The private Vs public sector debate in perspective

A dominant recurring theme in debates about development in India is about how the private sector can complement the government. In fact, there are a large number of influential voices who today feel that the private sector, if they are unshackled off their regulatory chains, can assume the dominant role in the development process.

In other words, they advocate that the government should put in place "the enabling framework" (translation - limited regulation and lower taxation) and should cede the space for the "markets to work its magic". At best, the government can continue to play a marginal role as service provider, if only to keep the markets competitive and honest.

Accordingly, it is suggested that governments should promulgate public policy that enables a dominant role for private sector in secondary and tertiary health care and education, urban infrastructure like water and sewerage, roads, electricity distribution and so on. In all these sectors, they argue, governments should step aside and free the private sector from regulatory restraints. They see government as having failed (and nonbody can dispute that) and therefore, as a corollary, the private sector should take over. So what gives?

There is no denying that over the past decade-and-half, the private sector in India has shown adequate capability to assume a greater role in this journey. However, this evidence cannot be stretched to conclude that the private sector is now capable of delivering the major share of the burden in delivering on these objectives. It is imperative that we place the role of private sector and governments in their proper perspective.

Let me illustrate this with the example of the provision of affordable urban housing. The mainstream debate on the issue is today focussed on putting in place an enabling framework that will help private developers bring more housing stock into the market, on unlocking the large chunks of government lands with various government agencies through public private partnerships (PPPs), and facilitating access to credit to home buyers. Supporters argue that these policies will help the private sector seize the initiative and meet the massive housing requirement for the economically weaker section (EWS).

This argument reveals a shocking level of disconnect with reality. The overwhelmingly major share of demand for affordable housing in cities comes from the EWS. Therefore, it is only appropriate that the priority for any policy that seeks to increase the supply of affordable housing should be on housing for EWS. This naturally means that LIG, MIG, and other categories of housing, while important, will be secondary priorities for public policy.

However, the aforementioned mainstream agenda is heavily skewed in the opposite direction. Private sector has an important, even dominant, role to play in the provision of housing for LIG, MIG, and other categories. But on purely commercial considerations, the burden of provision of EWS housing will have to vest with government.

Consider the commercials. The conservative cost of any decent 300 sqft multi-storied EWS house will be around Rs 2-2.5 lakhs. This is excluding the considerable cost of land and infrastructure. Assuming a tenor of 15 years and interest rate of 10%, a Rs 1 lakh loan will require an equated monthly instalment (EMI) of Rs 1100. This is about the maximum that an EWS household can pay. In fact, an EMI of Rs 800, which means a loan of Rs 75000 at the same terms, is a more realistic estimate. At the first estimate, assuming an upfront beneficiary payment of about Rs 20000, the subsidy will have to be Rs 0.8-1.3 lakh. Add in the land and infrastructure cost, the subsidy burden per unit will multiply a few times. Who is going to finance this construction subsidy? How many EWS beneficiaries can access banks for loan tie-up, especially given the massive NPAs banks have piled up in this category? Would it not be required for governments to use most of the available scarce pool of public lands for EWS housing?

Given this, governments will have to heavily subsidize any EWS housing schemes. Private participation will have to be confined to construction (on tenders), professional project management, and possibly outsourcing of rent collection and maintenance services. No PPP, innovative structuring of projects, or establishment of enabling policy framework can gloss over this reality.

In the circumstances, efforts to leverage private participation with allotment of government lands at concessional rates (or even free of cost) or provide generous fiscal concessions to developers, will merely constrain scarce public resources and detract from the more important and several times bigger challenge of building an adequate stock of EWS housing. In other words, by following the mainstream agenda, we will end up, at best, meeting the objectives with respect to a small part of the market, while overlooking the major portion of the market. None of this is to downplay the importance of LIG, MIG, and other parts of the market, but only to argue that its promotion should not come at the cost of the much larger market and public policy priority regarding EWS housing.

The choices that face public policy makers are stark. Should we allot scarce public lands to private developers or take up development on PPP so as to promote LIG/MIG housing or should we use them to develop stock of public EWS housing? Similarly, who should take precedence in the use of government's limited fiscal resources in the housing sector?

Similar analysis can be done for many other sectors to expose the ignorance that masquerades as informed opinion and knowledge in advocating a dominant role for private sector and a marginal role for government in the development process in those sectors. I believe that if governments have been found to fall short in delivering its objectives, the solution is not to simply abdicate the responsibility and cede ground to private sector. This would be unwise, especially in areas where the inherent nature of the problem makes the private sector unsuitable and government participation imperative.

In the circumstances, while encouraging private participation, the main focus of the debates should be on policies that strengthen the government's ability to manage such initiatives and increase their likelihood of success. The scarce financial and administrative resources of public agencies should be channeled towards ensuring bang for the buck with its full range of objectives. Simplifying the problem by taking the easy way out will only exacerbate the problem. Further, public policy should not be captured to fuel the interests of certain categories of consumers and participants within each sector.

Enabling reservation requirements in Urban Housing

My op-ed in Mint today presents an alternative strategy to enabling the regulatory requirement that earmarks certain proportion of land in layouts and built-up area in apartment complexes.

The larger message is that simple and apparently logical regulatory restrictions come up short when faced with real-world implementation. In the circumstances, a more nuanced strategy that aligns the incentives of all sides stands a better chance of success.

The derivatives contract in slum housing!

Slumania is a squatter slum in the Urbania Municipality of Corruptionland. It houses nearly 500 families in 3 acres of government land. Like other such slums, it has all the features of un-planned growth - small and irregular lanes, no side drains and sewerage network, leaking water lines, unhygienic surroundings etc. The election promise of Aya Ram, the local MLA, was to get a multi-storied housing colony sanctioned with roads, water and sewerage lines.

Finally, thanks to the his efforts, as part of the National Urban Development Mission (NUDM), the Government have sanctioned multi-storied (G+3) housing units with all infrastructure facilities. The Urban Community Development wing of Urbania Municipality does the Socio-Economic Survey (SES) to document the list of beneficiaries. Possession Certificates (PCs) of all beneficiaries are prepared and kept ready for distribution.

Simultaneously, Aya Ram's cronies swing into action. They demand that Rs 10000 be paid by each household to ensure registration. This is despite their name already having been cleared in the SES conducted by the Municipal authorities. Now, Rs 10,000 is not a small amount for the beneficiaries. Most of them already face an uphill struggle to pay the Rs 10000-20000 beneficiary contribution required to get the house sanctioned. Despite this, they immediately pay Aya Ram's extortionary tribute.

Why do people pay the premium despite their name finding place in the SES list and the assurance of a formal government mandate, the PC? This requires an examination of the post-sanction risks faced by the PC holder. After the sanction, the processes of tender finalization and completion of work, would take atleast 12-18 months. Even the process of physical allotment has numerous uncertainties associated. This is a long enough window for several risks to surface - the local muscleman may arm-twist the beneficiary off his PC, Aya Ram's cronies may collude with officials to issue duplicate certificates on the same house (thereby robbing the beneficiary off his allotted house), and so on. So here is the economic rationale behind the exorbitant premium,

1. The premium is a hedge against these risks. It is the cost of buying protection against these uncertainties. The contract is a form of derivative - beneficiary being the protection buyer, Aya Ram the protection seller, and protection against dispossession is the risk being purchased! The payment made to Aya Ram's cronies is proportional to the perceived risks to obtaining final possession of the house. In many respects, it is the simplest of insurance contracts.

2. The willingness of the beneficiaries to pay an exorbitant premium, despite possessing a government issued and legally valid certificate (the PC), is a reflection of the credibility deficit of government contracts. In other words, the premium is a measure of the cost of the contract (even government ones) enforcement in such environments. Higher the premiums, greater the institutional credibility deficit or weaker the contract enforcement conditions.

More on urban housing projects - lessons from Atlanta

This blog has consistently advocated that the public housing policy for urban poor in India move away from a strategy that aims to provide ownership rights to one that builds up housing stock and then rents them out. I have also argued that the rental allotments should be made through vouchers, with the beneficiaries having the flexibility to redeem them in private housing units.

This is largely similar to the public housing policy in the US, where 2.2 million people live in public-housing units (spending an average of 8 years) and another 5 million live in private, voucher-paid housing (spending an average of 6 years). Public housing rents are fixed at 30% of household income and the vouchers, in place since 1974, costs the taxpayers $18 bn annually.

The public housing is dominated by extremely poor single-parent families (53% of public-housing households nationwide earn less than $10,000 a year, and only 13% have two adult residents), who also have an incentive to remain unmarried or maintain live-in relationships due to the manner in which rents are fixed (as a share of the household income). A large number of these dwellers have lost their jobs and have stopped looking for jobs, and these areas are characterized by high incidence of gangs and drugs, crime and violence.

Howard Husock has an interesting article where he explores the apparent success of Atlanta Housing Authority (AHA) with its public housing project reforms for the past two decades. The city's 14000 public housing units have been razed down to facilitate re-development on public private partnership mode and only 2000 are now left, mostly for the elderly. Private developers dedicated 40% of the new private housing units to tenants who qualified for public housing. Two-fifths of the residents re-located into these "mixed-income" complexes, while the remaining three-fifths received housing vouchers and used them to move into other private apartment buildings.

Further, unlike elsewhere in the US, the AHA also imposed a condition in 2004 that all the residents of these units - both the mixed-income complexes and those using voucher and living in ordinary apartment complexes - should work or atleast be enrolled in training programs. The work-requirement has evidently been successful - recent figures show that 62% of AHA-supported households are employed, up from just 18.5% in 1994, and most voucher recipients are re-certified as being eligible.

In operation for nearly a decade, these mixed-income units are well-maintained, with the remaining 60% of renters paying the market rates. Once the public housing units were razed down, crime has fallen, property values have risen and the hitherto blighted surrounding areas have developed.

Apart from the hardware issues, the re-settlement program was complemented with considerable efforts at "human transformation" - extensive and long-drawn personalized counselling for families to instil a culture of ambition, discipline, caring for children's welfare, healthy lifestyle etc. The services of non-profits and people who have moved out of these units were deployed in this effort. In the 2002-09 period, the AHA has spent more than $25 m in providing such counselling services to nearly 15000 people.

There are important lessons for policy makers, especially those trying to re-develop slums in-situ, even in countries like India with the AHA experiment. The business model of the private developers of the mixed-income housing societies should provide insights for developers in India. This assumes significance given that one of the greatest concerns for private developers is with the commercial viability of such mixed housing estates where atleast some of the existing slum-dwellers are re-settled.

The back-room support mobilization for such projects is an unheralded but critical determinant to the success of such re-settlement projects. It also underscores the critical role of human transformation in ensuring the success of such housing projects. Investments in this direction form the last priority for policy makers involved in such housing projects.

Revamping urban housing policies

A McKinsey Report (summary here) in 2010 estimated that 25 million urban households cannot afford housing, and estimates the demand to rise to 38 million by 2030. The Government of India have estimated an additional housing requirement of 26.53 million during the 11th Five Year Plan (2007-12).

Bridging this deficit is one of the biggest challenges facing urban administrators and infrastructure specialists in the country. Further, in view of the growing importance of urban growth (urban areas contributed 58% of GDP in 2008 itself), this is critical to sustaining our economic growth itself.

State governments across the country have adopted several policy variations to address this. The commonest strategy has been direct construction of housing units, either on vacant lands or on existing slums (by in-situ development). State governments have dovetailed funds from various Central Government schemes and bank loans to develop large numbers of housing units.

Another increasingly important approach has been to develop slums on public-private-partnerships (PPPs). The most popular form is one where developers are permitted to commercially develop a portion of government land allotted to them in return for constructing a defined number of dwelling units for the poor in the remaining land.

Other strategies include earmarking a portion of a layout or built-up area being developed for urban poor. The private developers would then sell these houses to the targeted category at prevailing market rates. It is hoped that this would both open up scarce urban land for housing and also cross-subsidize weaker section housing. As part of efforts to acheive the goal of "Affordable Housing for All", the National Urban Housing and Habitat Policy, 2007 (NUH&HP) mandates the reservation of "10-15 percent land in new public/ private housing projects or 20-25 percent of FAR (whichever is greater) for EWS/ LIG housing through appropriate legal stipulations and special initiatives".

The Andhra Pradesh Government has become only the latest state to notify guidelines making it mandatory to reserve 20% of developed land in all urban housing projects to the economically weaker sections (EWS) and Lower Income Groups (LIGs). This is in addition to 15% of built-up area being reserved for EWS and LIG in housing projects.

For the layouts, the maximum plot size for EWS is to be 35 sq.mts and 55 sq.mts for LIG. The plots are to be disposed to registered weaker section societies or to public agencies at prevailing market rates as per the Registration Department. Such societies should develop them as group housing schemes and not plotted development. The policy also provides for complete exemption on stamp duty, non-agriculture conversion charges, and development charges for one time registration of EWS/LIG and 50% of development charges and other fees for LIG plots.

I am afraid that such policies, while populist and logically appealing at first view, do not pass muster on rigorous analysis. For a start, they are cosmetic exercises and will do little to address the urban housing problem. Even if all the several formidable implementation problems are overlooked, the houses that can be built under this will be minuscule in comparison to the requirements, especially in the larger cities.

The fundamental objective of all these interventions should be to ensure that it increases the supply of urban housing stock with the least possible market distortions. However, such policies will not only fail to meet its objective, but will also generates market inefficiencies that can create other problems.

There are two categories of consumers who face massive urban housing shortages. The economically weaker sections, consisting mainly of migrant labor, exert the largest demand on the market. The lower-income and middle-income groups too form large shares of the demand for urban housing.

In fact, such strategies overlook the multiplicity of categories within urban poor themselves. At one end are those, primarily the LIG, who can possibly afford to buy these houses with a bank loan. At the other end of the spectrum are the largest numbers, especially the poorest, who cannot afford these houses and will be reliant on heavily subsidized housing.

More importantly, this will adversely affect the general housing market itself and conflict with the primary objective of making housing affordable for the non-poor. From the perspective of the private developer, earmarked development will effectively reduce the amount of land available for full realization of commercial opportunities.

The developers would naturally pass on this additional cost (by way of incomes foregone, the opportunity cost) to purchasers through higher prices. In other words, the buyers of the original housing units (who are not always the economically well-off) end up paying higher prices. And this too without the LIG and EWS necessarily getting houses at a low price (even if they get at low price, the government pays a very high subsidy).

In other words, the earmarking serves as a tax on home buyers. The middle-income group (MIG), themselves a large customer group and the engine that drives urban economic growth, will be the worst affected by this. Similar attempts to get developers part with a share of their housing, say by offering a share of developed space for social housing in return for additional FAR also translates into higher prices for buyers of the original units.

In any case, the extent of land that is likely to be made available through such interventions is too small to impose such a large cost on the general market itself. Finally, there is also the administrative nightmare of enforcing such programs. The wide variations in land values, itself non-transparent, complicates matters. Who are the LIG and EWS? How do we monitor the allocation process? Even if state governments agree to provide the subsidy, how will the price discovery happen and what will be subsidy? How do we ensure that these housing units are not captured by middlemen who in turn will rent it out to beneficiaries?

At a more fundamental level, the massive demand can be met only with a mix of policies that increase the supply of vacant lands and encouragess vertical growth. Since most cities have already run out of their stock of vacant and un-allocated government lands, it is important to tap the massive extents of un-utilized lands available with various government departments.

Another source for unlocking land is to re-develop the squatter settlements on government lands, both notified and un-notified slums, with multi-storied housing units. It is here that we run into the highly regressive regulatory restrictions on built-up area that can be developed in any land.

There are regulatory and infrastructural limits on vertical growth in our cities. Indian cities have amongst the lowest Floor Area Ratios (FAR), ranging from 1-3. In contrast, FSI in most Asian cities varies from 5 to 15 and in many Western cities goes up to even 25. However, such vertical expansion would also require investments in the appropriate enabling utility infrastructure.

Restrictive Floor Area Ratios (FAR) are the single biggest impediment to unlocking the potential of urban housing market in India. Among all the bigger economies, India has the lowest FAR, which restricts the amount of built-up area that can be constructed on a land. The commonplace manifestation of this is the absence of high-rise buildings in our cities. I have blogged earlier about the need for Indian cities to go vertical and infrastructure facilities to be planned to accommdate vertical growth.

As a recent World Bank paper points out, all these policies are a legacy of an era when the objective was to discourage urban migration and distribute growth to smaller cities and villages.

There are also other stifling policy restrictions. The McKinsey report found that state and central governments impose a total tax of 27% on housing. This is in addition to the several regulatory conditions that are also de-facto taxes that increase the real cost of urban housing.

Quinlan: The US led us into this mess, the US will lead us out

I spoke this morning with Joseph Quinlan, Chief Market Strategist of Bank of America Capital Management here in New York. Our conversation touched on a range of issues including: the Irish economic downturn, inflation, the Fed, oil prices and the credit crunch.

Here's some of what he had to say.

On Alan Greenspan:

This is his mess. He created this and he's in some ways trying to rewrite history right now. The Fed could have prevented the housing bubble. They totally blew that.

On the interest rate approach of the Fed versus the European Central Bank (ECB):

They have different sets of problems. In the U.S., the house is on fire, and the Fed has to concentrate on getting the fire out. The ECB inflation focus is legit. Jean-Claude Trichet has to be brave enough to bring the European economy into recession, or the brink of recession, in order to get inflation under control.

On how we'll know the fire is out in the U.S.:

We need three things: stability in the housing market, oil prices down around $100/barrel, and bank write-offs need to be in the late innings. The housing market is still very much in turmoil. I think the probability is strong that oil will come down to that level. But we need the bank write-offs to be in the late innings. We need to be in the bottom of the ninth. Right now, it's maybe the bottom of the seventh.

On trans-Atlantic economic ties:

What this current downturn shows us is that all the talk of 'decoupling' the U.S. and European economies was premature. Personally, I'd like to see policy makers in Europe and the U.S. work toward creating a single capital market on a trans-Atlantic basis. But that's probably too much to ask.

On how it will all play out:

My feeling is, the U.S. led us into this mess and the U.S. will lead us out. California and Florida will be in recession for at least a year more, but nationally we should see some easing of this crisis when the bank write-offs really start being moved out of the system.