The economy needs Ayn Rand

Today I read a debate on relevance of Ayn Rand's philosophy for today's economic context. I am now tempted to elicit my position on this debate. Thus I break a 1.5-year blogging hiatus!

I would not comment on the person who is against the motion in the debate, except that if I say that she is stupid than I would be making same kind of arguments that she has made in the debate.

However, I like the arguments made by the person in favor of the motion. His main argument is that it was not Greed but Government's (and Fed's) intervention that got us into this mess.

Before I describe my position, I want to mention that I have always admired Ayn rand. I find her writing and her interviews extremely clear and compelling. However, after my economics education, I have begun to slightly modify my views on capitalism and human nature. Below are my thoughts:

My position:

• Capitalism is the best economic system known to mankind
• However, only if there is an ideal starting point for the economy
• This ideal starting point is that individual wealth has been 'rationally' earned

Why capitalism is not working today?

We have never been anywhere close to the ideal starting point.

Firstly, individual wealth have never been 'rationally' distributed. Secondly, individual incomes have seldom been 'rationally' earned.

If today the world moves to laissez-faire capitalism, I still will have an edge over lot of others. This edge will not be due to my own innate merit. Instead, it would stem from my parents' wealth - due to which I could go to the best educational institutes.

Hence, unless there is a 'fair' starting point for all, capitalism will not work its best.


Why socialism or govt. intervention is not the right answer to today's problems?

1. Because it creates 'unfair' starting points for a few individuals
2. Because it removes 'rationality' from future income generation and distribution.

What can be done now to make capitalism work?

The only fix is to fix the starting points. Otherwise, we will continue to live in an imperfect economic world.

It is not at all easy to fix the starting points. However, below are my 2 cents:

1. Abolish private property on natural resources (e.g. land, oil, etc)
2. Enforce property rights on man made resources (e.g. Intellectual Property)
3. Devise a redistribution mechanism so as to fix the errors of the past
   

All of the above is easier said than done! But one needs to say it first - right?


P.S. Since I have used the word 'rational' so many times above, it is important that I state what I mean by it. Instead of defining it, I would try and triangulate it below:

Conditions for a rational system:

1. One can only keep the wealth that is earned by him, and by his own effort.
   
2. One can only keep the income that is earned by him, and by his own effort.

Tests for a rational system:

1. Universal sustainability: If the rules (or norms) of the game are followed by all, the system should be sustainable.
2. Efficiency: The system should lead to the most optimal use of scarce resources
   

Why consultancies exist?

In my opinion there are two fundamental reasons why management consulting (MC) firms exist:

1. Experience and expertise that an MC has in solving business problems: An MC has expertise in solving business problems which a business organisation often lacks. An MC can benefit from previous similar experiences and apply the learning to similar problems in fresh situations. e.g. a bank may not know how to enter a new market but an MC would most likely have assisted tens of other companies in a similar task. Thus, an MC offers value in terms of experience and expertise to that bank.
2. Presence of incentive incompatibility in business organizations: Every business decision faces business uncertainty and hence has some risk. Now an executive, who is just an agent of the shareholders (principals), will not take a risky decision unless he himself gets a return that satisfies his risk-return trade-off. In organisations such as investment banks this incentive incompatibility is low as the executives' bonuses are directly linked to the bank's profits. Hence, such IBs don't usually hire MCs unless it is for CDD (which is due to the reason explained in point 1). Now, MCs take a part of the risk and the return from the executive. Now, the executive's risk-return trade-off is satisfied and the MC's as well.
   

Materialism vs Idealism

What causes things to move or to act in the way they do?

A materialist believes that matter (things) shapes events. e.g. a materialist believes one will feel happier if one has a car, a house and a lot of money. So for a materialist, the source of happiness exists outside - in material things.

An idealist believes that ideas shape events. e.g. an idealist believes one will feel happier if one control his desires. So for a materialist, the source of happiness exists within oneself.

Who is right? I feel both are right to an extent.

In my past, I have certainly felt happier by possessing material things.
However, I have also felt happier after I controlled my desire to have an ice cream.

I believe that western philosophy is more Materialistic and Indian philosophy is more Idealistic. Americans extol material success. Whereas, Indians gurus focus more on self-control.

I believe this is due to different circumstances India and America have had historically.

India was a land of abundance in ancient times. Hence, matter was easily available and hence obtaining it was not really a virtuous task. So, self-control became a virtue.

In America, it was the opposite. Matter was not abundant explicitly. Hence, industrialists and businessmen had to extract matter by hard work and ideas. Hence, material success became desirable.

However, I believe we are more under the influence of materialism today than of idealism. We under-appreciate the power of mind.

A doubt... addressed

The question:

Before doing my MBA I used to ask myself two questions:

1. If a retailer only has 5% margin, why does he do the business?
2. Is he not better-off investing in stocks and making higher return?

The Aha!:

Now, after my MBA, I wonder how stupid I was!

Below is why the retailer should still be in the business:

First of all, we need to define his return on his investment (RoI). This can be defined as:

RoI = Income/Investment

Now, RoI can also be written as:

RoI = (Income/Sales) * (Sales/Assets) * (Assets/Investment)
= Margin * Asset Turnover * Leverage

[An MBA would instantly recognize that I am talking about the DuPont formula here].

Now, we can see that we are not comparing apples to apples when we compare 5% to 10% return on stocks - 5% is his margin, whereas 10% is his RoI.

Thus, his RoI should be = 5% * Asset Turnover * Leverage

Now, a big retailer can take loans and hence his leverage will be > 1. If he finances half of the assets through his own money and half through loans, then his leverage will be 2.

Now, if he sells all of his assets in 1 year, then he will make 10%!. Thus:

RoI = 5% * 1 * 2 = 10%

For unorganized retailers, leverage may not be possible that easily. Hence, these guys make money as follows:

1. Higher margins (15%-20%), as they mostly sell private-label stuff.
2. Understatement of income tax
3. High Asset turnover - by reducing their working capital needs (buying on credit, etc.)

Why is Oil rising?

Sources:
http://news.bbc.co.uk/2/hi/business/7048600.stm
http://en.wikipedia.org/wiki/OPEC
http://www.eia.doe.gov/emeu/cabs/topworldtables1_2.htm
http://www.jubileeinitiative.org/RiggedOil$.html
http://www.reuters.com/article/reutersEdge/idUSL0132223020071101

1. Geopolitical factors:

These are causing uncertainty in the market and helping to push prices up. Such as fears about possible Turkey-Iraq conflict. This conflict could threaten oil output in wider region - Iran, Iraq, Kuwait and Saudi Arabia. These countries produce about 20% of world oil supply and about 50% of OPEC supply. OPEC accounts for 66% of the world's oil reserves, and about 40% of the world's oil production.


2. The weak $:

This makes it cheaper for importers to buy dollar-denominated oil supplies, thereby increasing demand for oil. Although biggest oil importers are countries that have had no benefit from a weaker $ - countries such as US, Japan and China. Still, the $ has gone down against currencies that control about 25% of the imports of top-15 oil importing countries

3. Growing demand from India and China:

India and China have about 15% share of the imports of the top-15 oil importers. Moreover, the oil demand from these countries is growing by double digits every year!


4. Financial speculation:

Investors take bets on future oil prices by oil futures. Earlier this year, these speculators were long on oil. As the price of oil has increased above $90, the investors that sold the options to these speculators are scrambling to cover their positions. This has boosted demand as well.

Thus, it is not just physical demand/supply but also financial demand/supply that influences the markets prices of oil.

FAQs

Below are some philosophical questions I often ask myself:

1. Is it all in the mind?
2. Is everything cyclic? If so, why?
3. Is there a trade-off between discipline and creativity?
4. Why do we improve after practice?
5. Is crime a fact of life?
6. Are there a few basic principles governing nature and life?
7. Is victory over self possible?
   
8. Why some people do not like some other without any reason?
9. Why some people don't like love movies like KKHH, DTPH?
10. Why is SRK either loved or hated?
    
11. Why is Jeans so popular?
12. Why some kids who show promise don't achieve their potential?
13. Why do opposites sexes attract? Why do homosexuals exist?
14. Why do some songs become so popular, while others do not?
15. Are there some basic principles that govern aesthetics?
16. Why do properly directed erotic movies arouse better than porn?
17. Why do I admire Ayn Rand?
18. Why do two people fall in love?
19. Why a lot of love marriages fail?
20. Are all claimed love marriages really so?

I will try to answer some of these in my future posts.

Indian financial system

What follows is my understanding of a May 2006 McKinsey report on Indian financial system reform:


This report asserts that Indian financial system is inefficient, and it does not allocate capital efficiently i.e. to its most productive uses.

Indian financial depth is low as compared to other Asian nations. This means that India has 160% of GDP as financial assets.

Breakup as a % of GDP as of 2004:

1. Equity: 56
2. Corporate debt (Through Bonds): 2
3. Govt debt: 34
4. Bank deposits: 68

This is as of 2004. Today (2007) the equity is about 100% of GDP. So financial depth has probably increased to about 200%. In comparison, Japan and Singapore have 400% financial depth.

Another aspect that is different about India is its low corporate debt. Hence, companies have to rely upon banks for loans.

Indians are also world's largest gold consumers and these money could be channelled into more productive uses.

Most of the savings go into govt priority projects. Banks are obliged to hold 25% of their assets in govt bonds. Govt policies require banks to direct a big chunk of loans to agriculture and other priority sectors.

Indian banks only lend out about 60% of their deposits. This number is about 100% for UK and US.

Much of the banks funds go to fund the total govt deficit (including states). This is about 12% of the GDP!

Indian corporate bond market is just 2% of GDP because of several reasons:

1. High issuance costs due to complex regulation
2. Lengthy listing procedures
3. High disclosure requirements
4. Inadequate credit risk rating system
5. Inadequate dispute resolution mechanisms.

Hence, these banks avoid the hassles. They go for pvt placement, international bonds or bank loans. These bank loans crowd out smaller players who need funds to grow. [May be this is why PE is booming in growth capital in India ].

If these inefficiencies are removed, India can grow even faster!!