Sach Ka Samna

SKS seems to have ignited reactions from several people. I have not seen any episode of it, but have read about it, and believe that it is a disgusting show.

However, I would not go ahead and suggest that one morally polices such shows - 'coz that would be equivalent to suppressing freedom of expression.

I believe that if one really wants to counter such shows, then one must first understand why shows are succeeding, and then one must counter the underlying 'idea' such shows are based on.

SKS is succeeding 'coz it corroborates many people's underlying sense of life - that human beings are inherently degraded or corruptible. These people have sensed that they belong to this category, and hence they find comfort in seeing that other people's linen is dirty too.

I believe in the fundamental goodness of human beings. Hence, I think that such shows can be countered only by showing people that human beings are not fundamentaly 'bad' - that they have the potential to indeed be 'heroes'.

Epics like Ramayana and Mahabaharata projected such an image of man as a 'hero'. However, those heroes were elevated to be Gods or Avatars, and hence beyond human reach. If humans like Rama and Krishna existed, then it was a grave error to not portray them as human heroes.

Liquidity trap

The US is in a liquidity trap these days - much like Japan in 1990-2000 (the lost decade). After reading Krugman's blog, I think now I understand this phenomenon better, than I did when I first read about the liquidity trap in 2000.

In a normal situation, the interest rates in an economy are determined by level of savings (S) and investment (I) in the economy. If there are excess savings, then interest rates fall to equillibriate S and I again; and vice versa.

However, currently US is in a different situation. There is an excess of S which cannot be equillibriated to I by lowering interest rates - because interest rates are already close to zero! This is called liquidity trap.

However, as Krugman points in his blog, this situation allows US govt to increase fiscal expenditures without crowding out the private investment. Thus, the govt can use excess savings pool to finance some public expenditure without increasing interest rates!

Now, the question is that where did these excess savings come from? After all, US people don't save much, right? I think the savings came from mainly China, since the Chinese kept there reserves in US in $!

Why is inflation a fact of life?

I always used to wonder why, as I begun studying economics, is inflation a fact of life? Why do prices always seem to go up (on average)? Now I think I know the answer.

Inflation for a commodity could be due to its demand exceeding supply for a sustained period of time. However, I am here talking about overall prices. This I believe is mainly a monetary phenomenon (as pointed out by Friedman). Thus, historically, we have had more money chasing less goods and services. Hence, the overall inflation in most of the economies.

The questions is why would there be more money chasing less goods for a sustainable period of time?

I guess, the reason is deficit financing. Most governments over the world have been doing this. They print money to finance their welfare schemes and budgetary deficits. I guess this is the reason why we see inflation as a fact of life

The better the government's fiscal management, the lower the inflation. This relationship is evident if one looks at countries like US and Zimbabwe on two ends of the spectrum. India perhaps is somewhere in the middle with historical inflation in the range of 5%-7%.

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.)