Free rider problem

Unfortunately, yesterday somebody stole my car stereo while the car was parked in the parking. It was not just me but there were 5 more people who were complaining about the same. Let me describe the parking in my area- We have residential colonies and the parking slots are not permanent, so people park their cars near their houses-not necessarily in front of them.
I went up to the residential welfare association president to complain about what happened. He told me that he was helpless. He described the problem to me-
Problem: There are not many guards in the area. The existing guards are also very weak and are not that efficient
Cause of the problem: There were very few guards because there were no funds with the treasury to hire more. Why were there no funds? Well, the monthly service fee for security was not being paid by a significant number of residents.
So basically, only a few residents were paying money to the association to hire security guards for the residential colonies. This sounds like a typical free rider problem. A free rider is a person who receives the benefit of a so-called public good without paying for it. Few residents were not paying because they wanted others to pay for security.
Clearly, this is a problem
Solution:
Mr president suggested one solution- Make every individual pay a fee for every car they own. This will generate enough revenue to hire more guards. I like this solution. But the problem is that this fee is not a tax on the residents. Even if they don’t pay this fee, the association cannot do anything. This will also give the residents an incentive to lie about the number of cars they own.
Typically, solution to such problems lies with taxation. But, because the residential association is not a government unit, taxation is not an option.
Here is what I would suggest- Make every household pay a fixed fee. Assign an agent for every building (the agent should be a resident from the same building) in the residential area for collecting the amount. Have an incentivized structure for these individuals so they also get some share (1%-2%) from the total collection. I believe that a significant number of individuals who were not paying earlier would start paying. This fee is still not a tax. But collection from those individuals who were not paying anything earlier will increase as now the fee collection will be more organized & incentivized; agents will chase the residents and make them pay the fee. Seeing “friendly” neighbours collect money, residents will definitely start paying the fee.
Can you suggest any other solution?

Forex reserves swells to $ 253.83 bn

Forex reserves went up to $ 253.83 billion for the week ended March 20, up $ 5.1 billion, compared to $ 248.72 billion in the previous week...
Source: EconomicTimes

Good news: Lending rate coming down

4 banks cut PLR by 25-50 bps
Source:Business Standard

Deflation mystery- Still unsolved

Deflation not a threat to economy: Bankers
With inflation fast approaching zero per cent, bankers have sought to allay fears that the country may be in the deflation mode on grounds that the consumer price index was still high and deflation was a statistical phenomenon due to base effect.
"Deflation is unlikely to have any major impact on the economy. Negative inflation, if it happens, will occur mainly on account of declining oil prices, easing monetary policy. It is unlikely to stay long," IDBI Bank Chief Financial Officer R K Bansal told media here.
Source: EconomicTimes

Totally agree with the bankers on this. Additionally, I think-
1. Inflation by definition is change in prices over a period of time. Fluctuations in demand and supply keep happening in all the markets and all the time. Deviations in prices from the equilibrium due to such fluctuations should not be taken as trends. In short- Let us wait for another couple of months to see the price trend (both CPI and as well as WPI)

2. The key point here is that WPI is near zero percent and the CPI is still around 9%Is this good or is this bad? Well...difficult to say now. Anyways, what is more important right now is to see and understand the forces that have led to a dip in WPI (still will not call it a trend)? Given that we do not seem to be in a liquidity crisis right now, falling WPI could mean that either the demand is falling or the supply is increasing in the goods market. Given the slight fall in the optimism in the economy, I think it is the former.
There can also be additional forces at work here. But, it will be interesting to see how things change from here.

The good thing is that the common man may actually start believing that the inflation in at zero percent and may start spending. However, we don't want to move into a situation where the common man starts thinking that the inflation is going to continue to fall- this will make him delay spending now.

Economy needs more stimulus in 2009-10: Ahluwalia

Mr Ahluwalia had earlier said that the economy’s growth rate would be slightly less than 7% in the current fiscal and the next fiscal. "We are likely to get a growth rate less than 7%... between 6.5% and 6.7% in 2008-09," Mr Ahluwalia had said.

Source: Economictimes

What if RBI becomes a regular corporate bank?

Here is a hypothetical situation (Although I don't know why it cannot become a reality)- What if RBI turns into a regular Bank? I am just thinking of some of the implications of such an event.

Today the banks are reluctant to lend. In India, the inflation is zero percent and the lending rate is still around 9%. The RBI has been cutting the bank rate consistently, but to no benefit. Banks are not ready to bring down their lending rate. Now the question is that is there any quicker way of giving money to people?

What if RBI also starts playing the role of any normal corporate bank. Let it lend money to people/businesses/government at a lower rate than that is present in the economy.

Here is what will happen-

1. RBI will be able to not only increase money supply but actually increase
demand by lending at a lower rate
2. The private banks will face immense competition from the central bank. The result
will be that the pvt banks will also have to start lending at a lower rate

India - Managing the Impact of the Global Financial Crisis

This is a speech delivered at the Confederation of Indian Industry's National Conference and Annual Session 2009 in New Delhi on March 26, 2009. - By Duvvuri Subbarao, RBI Governor

The article talks about the various fiscal and monetary policies that have been announced to combat this crisis. Subbarao also talks about the outlook for India.

I don't agree with one point that he mentioned in his speech-

Finally, over the years, India has built an extensive network of social safety-net programmes, including the flagship rural employment guarantee programme. These uniquely Indian versions of automatic stabilizers should protect the poor from the extreme impact of the global crisis.

I don't think the flagship rural employment guarantee programme of the UPA is an automatic stabilizer by any stretch of imagination. An article in IndianExpress shows how the plan is behind in delivering its intended benefits- In most cases, the number of job-days are as less as 25, a government-sponsored panel said.
Anyways, I don't think of this as a major stabilizer and definitely not as an automatic one

India to grow at 6% this year: UN

Source:The Financial Express

Assumption of perfect knowledge

Yes, you will find implicitly or explicitly an assumption of perfect knowledge in any economic theory or model. Obviously, the market change is always dependent on the economic agents...and for that to happen these agents have to be sufficiently informed about the state of the economy.
Now, people depend on economic indicators for that knowledge. I am just wondering whether having more economic indicators (i.e., more informed/misinformed people) can have any impact on the speed with which market forces work.
For example- Developed countries like USA and Japan have several indicators that can help investors/consumers determine the state of the economy and make an informed decision. Here are some indicators for Japan that I came across –
1. Consumer Confidence Index: 26.4 (+0.2)
2. Overall Livelihood: 29.2 (+0.7)
3. Income Growth: 31.4 (-0.1)
4. Employment: 14.2 (-1.2)
5. Willingness to buy durable goods: 30.6 (+1.2)
Source
In a country like India it will be near impossible to get these indicators. This is bound to impact the speed with which market forces work here (India). You can find interest rate numbers, GDP growth, FDI/FII, etc, but you will not be able to get those second level of economic indicators, (as illustrated above) which may have a role to play in changing expectations and hence the speed of the change in the market

RISK FREE SUIT

Jos A Bank store in Illinois has launched a 'Risk Free Suit'. The store promises to refund the price of a suit if the purchaser loses his job. (AFP)
Source: Economic Times

Unemployment in India. How much?

Despite my best efforts I have not been able to find the unemployment trend in India.
The last official numbers are for 2005-06.

However, I did find some numbers on CIA factbook
According to it-
Population of India (est for 2008) is 1.16bn
Unemployment (est for 2008) is 6.8% i.e. around 7.9 mn unemployed. I think that this number is grossly understated. The unemployment number has to be in double digits.
Here is why-

More than 70% of the population lives in rural parts of India (in approximately 6,30,000 villages)

I came across an article on Indian express that puts the unemployment rate in Urban India and Rural India at 45% and 17% respectively, per the last NSS in 2005-06

Quick maths tells me that at least (17%*70%*1.16bn) + (45%*30%*1.16bn) should be unemployed. This recession has already taken a heavy toll on employment in urban India. Real unemployment has to be much more than the above no. (i.e. 294.6 mn or 25%of the total population). Whoa! I sincerely hope that there is something wrong with my calculation.

Deflation in India?

It's disinflation, not deflation, we're facing now

Last Thursday's inflation numbers -- a drop to 0.44 per cent in the wholesale prices index (WPI) -- brought more worries that cheers. That's because deflation -- a situation where prices, jobs and incomes keep falling on a sustained basis, and the economy keeps contracting -- has become a new cause for worry. Is India on the cusp of a debilitating deflation?

Certainly not, say the experts. "These fears of deflation are unfounded," Pawan Kumar Bansal, Union minister of state for finance, told a news agency.
Read more

Coming soon: Interest rate cuts

India’s Ahluwalia Says “More Room” for Interest Rate Cuts

India’s central bank has “more room” to cut interest rates further to combat economic slowdown and a global recession, according to Montek Singh Ahluwalia, deputy chairman of the nation’s Planning Commission.

Parliamentary elections scheduled for April and May complicate efforts to boost the economy because the government is banned from announcing new fiscal policies or stimulus steps until the voting is finished. Prime Minister Manmohan Singh’s government has backed the monetary stimulus by lowering taxes and increasing spending on infrastructure.

...“The new government when it comes into place probably in early June will almost certainly continue the fiscal stimulus policies we have followed,” said Ahluwalia. “We will use the opportunity, the scope that is available for monetary policies, to support these fiscal policies.”...

.... India’s politicians are one of the “major problems,” Rogers told the Wharton India Economic Forum via videolink from Singapore. The country has the “single worst bureaucracy in the world.” If a person can deal with that, “there are fortunes” to be made by investing in India, Rogers said.
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Some observtions:

1. Good to see that the RBI is looking to cut interest rates. With the inflation reaching near zero level the "Bank" does not have any choice left also. Borrowing has to become cheaper
2. On the fiscal expansion- I didn't realize that the govt is banned from implementing such expansionary fiscal policies. Thus it becomes more important to push for monetary expansion
3. Bureaucracy is bad for any economy. However, what bureaucracy does is that it acts as a friction against a fast moving machine. Higher the friction, slower will the machine run. If there is no friction then the machine will run smoothly and quickly- this can also make it be uncontrollable.

Bureaucracy without corruption is acceptible but bureacracy with corruption is devastating. I think the former is present in India.

Another growth prediction for India - 4.6%

CLSA sees India GDP growth at just 4.6%

Broking house CLSA Asia-Pacific Markets on Wednesday termed India as one of the riskiest markets to be invested in at the moment. The outfit has forecast a GDP growth of 4.6% in 2009-10, and expects the domestic economy to stabilise only by early 2010. Further, it has projected public sector deficit to rise to 14% of GDP in 2009-10, and the rupee to fall to 57 to the dollar by the end of this year.
The broking house, however, has said an Argentina-styled debt crisis was unlikely. “The bulk of Indian government debt is domestically held and Indian banks are eager buyers of government securities. However, not only is the government’s $500-billion infrastructure programme on the back burner, but the spread between private and public sector borrowing costs has widened, bad news for private investment spending,” the note said.
CLSA opines that capital outflows — both portfolio and FDI — could continue for some time. “A rapidly widening budget deficit, coupled with slowing growth, falling investment returns, a substantial current account deficit and growing global risk aversion (which is underpinning the flight to safety into the $) suggest that these trends will continue,” it said.
Source
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CLSA makes some astounding and ridiculous predictions. Here is my take on it-
CLSA has a forecast of 4.6% in 2009-10 and projects that deficit will rise to 14% of GDP. I strongly believe that a forecast of 4.6% is based on the assumption that India’s fundamentals are weak and are further weakening- something I strongly disagree with. Also, if the deficit actually rises to 14% (from current ~5%) then India would not be growing at 4.6% but somewhere around 7%. For the debt/GDP ratio to reach ~14%, India will have to make some huge investments and this is exactly what is required at the moment (although may be not as much predicted by CLSA). So the growth and deficit predictions are counterproductive

All in all- I don't agree with anything that they are saying and I am sure I am not the only one.

Why India should not listen to IMF

IMF wants India to fight slowdown by easing money supply

The International Monetary Fund today urged India to further ease money supply to fight economic slowdown while cautioning that
additional expenditure and more tax reliefs could raise public debt to unsustainable levels.

Commending the steps taken by the Reserve Bank to ease money policy by reducing key policy rates and ratios, the IMF in its annual review of the Indian economy said, "(there is) scope for further monetary easing, in light of projected decline in inflationary pressures and the need to reinforce confidence and sustain bank credit."

Read more

I respect IMF and its opinions. I also understand that IMF's advice will always be biased towards monetary and not fiscal policies. However, I don't think that at this stage India needs to be worried about debt levels. It is a time to invest and ensure that the economy is moving.

A high debt/GDP ratio is never good. However, instead of reducing the numerator (debt) you can also focus on increasing the denominator (GDP).
This is a very uncertain time for the economy. Every govt should adopt a mix of fiscal and monetary policies to tackle the situation.

So...don't listen to IMF- Spend and invest(at least not now)

Perception is reality

The role of expectations is very very important in economics. Expectations plays a key role in driving demand. Expectations are driven by perceptions and perceptions are driven largely by the announcements that you hear. Quite often these announcements are made by leading organizations, economists, or even political leaders.
In short- What these leaders or organizations say actually does play a key role in how the market moves.

Here is an experiment to explain this-
Consider a room with 100 people and assume that they stay there for the next few weeks.
Scenario A
Now, before letting them go tell them that the economy is in a bad shape and soon there will be a financial crisis. What would you expect from these people when they go out in the real world?
I expect them to be bearish about future and share they concern with other people, who in turn will pass on this bad/sad mood to others.
Scenario B
Before letting them go tell them that the economy is growing. Everyone is happy and bullish about future. Go enjoy life.
I would expect them to go out happy spread this happy feeling to others.
Points I am trying to make are the following:
1. If political leaders and economists show optimism/pessimism in their speeches/announcements then this will influence the rate of change (positive or negative)
2. The perceptions are taken to be reality by not some but many individuals. Not every individual will keep a check on how interest rates/inflation/GDP is moving. They will get influenced a lot by what they are hearing

A headline that caught my attention

Buy a house to save more tax
Investment in a house could be the best way to save tax. As prices of residential units have gone up in the range of Rs 50 lakh and over, tax experts say buying a second house for investment purpose will save even more tax than that over the first house you bought for personal use.

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Thank god it was an advice from a tax expert and not from an economist!!


Demand driven by investment needs has different characteristics than the one driven by consumption needs. The demand curve is upward sloping in the former case.

In an investment scenario a vicious cycle starts- Everyone starts demanding goods for investment purposes thinking (hoping) that there will be someone out there who would be willing to buy this good at a higher price. This is also known as greater fools theory.

This is a zero sum game. Somebody has to loose and somebody has to win. Investment returns are dependent on uncertainity on future. Clearly, if everyone knew how prices would change in the future then everybody would become a bear or a bull and their would be no one on the other side.

However, these are VERY uncertain times. As an individual living in such times, I will definitely not be buying any houses in near future!

World Bank lays down the ideal plan for India

India should boost money supply, focus on infra: WB

World Bank chief economist Justin Yifu Lin on Friday, noted that by investing in the bottlenecks of the country like infrastructure, India could see pick up in demands, especially in the face of current crises, which would pave the way for a longer-term growth.

“Lin also pointed out that the monetary policy should be such that to reduce interest rates and increase money supplies, so as to spur demand. If money is invested properly, it wouldn’t lead to inflation and higher rates. Investment in infrastructure could revitalize manufacturing in India, which accounts for only 16% of the country’s total output, and contribute significantly to job creation,” said Lin who was addressing a press conference in Mumbai

Read more

Army headcount getting affected by policies

The armed forces is the greatest recruiter in India right now. Here is good example of how the government is ensuring employment for people and at the same time the army is taking advantage of the job situation/crisis. (I am refering to an article in Times of India, 16th March)

Here is another extreme example -

Taiwan to cut troops 16% over five years

Taiwan will cut troops by about 16 per cent over the next five years, officials said on Monday, in part as a streamlining measure and in part in response to a perceived lower-level threat from political rival China.

The defence ministry will reduce Taiwan’s military police to a command centre under the army, part of a long-term effort to cut troops from a 1970s Cold War high of about 600,000 to 210,500 in 2014, going for quality over quantity, military sources said.

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Although I think the Indian govt has taken the right step in this situation, Taiwan govt's step does not impress me.
Here is why-
1. This is not any normal job. People in this job are motivated not by money but by the love for their country. You cannot/should not move people like that
2. The govt could have used the troops productively. The ones that are being laid off could be given alternate employment
3. If the Taiwan govt thinks that in times of political crisis they will be able to recruit people immediately and send them to war, then it is wrong. There is a lot of training and hardwork involved. Soldiers cannot be asked to go home and come back after a year in case there is a war

Most importantly- the soldiers should be respected

Record fiscal deficit - Not a worry, let's invest

Just to add to what I mentioned in my previous post.

This is no time for governments to curtail investment. Countries such as USA and China and also others are investing heavily in their attempt to come out of this recession quickly.

US Fiscal Deficit Projected At 12.3% of GDP In 2009

China budgets record-high fiscal deficit in fight against global crisis

Illogical prioritization

Govt should get back to 3% fiscal deficit target by 2010-11: Virmani

Chief Economic Advisor in the finance ministry Arvind Virmani said the country should aim at limiting its fiscal deficit--the gap between
total spending and most of the receipts--to the 3% mark by 2010-11.
India's fiscal deficit is projected to more than double to 6% of GDP this fiscal against the budgetary target of 2.5%. For the next fiscal, the deficit is estimated to be 5.5% of GDP. Virmani said India has provided one of the largest stimuli in the world, leaving aside countries that are directly the source of the crisis.

I agree that fiscal deficit should always be watched. But this should not stop the government from investing. Govt should not be scared to invest just because the fiscal deficit is going up.

This is a global recession. It is an exceptional time. How can we talk about containing the fiscal deficit at this time. Government should definitely borrow more and invest in public private partnerships. Ofcourse this may drive up the interest rates. But a fine balance will need to be maintained.

To maintain the deficit new measures should be put in place to stop the revenue leakage. Still a significant percentage of the revenue is lost as people fail to pay income/sales taxes.

INDIAN GOVT- DONT STOP INVESTING. THIS IS THE ONLY WAY RIGHT NOW TO MOVE OUT OF THIS SLUMP QUICKLY

U.S. jobless rate hits 25-year high, payrolls dive

The U.S. unemployment rate hit a 25-year high of 8.1 percent last month as employers buckling under the strain of a severe recession axed 651,000 jobs, government data showed on Friday.
The manufacturing sector shed 168,000 jobs in February, after eliminating 257,000 positions the prior month. Construction industries bled 104,000 jobs in February after losing 118,000 in January.
The service-providing industry slashed 375,000 positions after shedding 276,000 in January.
Read the full article here

Obama's policy on bonus cut - a good political move but a counterproductive economic policy

Treasury Restricts Executive Pay for Bailed Out Companies
http://www.thecro.com/node/770
President Barack Obama and the treasury department moved to restrict executive pay packages at financial firms receiving “exceptional financial recovery assistance.”
At such firms:
• The policy limits senior executives to $500,000 in total annual compensation, except for restricted stock awards. The stock could be cashed in when the government has been repaid
• The senior pay structure and strategy at such firms must be fully disclosed and subject to a “say on pay” shareholder resolution
• A clawback provision would permit recovery of bonuses and compensation from top executives found to have knowingly provided inaccurate information or performance
metrics to calculate their own incentive pay
• Top executives would be barred from receiving golden parachute payments
• Boards would have to adopt policies relating to approval of luxury expenditures such as aviation services, office renovations, entertainment and holiday parties
• The administration said it would host a conference on “executive pay reform at financial institutions” to identify best practices and guidelines


I don’t quite understand the motive behind this decision. Is it to punish the executives who have led the economy into the recession or ensure that future executives don’t commit such mistakes again? Some may argue that the answer to both the problems is the same. But I think otherwise.
Economy is already in recession. Time is ripe to develop new leaders. From a political point of view it is understandable that Obama wants to reduce the executive pays and bonuses of executives whose companies are receiving bail-out packages. However, from an economic standpoint I don’t understand the rationale behind the decision to reduce pays and bonuses.
Obama’s policy has its pros and cons-
Pros
1. Less money will go as compensation that means more money towards operations and
investment
2. Executives might think that this is more of a punishment for their bad decision making and might start taking less risk (I am not even sure how relevant this is in the real world)
3. Obviously more votes for the democrats

Cons
1. There will be no incentive for executives to perform better (or even stay in the firm) especially because the pay is less and the stock awards would be allowed to be cashed when the government has been repaid (which will mean much more than 5 years)
2. There will be no incentive for new potential executives to join these companies. Clearly, they will get much more outside of these companies. Hence, these companies are bound to face talent shortage

Obama’s decision is driven more from the point of reducing the inequality.
His rationale- When there are millions unemployed then how can a few enjoy the millions(in compensation)

In my mind- The compensation structure should not be changed much. Only the incentive structure should be tweaked a little bit. Instead of tying the bonuses to stock value and revenue growth a new structure should be designed that ties the bonus incentives to more fundamental things. May be reduction of % of NPAs in the book, etc
I don’t know of anyone who would like to join such firms (bailed-out) as an executive. Do you?

Creating an incentivized structure

A key requirement of any policy should be to create an incentive structure for all the agents in the economic system that enables the agents to act in a manner that best allows the policy to meet its ultimate objective.

Let us understand this with a simple example. Assume a simple economy where the citizens own highly fuel in-efficient cars that run on precious petrol. The government will have multiple policy options to reduce the pollution level. Here are a few (of the many) options-
1.Regulate the production of fuel in-efficient cars (actually effectively banning them)
2.Highlight how in-efficient cars are harming the economy and hope that conscious citizens hear the government’s call to change cars
3.Announce that people owning fuel efficient cars will get a tax cut and penalize the owners of fuel in-efficient cars with a pollution tax

Let us evaluate these options-

1.Supply side action. It will just help in increasing the ratio of fuel efficient to fuel in-efficient cars. The citizens here have no incentive to convert to fuel efficient cars. Hence, this is obviously the most in-effective policy
2.Demand side action. The government assumes that the citizenry has a moral duty towards the society. The effectiveness is very unpredictable unless the assumption of the government is true
3.Another demand side action. In this case the government creates an incentive structure. The government understands that in order to flush out the in-efficient cars from the system, the citizens need to play an active role. In order to force/enable the citizens to change their cars there needs to be a system of incentives. The citizens should have an incentive to change cars

Today, a number of companies give bonuses to CEOs and other executives. Ever wondered why these bonuses even exist? Cleraly an example of an incentivized pay structure.

I strongly believe that these economic agents are the key to any policy success, hence the effectiveness of any policy depends on how strong/leak-proof the incentivized structure is