Air India’s Failure: Epitome of Bureaucratic Enterprises

Massive infusion of taxpayer money has failed to revive the viability of government owned airline carrier, Air India

From a Bloomberg report,

Indian taxpayers gave Air India Ltd. $1.7 billion as bailout funds in the past four years. The airline now says it lacks cash to purchase spare parts.

That’s grounded 16 aircraft for the nation’s oldest carrier. Without the funds, the airline is also unable to refurbish some of the idled planes before returning to lessors.

“Some are just empty shells standing,” Air India Chairman Rohit Nandan said about the grounded aircraft. “We are in the process of returning some leased planes.”

The grounded planes add to the struggles of the former monopoly carrier saddled with about $8 billion of debt and six straight years of losses. Air India has also lost market share as discount carriers that started flights less than a decade ago lure passengers with the latest fleet and cut-rate fares.

Inability to fully utilize the fleet means Air India, the nation’s largest by number of aircraft, will operate fewer local flights than smaller rivals. The flag carrier won approval to operate 1,788 departures a week in the six months through September compared with IndiGo’s 2,821 and SpiceJet Ltd.’s (SJET) 2,467, according to the Ministry of Civil Aviation.

“It’s a criminal waste of public money,” said Harsh Vardhan, chairman of Starair Consulting, a New Delhi-based company that advises airlines. “With all this funds pumped in, what’s stopping Air India from spending on aircraft? They have to deploy fleet, expand network, increase frequency and go for market share.”

Since the Indian government liberalized the airline industry via the repeal of the Air Corporation Act of 1953 in 1994, privately owned firms dominated the market share. Air India’s share, from a monopoly, had been reduced to an estimated 18% of the domestic market.

The merger between Air India and Indian airlines, hobbled by labor unions, have reportedly been a factor in Air India’s continued losses.

Another important variable has been high prices of jet fuel which emanates from high taxes, around 32% of aviation fuel comes from a combination of sales tax, excise tax and freight related costs, as well as, from the inefficiencies of state owned oil marketing companies. High fuel prices has made domestic airlines less competitive relative to international counterparts. As of 2011, 5 of the top 6 major airlines were in the red.

Air India’s case is a classic example of the difference between bureaucratic firms and private companies which boils down to economic calculation.

As the great Ludwig von Mises explained:

A bureau is not a profit-seeking enterprise; it cannot make use of any economic calculation; it has to solve problems which are unknown to business management. It is out of the question to improve its management by reshaping it according to the pattern of private business. It is a mistake to judge the efficiency of a government department by comparing it with the working of an enterprise subject to the interplay of market factors…

Like any kind of engineering, management engineering too is conditioned by the availability of a method of calculation. Such a method exists in profit-seeking business. Here the profit-and-loss statement is supreme. The problem of bureaucratic management is precisely the absence of such a method of calculation.

In short, political enterprises are operated mainly from political goals, whereas the free market runs under the discipline of profit and losses. 

One should also make a distinction between private companies operating under the influences of politics or rent seeking “crony” firms.

China’s Stock Markets: Sovereign Funds and Central Banks Open to Invest More

The Chinese government has a bias for international political contemporaries. 

They prefer central banks and government controlled Sovereign Wealth Funds (SWFs) to have greater exposure in their stock markets in the assumption that these entities are “long term” investors than the private sector counterparts

From Bloomberg,

China scrapped a ceiling on investments by overseas sovereign wealth funds and central banks in its capital markets, part of government efforts to encourage long-term foreign ownership and shore up slumping equities.

SWFs, central banks and monetary authorities can now exceed the $1 billion limit that still applies to other qualified foreign institutional investors, according to revised regulations posted yesterday on the State Administration of Foreign Exchange’s website.

The Shanghai Composite Index (SHCOMP) jumped the most since October 2009 yesterday after the head of the Hong Kong Monetary Authority said Dec. 13 that China may relax or abolish a rule that requires Renminbi Qualified Foreign Institutional Investors to keep most of their funds in bonds. The China Securities Regulatory Commission has cut trading fees, pushed companies to increase dividends and allowed trust companies to buy equities since Guo Shuqing took over as chairman last year.

Introducing more long-term funds from abroad will help improve market confidence, promote stable growth in capital markets and provide “robust” investment returns to domestic investors, the regulator said in May, a month after the government more than doubled the total quota for QFIIs to $80 billion from $30 billion….

QFIIs can repatriate their principal and investment returns after a lock-up period ends, though the monthly net remittances cannot exceed 20 percent of their total onshore assets as of the previous year, according to yesterday’s rules. Open-ended China funds can remit funds on a weekly basis under the new regulation, compared with monthly in the previous version announced in 2009.

The Hong Kong Monetary Authority, Norges Bank, Government of Singapore Investment Corp. and Temasek Holdings Pte.’s Fullerton Fund Management Co. have all reached the $1 billion limit as of Nov. 30, with QFIIs’ approved quotas totaling $36.04 billion, according to SAFE, the currency regulator. Foreign investors can only invest in capital markets through QFIIs.

The benefits from capital intermediation seems well understood by the Chinese government. 

It is only in the prism where the incentives driving public sector ownership appears to have been mistakenly lumped as purely profit oriented enterprises similar to private corporations which gave SWFs the precedence.

In reality, the positioning of political or public financial institutions on international capital markets are different. They are based on (political) priorities and parameters diverse from their private sector peers (such technical operating differences may due politically determined guidelines).

This article gives us a clue, from ai-cio.com

SWFs, similar to other institutional investors, are less likely to invest in private equity versus public equity internationally, according to a newly published paper, written by Sofia Johan of York University, April Knill of Florida State University, and Nathan Mauck from the University of Missouri.

However, the economic significance of this impact is surprisingly low, the paper asserted. "Unlike other institutional investors, SWFs are more likely to invest in private equity versus public equity in target nations where investor protection is low and where the bilateral political relations between the SWF and target nation are weak." The research demonstrates that contrary to non-governmental institutional investors, SWFs do not seek protection by investing in private equity in nations that provide strong investor protection.

Surprisingly, cultural differences play a marginally positive role in the choice to invest in private equity outside of a SWF's own sovereign nation. "Comprehensively, we find that SWFs act distinctively from other traditional institutional investors when investing in private equity," the authors claimed.

Furthermore, according to the paper, SWF investment in private equity may be primarily financially motivated as SWFs tend to underperform in the public markets.

As one can note the degree of bilateral relations differs and serves as example to a politically determined SWF fund management framework.

In 2009, pension funds, insurance companies and mutual funds dominated long term investing with over US$65 trillion in OECD economies. The share of SWF has also grown, given their hefty $4 trillion stockpile, but represents a fragment relative to the overall investible exposure by the private sector.

The above is a categorization of long term investors from the World Economic Forum shows that private sector remains the largest dynamic as long term investors

In addition, given the highly volatile politically charged environment, such priorities may change. Past performance may not serve as a useful guide for future actions. Long term may become short term and vice versa depending on how changes evolve.

Also, there is no technocratic magic on public investments. Bureaucrats don't outsmart the private sector.

Public funds like sovereign wealth funds are manned by people too. They are seduced to the herding effect as evidenced by their recent price chasing action of Emerging Market debt

This anecdotal evidence from Reuters.com

Sovereign wealth funds, along with other crossover investors, such as European pension funds, were in hot pursuit of EM credit in 2012, but US pension funds "missed the boat" after buying one too many underperforming EM equity trades, said Chang.

So SWFs can be short term as much as it can be long term

 

And to repeat the earlier point: The priorities of the public funds can be influenced by political circumstances whether domestic or international.

Take for instance, California Public Employees' Retirement System (CalPERS), the US largest public pension fund recently filed for bankruptcy in response to the bankruptcy proceedings made by two cities Stockton and San Bernandino. 

Bankruptcy may turn long term investments into short term.

Bottom line: While the Chinese government’s thrust to liberalize her capital markets should be seen in a good light, which I believe encapsulates her path or grand design towards the yuan’s convertibility in order to challenge the US dollar hegemony as international currency reserve, her order of priorities in favor of SWFs seems unjustified. 

Instead, China’s government should aggressively liberalize her capital markets. Capital flows are not the problem. Bubble policies are.

Finally, the above report has allegedly bolstered the Shanghai Index to break above the 50-day moving averages with Friday’s eye popping 4.32% gains

Such sharp recovery seems to indicate of a major inflection point for China's major benchmark. Part of which may be intended to paint a welcoming picture for the ushering in of the newly appointed leaders.

As I wrote last Sunday:

Given the recent record liquidity injections by the People’s Bank of China (PBoC) which coincided with the latest leadership changes, and improving signs of credit growth, perhaps from stealth stimulus coursed through State Owned Enterprises (SoE), accelerating signs of improvements on infrastructure investments, and with retail investors almost abandoning the stock market out of depression, China’s reflationary policies may yet spark new bubbles in both the stock market and the property sectors…

Recovering prices of industrial metals also seem to underpin and or portend for China’s stock market recovery.

A reflation of China’s asset bubbles will likely be supportive of the recent gains attained by ASEAN bourses.

Recent surge in industrial metals (GYX) have presaged this. And I believe that China’s market participants have been looking for an excuse to push up the stock market and found one in the liberalization report that favored SWFs.

BSP's loan to the IMF: Costs are Not Benefits

The simmering debate over the proposed loan to the IMF by the Bangko Sentral ng Pilipinas (BSP) can be summarized as:

For the anti-camp, the issue is largely one of purse control or where to spend the government (or in particular the BSP’s money) seen from the moral dimensions.

For the pro-camp or the apologists for the BSP and the government, the argument has been made mostly over the opportunity cost of capital or (Wikipedia.org) or the expected rate of return forgone by bypassing of other potential investment activities, e.g. best “riskless” way to earn money, appeal to tradition, e.g. Philippines has been lending money to the IMF for decades, and with some quirk “foreign exchange assets …are not like money held by the treasury” which is meant to dissociate the argument of purse control with central bank policies.

I will be dealing with latter

This assertion “foreign exchange assets …are not like money held by the treasury” is technically true or valid in terms of FORM, but false in terms of SUBSTANCE.

Foreign exchange assets are in reality products of Central Banking monetary or foreign exchange policies of buying and selling of official international reserves (Wikipedia.org)

This means that foreign exchange assets and reserves are acquired and sold by the BSP with local currency units, or the Philippine Peso, prices of which are set by the marketplace

It is important to address the fact that the local currency the Peso has been mandated as legal tender by The New Central Bank Act or REPUBLIC ACT No. 7653 which says

Section 52. Legal Tender Power. -

All notes and coins issued by the Bangko Sentral shall be fully guaranteed by the Government of the Republic of the Philippines and shall be legal tender in the Philippines for all debts, both public and private

This means that ALL transactions made by the BSP based on the Peso are guaranteed by the Philippine government. This also further implies that foreign exchange assets held by the BSP, which were bought with the Peso, are underwritten by the local taxpayers. Therefore claims that taxpayer money as not being exposed to the proposed BSP $1 billion loan to the IMF are unfounded, if not downright silly. We don’t need to drill down on the content of the balance sheet and the definition of International Reserves for the BSP to further prove this point.

The more important point here: whether foreign exchange or treasury or private sector assets, we are dealing with money.

And money, as the great Austrian professor Ludwig von Mises pointed out, must necessarily be an economic good, the notion of a money that would not be scarce is absurd.

As a scarce good, money held by the National government or by the BSP is NOT money held by the private sector.

Therefore the government or the BSP’s “earnings” translates to lost “earnings” for the private sector.

Costs are not benefits. To paraphrase Professor Don Boudreaux, that the benefit the BSP gets from investing in the asset markets might make sacrificing some unseen private sector industries worthwhile does not mean such sacrifices are a benefit in and of itself.

The public sees what has only been made to be seen by politics. Yet the public does not see the opportunities lost from such actions. Therefore, the cost-benefit tradeoff cannot be fully established.

Besides, any idea that loans to the IMF is risk free is a myth. There is no such thing as risk free. The laws of economics cannot be made to disappear, or cannot become subservient, to mere government edicts as today’s crisis has shown. Remember the IMF depends on contributions from taxpayers of member nations. And for many reasons where taxpayers of these nations might resist to contribute further, and or where the loan exposures by the IMF does not get paid, then the IMF will be in a deep hole.

As I pointed previous out the risk to IMF’s loan to crisis nation are real. There hardly has been anything to enforce loan covenants or deals made with EU's crisis restricted nations.

Also, it is naïve to believe that just because the Philippines has had a track record of lending to the IMF, that such actions makes it automatically financially viable or moral. This heuristics (mental short cut) wishes away the nitty gritty realities of the distinctive risks-return tradeoffs, as well as the moral issues, attendant to every transaction. Here the Wall Street saw applies: Past performance does not guarantee future outcomes.

It is further misguided to believe that the government (in particular the BSP) behaves like any other private enterprises.

As a side note, I find it funny how apologists use logical verbal sleight of hand in attempting to distinguish central bank operations from treasury operations but ironically and spuriously attempts to synthesize the functionality of government and private enterprises.

Two reasons:

1. Central banks are political institutions with political goals.

As the great dean of Austrian School of economics, Murray N. Rothbard pointed out,

The Central Bank has always had two major roles: (1) to help finance the government's deficit; and (2) to cartelize the private commercial banks in the country, so as to help remove the two great market limits on their expansion of credit, on their propensity to counterfeit: a possible loss of confidence leading to bank runs; and the loss of reserves should any one bank expand its own credit. For cartels on the market, even if they are to each firm's advantage, are very difficult to sustain unless government enforces the cartel. In the area of fractional-reserve banking, the Central Bank can assist cartelization by removing or alleviating these two basic free-market limits on banks' inflationary expansion credit.

2. The guiding incentives and structure of operations for government agencies (not limited to the BSP) is totally different from profit-loss driven private enterprises.

Again Professor Rothbard,

Proponents of government enterprise may retort that the government could simply tell its bureau to act as if it were a profit-making enterprise and to establish itself in the same way as a private business. There are two flaws in this theory. First, it is impossible to play enterprise. Enterprise means risking one's own money in investment. Bureaucratic managers and politicians have no real incentive to develop entrepreneurial skill, to really adjust to consumer demands. They do not risk loss of their money in the enterprise. Secondly, aside from the question of incentives, even the most eager managers could not function as a business. Regardless of the treatment accorded the operation after it is established, the initial launching of the firm is made with government money, and therefore by coercive levy. An arbitrary element has been "built into" the very vitals of the enterprise. Further, any future expenditures may be made out of tax funds, and therefore the decisions of the managers will be subject to the same flaw. The ease of obtaining money will inherently distort the operations of the government enterprise. Moreover, suppose the government "invests" in an enterprise, E. Either the free market, left alone, would also have invested the same amount in the selfsame enterprise, or it would not. If it would have, then the economy suffers at least from the "take" going to the intermediary bureaucracy. If not, and this is almost certain, then it follows immediately that the expenditure on E is a distortion of private utility on the market — that some other expenditure would have greater monetary returns. It follows once again that a government enterprise cannot duplicate the conditions of private business.

In addition, the establishment of government enterprise creates an inherent competitive advantage over private firms, for at least part of its capital was gained by coercion rather than service. It is clear that government, with its subsidization, if it wishes can drive private business out of the field. Private investment in the same industry will be greatly restricted, since future investors will anticipate losses at the hands of the privileged governmental competitors. Moreover, since all services compete for the consumer's dollar, all private firms and all private investment will to some degree be affected and hampered. And when a government enterprise opens, it generates fears in other industries that they will be next, and that they will be either confiscated or forced to compete with government-subsidized enterprises. This fear tends to repress productive investment further and thus lower the general standard of living still more.

From here we derive the third view that distinguishes from the two mainstream camps:

Government is NOT supposed to “earn” money. Government should leave the private sector to earn from productive undertakings. Whatever “surpluses” or “earnings” should be given back to the taxpayers. How? By reducing taxes, by cutting down government spending and or by paying down public debt.

The “returns” from these actions will surely outweigh gains made from political speculations. Unfortunately this has been unseen.

As the great Frederic Bastiat once remarked

Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil.

Quote of the Day: Why Government is Not Private Business

From Professor Arnold Kling,

In business it is actually really hard to get people to do what you want. In fact, understanding that fact is exactly what sets CEOs apart from policy wonks. Policy wonks think that you write a law and that solves a problem. They think that you promulgate regulations and people do not figure out how to game those regulations.

Someone with business experience would never announce a mortgage loan modification program and expect it to be implemented in a matter of weeks (remember, a mortgage is a legal document that is somewhat antiquated with procedures that differ by state and local jurisdiction; remember that, prior to 2008, mortgage servicers had very few staff with any experience at all in loan modification; remember that when you introduce entirely new parameters into a highly computerized business process, somebody has to determine which systems are impacted, gather requirements, redesign databases, develop logic to protect against data input errors, develop a test plan,...). Someone with business experience would not enact a program that fines companies for failing to use a fuel that does not yet exist. Someone with business experience, I dare say, would understand that chaotic organization has consequences.

The fundamental difference between private business and government is the use of force.

To survive or to thrive, businesses must persuade consumers that their products or services offered are worth the use, the consumption or the ownership, in order for consumers to conduct voluntarily exchanges. Failing to do so means that these private sector providers would lose out to the competitors.

On the other hand government, operating as mandated or legislated monopoly, forces people to comply with their edicts or regulations under the threat of penalty (incarceration, fines and etc.) for non-compliance.

In other words, for businesses, the distribution of power to allocate resources is ultimately decided by the consumers, whom are guided by price signals and where the consumer represents as the proverbial 'king'. Whereas for government, it is the politicians and bureaucrats who decides, whom act based on political priorities rather than by price signals.

Social power, thus, is distinguished between market forces relative to political forces.

Yet there are many other significant differences.

So comparisons of “government run as business” is not only patently misguided but a popular fallacy which needs to be straightened out.

Video: Understanding The Difference Between Private and Public Enterprises

Dr. Robert Murphy explains the fundamental difference between private businesses and public enterprises.