More on the distortions around NREGS

The National Rural Employment Guarantee Scheme (NREGS), as the name suggests, is an unemployment insurance program for the rural poor. In simple terms, the government steps in as the employer of last resort, with a minimum wage guarantee, if the labourer is not able to find employment in the regular market.

However, an article in The Times of India on 18.1.2012, about an apparent lack of interest for NREGS in Warangal, is a very accurate reflection of the misconceptions about NREGS and its gradual slide from being a demand-driven to a supply-driven program.

The central government’s flagship programme MNREGS has not found many takers in Warangal. This when the district had bagged first place in the state last year in providing work to farm labourers under MNREGS and spent huge funds on works... this year Warangal has fallen to 15th position in the chart... At the recent vigilance and monitoring committee meeting, it was revealed that MNREGS implementation in 2011-12 has come a cropper... According to District Water Management Authority (DWMA) officials, the farm workers are not showing any interest to carry out the MNREGS works as the private sector is ready to pay more for their work.

In states like Andhra Pradesh, even in Warangal, NREGS can no longer be considered as not having takers because of lack of awareness or other high access barriers. In the circumstances, the low demand this year, especially in the backdrop of last year's excellent performance, is most likely to be due to reduced demand. However, instead of viewing the drop in NREGS enrollment this year as an indicator of a stronger economy and more private sector job opportunities with increased wages (say, private farm labour wages having risen, making it more attractive over NREGS), the newspaper article considers it a governance failure.

Such an understanding of the NREGS, representative of the mainstream view of the program, will come in the way of any exit strategy, even if the market is able to provide employment at higher than the NREGS wages. This conception arises when we view NREGS as an end in itself, rather than as a means to insure or protect against a market failure or deficiency. Ironically, its success may itself prove to be NREGS's greatest failing!

Price controls are back?

The Andhra Pradesh government has announced its decision to set up a price monitoring committee to control inflationary pressures.

Taking serious note of the rise in the prices of essential commodities, Mr. Kiran Kumar Reddy announced plans to form a price monitoring committee to tackle the situation. The new mechanism will not only deal with people involved in hoarding and black-marketing of produce with an iron hand, but also play a key role in fixing prices.

"Fixing prices"? Hmm!!

Observations on the Aarogyasri program

Aarogyasri is a hugely popular health insurance program initiated the Government of Andhra Pradesh. Administered by a government-run Aarogyasri Trust, it covers all the below poverty line (BPL) citizens, and provides for pretty much the entire spectrum of high-value tertiary treatments. In the language of insurance, the Aarogyasri is a single-payer (government), mandatory coverage (for all BPL families), pure community rated (same insurance rate for all those covered) insurance scheme.

Its supporters point to four features of the program as proof of its widespread appeal. One, it covers all the major medical conditions, with a generous coverage of upto Rs 2 lakh per family every year. Two, it provides un-paralleled choice to patients, giving them the freedom to choose any hospital, government or private, for their treatment. Three, it provides for completely cashless treatment in any of the empaneled hospitals. Four, the scheme incentivizes government doctors by earmarking a share of the payments recieved by their hospital for treating Aarogyasri cases to the doctors and staff.

However, it is precisely these four attractions that form the basis of concerns about its long-term sustainability.

1. The universal coverage is a red herring. In reality, the supply-side is severely constricted by the available treatment facilities. In fact, even with the spurt of private hospitals in the wake of the program, less than a quarter of patients suffering from a covered medical condition are likely to be treated under the scheme.

Herein lies one of the biggest challenge for the scheme. If the present trend continues, more private hospitals will crop up, if only to exclusively service patients covered by the scheme. This will in turn increase the available treatment facilities and thereby the actual claims processed by the insurer. It is inevitable that premiums will keep going up for years to come, merely due to the addition of new treatment facilities.

As the numbers of private hospitals increase, there will also be increased pressure to expand the pool of covered procedures. This too will drive premiums north. Adding to all this will be the universal trend of rapidly increasing medical treatment costs. Will the government budget prove deep and resilient enough to meet all these upward pressures?

2. The level of patient choice in Aarogyasri is simply unprecedented, a luxury not available to even patients in many developed economies. Given the state of government hospitals and the incentives of private and government hospitals (the former have no incentive to chase patients), patients are more or less certain to prefer the former. This would be a shame since most government secondary and tertiary care hospitals have well qualified doctors and adequate diagnostic and surgical devices, though the quality of service delivery is questionable. Questions will invariably have to be asked about whether it is possible to leverage the Aarogyasri program to improve the quality of service delivery in government hospitals.

3. Related to the previous point, the prevailing government policy on secondary and tertiary healthcare provides for no synergy between the government's own single-payer Aarogyasri health insurance program and its existing secondary and tertiary care facilities. In fact, they are each considered distinct and mutually exclusive. This is unlike the health insurance model in most western countries, where there are strict protocols for referrals, with cases being referred to private hospitals only when government hospitals are unavailable.

An application of the same model would have brought in the government hospitals as a major health service providers in the Aarogyasri scheme through a similar protocols-based sharing of cases between them and private hospitals. It would also have enabled resource-strapped Government hospitals to access payments from the Aarogyasri program. This cash flow becomes all the more important since the state government reduced its budgetary allocation to all these hospitals in lieu of the Aarogyasri allotment. In simple terms, the budgetary allocations to Aarogyasri and existing government hospitals being a near zero-sum game (net allocation being more or less the same), the private hospitals benefitted at the cost of the government hospitals.

4. Further, once the patient is admitted by the private hospital, given the pay-per-intervention payment system, their incentives are strongly aligned towards over-treatment. Since the treatment is cashless, the incentives of the patient are aligned towards accepting the "best" available treatment. Unfortunately, in the prevailing model, the incentives of the doctors are aligned towards projecting expensive invasive surgical procedures as the "best" option. For example, irrespective of the medical condition and the age profile of the patient, irradiation therapies are generally preferred (by both doctors and patients) over medication. In simple terms, the most aggressive treatments have become the standard of healthcare.

In standard insurance schemes, insurers have to keep a strict vigil on the pre-authorization process (when the tests are done and the patient is screened for a particular surgery/therapy) so as to minimize over-treatment. This is all the more so since the payments to health service providers (doctors and hospitals) are on a pay-per-procedure/intervention basis, as against the less distortionary fixed payment for treatment of a medical condition.

The Aarogyasri program too makes payments to hospitals based on a pay-per-procedure basis. In fact, the tender premiums quoted by the insurers are based on this premise. The Trust prefers this approach since it believes that its in-house pre-authorization process is rigorous enough to effectively screen patients and prevent over-treatment. In fact, effective pre-authorization is the forte of the best Third Party Administrators (TPAs) hired by the insurers. If the Aarogyasri Trust does this effectively, then it has to be counted among the most effective TPAs. In any case, as the program expands, maintaining such rigorous pre-authorization process will become difficult.

However, unless it moves away from the in-house pre-authorization process to a purer insurance model, it may not be possible to change the payment model. A medical condition based payment approach is much more complex to administer and riskier too and may not be possible with an in-house model of pre-authorization.

5. In simple terms, the incentives under the Aarogyasri scheme offered a cash reward top-up to doctors for doing much the same procedures which they were doing through their regular hospital in-patient channel. This has the potential to create a moral hazard - the doctors who internalize the incentive and do these procedures come to slowly view these incentives as entitlements.

This turn of events can damagingly distort the incentives facing doctors, especially if at some point in time the government decides to abandon Aarogyasri and decides to revert back to the old model of government institutions based health care. Further, it cannot be denied that atleast some doctors are likely to be disincentivized in taking proper care of patients not covered by Aarogyasri. Also, what about the cash incentive crowding out intrinsic motivation?

Aarogyasri incentive structuring is a powerful example of the need to exercise great caution when we introduce performance-based pay systems into government bureaucracies. Unless carefully structured, cash incentives not only distorts the current implementation, but it also generates adverse expectations which come in the way of future implementation of performance based pay. In some ways, this is similar to a situation where a doctor abruptly replaces a commonplace but effective drug with a powerful new medication against a particular virus/bacteria, only to find after some time that the second generation drug too is losing sting, leaving us with limited available options to effectively treat the microbe.

So what can be done to make the Aarogyasri program more cost-effective without radically tinkering with its existing model?

For a start, it is imperative that there be a clear protocols-based system of referrals, so that the existing government facilities are more closely integrated into the Aarogyasri scheme. The government hospitals benefit by way of accessing more funds and thereby better diagnostic and surgical facilities. It will also help the government accommodate the massive budgetary support that is inevitable in the coming years as the scheme grows.

A treatment facility wise mapping of government hospitals can help route Aarogyasri patients to those hospitals for specific medical conditions. Only those cases which cannot be treated in these hospitals (for either lack of bed space or lack of required facilities) should be referred to private hospitals. Simultaneously, there should be a vigorous campaign to improve service delivery standards in secondary and tertiary hospitals.

The incentive system for government doctors provided for under the Aarogyasri scheme has to be either dismantled or be made more nuanced. If the later is preferred, the incentives should kick-in only after a certain performance benchmark is breached.

Under the Aarogyasri scheme, the insurance premium quoted by the insurer is a function of the number of procedures/therapies covered, N, the respective price (to be paid to the hospital) fixed for each surgery/therapy (or medical condition) i, Pi, the number of empaneled hospitals (or number of available treatment beds for each surgery/therapy i), Ei, and the disease incidence risk among the population pool insured for each medical condition i, Ri.

In other words, Premium, Pr = f(N)+g(Pi)+h(Ei)+q(Ri)

Insurers seek to ensure that their expenditure due to claims and administration costs is lower than the premiums collected.

Of these, the most important parameter is the prices of procedures. Neither the insurer nor the health service providers have an incentive to control it. The health service providers are the direct beneficiaries of higher procedure rates and therefore lobby hard for maximizing procedure prices. The insurers merely pass on these higher prices on to the consumers by way of higher premiums.

The insurer seeks to minimize his claim outgo either by limiting the number of empaneled hospitals (so that the numbers of cases that can be treated is controlled) or turning away (on some pretext or other) those who claim treatment. Both these problems can be addressed. The former can be mitigated by defining the list of empaneled hospitals in the tender itself, including those which are likley to be added each year and details of when they will become operational. Since the premiums are revised each year and it takes atleast an year for establishing any hospital, such up-front disclosure is not likely to create any problems. The later can be overcome by making it mandatory to treat all the patients pre-authorized by the Aarogyasri Trust.

Both the aforementioned conditions, coupled with upfront disclosure of number of surgeries/therapies, transparent fixation of prices for each procedure, and government-run pre-authorization can substantially align the incentives of all parties. If these conditions are fulfilled, the insurer's bid would be determined purely based on his actuarial risk calculation for the insured risk pool and their administration costs. Such bids are more likely to generate efficient outcomes, since it increases the likelihood of the successful bidder also being the most efficient insurer.

On structuring lease concessions

The Hindu reports of a concession agreement signed between the Andhra Pradesh Tourism Development Corporation (APTDC) and a private hotel operator, Amogh Group of Hotels, for leasing out one of APTDC's centrally located Tourism complex in Hyderabad. Under the 15 year lease, terms of which have been arrived at through an open competitive bidding process, the private operator will be allowed to run the 84 room complex as a three-star hotel. The operator will pay Rs 23 lakh per month as rental fee and also provide 20 rooms to the state General Administration Department (GAD) for accommodating state guests.

This apparently simple lease agreement could be the setting for a simple thought experiment. The APTDC and state government's desired objectives are two-fold - accessing 20 rooms for the GAD, while maximizing the lease rental. There are two possible approaches to achieve this objective. One, as the APTDC has done, is to clearly state upfront the 20 room GAD requirement and then invite hotel operators to quote on the lease rental. Alternatively, treat the two as separate requirements and then let the private operator quote a lease rental for the entire hotel. Subsequently, the 20 rooms can be leased in either on mutually agreeable terms from the the same operator or a separate tender can be called for leasing in 20 rooms from any private hotel across the city.

Which of the two approaches is likely to be more beneficial - generate higher net returns - for the state government? An examination of the incentives and option values that bidders face would be illuminating.

In the first case, the operator factors in the costs and benefits of already having committed the 20 rooms. At a cognitive level, he has made two trade-offs - one on the lease rental amount for the 64 rooms and another on the lease amount that he sets-off against the 20 rooms. I am inclined to believe that he makes them as two separate decisions, under-weighting (or minimizing the rent pay-out) the first and over-weighting (maximizing the rent receipt) the second. There is also the option value he attaches to having foreclosed the option of retaining all the 84 rooms. In other words, there are atleast three factors that influences his decision, all of them having the effect of working towards keeping down the lease rental payout to the government. The multiplicity of incentive factors, all working separately, distorts the decision-making environment and each works towards bidding down the quotes.

In the second case, the operator is primed into bidding for the entire property and retains the option of whether to give or not give the 20 rooms. To that extent, the option value is discounted in the bid. There is considerable clarity in the bidding environment. The only factor working in the bidder's mind is to get the best possible deal on the lease rental. In this case, the competition between bidders will work towards keeping all the bidders honest.

After the hotel, with all rooms, is bidded out, the government could negotiate and seek mutually agreeable lease terms. Alternatively, it could call tenders for leasing in 20 rooms from any existing hotel, within certain areas of the city. Either way, more so with the second approach, there would be more efficient price discovery with respect to the lease rental for the GAD rooms. It is possible that there are certain private hotel operators who would want to use the signal of government business to improve their hotel business itself and would therefore quote at a discount.

The populist assualt on incentives - MFI loan defaults

I had blogged earlier about a study by Citigroup economists Willem H. Buiter and Ebrahim Rahbari where they identified factors that could affect future global economic growth. One of the more interesting factors pointed out was the dangers to growth genereated by "the populist assaults on the incentives to work, save and invest". Here is one such example.

Mint quotes Vijay Mahajan of Basix who claims that, thanks to the state-wide default on Microfinance Institution (MFI) loans by self-help groups (SHGs) in Andhra Pradesh, there could be "92 lakh households in Andhra Pradesh who are appearing on the defaulters list of the National Credit Bureau".

Even assuming an element of exaggeration in the figure, it is an extraordinary situation. As far as I can remember, this is the first truly big example of a full-scale debt default by a large section of population. Unlike the loan waivers, where governments decree to write-off loans, here is an example of borrowers deciding to collectively and unilaterally extinguish their debt obligations, without abrogating their loan contract with the MFIs.

First, there is the legal-technical issue of these defaulters, forming a major share of SHGs and women in Andhra Pradesh, losing their credit-worthiness in a single stroke. How would the banks classify or risk-weight future loans to this massive category of borrowers?

More importantly, the larger message that would have been internalized by these women and their communities is that their contractual obligations to their lenders is no longer sacrosanct. The hitherto entrenched belief among borrowers that their private debt will always have to be re-paid is now shaken (the loan waivers have long since shaken this belief on government debts).

Similarly, lenders, of all kinds (who lend to these people), will now be aware that the credit risk of their borrowers have suddenly spurted. Markets will price it accordingly, with higher rates and stronger conditions, which in turn will adversely affect access and hurt borrowers. Unfortunately, this moral hazard is not limited to just borrowers and lenders. It covers all forms of contracts, and this is an even bigger concern.

As standard economic theories have taught us, a market economy is underpinned by bonds of loyalty and trust which facilitates contracts that form the basis of most market-driven transactions. There are a number of studies which have shown that developing countries have weaker contract obligation and enforcement capital and they are binding constraints on economic growth in these economies. The MFI default would surely have diminished the already limited contract capital available in such societies.

In this context, governments need to ensure that their policy decisions do not distort incentives. In the instant case of MFI loan defaults in Andhra Pradesh, even if the government wanted to punish the MFIs, it would have been appropriate if it was done without distorting incentives.

One approach would have been to, in some form, recover the loans through the regular government SHG institutions, with or without interest. The recovered amounts could then have been returned back to the banks that financed the MFIs. This would have punished the MFIs, who would have been deprived off their profits and would suffer credibility loss, without distorting borrower incentives nor causing loss to the financial institutions that funded the MFIs.

Why incentives alone are not enough?

Econ 101 would have it that successful public policy is that which is designed with appropriately aligned incentives. However, the complexity of the real world means that when implemented, many of these incentives, doubtless laudable when seen in isolation, results in often undesirable outcomes. Here is one recent example.

Under the popular Arogyasri health insurance program run by the Government of Andhra Pradesh, government hospitals and its doctors are incentivized by way of cash payments for each patient treated. The presumption is that once the incentives are appropriately aligned, government hospitals would be able to attract patients under the scheme and use the incentive amounts to improve infrastructure and buy equipments.

However, it has been found that this incentive architecture has not been adequate to get government hospitals to attract patients under Arogyasri. Here are two possible reasons, which also informs us about the complexity involved in designing public policies.

1. It is an open secret that many government doctors, especially specialists, practice in private hospitals outside their regular working hours. There is evidence to suggest that these doctors are being offered much higher incentive payments by the private hospitals for every patient treated under Arogyasri. In fact, the government doctor even becomes a link to attract the patient to the private hospital. In other words, there is an unforeseen and even bigger incentive at work that nullifies the incentive structure built-into the scheme.

2. Most government hospitals do not have the required basic physical infrastructure and equipments to carry out many of the procedures. Further, even when they do have the equipments, the hospital environment is not conducive to attracting patients and for performing surgeries. Most often, the doctors in government hospitals face problems from lack of electricity or water, absent or recalcitrant nurses and attendants, equipments facing minor repairs or without consumables, and so on, all of which come in the way of their work. In contrast, in a private hospital, the doctor can merely walk into the operation theatre and carry out the surgery without any concern for managing the hoospital environment.

Therefore, despite the presence of the all facilities, patients prefer the private hospital and doctors exhibit an inertia to carry out operations. The last-mile cost imposed by the environmental challenges and the resultant behavioural inertia to do surgical procedures in the hospitals is often large enough to prevent the treatment getting carried out in the hospital despite the incentive to do so.

Both these reasons again highlight attention to the fact that while structuring incentives is necessary, it is far from adequate to ensure the achievement of public policy objectives. In this case, perversely enough, the program may have had the effect of widening the existing deep divide between government and private hospitals and creating a new divide between the good and poor government hospitals.

Are SHGs a public good?

Over the past year or so, the micro-finance movement has been the subject of intense scrutiny, faced with charges of fraud and exploitation. In Bangladesh, the Grameen bank and its iconic founder Mohammed Yunus have been accused by the Government of accounting fraud and diverting money. In Andhra Pradesh, micro finance institutions (MFIs) have been found indulging in practices that exploit the poor.

I have already blogged and written about these allegations and will not dwell on them here. Suffice to say that there are critical procedural/administrative problems and more importantly, serious corporate governance issues with many MFIs. In the absence of meaningful steps to address them, there are strong headwinds against any sustainable progress for the MFI model.

However, there are two interesting macro-perspectives from this debate, especially in Andhra Pradesh, that deserve greater discussion.

1. There is the argument that the spectacular success of MFIs in Andhra Pradesh overlooks the role of the government in creating a million-strong Self Help Groups (SHGs) that the MFIs could readily use (a la "ready cooked food"). There is palpable resentment at the fact that the MFIs, who merely walked in and piggy-backed on the fruits of the state government's efforts of more than a decade to develop SHGs, are claiming and getting a disproportionate share of the credit for the success of micro-finance activities in Andhra Pradesh.

In fact, the officials of the state government have even gone on record to argue that MFIs should confine themselves to non-SHG lending, "They cannot make profit by lending to the poor. Let them lend to the rich and make profit and leave welfare of the poor to the Government."

Without getting into the merits of how the credit for the success of micro-finance should be apportioned, it may be useful to examine what should be respective roles of the government and private sector in such areas.

Clearly, there are two distinct activities - formation and strengthening of SHGs and micro-lending to these SHGs. The strength of the former determines the success with the latter. In other words, SHGs form the fixed social infrastructure on which micro-finance rides.

I am inclined to see striking parallels between SHGs and classic public goods. It is now well-documented that apart from being channel to funnel credit to the poor, SHGs also play a critical role in women's empowerment and is a platform for enhancing the effectiveness of government interventions in many areas. Therefore, the net social benefits of SHGs exceed its net private benefits to the agency forming such groups. Private agencies like MFIs will naturally have less of an incentive to invest time and resources in forming SHGs.

In the circumstances, as is the case with public goods, it may be appropriate if governments focus on the formation of SHGs and invite the private sector to play a greater role with micro-lending. This does not mean an exclusive role for each in their respective areas, but a major role. So the way forward may be for governments to focus on forming SHGs and strengthening them, and for private sector to partnering with governments in increasing the volume of micro-lending. And all this assumes that the governance and other problems related to MFIs are largely resolved.

2. The second issue is related to the respective roles of the government and the private sector in combating poverty. More specifically, the success of the MFIs (most conspicuously, the success of SKS with its IPO) has generated a strong feeling that MFIs are making super-normal profits by exploiting the poor. This in turn raises the issue of what should be ethical standard for private agencies working in the area of development, the so called social enterprises.

Is it alright for a private social enterprise firm, playing by the rules of the game (assuming that the rules are themselves fair), to make profits even as it delivers on certain social objectives (as being delivered through the regular government initiatives)? In this case, is it acceptable if MFIs follow the rules, make micro-loans, and in the process also make handsome profits? Or should their profits be capped at some level? Or should the cost of lending be brought down and thereby reduce the excessive profit margins? Or should a share of their huge profits be ploughed back into helping the poor in some other effective manner?

In other words, is it acceptable for a private social enterprise, functioning with its capitalist efficiency and playing by the letter and spirit of the rules of the game, to work towards the objective of maximizing its profits?