Vivek Kaul
The sale season is currently on. If you are the kind who likes to frequent malls on weekends (or even weekdays for that matter) you might have realised by now that discounts are on offer, almost everywhere.
The question is why do retail stores do this? As Tim Harford writes in The Undercover Economist “We’re all so used to seeing a store-wide sale with hundreds of items reduced in price that we don’t pause and ask ourselves why on earth shops do this. When you think hard about it, it becomes quite a puzzling way of setting prices.”
And why is that? “The effect of a sale is to lower the average price a store charges. But why knock 30 percent off many of your prices twice a year, when you could knock 5 percent off year around? Varying prices is a lot of hassle for stores because they need to change their labels and their advertising, so why does it make sense for them to go to the trouble of mixing things up?,” asks Harford.
There are multiple reasons for the same. As Harford writes “One explanation is that sales are an effective form of self targeting. If some customers shop around for a good deal and some customers do not, it’s best for stores to have either high prices to prise cash from loyal(or lazy) customers, or kow prices to win business from the bargain-hunters. Middle-of-the-road prices are not good: not high enough to exploit loyal customers, not low enough to attract bargain-hunters.”
Also, if the firm were to offer a fixed discount (say 5%) all through the year, it wouldn’t be regarded as a discount by consumers at all. This would happen simply because consumers would not have anything to compare a regular discount of 5% with. A regular discount of 5% compared with a regular discount of 5%, essentially implies no discount at all.
For any bargain to look like a bargain what economists call the “anchoring effect” needs to come into play. As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect”.”
The normal price of any product is the “price” a consumer is anchored to. As Barry Schwartz writes in The Paradox of Choice: Why More is Less “The original ticket price becomes an anchor against which the sale price is compared.”
This comparison tells the bargain hunters that a bargain is available and encourages them to get their credit cards out. Interestingly, research shows that people end up spending much more when they use their credit cards than when they spend cash.
Gary Belsky and Thomas Gilovich point this out in Why Smart People Make Big Money Mistakes and How to Correct Them, “Credit card dollars are cheapened because there is seemingly no loss at the moment at the purchase, at least on a visceral level. Think of it this way: If you have $100 cash in your pocket and you pay $50 for a toaster, you experience the purchase as cutting your pocket money in half. If you charge that toaster though, you don’t experience the same loss of buying power that your wallet of $50 brings.”
“In fact, the money we charge on plastic is devalued because it seems as if we’re not actually spending anything when we use cards. Sort of like Monopoly money,” the authors add. Given this, when people do not feel the pain of spending money, they are likely to spend more. “You may be surprised to learn that by using credit cards, you not only increase your chances of spending to begin with, you also increase the likelihood that you will pay more when you spend than you would if you were paying cash,”Belky and Gilovich write.
This benefits the retailer offering the discount. What he loses out on by offering a discount on the product, he more than makes up for through an increase in volumes.
Of course, there are other reasons like trying to get rid of inventory, before a new season comes on. If the retailer has not been able to sell too many jackets during the winter season, he might try to offload it at a discount before the summer season comes on, instead of holding it back till the next winter season. High end designer stores face the risk of styles going out of fashion. Hence, they need to get rid of their inventory pretty quickly. But this doesn’t really hold for everyone (Think about this: how many of us wear clothes that are radically different in style when compared to last year?).
Hence, retailers essentially have sales to get the anchoring effect going, which, in turn, encourages people to get their credit cards out, and spend more money than they normally would. To conclude, here is a tip to avoid the crowds during the sale season. One day before the sale opens, go the store and check out what you want to buy. If you are buying clothes, figure out what you like and check out whether they fit. Visit the store again the next day, and simply pick up the clothes you liked (to the condition that they are on discount). This will ensure you may not have to spend time standing in a queue before the trial room, waiting for your turn.
The article originally appeared on www.firstbiz.com on February 5, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Month: February 2014
The Aadhar joke is on us
Vivek Kaul
In a speech that Rahul Gandhi, the Vice President of the Congress party, made on January 17, 2014, he requested the Prime Minister Manmohan Singh to provide 12 cooking gas cylinders a year at the subsided rate, instead of nine.
Since the request came from the Gandhi family scion, the normally slow Congress led United Progressive Alliance (UPA) government acted quickly for a change, and before the end of January 2014, the cap had been raised. From April 1, 2014, consumers will get one subsidised gas cylinder a month. This increase in cap is expected to increase the subsidy burden of the government by Rs 5,000 crore.
Along with increasing the cap, the government has also suspended the Aadhar card-linked Direct Benefit Transfer for LPG (DBTL) scheme. This scheme had been implemented in 289 districts in 18 states. In January 2014, it had been extended to a further 105 districts including Delhi and Mumbai. Under this scheme, the consumers bought the cooking gas cylinder at its actual market price. The subsidy amount was then transferred directly into their Aadhar card linked bank accounts.
So, a resident of Delhi, where the scheme was recently launched, while buying a gas cylinder would have had to pay Rs 1,258 for a 14.2 kg cylinder. The cost of the subsidised cylinder is Rs 414 in Delhi. Hence, the difference of Rs 844 would be paid directly into the Aadhar linked bank account of the consumer.
The trouble is that many people still do not have Aadhar accounts. And those who have it have not been able to link it to their bank accounts. Hence, the government has set up to review the DBTL scheme. In an election year, the worst thing that can happen to a government is that its subsidies do not reaching the citizens. By forming a committee to review the DBTL that discrepancy has been set right.
Anyone who has implemented even a very basic project would tell you that it is very important to do a SWOT(strengths, weaknesses opportunities, threats) analysis of the project. A basic SWOT analysis would have shown that the first problem in the DBTL scheme would be people not having Aadhar cards and those who had it, would not have had it linked to their bank accounts.
But the government and Nandan Nilekani, the chief of Unique Identification Authority of India (UIDAI), have been in a hurry to showcase Aadhar. UIADAI is in charge of implementing Aadhar. In fact, a recent report on the website of the Moneylife magazine pointed out that Nilekani is a member of almost every committee that has been making Aadhar mandatory “for citizens to access several services and benefits” from the government. Guess, he is not bothered about the conflict of interest his being on these committees creates, even after having held one of the top jobs at Infosys, one of India’s most ethical companies. In the recent past, the political ambitions of Nilekani have come to the fore. Does that explain his hurry to get Aadhar up and running and everywhere?
What is interesting is that the oil marketing companies (OMCs) (i.e. IOC, BP and HP) continued to insist on Aadhar linked bank accounts for subsidy payments in case of cooking gas, even after the Supreme Court ruled that Aadhar should not be made mandatory for availing any services. The September 2013 order had unequivocally said that “no person should suffer for not getting the Aadhaar card in spite of the fact that some authority had issued a circular making it mandatory.”
Even before the Supreme Court had ruled, Rajiv Shukla, minister of state for parliamentary affairs and planning, had said on May 8, 2013, that the “Aadhaar card is not mandatory to avail subsidized facilities being offered by the Government like LPG cylinders.”
The irony is that the form Aadhar enrolment form clearly states that “Aadhar enrolment is free and voluntary”.
If enrolment into Aadhar is free and voluntary, how could the OMCs have insisted on Aadhar linked bank accounts for payment of cooking gas subsidies? And why did the Supreme Court have to rule that Aadar should not be made mandatory for availing any services? The situation should not have reached that stage. In the world of Nandan Nilekani and the government of India, free and voluntary, clearly means something that you and I do not understand.
Interestingly, Montek Singh Ahluwalia, the Deputy Chairman of the Planning Commission, did some straight talking on Aadhar (UIDAI was created by a notification of the Planning Commission in January 2009), at Davos in January 2011. “We will simply make it compulsory for those benefiting from government programmes to register for the UID number,” Ahluwalia remarked. And that is what seems to be happening. In Maharashtra, the government employees have been ordered to get Aadhar cards so that their salaries can be paid into Aadhar linked bank accounts. In Delhi, Aadhar is compulsory for marriage registrations.
Nilekani has tried to explain this by saying “Yes, [Aadhaar] is voluntary. But the service providers might make it mandatory. In the long run I wouldn’t call it compulsory. I’d rather say it will become ubiquitous.” As stated earlier Nilekani is a member of almost every committee that has been making Aadhar mandatory. In fact, as he put it in November 2012 “If you do not have the Aadhaar card, you will not get the right to rights.” When it comes to Aadhar, Nilekani and his masters have offered the nation a Hobson’s choice.
For more than four years now, the Nilekani led UIADAI has been collecting biometric information (photographs of the face, iris scans and fingerprints of all the 10 fingers) of the citizens of this country, without any statutory backing. The Aadhar card has been fostered upon the nation without any statutory backing. The Union Cabinet has approved the National Identification Authority of India Bill that will give statutory status to the UIDAI. But this bill hasn’t been introduced in the Parliament.
The joke, as always, is on us.
The article originally appeared in The Asian Age dated February 4, 2014.
(Vivek Kaul is the author of Easy Money. He can be reached at [email protected])
Sensex falls 4% in a week but easy money rally will be back soon
Vivek Kaul
The BSE Sensex has now been falling for close to a week now. As I write this, it’s trading at around 20,000 points, having fallen by nearly 4% since January 27, 2014.
The main cause of this fall has been the decision of the Federal Reserve of the United States, the American central bank, to go slow on printing money. In a meeting on January 29, 2014, the Fed decided to print $65 billion a month, in comparison to $75 billion earlier.
By doing this, the Fed signalled that it would be going slow on the easy money policy that it had unleashed a few years back, in order to revive the stagnating American economy. The money printed by the Federal Reserve was used to buy government bonds and mortgage backed securities, in order to ensure that there enough money going around in the financial system. This led to low interest rates and the hope that people would borrow and spend more money, and thus help in reviving the economy.
Investors had been borrowing at these low interest rates and investing money all over the world. But with the Federal Reserve deciding to go slow on money printing (or what it calls tapering), this game of easy money is likely to come to an end, soon. At least, that is the way the markets seem to be thinking. And that to a large extent explains why the Sensex has fallen by close to 4% in a week’s time.
One of the major reasons behind the Federal Reserve’s decision to print less money has been the falling rate of unemployment. For the month of December 2013, the rate of unemployment was down to 6.7%. In comparison, in December 2012, the rate had stood at 7.9%. This is the lowest unemployment rate that the American economy has seen, since October 2008, which was more or less the time when the financial crisis started. This measure of unemployment is referred to as U3.
A major reason for the fall in the unemployment numbers has been the fact that a lot of people have been dropping out of the workforce. In December 2013, nearly 3,47,000 workers left the labour force because they could not find jobs, and hence, were no longer counted as unemployed. This took the number of Americans not working to a record 102 million. As Peter Ferrara puts it on Forbes.com “In fact, all of the decline in the U3 headline unemployment rate since President Obama entered office has been due to workers leaving the work force, and therefore no longer counted as unemployed, rather than to new jobs created…Those 102 million Americans are the human face of an employment-population ratio stuck at a pitiful 58.6%. In fact, more than 100 million Americans were not working in Obama’s workers’ paradise for all of 2013 and 2012.” Interestingly, the labour force participation rate, which is a measure of the proportion of working age population in the labour force, has slipped to 62.8%. This is the lowest since February 1978. Also, in December 2013, the American economy added only 74,000 jobs. This was lower than the 1,96,000 jobs that Wall Street had been expecting and was the lowest number since January 2011.
What this means is that even though the rate of unemployment is at its lowest level since October 2008, things are not as well as they first seem to be. Interestingly, in December 2013, the U6 “rate of unemployment” which includes individuals who have stopped looking for jobs because they simply can’t find one and individuals working part-time even though they could work full-time, stood at 13.1%. This was about double the official rate of unemployment of 6.7%. Interestingly, through much of 2013, the U6 rate of unemployment was double the official U3 rate of unemployment.
What all this tells us is that the unemployment scenario in the US is much worse than it actually looks like.
In this scenario it is unlikely that the Federal Reserve can keep tapering or reducing the amount of money that it prints every month. Other than the rate of unemployment, the other data point that the Federal Reserve looks at is consumer price inflation as measured by personal consumption expenditure(PCE) deflator. The PCE deflator for the month of December 2013 stood at 1.1%. This is well below the Federal Reserve target of 2%.
If the PCE deflator has to come anywhere near the Federal Reserve’s target of 2%, the current easy money policy of the Federal Reserve needs to continue. As Bill Gross, managing director and co-CIO of PIMCO wrote in a recent column “the PCE annualized inflation rate– is released near the 20th of every month but you will not see CNBC or Bloomberg analysts waiting with bated breath for its release. I do. I consider it the critical monthly statistic for analyzing Fed policy in 2014. Why? Bernanke, Yellen and their merry band of Fed governors and regional presidents have told us so. No policy rate hike until both unemployment and inflation thresholds have been breached.”
Given these reasons, it is safe to say that foreign investors will continue to be able to raise money at low interest rates in the United States, in the months to come. Hence, the recent fall in the Sensex is at best a blip. The easy money rally will soon be back.
The article originally appeared on www.firstbiz.com on February 4, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Is inflation targeting really the way out for India?
Vivek Kaul
The Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework of the Reserve Bank of India (RBI) was recently released. The Committee has recommended that the RBI follow a policy of inflation targeting. This strategy essentially involves a central bank estimating and projecting an inflation target, which may or may not be made public, and then using interest rates and other monetary tools to steer the economy toward the projected inflation target.
The Committee has recommended that the RBI sets an inflation target of 4%, with a band of +/- 2 per cent around it . The Committee has further recommended that the “transition path to the target zone should be graduated to bringing down inflation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and 6 per cent over a period not exceeding the next 24 month period before formally adopting the recommended target of 4 per cent inflation with a band of +/- 2 per cent.”
These recommendations are in line with the thinking of the RBI governor, Raghuram Rajan. Rajan believes that the RBI should be concentrating on controlling inflation, instead of trying to do too many things at the same time.
As Rajan wrote in a 2008 article (along with Eswar Prasad) “The central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
And given this the RBI ends up being neither here nor there. As Rajan and Prasad put it “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should ‘just’ focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms“The RBI can best serve the cause of growth by focusing on controlling inflation.”
So far so good. The trouble is that inflation targeting has come in for a lot of criticism since the advent of the current financial crisis. As Taumir Baig and Kaushik Das of Deutsche Bank Research write in note titled RBI’s path towards (soft) inflation targeting and dated January 22, 2014, “The period since the 2008 global financial crisis has not been kind to the theory and practice of inflation targeting. After two decades of enthusiastic embrace by many central banks, both from advanced (e.g. Australia and UK) and emerging market (Brazil, Thailand) economies, the wisdom and efficacy of inflation targeting have came under intense scrutiny.”
And why is that the case? Inflation targeting might have been one of the major reasons behind the current financial crisis. Stephen D. King, group chief economist of HSBC makes this point in his book When the Money Runs Out. As he writes, “the pursuit of inflation-targetting … may have contributed to the West’s financial downfall.”He gives the example of the United Kingdom to make his point: “Take, for example, inflation targeting in the UK. In the early years of the new millennium, inflation had a tendency to drop too low, thanks to the deflationary effects on manufactured goods prices of low-cost producers in China and elsewhere in the emerging world. To keep inflation close to target, the Bank of England loosened monetary policy with the intention of delivering higher ‘domestically generated’ inflation. In other words, credit conditions domestically became excessively loose… The inflation target was hit only by allowing domestic imbalances to arise: too much consumption, too much consumer indebtedness, too much leverage within the financial system and too little policy-making wisdom.”
Essentially, since consumer price inflation was very low, the Bank of England, the British central bank, ended up keeping interest rates low for too long. This led to a huge real estate bubble in the United Kingdom. A similar dynamic played out in the United States as well, where inflation between 2001 and 2004 varied between 1.6 and 2.7 percent.
With interest rates being low, banks were falling over one another to lend money to anyone who was willing to borrow. And this gradually led to a fall in lending standards. People who did not have the ability to repay were also being given loans. As King writes, “With the UK financial system now awash with liquidity, lending increased rapidly both within the financial system and to other parts of the economy that, frankly, did not need any refreshing. In particular, the property sector boomed thanks to an abundance of credit and a gradual reduction in lending standards.”
This inflation only focus turned out to be disastrous as other economic factors were ignored. As Felix Martin writes in Money—The Unauthorised Biography “The single minded pursuit of low and stable inflation not only drew attention away from the other monetary and financial factors that were to bring the global economy to its knees in 2008—it exacerbated them… Disconcerting signs of impending disaster in the pre-crisis economy—booming housing prices, a drastic underpricing of liquidity in asset markets, the emergence of the shadow banking system, the declines in lending standards, bank capital, and the liquidity ratios—were not given the priority they merited, because, unlike low and stable inflation, they were simply not identified as being relevant.”
India currently suffers from high inflation and not low inflation. But while deciding on a policy all factors need to be kept in mind. And the view in the Western world now seems to be that inflation targeting was one of the major reasons for the real estate bubbles that led to the current financial crisis. The RBI needs to keep this in mind.
Also, the bigger question about whether the RBI can play a role in curbing inflation continues to remain. If one looks at the consumer price inflation index, food and fuel items constitute 57% of the index. RBI’s interest rate policy cannot play any role in curbing the prices of these two items. As Chetan Ahya and Upasana Chachra of Morgan Stanley Research write in a report titled Where Are We in the Boom-Bust-Adjustment Cycle? dated January 16, 2014, “high rural wage growth has also been a key factor behind the bad growth mix. We believe the national rural employment scheme (NREGA) has been one of the key factors pushing rural wages without matching gains in productivity. Rural wages have shot up since just after the credit crisis from early 2009, when the full implementation of NREGA started showing an effect. The rural wage growth rate moved up from 10-13% in 1H08 to an average of 18.7% over the last three years – without a matching increase in productivity. In our view, this has been one of the key factors resulting in higher food, services and overall CPI inflation as well as inflation expectations.”
Hence, the only way the food inflation and in return the consumer price inflation can be controlled, is if the government decides to control its fiscal deficit. Fiscal deficit is the difference between what a govenrment earns and what it spends. The RBI cannot play any role in this, other than suggesting to the government that its fiscal deficit is high.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
The article originally appeared on www.firstpost.com on January 23, 2014