Global Recession- Who Is The Culprit?

Everybody has been talking about the root cause of the financial crisis. Some blame the bankers, some blame the greedy house owners, few blame the FED, many blame the regulatory authorities. Who is the real culprit is difficult to identify. In an integrated world it is not easy to say whether 'X' led to 'Y' or 'Z' led to 'Y'. However here is my assessment-

Two primary causes-
1. Low interest rates
2. Less regulation

I believe that economics is driven by incentives. If you give the right incentives to people then there will be overall beneficial growth.

Low interest rates
The housing bubble collapse is seen as the core cause of this recession. Why do you think there was a housing bubble? Because people who didn't have the money to buy a house also became house owners. They were able to borrow money at a low rate and were encouraged by the Fed to borrow more. In other words these people had an incentive to borrow. Why were the rates so low? Well... Fed chose to keep them low. Their reasoning is that they wanted to take the economy on a growth path after the 2001 recession. But the problem was that the rates were kept too low for too long. Why?

Less regulation
Bankers and other financial institutions wanted investment vehicles where they could invest money. They could not find any. So guess what? They created their own...they created complex structures which were difficult to understand. Nothing wrong till now. Bankers are greedy like common people. They have to be profit seeking. Profit seeking behaviour of the companies is an essential condition for any economy. Innovation and technology development is an outcome of such profit seeking behaviour. It is a reality and can't be ignored or ridiculed. The problem started when the regulatory authorities were not able to (or even willing to) detect it. In other words the bankers did not have an incentive to stop such practices. Why were such practices (totally legal) not detected? Is the answer -crony capitalism

I completely blame the Fed. Alan Greenspan has admitted that he got it wrong. Fed set the wrong incentives for the people/institutions.

Fed did things that it was not supposed to be involved in. Fed is not there to boost the housing market. Today, most of the economists believe that supply of money directs the growth of an economy. Power is in the money. But, money is with the Fed. There should be no room for error by the Fed.

The following are some the responsibilities of 'The Board of Governors
of the Federal Reserve System'- Source: FederalReserve

1. The primary responsibility of the Board members is the formulation of monetary policy. The seven Board members constitute a majority of the 12-member Federal Open Market Committee (FOMC), the group that makes the key decisions affecting the cost and availability of money and credit in the economy. The other five members of the FOMC are Reserve Bank presidents, one of whom is the president of the Federal Reserve Bank of New York. The other Bank presidents serve one-year terms on a rotating basis. By statute the FOMC determines its own organization, and by tradition it elects the Chairman of the Board of Governors as its Chairman and the President of the New York Bank as its Vice Chairman.

2. The Board sets reserve requirements and shares the responsibility with the Reserve Banks for discount rate policy. These two functions plus open market operations constitute the monetary policy tools of the Federal Reserve System.

3. In addition to monetary policy responsibilities, the Federal Reserve Board has regulatory and supervisory responsibilities over banks that are members of the System, bank holding companies, international banking facilities in the United States, Edge Act and agreement corporations, foreign activities of member banks, and the U.S. activities of foreign-owned banks. The Board also sets margin requirements, which limit the use of credit for purchasing or carrying securities.

4. In addition, the Board plays a key role in assuring the smooth functioning and continued development of the nation's vast payments system [see Fedwire and Payment System Risk Policy].

5. Another area of Board responsibility is the development and administration of regulations that implement major federal laws governing consumer credit such as the Truth in Lending Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act and the Truth in Savings Act [see Consumer Information and Community Development].

India...creating real assets

Govt clears 22 FDI proposals worth Rs 541 crThe government has cleared 22 proposals, including those of Yamaha and Nokia, that will bring in Rs 541.25 crore of foreign direct investment (FDI) into India.

These are all positive signs. FDI is always better than FII. FDI shows that companies are confident of investing in the country. This creates 'real' assets and employment. I will anyday prefer FDI inflow of Rs 1,000 cr to FII inflow of Rs 2,000 cr

Some good news for the industry...

Core sectors rebound to hit 6-mth high growth of 2.9%

Holiday Reforms In Japan

The government is considering holiday reform to increase tourism and relieve crowding problems that often accompany vacations. In addition to creating more three-day weekends by switching holiday dates, the government is considering staggering summer breaks at schools by region.
The Tokyo Metropolitan Government and Chiba Prefecture, among others, have already created special holidays, mainly for students at public elementary and junior high schools.
The central government is discussing ways to prompt employees to take more paid holidays. One idea is to change accounting standards so that companies are required to book reserve provisions for unused holidays as debt.
Japan ranks lowest in terms of use of paid holidays, with over 50% of the total going unused annually. The government estimates that using the full amount would create about 1.5 million jobs and generate economic benefits of about 12 trillion yen.
The government plans to work out the details of its plans with the relevant ministries and industries.
Source: The Nikkei

Three day weekends...longer summer breaks. I like the idea. At a time when people are concentrating on bringing a banking reform and designing a export strategy, Japan is going to a new level to boost demand. Obviously the flow through will not be 100%, but still this is a costless policy.

More on free market theory...

I have been seeing videos and reading articles of Milton Friedman. His theory/approach about free market sounds very convincing. People should be free to make decisions. No force (govt) should be applied on them. If selfish people serve their interests then the market will reach the equilibrium state.

I agree in principle. Freedom to choose/live/eat/sleep/consume/invest should be there. But there is something that I don't agree with- Extreme freedom. Some regulation has to be there.
Friedman's theory works under the assumption that every individual is well informed and quite able to make the right (right for him/her) decisions. Is that really true? I don't think so.
There are mainly three problems:
1. Not all people are educated. How many people today understand the tax structure or incentives such as lower interest rate? Unfortunately, not all (Not in India). 70% of the population stays in rural areas.
2. Not all people are fully informed. Do you know exactly how is the govt taxation structure going to affect you next year?
Unfortunately, mostly people are misinformed and need to be guided. If they are given extreme freedom, then their inability to take right decisions for themselves can severely hamper their quality of life.
3. All people are selfish but some are also immoral. Some people don't care about others at all. They just want to pursue their personal goals...not matter what the cost to the society.
For example- Friedman has often criticized democracy. He says that in a democracy people vote for those who want power. Hence, democracy only brings powerful (and selfish) people in the government. That doesn't sound good.
Ok. Back to the example- Today terrorism is a reality. There are a bunch of people who misguide others in the name of religion. Illiterate and poor people are chosen (or recruited) as terrorists. What would Mr Friedman say to that? People are free to choose what they want to do? But Mr Friedman...their choice is wrong...they are killing those who didn't choose death for themselves

Free market theory is a principle. It (in theory) should be applied to every aspect of life. Although, I do believe that people should be free to make a choice, but govts role in the whole system cannot be undermined. Govt is life a referee in a game. Whenever there is a foul, all players should look upto it for guidance and justice.

Problems with slashing salaries in your firm ?

In this uncertain economic environment, employers have been busy with slashing salaries. Sounds like an easy solution to tackle rising costs...right? But there are problems with slashing salaries:

1. There is a mismatch in the salary and the expectation of employees: Any employee would like to earn the maximum that its employer is willing to pay. However, every employer would always like to pay the minimum that the employee is willing to work for. This mismatch gets even more clearer/evident/realistic in such uncertain times. Employers sometimes by slashing salaries reduce the salaries to a level that is below the min expectation of the employees. Employees in such situations may/may not leave in the bad times but will certainly leave their employers when the times become better. Employers in a way will always risk loosing employees at the turn of the tide

2. Employee motivation/commitment goes down
Salary slashing always brings along with it motivation/commitment slashing. Not a difficult concept to understand right?

Here is one "courageous" solution for the employers-

a. Ask every employee to bid for his/her salary. Essentially, ask every employee to indicate a salary corridor that he/she expects from the firm in such uncertain times
b. Tell the employee that the company has already fixed his/her salary, but it will not reveal it.
Rules- If the employee indicates a salary that is 20% to 30% more than what the firm has fixed, then the employee should be asked to leave the firm. But, if the indicated salary corridor is less than or equal to the salary fixed by the firm, then he/she should be paid that much

This sounds like a simple solution, but it addresses the real challenges that the companies face-
1. It filters out people who have high expectations. Anyways, these people either would have left immediately after a salary cut or would have left later when the economy would have bounced back. Clearly, firm will get rid of people it thinks have high expectations
2. Due to fear of getting fired, employees will always be a bit conservative in their bids. This will not only lower the overall payroll bill, but will also make the employees feel that they are getting paid in-line with their expectations
3. No one will blame the firm for slashing any salaries. People will be in a way negotiating their own salaries. ( I am sure that Milton Friedman would have been very happy to hear of such a solution- A solution that gives the power to the people)

Friedman On Drugs

Friedman argues for legalization of drugs.
This is a moral issue. I really don't think that there should be any debate on this.
Drinking of alcohol is illegal for minors. Should we start thinking about legalizing it just because it will bring in more revenue for the manufacturers/retailers and also government (through sales/VAT tax collection)?

Increase in South-South trade

Australia for expanding ties with India
Besides mining, agriculture, education and services, which were some of the core areas of bilateral trade and investment between India and Australia at present, Australia was keen to focus on other potential areas of business like food and beverages business, automotive sector, aerospace industry etc, informed Micheal Carter, Counsellor Commercial, Australian Trade Commission.
“India happens to be the fourth largest export destination for Australia, it is a very important strategic partner for trade, but the current export import activity between the two countries is largely confined to mining and mining resources, education, services, agriculture, and more of a resource-based relationship which can be widened. There is a lot of scope for business and possible collaboration in the areas of food and beverages particularly wine, travel and tourism,” he said.

Australia's exports to India was worth around 12 billion Australian dollars last fiscal.

With a fall in demand from the developed countries like USA, Germany, and the UK, a number of countries are beginning to look for new key trade partners. Although, India is the 4th largest destination for India, Australia is trying to expand trade. This is very critical for countries (like India and Australia) that have a robust banking system in place. For such countries, demand will either come from within (i.e., domestic consumption) or from external sources (i.e., non USA, UK type countries)
Expect to see more trade agreements in the future.

Split or Steal?

http://www.youtube.com/watch?v=p3Uos2fzIJ0

The above is a link to a video of a game show- Golden balls
I saw this video on Greg Mankiw's blog

Great video!! There are three key components- 2 participants and one large bag of money. Each player has to choose one option- Either 'Steal' or 'Split'. The owner of the money is determined based on the choices that these participants make.

Here are the rules:
1. If both the players choose steal then no one wins anything from the prize money
2. If both the players choose split then the money gets split between the two
3. If one chooses steal and the other split, then the full amount goes to the former

Sounds similiar to the prisoner's dilemna problem?

Not exactly. There is a slight difference here. In the actual prisoner's dilemna problem the two individuals are not allowed to talk to eachother. So decision making is very difficult. One has to assume what the other person will do and then take a decision based on it.
However, in this game show the participants are allowed to talk to eachother before making a choice. This does not make one's job easier but it certainly gives a chance to an individual to convince the other person to choose something (in this case 'split'). For example, if you and I are in the game, then I can convince you to split the money with me by choosing 'split'

Obviously 'split'-'split' is one option. But again this means that both the participants will have to trust eachother. You can never be sure about anything here.

In all the different videos that I have seen, i noticed, a typical style of people was to convince the other person to choose 'split'. Then, the smarter (and evil) ones, after convincing his/her opponent to choose 'split', would choose 'Steal' themselves. This is how most of the people (if not all) approach this situation. Effectively, the winner betrays the other person. I didn't see any winner enjoy his/her victory. After all adopting this strategy will mean betraying someone on the NATIONAL TELEVISION. I wouldn't like to show people that I can betray others for some money.

I can think of another strategy. Let us assume that there are 2 players in the game 'A' and 'B'. Our objective is to make A win more than 50% of the prize money (i.e., by not splitting the money).

When 'B' tries to convince 'A' to choose 'split', 'A' tells 'B' that he/she will choose 'steal' and is ready to give a share of your prize money to 'B'. How do you think will 'B' react? He/she will have two options-

1. Choose 'steal'- 99% of the people will not choose this. 'A' has already made it clear that he/she will choose 'Steal'. Now if 'B' chooses 'steal' then obviously no one will win anything...and this will also make 'B' look like an idiot on national television. Why will anyone choose 'steal' when he/she knows that the other person will also be choosing 'steal'
2. Choose 'Split'- All the Bs of the world will prefer choosing this. Obviously 'A' has made it clear that it will share a certain percentage of the prize money. B' will have no other option but to trust 'A'

Why is this approach better? This approach will make things predictable for both the parties. There is no ambiquity. Obviously player 'B' can also choose 'steal' and make sure that no one wins anything. But I don't think that anyone would do that (not on national television)
This will not make 'A' feel guilty about winning. After all it was a deal!!

Update: My friend Pooja very rightly pointed out that the game show organizers may not allow people to negotiate like that. Such an agreement between all the A's and B's of the world will reduce the game show organizer's probability to retain the prize money from 1/4 to zero

Government officials talk up country’s economic prospects

Source: Economictimes

Private banks start lowering lending rates

Source:Business-Standard

Dose of the day: Tax cuts...but with a difference

Everytime an economic crisis arisis the debate between those who advocate free market play and those who advocate state intervention becomes hot. A similar kind of debate started when this economic crisis started last year. Thankfully, now people unanimously agree that in order to come out of this crisis the state will have to play a pivotal role.

In the past few months the RBI has lowered its policy rates drastically and has urged the banks to lower their lending rates. I am completely in agreement over this. However, today I see excessive reliance by the govts on monetary policies. There is a need for fiscal policies too. It is essential to understand that in a country like India there is no liquidity crunch. We have a demand crisis.
Cheap loans will be taken up by only those who can see demand for their goods. For example: As a CEO of a manufacturing company, I wouldn’t take cheap loans to expand unless I see some demand for my goods. Why are people not buying? Is it because they are short on cash or don’t have access to cheap money? Both to some extent

Today there is a need to boost demand and increase confidence. This recession will worsen if we don’t boost demand.
How to boost demand? This is where fiscal policy comes into play. Indian govt has already announced several stimulus packages. Actually, some people have been asking the govt to stop this spending as it is leading to higher debt levels. Coming back to the point- We can boost demand if we give money to the people. We need tax cuts. But there are two problems with simply reducing taxes-
1. Tax revenue will fall –something that the govt may not want at this time
2. People will definitely welcome this step, but may not start buying. In a country where there is no proper social security, people may be more tempted to save that extra bit of money. (Makes sense- In uncertain times, I would definitely start saving more)

Can we have a plan that not only gives people more money but also gives them an incentive to buy more? I can think of one
The Income tax department gives a Rs 1 lac deduction under section 80c to income earners. This Rs 1 lac deduction is allowed for those who invest this amount in mutual funds/PF/govt securities or other money market instruments that come under section 80c. This provision allows people to subtract that amount from their taxable income and save tax. What happens with all these savings? Basically these savings are loaned out to others. Savings become investments. This is a way through which the govt incentivizes people to save and invest. This is govts way of making people save. Can there be a similar way through which the govt can make people buy and consume?

Yes, here is the plan-
Similar to giving a tax deduction for purposes of saving, the government should give a tax deduction to give people an incentive to buy more. Let’s say that govt gives an additional 50,000 tax deduction under the law to people who consume durable goods. People who buy such goods and shows receipts of such purchases to the govt will get a tax deduction for that amt (less than or equal to 1 lac). How to keep track of this consumption? Well, the govt can start manufacturing special machines that can generate a unique receipt number. Ex- For consumers in New Delhi- receipt nos may start from NDLXX___. These machines can be sold to all companies in the relevant industry.
Now this is a simple plan, but its implementation can have huge benefits-
1. Tax revenue- Yes, the income tax revenue will fall in general. However, the govt will be able to generate more sales tax revenue by expanding the tax base. Sales tax revenue leakage has been a problem for a long time. But now companies will have to buy such govt manufactured machines which will generate receipts and consequently track the sales
2. Demand- Consumer demand will increase. As I mentioned earlier, India is not in a liquidity crunch. Now people will have more money and more incentive to buy goods. Just as the govt used to make people save money by giving tax deductions, now it can make people consume more by doing the same
3. Employment in the govt sector- This new machine will have to be manufactured somewhere...and you will obviously need people to do the manufacturing, distribution, governance, etc

This plan is very ambitious and has its own shortcomings- Given that it is a fiscal policy, its approval by the parliament may take sometime and may also face resistance. Also, manufacturing & distribution of such machines will take sometime.
But I think that this is a long term solution. It is not just to tackle this recession.

Any thoughts?

India’s growth may drop to 4.3% in 2009: OECD

India’s economic growth may slow to an 18-year low of 4.3% in 2009, with falling exports offsetting expansion in domestic demand, the Organization for Economic Co-operation and Development (OECD) said on Tuesday.
Though the country’s gross domestic product (GDP) grew at a meagre 1.3% in 1991-92, the only growth rate comparable with the current projection was in 2000-01 at 4.4%.
OECD economist Sean M. Dougherty told Mint that “this is due to a fairly broad-based slowdown in global economy and less to do with the Indian economy,” adding that India’s external sector will bear the brunt of the slowdown.
Source: LiveMint

4.3% looks very pessimistic.

Here are some of the other predictions for the growth of the Indian economy in 2009-10:

World Bank-4%
CLSA- 4.6%
IMF-5.1%
UN- 6%
ADB-6.5%
Indian govt-7.1%