Month: May 2013

10 reasons why Amartya Sen is wrong about the food security bill

Amartya_Sen_NIH
Vivek Kaul
Amartya Sen, who won the Nobel Prize for economics, in 1998, has been a big votary of the Food Security Bill being passed. “The case for passing this Bill is overwhelming…I would prefer this Bill to not having a Bill at all,” Sen said at a press conference yesterday.
The bill envisages to distribute highly subsidised rice and wheat to almost two-thirds of India’s population of 1.2 billion. In terms of its sheer size, this would be perhaps the biggest ever programme to distribute subsidised food grain to citizens of any country. And given this it is more than likely to have consequences, which the government of the day is either not thinking about or is simply not bothered about.
Given these consequences, Sen’s support for the Bill seems more ideological than logical. This conclusion can be easily drawn after a quick reading of a report titled National Food Security Bill: Challenges and Options authored by Ashok Gulati, Jyoti Gujral and T.Nandakumar (with Surbhi Jain, Sourabh Anand, Siddharth Rath, and Piyush Joshi) belonging to the Commission for Agricultural Costs and Prices (CACP), which is a part of the Ministry of Agriculture. This report was released in December 2012.
The report highlights many reasons on why the Bill in its current form is a recipe for sheer disaster and is not desirable at all, and should be junked at the earliest opportunity.
1. The expenditure behind the food security bill is stated to be at Rs 1,20,000 crore. But this the CACP report feels is just the tip of the iceberg. This expenditure does not take into account “additional expenditure (that) is needed for the envisaged administrative set up, scaling up of operations, enhancement of production, investments for storage, movement, processing and market infrastructure etc.”
So what is the likely cost of the food security bill going to be? “The total financial expenditure entailed will be around Rs 682,163 crore over a three year period,” the report estimates. This is much higher than the Rs 1,20,000 crore per year estimate being made by the government. The question is where is this money going to come from? The government is already reeling under a very high fiscal deficit and is under pressure from international rating agencies to cut down on flab. A high fiscal deficit also means higher interest rates as the government will have to borrow more. It will also lead to higher inflation.
2. Estimates made by CACP suggest that over the next three years the cost of distributing rice and wheat at a subsidised price is going to come to Rs 5,12,428 crore. This calculation does not include other costs of creating the required infrastructure to run the scheme. Of this, the leakage is expected to be at 40.4%. So, nearly Rs 2,07,000 crore will be siphoned off by middlemen.
What is ironical is that the government wants to introduce the right to food security through its public distribution network rather than use a cash transfer system like Aadhar, which it has been creating parallely. The government’s public distribution system is perhaps the biggest distribution system of its kind in the world. But it has virtually collapsed in several states leading to huge leakages.
“It may be noted that this Bill is being brought in the Parliament to enact an Act when internationally, conditional cash transfers (CCTs), rather than physical distribution of subsidised food, have been found to be more efficient in achieving food and nutritional security,” the report points out.
3. The food security bill in its current forms works with the assumption that cereals like rice and wheat are central to the issue of food security. Rice and wheat will be made available at extremely subsidised prices as a part of right to food security. But the irony is that more and more Indians have moved away from cereals towards a protein based diet in the recent years.
As the report points out “As economic growth picks up, it is common to observe a change in dietary patterns wherein people substitute cereals with high-value food…Share of expenditure on cereals in total food expenditure has declined from 41% in 1987-88 to 29.1% in 2009-10 in rural areas and from 26.5% in 1987-88 to 22.4% in 2009-10 in urban areas. The Bill’s focus on rice and wheat goes against the trend for many Indians who are gradually diversifying their diet to protein-rich foods such as dairy, eggs and poultry, as well as fruit and vegetables. There is a need for a more nuanced food security strategy which is not obsessed with macro-level food-grain availability.”
4. A nuanced strategy is also needed because the right to food security also aims at improving the nutritional status of the population especially of women and children. But just ensuring that women and children have access to subsidised wheat and rice is not going to take care of this. As the report points out “Women’s education, access to clean drinking water, availability of hygienic sanitation facilities are the prime prerequisites for improved nutrition. It needs to be recognised that malnutrition is a multi-dimensional problem and needs a multi-pronged strategy.”
5. The right to food security creates a legal obligation for the government to distribute rice and wheat to those who are entitled. In order to fulfil this obligation the government will have to procure rice and wheat from the farmers. It currently does that through the Food Corporation of India(FCI) at a minimum support price(MSP). The MSP is declared in advance and the farmer knows what price he is going to get for the rice and wheat that he sells to the government.
The way the current system works is that FCI is obligated to buy all the rice or wheat that the farmer wants to sell as long as a certain quality standard is met. This has led to a situation where farmers find it favourable to produce rice and wheat because they have a ready buyer for all their produce, at a price they know in advance.
This has led to a severe imbalance in the production of oil seeds as well as pulses. As the report points out “India imported a whopping US$ 9.7 billion (Rs 46,242 crore) worth of edible oils in 2011-12 – a 47.5 percent jump from last year and pulses worth US$ 1.8 billion (Rs 8767 crore) during 2011-12- an increase of 16.4 percent as compared to last year.”
To distribute rice and wheat under the right to food security the government will continue using FCI and keep declaring a minimum support price. This means farmers will continue to get assured procurement when it comes to wheat and rice. And this will have several consequences. As the report points out “Assured procurement gives an incentive for farmers to produce cereals rather than diversify the production-basket…Vegetable production too may be affected – pushing food inflation further.”
6. Indian agriculture is still highly dependent on rainfall with 50% of area under cultivation still at the mercy of good monsoons. Irrigation wherever its available is also dependent on rainfall. So what happens in a situation of drought? As the report points out “A case in point is the drought year 2002-03 where the production of wheat and rice fell by 28.5 million tonnes over the previous year (overall food-grain production dropped by 38 million tonnes). It took 3 years to make up and it was only in 2006-07 that the production exceeded the 2001-02 level.”
If a drought situation crops up, will the government resort to imports? Is it a feasible option? Turns out it is not. “Rice is a very thinly traded commodity, with only about 7 per cent of world production being traded and five countries cornering three-fourths of the rice exports. The thinness and concentration of world rice markets imply that changes in production or consumption in major rice-trading countries have an amplified effect on world prices..This is especially true in the case of rice, as global markets are much smaller. India’s entry into the international market as a large buyer could exert significant upward pressure on prices,” the CACP report points out. Hence, any shortage of rice in India, is going to send world prices of rice through the roof. Also if the government continues procuring as much in a drought year as it has in previous years, it will leave very little of rice and wheat available for the open market, sending their prices through the roof.
7. The right to food security will mean that the government will use its public distribution system to distribute rice and wheat throughout the country. The trouble is that FCI, currently procures a major portion of rice and wheat from a few selective states. “70% of rice procurement is done from Punjab, AP, Chhattisgarh and UP while 80% of wheat procurement is done from Punjab, Haryana and MP alone,” the report points out. This will need infrastructure to be created and that will cost money.
As the report points out “From a logistics point of view it could be cheaper to procure food-grains from states like MP, Bihar, Gujarat etc and deliver the food-grains to neighbouring deficit states in central, eastern and western India rather than procure from a handful of surplus states in North and South and distribute food-grains across the deficit states in India. But such a system would need ramping up of procurement efforts in emerging surplus or self-sufficient states in cereals, such as Uttar Pradesh, Bihar, West Bengal, Assam, and Orissa.” And that is easier said than done.
8. In many such states where the operations of FCI are huge, the government has become the number one procurer of rice and wheat. With right to food security coming in, this procurement is only going to go up. And that will create its own share of problems. “In several states like Punjab, Haryana, Andhra Pradesh, Madhya Pradesh, and Chhattisgarh, one observes that the state is overwhelmingly dominant in procuring rice and/or wheat, leading to almost a situation of monopsony. Any further increase in procurement by the state would crowd out private sector operations with an adverse effect on overall efficiency of procurement and storage operations, as well as on magnitude of food subsidies and open market prices,” the CACP report points out.
9. What has also been observed that FCI does not have economies of scale. As it procures more, its cost of procurement goes up. As the CACP report points out “The economic cost of procurement to Food Corporation of India (FCI) has been increasing over time with rising procurement levels – demonstrating that it suffers from diseconomies of scale with increasing levels of procurement. Currently, the economic cost of FCI for acquiring, storing and distributing foodgrains is about 40 percent more than the procurement price.” If right to food security becomes an Act, FCI’s procurement of rice and wheat will go up, and so will its cost of procurement. This will mean a higher expenditure on part of the government.
10. The government will also have to keep increasing the MSP it offers on rice and wheat. This will have to be done to incentivise farmers to produce more rice and wheat to help the government distribute it to the entitled beneficiaries. The farm labour costs have been on their way up. As the report points out “There is an acute shortage of labour in agriculture that has suddenly cropped up in these three years. In some states, labour costs have gone up by more than 100% over the same period. Due to these rising costs, the margins of production for farmers have been declining both for paddy and wheat . Therefore, the government may have to raise procurement prices for rice and wheat to encourage farmers to increase production of these staples. As the cost of production of crops is rising, MSP can’t be kept frozen.” This means that the government expenditure on right to food subsidy will keep going up.
To conclude, its time Amartya Sen read this report and made himself aware of the problems the right to food security can create for India.
The article originally appeared on www.firstpost.com on May 7,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why is DU in such a hurry to introduce a four-year degree?

du
Vivek Kaul 
Daniel Kahneman, a Nobel Prize winning psychologist (he won the Nobel Prize for economics) , in his book Thinking, Fast and Slow, writes about a very interesting experience in designing a course he wanted introduce in high schools in Israel. Kahneman is currently the Eugene Higgins Professor of Psychology Emeritus at the Princeton University in the United States. But he started his career in Israel.
As he writes “I convinced some officials at the Israeli Ministry of Education of the need for a curriculum to teach judgement and decision making in school. The team that I assembled to design the curriculum and write a textbook for it included several experienced teachers, some of my psychology students, and Seymour Fox, then dean of the Hebrew University’s School of Education, who was expert in curriculum development.”
The team used to meet every Friday afternoon. In a year’s time they managed to construct a detailed outline of the syllabus, write a few chapters and even run a few sample lessons in the classroom. At this point of time Kahneman thought of running a small exercise and asked the team he was working with, to write down the time they thought it would take to present a complete textbook to the Ministry of Education, which could then go ahead and introduce the course.
As a part of the exercise Kahneman asked Fox, who was an expert at curriculum development, what had his previous experience been like. How much time did the teams in previous cases take to complete, what they had set out to do, Kahneman specifically asked Fox. ““I cannot think of any group that finished in less than seven years…nor any that took more than ten,””replied Fox.
Now contrast this with what is happening at Delhi University, where Vice Chancellor Dinesh Singh, is trying to introduce a four year course to replace the current three year one. As things stand as of now, the four year course is expected to be introduced in a few months time, when the next academic session of the university starts.
The work towards introducing a four year course started only in September last year and in December a proposal to that effect was passed. As an article in the Outlook magazine points out “At a hastily called emergency academic council meeting, held on a restricted holiday (December 24), the proposal for the overhaul was passed. The agenda pap­ers of the meeting were made available to council members only two days bef­ore the meeting.”
The new academic session of the university starts in July, later this year. In six months time, between July and December, the Delhi University is trying to change the fundamental way it teaches, when it took at least seven years to introduce just a new course in the high schools of Israel.
Now that does not mean that India should also take seven to ten years to overhaul its education system, just because Israel used to do that. But the larger point is that changing the fundamental way of teaching in a central university cannot be done overnight, which is what Delhi University seems to be trying to do.
The first question that needs to be answered is that why is the change being made? Satish Despande, who teaches at the Delhi School of Economics told Outlook, “Not a single public document has been distributed for the rationale beh­ind introducing the four-year course. So, all we are saying is, tell us why.”
The purported reason that seems to be coming out is that it will help those students who want to go to the United States for further studies. As Swapan Dasgupta wrote in a column in The Times of India yesterday “Shashi Tharoor proclaimed his support for the four-year degree course Delhi University is set to introduce from July. Tharoor’s logic was simple: the American 12 + 4 pattern has become the norm. “Indian students with 10+2+3 were made to do an extra year in the US. It was frustrating for many.””
Tharoor passed out of St Stephens College in Delhi, and then went to do his PhD from the Tufts University in the United States. Given this, Tharoor’s concern for those students of Delhi university who go to the United States for further studies is understandable.
But what about the ‘lesser mortals’ who decide to stay back and carry on their education or work to make a living, in India? As Ramachandra Guha writes in a column in the Hindustan Times “The logic of converting an established three-year degree programme into one of four years has not been carefully examined. When all other public universities in India have a three-year programme, how can one university alone stand out? The argument that the change will help students get admission into American universities is extremely elitist, since that possibility is open to (at most) 1% of DU students.”
Even if one does not get into the specific reasons for this change, there are other practical issues that need to be addressed.
The new four year structure allows students to drop out at the end of two or three years. Where will these students stand? Will a student who completes three years at Delhi university be eligible for its Post Graduate courses?
As mentioned earlier, Delhi university is a central university, which attracts students from all across the Eastern and Northern India. So will students who complete three year courses from other universities all across India, be eligible for Post Graduate courses on offer at the Delhi university?
If yes, then shouldn’t that be the case with students who complete three years at Delhi university? And if that is the case then why have a four year course at all? These are practical questions which need to be answered for the benefit of students who plan to apply in the various colleges affiliated to Delhi university later this year.
Then there is the problem of how will others treat Delhi university students who drop out at the end of two or three years? Will these students be eligible for MBA/UPSC/PO/any other exam that requires a three year bachelors degree?
That’s the practical part of it. Now lets come to the learning part. A senior administrator of the Delhi university told The Telegraph “Students are not gaining adequate skills and fundamental knowledge on matters relevant to life. The four-year course aims to teach those subjects that are relevant for students for their career, personal conduct and good citizenry.” The question of course is why can’t that be done in three years instead of four? And if its not being done in three years time what is the guarantee that it will be done in four years time?
The way the university plans to go about doing is this is putting students through 11 basic courses in the first two years. As Jayati Ghosh writes in The Hindu “Regardless of their previous training or choice of subject, allstudents will be forced to take 11 foundation courses, which will occupy most of their time in the first two years. These include two courses on “Language, Literature and Creativity” (one in English and the other in Hindi or another Modern Indian Language), “Information Technology,” “Business, Entrepreneurship and Management,” “Governance and Citizenship,” “Psychology, Communication and Life Skills,” “Geographic and Socio-economic Diversity,” “Science and Life,” “History, Culture and Civilisation,” “Building Mathematical Ability” and “Environment and Public Health.”
While broadening the horizon of students is always a good idea, doing it in an unplanned way can have unpleasant consequences. There are multiple questions that crop up here. Who will teach these courses? Are the current lot of Delhi university equipped enough to teach these courses? The Delhi university currently has 4000 vacancies for teachers. So is it in a position to take on this extra burden? What about the text books for these courses?
Also what will be the level of these courses going to be? As Ghosh puts it “These courses will have to be pitched at a level that can be understood by anyone with a basic school qualification. So the course on, say, “Building Mathematical Ability,” must be comprehensible to a student who has not done Mathematics at the Plus Two level, which would make it too basic to retain the interest of students who have already done it in school.”
The multi-disciplinary course goes against the entire idea of the Indian education system where students are expected to pick up their broad specialisation at the 10+2 level.
There are too many questions which need to be answered before a four year course can be introduced. Introducing the course without answering these questions would amount to experimenting with lives of students. Something that should not be done.
Let me conclude this with a personal experience. My three year bachelors degree in mathematics from Ranchi University took me four years to complete. The university during those days was running a year late. Final year exams which should have happened in May-June 1998, finally happened in May-July 1999. In fact, we were told that we were lucky because in the late eighties and the early nineties it took even five and a half years to complete a three year bachelors degree from Ranchi University.
In the end it were students like me who lost precious time because the university system kept screwing up. If the Delhi university goes ahead with its four year programme in its current shape, it is the students who will have to pay for it.
 
PS: And who has come with the names for the new Delhi university degrees? The university will award an Associate Baccalaureate (after 2 years), a Baccalaureate (after 3 years), and a Baccalaureate with Honours (after 4 years). Can we at least have names for degrees which we can pronounce, the fascination of Delhi university and Dinesh Singh for French notwithstanding.
The article originally appeared on www.firstpost.com on May 6,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
 
 

Europe and US may have caught the Japanese disease

deflationVivek Kaul  
Before things get better, they get worse.
The Federal Reserve of United States has been on a money printing spree over the last few years. Currently it prints $85 billion every month. This money it uses to buy bonds from banks and financial institutions and thus puts ‘new’ money into the financial system.
The hope and the economic theory behind this is that banks will lend this new money to ‘prospective’ borrowers, who will spend it to buy things ranging from homes to cars to consumer goods. This in turn will revive the stagnating American economy.
The money that the Federal Reserve puts into the financial system every month also ensures that there is enough money floating around, and thus interest rates continue to remain low. People are more likely to borrow and spend money at low interest rates than high.
The money printing will also create some inflation, the hope is. As this ‘new’ money chases the same amount of goods and services, prices will start to rise at a reasonably fast rate. In a scenario where prices are rising or are expected to rise, people are more likely to buy goods and services, rather than postpone their purchases.
All this buying will give a fillip to businesses and that in turn will help the overall economy grow faster. And this is how things will get better.
As things stand as of now, this economic theory doesn’t seem to be working, dashing all hopes. In fact, inflation instead of going up, has been falling in the United States. The Federal Reserve’s preferred measure of inflation is the personal consumption expenditure (PCE) deflater. This for the month of March stood at 1.1%, having fallen from 1.3% in February. The number stood 1.92% in March 2012.
What this tells is that the rate at which the personal consumption expenditure is growing has been coming down over the last one year.
A similar situation seems to be prevailing in Europe as well. As Ambrose Evans Pritchard recently wrote in a column in The Daily Telegraph “The region’s core inflation rate – which strips out food and energy – fell to 1% in March. This is far below expectations and leaves monetary union with a diminishing safety buffer.”
What this tells us is that attempts by the Federal Reserve and the European Central Bank, to get inflation and consumption going by keeping interest rates low, haven’t yielded the results that had been hoped for. People are not interested in borrowing and buying things even though interest rates are at very low levels.
In fact now there is an inherent danger of inflation getting into negative territory or what economists calls deflation. “Over the last 15 years most investors have refused to contemplate that events in the West are playing out in a similar fashion to Japan in the 1990s. But the latest inflation data out of both the US and eurozone should ram home the fact that we are now only one short recession away from Japanese-style outright deflation,” writes Albert Edwards of Societe Generale in a report released on May 2, 2013.
“The eurozone is tracking the experience in Japan in mid-1990s. there is a very high risk of a slide into deflation,” said Lars Christensen, a monetary theorist at Danske Bank, told Evans Pritchard.
Japan had experienced a huge real estate bubble and a stock market bubble in the mid to late 1980s. After these bubbles cracked, the country experienced a deflationary scenario, where prices were falling. The falling prices had a huge impact on economic growth. When prices are falling, or expected to fall, people tend to postpone purchase of goods and services, in the hope of getting a better deal. This means lower revenues and hence lower profits for businesses. It also leads to slower economic growth.
Such an economic scenario is now expected to hit both the United States as well as Europe.
In fact some of this has already started to play out. As a newsreport in the USA Today points out “The reports also show evidence of an economy weakening — a hiring pullback, a drop in construction spending and slowing manufacturing growth, among others.” So the American economy already seems to be entering the slowdown mode.
Suggestions have been made in the recent past that the Federal Reserve will wind down its money printing in the days to come. As Patrick Legland and Dr Michael Haigh of Societe Generale pointed out in a report titled The End of the Gold Era released around one month back “the Fed’s balance sheet will continue to expand at $85bn/month through September, at which point purchases may be tapered modestly to $65bn/month until being fully terminated at the end of the year.”
But with a deflationary scenario looming that doesn’t seem to be a distinct possibility. The Federal Reserve hinted at this in a statement released on May 1 where it said “To support a stronger economic recovery and to help ensure that inflation, over time…the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”
What this tells us is that the Federal Reserve plans to continue printing money and use it to buy $85 billion worth of bonds (mortgage bonds worth $40 billion and American government bonds worth $45 billion) every month. As Edwards puts it “With inflation now massively undershooting the Fed’s own 2-2½% target range there is nothing to stop the Fed keeping their foot pressed down hard on the gas pedal.”
As pointed out earlier the hope is that money printing will lead to some inflation and that in turn will get people to start consuming and drive economic growth. If it doesn’t there will be trouble. As the USA Today points out “if consumers and businesses are convinced prices of goods and services are falling, they tend to delay spending if possible. They want to wait and get the lowest price they can. That sentiment would snuff out the bull market, likely in an alarming sell-off.” And once deflation sets in, it becomes very difficult to break out of it, as has been proved in Japan’s case.
The trouble of course is that like has been the case in the past, this new money may not reach the people it is intended for, simply because they are no longer interested in borrowing and consuming.
Instead this money will be used for speculation. As economist Bill Bonner wrote in a recent column “The Fed creates new money (not more wealth… just new money). This new money goes into the banking system, pretending to have the same value as the money that people worked for. And people with good connections to the banks take advantage of the cheap credit this new money creates to aid financial speculation.”
The difference will be that instead of the money going into the stock market this time around it will go into bonds. As Edwards puts it “Quantitative easing (a sophisticated name for money printing) seems, in large part, to be bypassing the real economy, liquidity will evaporate from equities if we dive into a deflationary recession. Where will all the liquidity then go as quantitative easing is ramped up still further? It will go into ridiculously expensive bonds.”
But that doesn’t make bonds a safe investment bet. The American government is largely broke and not in a position to repay these bonds. “We remain of the view that on a 3-5 year time horizon bonds will prove to be a toxic investment and rapid inflation is the likely longer term outcome,” writes Edwards.
As the old Chinese curse goes “may you live in interesting times”. These surely are interesting times. 
The article originally appeared on www.firstpost.com  
Vivek Kaul is a writer. He tweets @kaul_vivek
 
 

Dear KC Chakrabarty, here’s the real reason why people invest in Ponzi shemes

KC-Chakrabarty
Vivek Kaul 
A standard explanation that seems to be emerging about why Ponzi schemes keep occurring in different parts of the country is that India does not have enough banks. And this lack of banks leads people to invest in fraudulent Ponzi schemes.
A Ponzi scheme is a fraudulent investment scheme in which the illusion of high returns is created by taking money being brought in by new investors and passing it on to old investors whose investments are falling due and need to be redeemed.
K C Chakrabarty, the deputy governor, is the latest individual who has jumped onto the more banks equals fewer Ponzi schemes, bandwagon. “The fact that people have to rely on such entities for their saving needs indicates a failure on the part of the formal financial system to reach out to such groups and earn their trust and confidence through a transparent and responsive customer service regime,” Chakrabarty said yesterday.
“The need of the hour is to ensure that our unbanked population gains access to formal sources of finance, their reliance on informal channels and on the shadow banking system subsides and, in the process, consumer exploitation is curbed,” he added.
So what Chakrabarty is effectively saying is that only if people had a bank in their neighbourhood they would have stayed away from a Ponzi scheme like Saradha. While it simple to come to this conclusion which sounds quite logical, the truth is not as simple as it is being made out to be.
Lets consider a few Ponzi schemes that have done the rounds lately. MMM India which promises to double the investment every month, needs prospective investors to have bank accounts. So here is a Ponzi scheme which is using what Chakrabarty calls the ‘formal financial system’ to flourish.
Before that there was the Speak Asia Ponzi scheme. In this scheme investors needed to fill online surveys. Anyone who has access to internet in India is most likely to have access to a bank account as well. So people who invested in Speak Asia, did so because they wanted to not because they had no banks in their locality.
Then there are Ponzi schemes which involve investments in gold coins. People who can buy gold coins won’t have access to a bank account?
Or lets take the case of Emu Ponzi schemes which had become fairly popular in parts of Tamil Nadu. The pioneer among these schemes was Susi Emu Farms. It promised a return of at least Rs 1.44 lakh within two years, after an initial investment of Rs 1.5 lakh had been made. This was the model followed by nearly 100 odd emu Ponzi schemes that popped up after the success of Susi.
Again anyone who has Rs 1.5 lakh to invest in a Ponzi scheme will not have access to a bank? That is rather difficult to believe. As Dhirendra Kumar of Value Research puts it in a recent column“Could it be that all those people who put money into Saradha wouldn’t have done so if they had a bank in their neighbourhood? Very unlikely. A lot of the deposits seem to have come from towns where there would have been banks. Moreover, almost every ponzi scheme that has come to light in the last few years has actually flourished in towns and cities. The investors who fell for StockGuru or the Emu farms or other schemes all had access to legitimate alternatives.”
So what is it that gets people to put their hard earned money into Ponzi schemes rather than deposit it into banks? The simple answer is ‘greed’. We all want high returns from the investments we make. And Ponzi schemes typically offer significantly higher rates of return than other investment options that are available at any point of time.
Having said that ‘higher returns’ are not the only reason that lures people into Ponzi schemes. There are other factors at work, which along with the lure of higher returns, ends up making a deadly cocktail.
Typically people do not like handing over money to someone they do not know. In small towns, people end up investing money into a Ponzi scheme through an agent they happen to know. So even though they have no clue about the company they are investing in, they feel they are doing the right thing because they know the agent.
In the case of Saradha, agents of Peerless General Finance and Investment were used to collect money. Peerless had a good reputation among the people of West Bengal, having been in the business of collecting small savings since 1932. This helped Saradha establish the trust that it needed to, during its initial days of operation.
As a report in The Indian Express points out “The selection of agents, a crucial link in the chain, was done very carefully by Saradha. Those picked were generally ones who wielded influence in their locality and in whom people had confidence.”
What also helps is the fact that agents are paid reasonably high commissions, leading to a higher level of motivation and thus better service. The agents typically come to homes of prospective investors to get them to invest money. So clearly there is better service on offer unlike a bank. There is very little need for documentation ( PAN No, Address proof etc not required) as well, unlike is the case with a bank.
Let us briefly go back to the more banks fewer Ponzi schemes argument. As the Indian Express report cited earlier states “One important reason for chit funds mushrooming(they are really not chit funds, but Ponzi schemes) in West Bengal is the absence of easy access to banks and other financial institutions. According to an estimate of the state Finance Department, of the 37,000 villages in the state, nearly 27,767 have no bank branch.”
While villages may not have access to a bank, they do have access to post offices. And India Post runs many small savings schemes, in which people can deposit money. But in West Bengal people seemed to have stayed away from these schemes. A report published in December 2012, in The Hindu Business Line quotes Gautam Deb, a former housing minister as saying “small savings and post office collections in West Bengal during the April-October 2012 period were merely Rs 194 crore, against the targeted amount of Rs 8,370 crore.”
So why did people stay away from the post office schemes and get into Ponzi schemes? For one the returns offered on Ponzi schemes were significantly higher. The second reason obviously is the significantly better level of service that Ponzi schemes offer with agents getting higher commissions.
In fact, there are no commissions on offer for selling post office savings schemes. As Kumar points out in his column “The post office offers excellent schemes with a huge reach in rural and semi-urban areas but can it compete on sales and marketing? In fact, when the government eliminated commissions on PPF and other deposits in post offices in 2011, it effectively eliminated whatever little sales muscle there was.”
The formal financial system thus finds it very difficult to compete with unscrupulous operators like Saradha. It is not easy for it to offer higher commissions as and when it wants to simply because it has got rules and regulations to follow. As Kumar puts it “They (i.e. the Ponzi schemes) spend much more on sales commissions, on offices, keeping politicians happy and getting media coverage because they can just dip into the deposited money for all these expenses. Therefore, even if legitimate financial services are available passively, they won’t be able to compete.”
Another reason why the people of West Bengal fell for Saradha was the fact that the Ponzi scheme came to be very closely associated with Trinamool Congress, the party that rules the state. The ‘formal financial system’ cannot afford to do anything like that.
When we take all these reasons into account it is safe to say that the more banks fewer Ponzi schemes argument doesn’t really work. Even if more banks are established, the banks will not be able to compete with the level of service and commissions that Ponzi schemes can offer. Hence, it is very important that unscrupulous operators who are caught running Ponzi schemes are punished and justice is delivered as soon as possible. This will ensure that anyone who wants to start a Ponzi scheme will think twice before he acts. And that is the best way to protect people from Ponzi schemes.
The article originally appeared on www.firstpost.com on May 3, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)