payout.

Unlike the SWA, the OSFA is an insurance agency that is not obligated beyond its payout upon a spill incident. It could, if it were so permitted, choose to bank its profits from OSGIP 'operations'. However, as a prudent insurance firm, the OSFA might sponsor or fund activities and services as diverse as OSHA training, Ocean Vessel Information Systems, Weather Information Systems, and even the subsidizing of loans meant for replacing aged ships. Such supplementary 'investments' enhance the reliability of ocean transport of liquids and reduce the risk of spills, thus protecting the environment, the shippers, and indeed, the crude producers and suppliers. The question arises how one may ensure SWA's gains from EPN operations are translated in to real, verifiable environmental gains, and not creamed off from the cake by politicians who negotiated its face value to start with. Toward resolving this crucial matter, it'd be appropriate to conceive of Efficiency Services Firms, EfSF, and Environmental Service Firms, EnvSFs. Efficiency Service Firms engage in the planning and implementation of economy-wide closed-cycle technologies that contribute to reductions in material intensity of processes and products that eventually obtain reductions in the generation of solid waste and energy consumption. The primary business of Environmental Service Firms is to provide environmental services toward the remediation and restoration of the environment despoiled by (production- and) consumption-externalities. These Environmental Service Firms seek the advice of Environmental Advisors who suggest appropriately-scoped remediation and restoration programs that reduce the multi-media externality from the transportation, disposal and landfilling of solid waste. Both types of firms are empowered by an enabling regulation to obtain loans from Banks participating in EPN operations. Cognizant, on one hand, of the interest rate volatility during a macro-cycle, and on the other, of the potential future gains to the SWA from its EPN operations (which they are in a position to discount prospectively), and taking in to account the potential for business growth, the banks issue loans to EfSFs and EnvSFs upon certification of expected efficiency and environmental gains by the Advisors. These loans, vide the regulation, turn in to the conditional obligation of the SWA.

Upon the conclusion of the program, the EfSFs and EnvSFs submit their report listing remediation costs and environmental benefits as verified/vouched for by the Environmental Auditors, to the SWA. The SWA, on being satisfied with the claims of environmental gains, pays the creditor-banks off in order of descending net benefits. If the Advisors were prescient, the EfSFs and EnvSFs diligent, the Auditors sincere, and the Banks perfectly foresighted, efficiency and environmental services would be provided exactly to the point where marginal benefits equaled marginal costs. The SWA would then have just enough profits to pay off all loans extended by the banks to the EfSFs and EnvSFs. In the general case however, under-provision of environmental services, implying closed cycle technology or restoration activity whose incremental benefits were larger than incremental costs were not undertaken, would let the SWA cream some profits away from its EPN operations which it might further divert to expanding landfills. Similarly, too early, or too much an adoption of new technology and excessive remediation beyond the 'MB=MC' point (or incorrect valuation of costs and benefits), could result in the SWA running out of profits to discharge its loan obligations. When this happens, the banks suffer a loan default, and take the Advisors and the Auditors to task.

Thus designed, this proposal exploits financial incentives and macro-cycle volatility, often the handiwork of politicians hand-in-glove with the industry, to foster efficiency gains and obtain multimedia environmental gains. Amalgamated with an Insurance Aggregator, the OSGIP is administered by a financially more secure entity; profits from OSGIP 'perpetuity operations' are channeled to spill risk-abating activities. On the other hand, the EPN serves many interests, in particular trade, while providing real environmental gains from its discount and buyback operations. Larger the interest rate 'hi-lo' spreads within a macro-cycle, the higher the potential gains for the SWA and OSFA from EPN and OSGIP discounting and buyback operations, and the larger the environmental remediation programs that they can support. The choice between EfSFs and EnvSFs increases competition for SWA funds, and balances efficiency against environmental equity. The fear of loan default ensures banks involved in EPN operations are diligent in issuing loans to only to worthy projects proposed by the EfSFs and EnvSFs. The proposal is an efficient means of balancing progress toward a closed-cycle economy while obtaining remediation of past environmental excesses.

Trade red mud for gasoline? How 'bout your garden for my lake ... Ooops! Your garden and your lake !

Consumer Activism Vs Energy Economissm ?

Ganga Prasad G. Rao

http://myprofile.cos.com/gangar

Ever so often, we come across those occasions when our professional prudence is extended and challenged by ethical dilemmas. Physicians weighing the pros and cons of referring a patient for a procedure or to a specialist not unaware of the gain to their practice; an HoD extending the PhD program of a candidate to squeeze out a couple more semesters of teaching to avoid a costly faculty recruitment; even policymakers and bankers winking lagged-asynchronously with the RBI when it comes to monetary moves that shake up the bourses. But would it be 'harakiri' of an Energy Economist to break the bounds of his discipline, tear the fence of professional decency and question the  logic of revised power tariffs - self-interest or otherwise?

Just the past month, the Chief Minister of TN proposed the revised power tariffs applicable for various classes of TANGEDCO customers. Surprise, surprise....No surprise! The tariffs were merely an escalation of rates for various slabs - more taxing of the Conspicuous Consumer than of the 'Cave dwellers'. My angst at the revised tariffs stems not as much from the hike; the hikes are significant and perhaps necessary; it is about all the other factors that go in to the price of power, but are taken for granted by the authorities, and sadly, forgotten by the consumer.

I am no Buddha, the Enlightened, but yes, the tariffs announced are meant for supply of power at 220 volts. But in India, where discounts are a way of life, would you really blame the TANGEDCO for delivering power discounted of its voltage? If I were the devil himself, my repartee would be: Doesn't the refrigerator chill your beer at 200 V? And aren't your TV images even more sinuous at 180V? Then why the sermon? Just play along and pray while the reaper reaps the guaranteed return on the expanded asset base necessary to fulfill the incremental demand of them power thievers!

Correct me if I stray from truth, but a tariff hike is meant to garner additional revenues, and alleviate the recurrence of extended power-cuts. And yet, the hike in tariff has had virtually no impact upon the hours of power interruptions that consumers suffer in the State. A 50% increase in tariff rate in certain slabs has no supply response? Incredible? Or, has TANGEDCO found it expedient to exploit the habit-formation around the routine power cuts to hawk within-state power generation and its quota from neighboring states at Rs12 a unit and get away with the excuse the loot covers for past subsidies (which in reality have since been 'capitalized' in asset reconstruction involving replacement/expansion of generation capacity)? If uninterrupted power were supplied at Rs5 a unit, I wouldn't be the fool for paying the same tariff with 60 hours of scheduled monthly interruptions and, lord be kind, as many number of unscheduled interruptions at various times of the day in peak summer? Would I be? Perhaps the tariffs are a package deal for consumers with implicit 'peak utility reduction'? Know what I mean, Consumer Economists?

True, prices are determined by supply and demand (indeed, water sells at a premium to gasoline), but shouldn't a socialized power sector feeding off public sector coal companies, pass on to consumers the cost-savings from new generation and transmission technology, from scale economies, and from efficiency gains from tapping the expanded national power grid, not to mention the gains from competition consequent the entry of new firms and the advent of new generation, transmission and distribution technologies? Instead, and to the contrary, I fear our power regulators are dancing the tango with political bigwigs to delay new investment in carbon- and non-carbon-based generation in line with a FII-dictated tariff and stock price 'expectations' (For those of you economists, 'rational expectations' indeed !)? Power may be a commodity on the grid and at the power exchange, but it sure turns a luxury closer to your home!

So, wise guy, where are we going with all this? Preach not, if thy hath not the cure. The cure, hallowed be thy name, is almost divinely simple. Thanks to the fore-sighted engineers of past decades, we boast of a widespread, almost universal prevalence of 3-phase power connections to end users. Let's leverage the same to switch over to a '3 phase - 3 distributor' configuration and introduce competition among power distributors at the consumer end of the network. With suitable hardware and software enhancements, including and in particular, a 'multi-supplier' digital power consumption meter with memory and 2-way interactivity, each power consumer - whether residential, institutional, commercial or industrial - would, by way of their 3-phase connection, have the option to put on tap one of three distribution companies for any one tariff period: the local SEB supplying power on a conventional, subsidized, slab-tariff basis; a nationally-competitive power supply firm, that drawing upon its wide reach thru the power grid, offers power on a 'Time of Day' basis; and an internationally competitive 'Full-cost Green Power' that exploits natural, geographical, and seasonal advantage to offer power on a 'day ahead prices' basis. Consumers, with the option to switch between the 3 phases (which now double up for 3 distribution firms) would have the choice to exploit state subsidy, national competition in power generation, and, even nature's bounty! All that it'd take for consumers would be to verify the day-ahead 'Green offer' on their 'multi-supply' meter, evaluate its competitiveness vis-a-vis, on one hand with the time-invariant tariff slabs for SEB power, and on the other with expected National ToD prices, and, with a flip of the phase-switcher, lock their choice for the 'morrow. The ensuing competition from the recurrent household, commercial and industrial choices, would resolve many ills that plague the current system: lack of competition in power supply, lack of consumer choice, the tyranny of 'scheduled' power cuts, the nasty surprises that unscheduled interruptions are, and even voltage woes. Power generators and distributors too would receive signals from the various classes of power users and attune their fuel, generation and pricing strategies. All stakeholders - generators, transmission firms, distributors and end users - stand to benefit from efficiency gains, which in turn behooves well for the financial and environmental sustainability of the power sector (consistent with income and preferences of end users).

Here, let's raise a toast to competition and choice in power supply, rational tariffs...Yikes!, A power cut, again.

Yet again?....You mean no candle-light dinner? Yup, got that right! No...wait, ...Yes...No...No....Yes !!

Export Your National Debt!

Export Your National Debt!

Ganga Prasad G. Rao
http://myprofile.cos.com/gangar

To call it day-light robbery would be an understatement of the future century! I allude to the 10^n dollar debt that many nations, in particular the US, have racked up over the past decades - decades of profligate living, white elephant ‘investments’, unsustainable entitlements and unholy wars – and which have been unloaded upon the global capital markets to the detriment of the unsuspecting and prudent, diversified global citizen. And now, as the world economy comes to a grind with the spread of one economic malaise /financial contagion after another, the financialcrises induced by these debts have reduced the viability of several provident funds, be they insurance, pension, social security, or education. The looming deficits have threatened the macro-stability of nations, even their ability to pay (inflated) wages and bills, and reduced governments to hawking assets as collateral for additional debt to fund day-to-day governance. (It’s a mystery afflicted Western democracies even issue, in these troubled times, long bonds for yields of a measly few percent!).The trouble with debt servicing is that it reduces discretionary spending, the very basis of Keynesian economics. One can only wiggle so much when pushed in to a debt trap! No government has the audacity to undertake large investments, even if prudent in the long run that increase the debt burden while in the midst of a crisis. To compound the problem, any cutback in Government spending and wages as part of an Austerity program reduces Disposable Income, which puts the brakes on the entire Consumer economy - the roots that sustain Western Capitalism. Bottom line: Debt is a very real pain, unless you mean not to pay it!

Now there are as many plans to resolve the debt crisis as there are currencies in the world. A unified global currency (and Socialized Global Debt! Hey!, Didn’t we spill in the oceans, police your seas, trespass in to your ports and say hello to the sea-side nuclear installation of your US-AID subsidized nation with our billion dollar-apiece nuclear subs?). Better yet,capitalize the Global Heritage sites and Wilderness parks by dissolving the national debt as ‘WTP Capital’ to be paid inby generations of vacationers from across the seas.Outrageous? Then, hold your breath, here’s one that takes the cake! Export your debt! Export? You mean all $14 T..R..I..L..L..L..L..I..O..N of it? Yes, sell the debt, why even auction it away! Incredible? But there must be a catch. Sure, there is .... in fact, a very real, palpable, even a permanent‘earnings and lifestyle cost’ on the populace; yet the strategy is novel and no fantasy. It will shrink the debt almost overnight. But who will bell the cat,…I mean, buy the debt? and why? Wouldn’t that be akin to relieving Atlas off his burden to stake a slice of it?

Strange as it might seem, even an indebted nation is necessary to a globalized world in which nations must exploit their competitive advantage in international trade to sustain their economies.In nations with high capital cost due uncertainty in political terms and policy switches, the Industry might seek the certainty of an export quota to reduce the cost of capital of its investments and operations. Certainty in export revenues (and control over the time profile of exports) could substantially alleviate the necessity to hold large inventories and engage incostly hedges, and risk abatement strategies. If exports were that important to nations, wouldn’t they be eager to pursue it, even be willing to negotiate some? After all, who wouldn’t want to export to the US, the capital of profligate consumption? And what could be more ‘patriotic’ of exporters to the US than to buy off their national debt - not in their individual business capacity, but as a nation - in return for a guaranteed export market (a Guaranteed Export Quota, GEQ) over an entire decade or more? That, then, is one of the pillars upon which the strategy rests. It leverages the strategic shadow value that developing economies have for developing economies, to force them to buy in to debt obligations that are bundled with guaranteed, multi-year export quota rights at auctions in competition with other export-seeking nations. Nations seeking to export to the US on a long-term, guaranteed basis, would be required to buy and discharge some of that nation’s debt as well. Put another way, the US would be exploiting its ‘monopsony power’ as the major consuming nation, to pressure exporting nations in to sharing their export rentstoward the discharge of its national debt. Since many nations would compete in the auctions for the bundled debt-export quota, they would, in effect, be pricing the ‘bad’ in to the ‘good’. The bidding would reflect as much the competitiveness of exporting nations as it would their ability to leverage the export quotas to boost their domestic economy. Exporting nations would exploit their competitive advantage – whether from natural resources, concentration of factor endowments, spatial advantage,technological superiority, or some combination,to grow their economic pie from exporting high margin products under the GEQ, while paying off the bundled debts as well. Critically, the GEQ only specifies the total value of exports over the contracted period, and specifically not the timing, constitution of exports or the price of export goods, all of which are determined by participants in the export market.

As for the auctions, they are intended to elicit the maximum amount of US debt that ‘Exporting Nations’ would accept with their bid for the GEQ; the GEQs being hawked piecemeal with a fixed validity period: say $100B Export quota valid over 10 years. Thus, and for example, an Exporting Nation may bid $50B of debt obligations to secure the $100B GEQ. The initial auction rounds would be dominated by those nations with the macro-economic acumen to leverage the GEQs in to large GDP gains – sort of a large export-driven multiplier effect - and by nations producing and exporting high value, high- margin goods. Subsequent auction rounds would see successively lower bids for the bundled debt, implying lower margin exports, until the benefits of securing the GEQ do not compensate for the added burden of debt obligation. Following this 1st round auction war across nations, the Governments of winning ‘partner-nations’ could assign the GEQs strategically, or auction them in the 2nd round to industries and businesses at home. If the latter, then a portion of the rents from prospective export sales could be recovered upfront and applied to discharging the debt obligations. Industries bidding for multi-year export quota would bid for it much like they would for a license. The bidding would reveal, in part, their margins, their inter-temporal plans and discount rate/cost of capital. Businesses with a large margin or low cost of capital, and those with plans to exploit the quota in early years will likely bid higher than others. The GEQs will be fulfilled thru a Public-Private-Partnership Export-Oriented-Unit Joint-Venture vehicle, PPP EOU JV (with non-managerial, equity participation by the Government, and debt participation by ExIm Bank) with the more capital-efficient bidders, thus livening up the 2nd round auctions. Clearly then, the critical question is not whether they will buy the debt, but how they intend to leverage it.

The leveraging of the GEQ is the second pillar of this strategy. Understandably, a nation taking on (hundreds) of billionsin debt (and as much in export quota) would seek to generate twice that amount in profits and economic activity. That is no easy task; not even an assured outcome. In fact, it’d require some uncommon dexterity in economic and financial planning along with a large dose of foresight to pull it off. But if the GEQ - the guarantee being credible for obvious reasons -were considered, in effect, a ‘(to be earned) Receivable’ on the Revenue side of National Accounts of the bidding nation, the same could be used by its Government to sponsor the issue of Currency, Bonds, and Equityin amount equal the fresh investment funds necessary for Export-Oriented Units, EOU,to fulfill the export quotas. This ‘partner-nation’ would then discharge the debt obligations from export rents, from bond market ‘total returns’ (the bonds having been issued by the ExIm-Bank with the GEQ for collateral),equity dividends, and from larger tax revenues following expansion of the domestic economy. The exporting nation could further exploit the GEQ to structure its economic policies in an ‘Opposite Complement’ mode which would enable it toexploit exchange rate and export price-volume fluctuations to optimally manage both demand and inflation at home. In particular, if the exports were of the Consumer durable type, it’d be opportune to attune the interest rate regime in opposite phase with that of the debtor nation. Further, if the exporting nation aligned its consumer demand in line with the pattern of consumer demand in the debtor nation, that would further aid the exploitation of scale and scope economies at the EOUs – Be the ‘Lifestyle Followers‘ of the nation whose debt your exports discharge!

The question arises why these incentives do not obtain under the current system. After all, the US espouses and practices capitalism with free trade. Shouldn’t all economic opportunities have been exhausted so none remain to be exploited? The answer is manifold. First, capitalism did not anticipate a 14 Trillion debt. Second,a formal mechanism does not exist to exploit a ‘pareto opportunity’ that a combined GEQ-Debt bundle offers to the US and theexporting nations. Third, the multifarious cost-reducing and macro-planning benefits arising from the certainty of a large, extended export quota,that enable ‘exporting-nations’ to plan their economy around the ‘certain, but to be earned’ export windfall, has apparently not been fully appreciated. Besides, there is little natural incentive in the current system for a resource-rich nation to leverage its advantage with a technologically-endowed nation to offer an export package to an indebted nation in return for discharging its debt obligation.

It is but a natural incentive among the exporting nations owning an export quota to seek market power or otherwise overprice their exports. However, given the very real prospect of frontloading of exports and its price-dampening impact, and the macro-impacts of competition in the export market on exchange rates, it’d be prudent of exporting nations to play straight and maintain a justifiable exchange rate. In the context of the debt-bundled GEQ, exporting nations would also seek to export goods that are less capital-intensive so that the debt could be paid off with the minimum incremental capital on ground (or, conversely, the incremental GEQ capital could be put to maximum use).The US, on the other hand, obligated to import goods to a certain monetary value, would seek to limit its employment losses, and limit imports to those goods and services that were the least labor-intensive.

Equity impacts, especially upon the labor market, are foremost in the minds of political leaders. While the US would, as alluded above, seek to shield its workforce by limiting imports to the (locally) less labor-intensive goods and services, it’d would also find it advantageous to move some of its strategic (friendly) equity/sovereign debt investments in to the equity and debt markets of the ‘debt-partner’ nations in anticipation of the shift in production, following the GEQ 1st round auctions. As a complementary strategy,the debtor nation could also make unfriendly, speculatory investments in Currency markets to counter, on one hand, any diabolical market power strategies meant at cartelizing the export market, and on the other, to deny exchange rate manipulations aimed at gaining export advantage. The debtor nation would harvest the currency markets upon evidence of either cartelization or exchange rate manipulation. The ‘See Saw’ gains from playing the ‘within and across’ level-arbitrages and volatility across the ‘friendly’ and ‘unfriendly’ hedges could feed a proposed ‘service-sector wage match fund -or-social security match fund’ expressly for labor prospectively displaced by this policy.

Unfortunately, the proposed resolution to the debt crisis is neither unqualified, unconditional, nor universal. In fact, and to the contrary, this proposal is more a policy opportunity, an opportunity that must be explicitly and consciously tailored by combining economic advantages and bilateral policy synergies across trading nations. As with any policy, there are costs and benefits (and to both sides). For the US, the debt-bundled-with-GEQ policy implies an export of domestic production capacity, and an expansion of unemployment in sectors in which it isn’t internationally competitive. Whether the reduction in debt reduces long-bond yields (and medicare costs!) sufficiently to cover for the increase in unemployment (net of the ‘match-check compensation’) is a political question. As for exporting nations, the immediate cornucopia of a guaranteed export order is moderated by the realization exports would bring only normal returns due up-front harvesting of rents as 2nd tier auction premiums. The extraction of rents at each stage implies the exploitation of the factor with the most elastic supply. This implies exporters might cut corners in various ways incompatible with generally accepted labor and ESH standards. Thus, in the case of developing nations with a large workforce, labor exploitation and exploitation of the environment are likely outcomes.For this reason, it’d be preferable to adopt the PPP-EOU-JV export model. The necessity to toe the line in terms of consumer demand and macro policy too has a cost, albeit non-monetary.

$14 Trillion could mean several things: A Fiscal disaster, Christmas in a Neverland, a Policy maker’s delight, a workaholic Regulator’s champagne… and indeed a President’s nightmare! The proposal here is but a modest start on the long road to economic and policy sustainability; it should be evaluated against its ‘opportunity cost’ -the laissez faire.

Regulatory Lines and Cost-Benefit Lessons

Regulatory Lines and Cost-Benefit Lessons

Ganga Prasad G. Rao
http://myprofile.cos.com/gangar

Trekking is for lovers, or so one would believe. Why else would anyone walk miles of treacherous serpentine paths to be stung by spines and bees, suffer sunburns and risk exhaustion, only to turn around and walk what would be the equivalent of twice those miles? Brett though, was an exception. His love for trekking was an expression of his freedom, and distaste for the mundane and the routine. Working for the Strategy Group within the Industry-Government Regulatory Panel, IGRP, was supposed to be a breeze. Some considered it a liaison job and looked down upon him, but Brett, the Regulator on the Panel, did not care to stoop low and respond. Instead, what bothered him now, as he ambled along the trekking path, was the perpetual pressure to come up with new concepts and ideas that were at the same time incrementally more efficient, more equitable, and did not engender externalities. Ain’t that the responsibility of those smart-ass Harvard Graduates? Those 7-figure salaried ‘Royal class' who would catch a cold if they as much looked at Commoner graduates? But, sanity got the better of his jealousy, and he instead trained his thoughts at how he could impress the bosses in the Government and the Industry with his imagination and land the much coveted Chair of the Regulatory panel over the Ivy-league favourites. Early on, he realized he'd have to focus on ideas that expanded the economic pie rather than those that merely transferred revenues and rents from one section of society to another. Ask any economist what expands the pie, and his answer would be: Technological Innovation, Resource exploitation and WTP gains following income expansion. But were there sufficient incentives in the system to seek those innovations and fulfill the WTPs? And how would one set the ball rolling?

Pacing himself through the rugged terrain, Brett began at the top of the pyramid – the Judges, arguably the cream of the society in knowledge, expertise and social jurisprudence, whose charge it was to monitor their domain (whether societal or industrial) and determine if the extant constitutional system of laws, rules and regulations was enforced and monitored for intended outcomes, and who further ensured that the system anticipated loopholes and exceptions, and reformed/updated itself to scientific, health, technological and social developments.Judges on the Government side dealt with Social-, Environmental-, Health- and Safety- Externality, (SESH) issues, while those on the side of the Industry focused on more mundane issues such as Efficiency, Growth, Profits, Price, Inflation and Competition. In the course of their judgeship, the Judges came upon those cases, pleas,and plaints that stood out for the lacunae and inadequacies they revealed in the existing system - cases from which they would draw their specific lessons, and draw juridical generalizations as appropriate. As Brett imagined, the Judges would, during the proceedings, and post judgement, dwell upon the origins of the Case, examine what principles – economic, constitutional, or regulatory, were violated and why. They would ruminate on which law or Institution failed, for what reason, and on the recourses available to resolve the matter, including in particular, the necessity of additional legal stipulations or programs. Required to ensure a resolution even if in future, the Judges issued either a 'Stricture', or a 'Recommendation' to the Executive (if a SESH matter), or an ‘Issue Paper', if it concerned the Industry. The Stricture/Recommendation carried, explicitly or implicitly, the authority to structure an appropriate program, policy or regulation,at public cost.

Winding a path through the alternating rocky terrain and shrubs, Brett gave a free lien to his thoughts, or should we say, imagination. Now, the President, as the Head of the Executive, and seized as he was with governing the state, took note of the stricture/recommendations from the Judge. In fact, as he perceived it, he could, with a little bit of political and regulatory acumen, 'monetize' the recommendations, even the stricture, as a line item for a policy/regulatory program in his budget(Why, he could even have the Fed print money for the program! Did it not result in social gain?). Elsewhere, the Industry Judge penned an Issue paper to elucidate his thoughts upon a matter of particular concern between the Industry and the Government. The Issue paper evoked academic and professional responses that provided the grist for research discussed as Working papers at seminars and conferences. If a domestic issue, the Industry Association pursued it with the concerned Ministry or Department of the Government to obtain a just resolution. But when it involved MNCs, trade policy, or issues in the international arena, the Issue- and Working papers were forwarded to the World Bank which sponsored a grant to seek a policy resolution. The Bank came out with a Policy Study in public, and privately issued a Policy Line and a Lobby line consistent with the shadow value of the recommended policy remedy/reform. The Lobby Line, targeted at Policy-makers and legislators, wound its way through Ministries and the Parliament if a 'short-run issue', and if long, through the Planning/Investment/Competition Commission and influential Think-tanks. The Bank split its Policy Line between, on one hand, a fund to underwrite the cost of regulation and cover the one-time cost of regulatory compliance, and on the other, a strategic allocation of funds between long-term equity investments and liquid financial instruments, so it could reward the nation if it chose to accept the suggested policy reform, or reverse its liquid positions to send a message, if otherwise.

With the shrubs behind, and the sun beating down upon him, Brett trekked the straight path toward the local peak. He let his imagination loose again. And so when the Prez began his search for a Regulator to give shape to the Judge’s directions, the word spread faster than an earthquake would over the continental divide. Despite the competition from his Ivy League detractors, Brett fancied his chances, for he had developed a unique, patented regulatory ‘recipe’ that was the better for not following established theory. His regulatory twist involved consciously pairing SESH program lines with Industrial policy reform lines; the trick being to exploit the synergies of efficiency upgrades - the goal of policy reform - with equity enhancements deemed necessary to resolve the Judge’s SESH advisory. Brett, knowing most policy reform that enhanced efficiency tended to impact equity negatively, was careful in the choice of the Equity program to pair with Policy Reform. In general, he found it advantageous to choose Equity programs that involved those impacted by past externalities generated by the target sector of the policy reform. It was a half-way solution to internalize equity in to cost-benefit computations. But Brett didn’t stop with the Equity enhancement. He even went so far as to modify the Net Benefits criterion to suit the realities of political decision-making within a multi-party democracy. Realizing that the Executive would not mind either un-allocated funds, or the flexibility to cross-assign those unallocated funds as necessitated by the particular politico-economy context, he enhanced the net benefits criterion by adding to it the Residual Policy line. Vide this criterion, the Regulator would choose that option which obtained large,but not the largest net benefits, and yet, left a substantial Policy line unspent with the Executive. In addition, and in lieu of the sacrifice of the option with the largest net benefit, Brett counted in to his criterion, the overlap of equity impacts from each policy option with various SESH lines. Essentially, Brett counted in to his criterion, the avoided expenditures from the various SESH lines due the choice of a (sub)-optimal regulatory policy option. Thus designed, the ‘Brett Enhanced Net Benefits’, BENB Criterion, chose that combination of Policy option & SESH line that maximized a combination of efficiency, equity and the option value of holding unallocated resources.

The trek ahead was decidedly risky, with steep rock faces; in fact, Brett deemed rock-climbing skills essential.But Brett wouldn’t let the risks limit his professional fancies. If the Executive favoured him with the contract, he’d forthwith sub-contract with Consultants to ‘flesh out’ the costs, benefits and equity impacts of alternative regulatory options exploiting the Policy reform line, each different in scope and principles. If one proposal hinged on flexibility, another banked on scale and scope economies; yet another on prospective and contingent M&A activities, and even one that permitted a Monetary/Coasian Property rights resolution. These alternative regulatory proposals would compete for resources from the same Policy Line – the line issued by the World Bank or the National Industry Trade Association, and obtain different amounts of efficiency gains albeit with positive or negative equity impacts.

Finally, Brett made it … to the top of the scarp. Had the trek been worth it thus far? Why sure, for Brett had before him, if ethereally, a concise table that listed the costs and benefits of various regulatory options as evaluated by his consultants. The regulatory options competed for the same Policy line (issued by the Executive in response to a Stricture/Recommendation) and generally varied with regard to Costs (Spending), Benefits,and Net benefits. To these regulatory options he paired 4 different SESH Equity Lines representing 4 different equity programs, each with its own intended group of recipients. Next, Brett noted the extent of the incidence of the impacts of the 4 regulatory options with the intended group of SESH Equity line recipients. Applying the BENB Criterion, Brett chose that regulatory option-SESH program combination which maximized the sum of Efficiency gains, Equity overlap and unspent Regulatory Resources (and expressly excluded the SESH resources that remained untouched in his proposal).

At this point, and relaxing on the Mesa top in the warm afternoon sun, Brett found it useful to elucidate his concept with a real-life example. He chose the case of the health impacts of exposure to mercury and lead. The Judges had ruled that recent advances in medical sciences had established that the two metals, long suspected to be neuro- and geno-toxic, were indeed so at a concentration a further two magnitudes lower. In their recommendation to the Public Health Advisory Committee, the Judges endorsed the case for a tightening of exposure limits; they also explicitly supported compensating a wider swathe of the affected population. As an IGRP Regulator, Brett found this SESH recommendation of particular relevance, working as he was with a regulatory initiative to subsidize the capital cost of more efficient Combined cycle technology at thermal power plants; thermal plants being a significant source of mercury in the air.

Likening the Capital Cost subsidy to a Policy Line of $500M, and considering the various SESH lines, (including Mercury SESH line) Brett examined the 4 regulatory options. If he were fresh from Graduate school (or, one so orthodox he hadn't lost his virginity in the profession!), Brett would have been inclined to go with Option 4 for the largest Net Benefits that it obtained. However, as one walking the fine line between Judges, the Executive, the Industry Association, and for good measure, the World Bank, he tentatively chose the more pragmatic path that recognized, over and above Net Benefits, the worth of resources yet unspent (Net Benefits+Residual Policy Line, NBRPL). This criterion yielded Options 1 and 2 as equal favourites. But Brett was yet short of his optimum. Hadn't he envisaged exploiting any incidental overlap of equity benefits from the Capital cost subsidy policy with benefits intended for recipients of the various SESH lines? To examine that possibility, Brett further added to NBRPL, the Equity overlap (Regulatory benefits that doubled as Equity compensation) as determined for each SESH constituency. Now, the BENP criterion represented the sum of Net Benefits, Residual Policy Line, and SESH Equity overlap. Thus modified, the BENP criterion homed in on Option1 + SESH Line 4 as the optimum regulatory initiative. The BENP Score of $550M represented the sum of $200M in net benefits, $250M in unspent regulatory resources, and $100M in redundant SESH compensation due overlap in Mercury benefits. Put another way, the choice represented the benefits of avoided mercury pollution from adopting Combined Cycle technology that precluded a redundancy of compensation to the (potentially) Mercury-exposed from the Mercury SESH line. The chosen option obtained large efficiency gains to the industry, while ensuring a significant equity pay-off for an environmentally-denied group, and left the World Bank and the Executive with substantial leeway in the allocation of unspent Regulatory and Equity monies.

Brett was confident his paired approach would be optimal for an economy seeking to expand its pie efficiently, while simultaneously enhancing equity in the society. Proud of the universality of his approach, Brett hoped it'd turn the IGRP scales in his favor. With that hope and anticipation, he packed up for the long trek back home.....

Gotta beat the Monday morn congestion hour charges !

Active and Passive Vices…err…Voices…err…Values!

Active and Passive Vices…err…Voices…err…Values!



Ganga Prasad G. Rao
http://myprofile.cos.com/gangar


It was a dark storm that had engulfed the FinMin. The economy was in doldrums. Inflation was rampant, and every index of production intent on taking an ‘U’ and diving south. And to complicate matters, the capital markets were all too foresighted and taking plunges after plunges anticipating the economic downturn. The Economic Advisors to the Minister had their ear-ful but had nothing to offer beyond the usual prescriptions. With elections impending, the Minister was at his wits end, receptive to any suggestion, no matter how untried and untested to shore up his party at the polls. Now there’s always one who awaits the ‘Opportunity knocks but once’ circumstance. And who could it be but the infamous Iamsly. Years,… no, decades of doing business with corrupt politicians, whom he had enriched with crumbs from the mineral resources he had exploited, had turned him a billionaire many times over. Call it the pangs of patriotism, empathy for the profession/industry, or a desire to ‘give back’ to those whom he had so mercilessly exploited, but Iamsly was willing to consider a ‘not insubstantial’ donation to a few ‘worthy’ causes, if his excesses were overlooked. Christmas is all about giving, isn’t it?

Does it take a soothsayer to predict what happens when desire meets urge? Or, when one hears a rumor of money to be given away? They turned up sooner than a fly seeks spilled syrup! …Predictably, the first one thru the door claimed to represent those impenured by Iamsly’s International mining firm, in fact representing those accursed in the ‘resource curse’ era. Rubbing shoulders, the other smiling face offered his credentials; he represented the environmentally exploited, and yet in poverty. And forcing her way between the two, the fat lady drew Iamsly’s attention with her charm as she introduced herself as the Head of the Charities for the Aborted Unborns (and,sly sly, MIAs). Behind her was a, … well, many with their begging bowls, small, large, and… hmm.

Was it strategic, genius, or a mere coincidence when Iamsly’s Advisor-Son-Heir apparent -let’s call him Ash shall we? - suggested a ‘tri-partite’ round of Golf meeting between Iamsly, the Minister and the representatives of the various Charities? Perhaps the ‘unscheduled’ mid-term elections were around the corner, for the Minister, uncharacteristically, willingly accommodated the golf picnic, albeit after insisting upon an Attorney by his side. And so, they congregated, in the shade of the White Oak by the golf course. The preliminaries behind, Ash put forth his proposal. He recalled that, over the decades, the nation had witnessed several regime changes – from democratic to dynastic, autocratic to dictatorial…and that Iamsly was an ardent supporter of consensual democracy. Ash pressed the point that tax laws were obeyed more in the exception in those ‘doldrum’ years, then fixed against the Resource barons - ostensibly so the nation could tide over its growing pains, then overturned again to accommodate a dictator’s vengeance, and now were being repealed all over again. Was it Iamsly’s fault that he was incriminated in a dozen tax claims across three decades?

The pressure of the upcoming unscheduled mid-terms must have been intense, for the Minister was all ears. He wondered what the heir had in mind to resolve the matter?Capitalizing on the opportunity, Ash was quick to his point:Shouldn’t the Government, in the spirit of ‘reconciliation’, forgive prior the elections, the (tax) excesses of years past? Referring obliquely to the 2 dozen tax cases that he would inherit, Ash, proposed that the Ministry could repeal the tax laws and permit negotiated tri-partite settlements that channelled the disputed tax amounts to ‘worthy’ causes. Couldn’t we, argued Ash persuasively, in the spirit of the Yuletide, ….ahem…. add a clause that permitted Charities and NGOs to bid for the disputed tax monies set aside in escrow accounts? Why, they could compete amongst themselves in bidding rounds by varying the ‘degree of forgivance’ they would offer to the defendant, to sway the donation their way, and thus resolve the dispute amicably. What Ash didn’t divulge was his hope that the more severe the crash crunch the NGOs and charities faced, the worthier and the less-correlated their cause, (or, the looser their principles) the larger would be the degree of tax forgivance they would risk in the bidding rounds. Plainspeak: Forgive my ‘the-axe’ excesses and I fill your stockings!.

The Attorney interrupted Ash as he outlined his proposal, and insisted that any tax settlement be recorded formally as an affidavit in the arbitration documents to be signed by the Minister. But it was the Minister who foresaw that Iamsly(and his ilk) would get away with looting the Fort Knox in broad daylight, what with several Charities bidding for the ‘escrow largesse’. Uprightly, he insisted that the ‘forgivers’ have choice aplenty as to the party with whom to engage in the ‘forgivance business’. Surprised with the Minister’s acumen, Ash presumed the Minister would also be wise to the possibility NGOs would cross-compete and forgive the grossest of sins, crimes and evasions in bidding against each other even as they defended their own turf in interests dear to them. And indeed, the Minister, fearing the subversion of Justice, sought the opinion of the bemused Attorney, who suggested a EqSF/EfSF variant, that empowered those NGOs that truly believed in their cause, to outbid the more forgiving and the less-principled amongst them, and claim restitution for the ‘unforgiven’ wrongs via the ‘Bond market – Full key’ resolution. Ash cringed at the prospect of the bond market playing volatility on his escrow until the wrong was corrected, but played along fearing the talks would break down.

In the months that followed Iamsly, Ash, and those other Iamnasty,gathered under the watchful eye of the Attorney as the various charities and NGOs – environmental, health, social, animal rights, gay rights, you name it – bid against each other to offer various degrees of ‘tax forgivances’. A case of a $10 million tax avoidance was bid up to 60% forgivance, in return for a $2 million endowment to the environmental organization.A ‘tax case’ involving oil spill in the Mid-Atlantic counted for near nothing in a settlement with a Gay rights organization – the guilty excused a good 90% of his oil spill dues. In another dispute, a firm in the dock for a Superfund NIMBY violation, was cornered with a ‘meet you half-way’ offer by the Vietnam Vets,literally for the cake!Worse, a case of ‘Leaded Gasoline with 6% Benzene’ was bid away by an EqSF environmental organization that sponsored and underwrote a new issue of ‘Education for the Poor’ bonds with the wrong.

A lonely intern whom the Attorney had accompany him, took note of the ‘principals’ and ‘principles’ involved in the ‘tax forgivance – sin encashing – fund raising’ trading sessions, in particular the implicit ‘premiums and discounts’ across the various settlements. He hoped to collect sufficient data to put together a model that would facilitate the elicitation of overt and passive values for environmental and social causes, as well as WTAs among the ‘Forgivers’,and WTPs among the ‘Forgiven’ for various environmental sins that fouled the commons. He hypothesized that an incentive existed to permit the proliferation of Charities and NGOs, staff them with unethical managers, and hold their finances on a leash, so they’d be willing, even waiting to ‘forgive and forget’ the sins, omissions and commissions of the industry for a pittance. He hoped to get a Master’s thesis out of it. As for his thesis committee, the Attorney was already weighing upon him.....and an Iamnasty waiting in the wings to fund him even an entire year.

Here’s wishing him all luck! (and, years to his life)

Au Revoir !

Transition Robonomics!

Transition Robonomics !

Ganga Prasad Rao

http://myprofile.cos.com/gangar


Economics might be the Les Miserables of Social Sciences, but that did not stop John Jetson from day dreaming between his shifts as a week-on/week-off temp at the automobile factory and the Masters he pursued at the local Community college. And day dream he did, between his gulps of beer while fixing a tyre on his Chevy….this being a warm Sunday afternoon in August ….of a world in which he would wake up to breakfast served in bed by his very personal robot, of being robot-driven thrice a week to his very own Executive office, and apprised of his appointments by a robot Secretary, then supervising robots assembling robots, ….and, not to forget, lazing in the sun between work days writing lyrics set to robot music. But an all too familiar shrill voice woke him up. With a cantankerous 2-year old on one arm and a suckling baby on the other, his wife of 4 years was berating him to find a ‘real’ job, a full-time job that would bring soup to the dinner table instead of a ‘back to school’ program in Economics at 42 that impoverished the growing family.

“God”, Jetson murmured to himself, “should have turned certain female frequencies inaudible to men”. Honestly, why would anyone want to work when robots were at his beck and call? But reality got the better of his virtual self. Only last month had the smart-alec Engineers put the finishing touches on an AI-enhanced robot assembly line at the automobile factory south of Main Street. The entire community was outraged at the carnage that followed; the labor force cut in half and their families on the road on the double. And yet, it was necessary for the Big 4th to retain its share in the auto market and survive to fight another day. Besides, there weren’t too many employers waiting to offer him wages that supported his family and the College. Caught between a rock and a hard place, Jetson Sr. wondered why labor-saving technological change, a concept he had been taught in Production Economics, should bring misery to those who could least afford it? And what could the Government do to anticipate a world of robots running our factories? Couldn’t anyone find a “…..Hey, that could be my Master’s paper, even my ticket to graduation!” With a twinkle in his eye….and a mollifying hug and kiss…Jetson Sr., set out in his run-down Chevy to the College library with a scratch pad to prove his genius and, just perhaps, start along a new road, to new career.

Thank the Good Lord for mercies small and ...hmm?,... for the library was open, perhaps anticipating sophomores returning to school for an early start on their Fall semester. Jetson found a corner table, and literally ‘hit the books’. Taught to be methodical in research, Jetson began by writing down his objective: to maximize an Aggregate Social Welfare Function, SWF, for the society in general, but in particular labor, subject to various constraints that included the nation’s macroeconomic identity, an industry aggregate profit function, a population-evolution function, a ‘labor-supply’ function, a ‘Social’ (as opposed to ‘Private’) Resource discovery-cum-Reserve transformation function, and ancillary functions governing capital, wage and price formation in the economy. The objective and the constraints identified, Jetson began by specifying the Resource-Reserve functions. There was the conundrum of specifying the process of Resource discovery, and the transformation of Resources to Reserves. He addressed it by positing a 2+1 set of functions and identities.

The first function, ResDisc, represented the process of resource discovery as a multiplicative probabilistic process: the success rate being both a function of cumulative resources discovered and the Exploration Budget, ExpBud in the current period. The latter was a function of many variables, including Lifestyle expectations, LS, discount rate, r, rental rate of Capital, v, per-capita consumption, C/Pop (= y), ratio of domestic to international (resource) prices, p/P, Population, Pop, and Economic Policies, EcPol. The identity represented the addition of discoveries to the Resource Base, RoB. To model Reserve Base, ReB, the currently economic portion of the resource base, Jetson specified a third function of domestic and international prices, p & P, technology embedded in (net) capital investment, IT, capital K, wages, w, and a variable denoting the comprehensiveness and stringency of Environmental Regulations, ESHReg.

Next, he turned his attention to a Population growth function. Given the lags and the inertia of population dynamics, he chose the widely used Koyck-lag specification around an optimal Population, Pop*:

In his model, Population responded to changes in the underlying determinants and moved toward the target, Pop*, across time periods. The target, ‘optimal’ population was influenced by Lifestyle expectations, LS, the aerial extent of the political entity, D, National wealth, W, Capital, K, per-capita income, y (=Y/Pop), the price level, p, and notably, a measure of the economic policies followed by the political entity, EcPol (an euphemism for the extent of subsidy in the economy and trade policy). The National Wealth variable, W, was the aggregate value of net monetary (Liquid assets + Equity - Debt), ‘Real’ Land Assets, Gold, and further, included the imputed net present value of natural (in particular, mineral)-resources, ReB, that passed the definition of a ‘Reserve’.

Moving next to Labor Supply, Jetson modelled the fraction of population, Lf, seeking employment at any time, t. It had as its arguments, per-capita income, y, lifestyle expectations, LS, prices, p, wages, w and Wealth, W:

Thankfully, the National Macro-economic identity was easily specified:

where Y denoted GDP, C stood for Consumption, G for Government Spending (Infrastructure, ESH and Equity), and XM represented a net trade function.

For modelling factor demands, Jetson Sr. chose an Aggregate Industry Profit function, hoping the choice would enable lateral use in macro-financial modelling. pirepresented the sum of Retained Earnings, RE, and Dividends, Div. There was an additional complication concerning the nature of technical change – whether embodied, or disembodied. Jetson preferred the simpler alternative of technology manifesting itself via capital replacement. Embedded within the Profit function was a KLEM production function enhanced with Net Technical change, IT, and EnvReg as critical endogenous variables:

Jetson realized that for a large macro-system, the evolution of prices, p, a crucial determinant of lifestyle, too was of interest. He therefore posited a price-evolution function:

in which prices moved with per-capita consumption, capital, wages, GDP growth rate, international prices, economic policy and environmental regulation.

Finally, he turned his attention to the specification of the ‘Wage Evolution’ function. Well aware of the dichotomy between macro- and micro-economics as regards the endogeneity of wages, Jetson chose to model it endogenously given his intended focus on macro-labor policy. In specifying the wage evolution function, the Sr. envisaged it to be influenced, beyond the ‘tightness’ of the labor market, by the labor-saving nature of technical change, IT, as well as capital in place, Kt-1, the ratio to domestic to international prices, and Economic Policy:

With the above definitions and specifications in place, Jetson specified the SWF, given its political sensitivity, with particular attention to the labor market. He figured the society would seek to maximize employment among those seeking jobs, Lw/Lf, per-capita income, y (= Y/Pop), wealth, W, and ESH standards, but hold down the cost of living as represented by the vector of real prices, p. Thus, motivated, the SWF function read:

Gingerly, Jetson penned the ‘grand optimization system’ to sustain Social Welfare in a dynamic, capitalist system characterized by cost-cutting, labor-saving technical change:

Solving the 12-equation model was a monstrosity given the lags and inter-dependencies, but Jetson had the benefit of an ‘equation-crunching’ optimizing software on the ‘Cloud-enabled’ library computers that aided the analytical derivation of the critical relationships. Beyond the maximized SWF (and optimal factor demands), the rules specified a) Economic policies necessary to obtain an optimum population time profile that fit the larger optimization of social welfare, b) the implied optimum rate of change of technology-embodying capital, and, c) the implied relationship between labor demand and wages consistent with a scenario of continued labor-saving technical change and population projections.

Jetson didn’t like what he saw in the outputs spit out by the optimization routine. Yes, capital accumulation and reserve addition drove output growth, but population was a damper on wages. Life-style expectation and Economic policies played an important role in the economic growth of the society. ESH Regulations impacted upon labor supply thru its impact on living standards.

The optimal short-run labor demand, L*, was of the general form:

The coefficients indicated that optimal labor use, expectedly, fell with wages and capital in place, and with the pace of introduction of labor-saving technical change. Free trade resulted in labor-saving imports in times when p > P in sectors with k/l < K/L. The implied Capital-Investment, IT* was a function of the wage-rental ratio, the ratio of domestic to international prices, Economic policy, and Lifestyle Expectations, among other factors. Labor-saving technical change, motivated by the necessity to reduce costs and increase profits, would necessarily imply either a steep reduction in labor use and/or a significant drop in real wages in manufacturing. Given the ‘momentum’ in population growth, the prevalence of per-capita, subsidy-pandering politics, the arrival of AI-enhanced robot and automation technology, and aware of the ‘sacred cow’ that employment was, Jetson foresaw a tendency to politically accommodate blue-collar labor far beyond what was cost-efficient for the technically-advanced economy. The maximization of the SWF implied the society either manipulate trade policy in labor-intensive sectors, hold back technical change, reduce labor use, or accept deep cuts in blue-collar wages to accommodate advanced, cost- and labor-saving technology. It is surprising how even otherwise ordinary people rise to the occasion in times of crises. A humble roughneck though, Jetson foresaw a distant cloud of social strife if capitalism were to be pursued to its logical end. For a society to reap the benefits of advanced technology – the outcome of an elaborate system of education and research supported annually with billions of dollars worldwide, and employing the best of global talent - it’d be necessary to resolve the issue of Manufacturing Labor-employment and wages. It would be a challenge to a society that had stressed technology without anticipating suitable policies to address its social impacts; in fact, and to the opposite, even exacerbating it in to a crisis with its per-capita-based subsidy policies. Jetson perceived an opportunity to design a policy resolution to address the same. And although he hadn’t modelled it, Jetson anticipated that in all likelihood, the rise in incomes among households in a high-efficiency, high profit world would imply a concomitant increase in demand for service-sector employees, as affluent households demanded personal attention and customized services. It was perfunctory then to first consider a flexible mechanism for facilitating the smooth transfer of Manufacturing Blue-collar labor to the Service industry. With a deep sense of responsibility to future generations, he scoped out the ‘2-pronged Jetson Proposal’: the first part being a rather simple ‘Labor Switch-Points’ module, and the second, a more involved ‘Macro-financial’ module. The intention behind the ‘Labor Switch-Point’ construct was to both inform potential blue-collar Manufacturing labor of their relative likelihood of continued employment given changes in the underlying ‘shadow wages’ upon the advent of labor-saving technical change, and simultaneously offer a formal, automated mechanism to bring about a smooth transition in to employment in the Service sector. Toward that objective, Jetson posited both a ‘Switch Point Demand’ function and a ‘Switch Point Supply’ function - akin to Excess Labor Supply & Demand functions:

Jetson modelled the Service Sector as demanding Switch points, SwPtDS; the demand increasing in Service sector Output, Ys, but decreasing in manufacturing wages, wM, and Experience, ExpM, of prospective Manufacturing employees. To factor in family-stage-specific circumstances that obstructed the transition, he included, Dep, representing the number of dependents, as an additional variable (Jetson gulped hard for what it meant in his case). In a similar vein, the Supply of Manufacturing Sector Switch points, SwPtSM increased in wages, wM, and Net Investment, IT, but decreased in own Output, YM. In addition, Jetson added a variable, FD, representing Cumulative FDs subscribed to by Blue collar labor in lieu of wages (Jetson made a mental note to explain later what he meant by his ‘Wage-FD’ strategy). It captured the employer’s proclivity to retain employees willing to sacrifice wages for long-term financial security.

The demand and supply functions specified, Jetson set the ball rolling. He required a pan-industry Labor Organization to minimize the area to the left and below the intersection of the two functions in the SwPt–wM space. The intersection of the SwPt Demand function with the SwPt Supply function (plotted against wM) revealed the optimal Switch Points, SwPt*, below which the Service Sector made ‘Wage-protected’ offers to ‘redundant’ manufacturing employees. The equilibrium SwPt* varied with both Supply and Demand factors, thus lending a touch of uncertainty and cyclicity to the process of Labor migration. The Switch Point strategy facilitated the smooth transfer of Manufacturing labor to the Service Sector while protecting wages, and offered blue-collar labor the opportunity to tune their wages and savings in line with economic and labor-market prospects.

Having designed a mechanism that provided for a smooth adjustment in the Labor market, Jetson chose strategically to aggregate the Blue-collar work force across all Manufacturing industries separate from Service Sector Employees (in which, he included the Manufacturing White Collar employees as well). Next, he bought in to the Blue Collar Pension Fund Authority, PFA, which managed FD contributions as well as the stock purchases and bond assignments to each employee’s portfolio). He intended, given his read of the future, that the Blue-collar PFA would facilitate the implementation of a policy that would, in essence, reduce the wage-rental ratio, w/v, in each sector to that consistent with a robot economy as revealed in the K*, IT*, and L* expressions. In essence, he achieved it by offering wealth compensations to induce voluntary reductions in wages. Each blue-collar employee, whether in Manufacturing or Service Sector, was offered as much in stocks and bonds as the reductions he or she accepted from wages, toward purchase of Long FDs in to his or her pension account. The FDs, and the bundled, matched Stocks/Bonds ensured employees were left at least as well-off in the immediate term, and likely wealthier in the long-run. In this manner, Jetson de-linked wages from work hours, and effectively reduced the wage-rental ratio as it applied to, or, was perceived for operational and investment decisions, thus facilitating a transition to an AI-Robot Economy. Employees too, factored in the wage reduction for their consumption decisions, but made longer term lifestyle decisions based on assets they held with the PFA.

In choosing their Stock compensation for wages ‘sacrificed’ to the future as FDs, Blue collar employees were permitted their choice of stocks between ‘Own firm stock’, a zero-correlation ‘Perpendicular firm stock’ and a broad Stock market Index fund. The Employer, however, deferred the issue of FDs funds; instead it guaranteed ‘Earned Wage Payables, EWP, issued by the PFA. EWPs represented a ‘wages payable’ against the Employer, and listed as an ‘asset’ on PFA books in the sense it was liquid and could be encashed on demand. These EWPs were taken a lien upon by the pan-industry Blue-collar Labor Union, after which the PFA issued FD credits, FDCs (a ‘legal-twist’ that Jetson leveraged for a larger resolution) to the pension accounts of its subscribers.

Yet weary from thinking thru the first part of his proposal, Jetson moved on to the second. Lest the ‘wealth compensation for wage sacrifice’ strategy be presumed a mere re-classification of compensation, and given potential impacts upon various facets of the society, Jetson hastened to unravel a larger resolution for the Robotmation economy. In his resolution, the Fed was an independent agency in charge of ensuring financial stability – a charge that included the management of currency, bank deposits, bullion, interest rates and foreign exchange. Now, the Fed, as part of its duty to ensure financial stability, managed Asset-Liability balance of the economy, with a ‘back of the envelope’ thumb rule:

In the context of his task, Jetson imagined a creative re-interpretation of the above:

The Fed accommodated the demand for currency arising from the growth in Net Assets by either permitting or issuing IPOs/FPOs, issuing FDs or Long Bonds, or by managing its Foreign Currency and Bullion operations. Jetson was no genius, but he found the EWPs (which constituted an ‘earned payable’, a ‘Receivable’ on PFA books, and upon which the FDCs were issued), both an excellent ‘raison d’etre’ and a suitable ‘collateral’ for the issue of new Currency during asset re-balancing operations. By his reckoning, the Fed, rebalanced assets and liabilities around its endogenous instruments – the issue/manipulation of Currency, Bullion, IPO/FPO, Foreign exchange and Long Bonds. Jetson first required that Bullion be adjusted to cancel out changes in the FD and Foreign currency holdings:

Thus cancelled out, the Asset-Liability balance reduced to:

By his 2-step resolution, the Fed on one hand, adjusted its bullion operations to cancel out against foreign exchange and FD(C)s issued, and on the other, issued new Currency to equal the sum of IPO/FPO and Long Bonds issued. The Fed paid for the use of EWPs by ‘sponsoring’ the conversion of FDCs to FDs that were in turn credited in to the accounts of the Blue-collareds at the PFA. The Government ‘bought’ the new issue of Long Bonds from the Fed (or, equivalently, sponsored them), and forwarded them to the PFA toward its match for the participation of employees in the ‘Robotmation scheme’. In addition, the Government strategically bought in to the IPO/FPO so it could recover tax revenues lost from ROE-based tax-credits that it offered to firms when the stock appreciated post the rise in profits following introduction of Robotmation. Compensated, on one hand, with ROE-based tax credits, and relieved of immediately making good on the EWPs, manufacturing firms offered larger discounts on their stocks to their blue-collared employees in their ESOPs to pave the way for robotmation. The discounts, funded by the deferred EWP and limited to FD subscribers, served to further incentivize the participation of the Blue-collared in the ‘Robot Economy’.

Tying the loose ends, Jetson confirmed that his 2-pronged proposal compensated the wage sacrifices made by the Blue-collared labor in anticipation of a Robot economy three ways – FDs, Employer-discounted stocks, and Government-sponsored Long Bonds. Jetson verified that the Blue-collar Union cancelled its lien on the EWPs, and the PFA recovered its FD ‘principal’ – the face value of the EWPs issued – when the Fed ‘sponsored’ the conversion of FDCs to FDs. The Employers leveraged, and made good their deferred FD obligations to the PFA, by funding a discounted Stock offer to participating employees. The Government, too, found it convenient to leverage the issue of Long bonds by the Fed toward its Bond-obligations to the Blue-collar PFA. Further, it found the IPOs/FPOs a convenient asset class to invest in and recover tax revenues lost when those stocks appreciated upon the realization of higher profits following introduction of ‘robotmation’.

The bell rang to alert users the Community College Library closed 6pm sharp. Jetson barely had a minute or two on hand. Hurriedly he scribbled that his 2-pronged solution was of a pareto-nature that benefited all stakeholders – Labor, Capitalists, the Government and the broader society. The three-way compensation to the labor, and the ‘pareto’ nature of adjustments and incentives offered to the Industry and the Government brought about a much faster transition to Robotmation than was considered feasible.

Robotmation was both an opportunity and a threat to humanity’s future. Compensated with wealth accretions, Jetson had eased the Blue-collareds in to an orderly inter-generational transfer to the Robot economy without the mass unemployment and the social strife that had bedevilled other proponents. His resolution, in fact, anticipated and reduced the threat of social discord, while preserving the opportunity of genuine economic gain that a Robot economy offered. His brand of Robonomics was, he felt, particularly appropriate to per-capita-based subsidy economies grappling with a population crisis and a large public sector– a description that fit many emerging nations. But more to his ideals, Jetson believed his proposal was an appropriate transition policy from an inefficient/per-capita, subsidy-based, socialist economy toward a high profit, distributed capital ownership-based, and more efficient Closed Cycle/Robot Economy. It’d interest policy makers and politicians alike for the manner in which it tackled a highly sensitive social issue. The Jetson brand of finance was particularly apt to....

Interrupting himself before he could be shooed away by the library staff, Jetson walked out in to the yet warm late afternoon Sun. As he got to the Chevy, the sun glinting off its windshield, he thought ‘Gotta get the steering fixed soon’.

….. And no day-dreaming on the snaky way back home either!