Month: September 2015 | Page 6

7 September, 2015

An important economic lesson for India from the East India Company

When it comes to reading non-fiction nothing excites me more than reading books on economic history. Last month, I finished reading a fabulous book Why Nations Fail—The Origins of Power, Prosperity and Poverty by Daron Acemoglu and James A. Robinson.
The book has a few sections on India which make for a very interesting reading. It deals in some detail with the business model of the English East India Company.

Over the years, the English monarchy raised money in what could be called fairly innovative ways, at that point of time. One such way was by granting monopolies under the garb of developing national industry.

One such company, which was granted a monopoly, was the English East India Company that had been formed toward the last years of the rule of Queen Elizabeth I. On December 31, 1600, the Queen granted the company the Royal Charter for a period of 15 years.

Interestingly, the English East India Company, which even had Elizabeth I as one of its shareholders, was the first limited liability company in the world. The liability of the shareholders of the company was limited to their investment in the company. If the company failed, the debts of the company would not be divided among the investors.

From its formation in 1600 and up until 1688 “the East India Company enjoyed a government-sanctioned monopoly over the trade with Asia”. As Acemoglu and Robinson write: “In 1688 some of the most significant imports into England were textiles from India, calicoes and muslins, which comprised about one-quarter of all textile imports. Also important were silks from China. Calicoes and silks were imported by the East India Company.” Calico is essentially a plain-woven textile made from unbleached and often not fully processed cotton. (Source: Wikipedia.org)

India was the largest producer and exporter of textiles in the world at that point of time. “Indian calicoes and muslins flooded the European markets and were traded throughout Asia and even eastern Africa. The main agent that carried them to the British Isles was the English East India Company,” write the authors.

Things started to change in the late seventeenth century when the English textile producers started to grow bigger and became economically and politically more powerful. They wanted imports of cheap Indian textiles (calicoes) taxed or to even be banned. In fact, the wool industry managed to lobby the Parliament, which passed legislations in 1666 and 1678, making it illegal for an individual to be buried in anything other than a woollen shroud. This reduced competition that English textile producers faced from Asia in general and India in particular.

The lobbying continued and in 1701 the Parliament decreed: “All wrought silks, bengals and stuffs, mixed with silk or herba, of the manufacture of Persia, China, or East-India, all calicoes painted, dyed, printed, or stained there, which are or shall be imported into this kingdom, shall not be worn.”
This basically made it illegal in England to wear silks and calicoes produced in Asia. Nevertheless, it was still possible to import these textiles from India and other parts of Asia in order to re-export to other parts of the world.

This loophole (from the point of view of English textile manufactures) was finally plugged in. After December 25, 1722, it became unlawful “for any person or persons whatsoever to use or wear in Great Britain, in any garment or apparel whatsoever, any printed, painted, stained or dyed Calico.” This basically ensured that textile imports were no longer a competition for British manufacturers.

Further, the calicoes were the East India Company’s most profitable item of trade. It forced the company to change its business model as well. As Acemoglu and Robinson write: “In the eighteenth century, under the leadership of Robert Clive, the East India Company switched strategies and began to develop a continental empire…[It] first expanded in Bengal in the east…[It] looted local wealth.”

This had a huge impact on the Indian textile industry at that point of time. “This expansion [of East India Company] coincided with the massive contraction of the Indian textile industry, since, after all, there was no longer a market for these goods in Britain. The contraction went along with de-urbanization and increased poverty. It initiated a long-period of reversed development in India. Soon, instead of producing textiles, Indians were buying them from Britain and growing opium for the East India Company to sell in China,” write Acemoglu and Robinson.

So what is the relevance of this history in this day and age? The simple point is that it is very important for a country to make things if it wants to make economic progress or even stay at the level it currently is. Once the East India Company started getting into the empire building business, the Indian textile industry quickly collapsed. This collapse reversed economic development for a long time to come. And from making textiles for exports, we quickly moved on to producing opium.

In fact, as Cambridge University economist Ha-Joon Chang writes in Bad Samaritans—The Guilty Secrets of Rich Nations & the Threat to Global Prosperity: “History has repeatedly shown that the single most important thing that distinguishes rich countries from poor ones is basically their higher capabilities in manufacturing, where productivity is generally higher, and more importantly, where productivity tends to grow faster than agriculture and services.”

If this background is taken into account it becomes very clear as to how important the idea of “Make in India” really is. In fact, India’s trade with China clearly shows that enough is not being made in India.

As analyst Akhilesh Tilotia of Kotak Institutional Equities points out in a June 2015 report titled Making China make in India: “India’s trade deficit against China accounts for over a third of its trade deficit. India’s trade relationship with China is skewed significantly towards imports: 13% of all Indian imports are from China even as only 4% of Indian exports head to China.” Trade deficit is the difference between imports and exports.

In fact, as Tilotia writes this deficit would be a good starting point for ‘Make in India’. As he writes: “Of India’s imports from China over the past three years, more than half came from three categories: (1) electrical machinery and equipment, (2) nuclear reactors, boilers, machinery and mechanical appliances and (3) organic chemicals. Between these three heads, India imports more than US$30 bn of goods annually. The overall list makes for an impressive starting list for ‘Make in India’ though it is, of course, easier said than done.”

The column originally appeared on The Daily Reckoning on Sep 4, 2015

7 September, 2015

IMF’s love for printing more money is like treating the wrong ailment

Christine Lagarde, Managing Director of the International Monetary Fund (IMF), issued a statement at the end of the recent G20 meeting in Ankara in Turkey. G20 is essentially an organisation of the governments along with their central banks of the twenty major economies (19 countries plus the European Union) of the world. The finance ministers and the central bank governors of these countries along with those of the European Union, meet regularly “to discuss ways to strengthen the global economy,” among other things.

At the end of the summit in Ankara, Lagarde of IMF said: “The G20 meeting took place at a time of renewed uncertainty for the global economy…The major challenge facing the global economy is that growth remains moderate and uneven. For the advanced economies, activity is projected to pick up only modestly this year and next…A concerted policy effort is needed to address these challenges, including continued accommodative monetary policy in advanced economies.”

What Lagarde meant in simple English is that global economic growth continues to remain slow. And given that central banks of Western economies need to continue doing what they have been since late September 2008—i.e. print money and maintain low interest rates. The term “accommodative monetary policy” is essentially a euphemism for printing money to maintain low interest rates. The hope is that people will borrow and spend more at low interest rates, and economic growth will return.

But that really hasn’t happened. A significant portion of this printed money has found its way into financial markets around the world, leading to bubbles. Now Lagarde wants central banks to carry out more of the same.

Nevertheless, the fundamental problem with the developed countries still remains. As Raghuram Rajan and Luigi Zingales write a new afterword to Saving Capitalism from the Capitalists: “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things.”

Further, as Thomas Piketty points out in Capital in the Twenty First Century, between 1900 and 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level it was at in 1860. This has led to loss of jobs and a slow economic growth through much of the Western world.

This phenomenon which played out over a period of time. The Western governments and central banks tackled this by following an easy money policy, where they kept interest rates low and made borrowing easier for citizens. As Rajan and Zingales write: “They needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”

All this easy money ended up causing the financial crisis which started in September 2008. And now Lagarde wants the Western world to do more of the same. The Western world is likely to follow this, given that there is a great belief in central banks being able to engineer growth.

The trouble is that the basic issue discussed earlier, which is at the heart of low economic growth through much of the developed world is something that central banks cannot do anything about. Further, printing money in order to maintain low interest rates, in the hope of people borrowing and spending, can never lead to sustainable economic growth.

As James Rickards writes in The Big Drop—How to Grow Your Wealth During the Current Collapse: “Investors and the Fed [the Federal Reserve, the American central bank] have been expecting another strong expansion since 2009, but it’s not materialized. Growth today isn’t strong because the problem in the economy is not monetary, it is structural.”

This means economic growth cannot be created simply by maintain low interest rates.

Along with the Federal Reserve, other central banks through much of the developed world also believe that they will be able to engineer economic growth. But things have changed at the ground level. The sooner, the IMF and the Western central banks understand this, the better it is going to be for all of us.

The column originally appeared on Firstpost on Sep 7, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

3 September, 2015

How states can get around 2013 land acquisition law

In an address to the nation on the mann ki baat programme on All India Radio on August 30, 2015, the prime minister Narendra Modi, announced that the government would not re-promulgate the land acquisition ordinance. As he said during the course of his address: “Tomorrow [August 31, 2015] the Land Bill will lapse and I have agreed to it. The government will not re-promulgate [an] ordinance, but will include 13 points to reform the land acquisition law to benefit farmers.”

Up until 2013, the Land Acquisition Act 1894, a remnant of the British era, was in force. It gave more or less absolute powers to the government to acquire land wherever and whenever it wanted to, by paying a pittance for it. As Jairam Ramesh and Muhammed Ali Khan write in Legislating for Justice—The Making of the 2013 Land Acquisition Law: “The 1894 Act was a comparatively short legislation that left much to the discretion of the acquiring authorities.”

Many wrongs were committed by the government and the politicians under the 1894 Act. This Act was replaced by the Land Acquisition, Rehabilitation and Resettlement Act (LARR) 2013. The 2013 law calls for consent from 70% of families whose land is being acquired, in case of public private partnership projects and 80%, if the land is being acquired for a private company.

A social impact assessment also needs to be carried out. This assessment needs to answer questions like whether the “proposed acquisition serves public purpose” and “whether land acquisition at an alternate place has been considered and found not feasible”. Over and above this, the 2013 law also has clauses dealing with rehabilitation and resettlement of those affected by the purchase of land and the compensation they need to be paid.

In fact, Bhartiya Janata Party (BJP), which was in the opposition at that point of time played a key role in the passage of the 2013 Act. The standing committee formed to look into the Land Acquisition, Rehabilitation and Resettlement Bill 2011, which finally led to the 2013 Land Acquisition Act, was headed by the current Lok Sabha speaker Sumitra Mahajan. The committee made 28 recommendations out of which 26 were accepted. Recommendations made by Sushma Swaraj, the then leader of opposition in the Lok Sahba, were also accepted. The point being that the BJP played a key role in the passage of the bill, which it has wanted to dilute after coming to power.

The problem was that all land acquisition came to a standstill after the Act was passed. What did not help was the fact that the Indian corporates over the years have become used to the government providing them with all the land they require on a platter.

In December 2014, the Modi government, after being in power for six months, brought in an ordinance that proposed changes to the 2013 Act. As mentioned earlier, to acquire land under the 2013 Act consent of 70% of land owners in case of public private partnerships and 80%, in case land is being acquired for private projects, is required.

The ordinance did away with this consent clause for affordable housing, defence, rural infrastructure, industrial corridors and infrastructure projects. The social impact assessment clause was also done away with in these cases.

The trouble was that the exempt categories were very broadly defined and almost anything could come under them. As Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital wrote in a recent research report titled Failure to amend land law to exacerbate sense of ‘policy drift’: “The opposition as well as supporters of the NDA alike were aghast by the proposed legislation as potentially these five exempted categories could cover a majority of projects for which land can be acquired…For instance, how is rural infrastructure defined? Can a shopping mall be defined as rural infrastructure? Can land be acquired for a mandi and the top floors turned into a multiplex?”

The Lok Sabha, where the Congress has only 44 members, eventually cleared the changes that the ordinance would make to the 2013 Act, in May 2015. But the changes did not go through the Rajya Sabha, where the Modi led National Democratic Alliance does not have enough members.

Meanwhile, the government re-promulgated the ordinance thrice and after August 31, 2015, the ordinance was allowed to lapse. The government understood that it would not be able to push the changes through the Rajya Sabha.

This means that we are now back to the 2013 Act, under which almost no land acquisition has happened. The question is what happens from here? The states needs to take the lead and come up with their own laws in order to ensure that the land acquisition process continues.

As finance minister Arun Jaitley wrote on his Facebook page yesterday: “Acquisition of property is a List-III, Entry 42 subject provided for in the concurrent list. The provisions of article 254(2) clearly provide that a State Government can bring a legislation on a Concurrent List Subject which conflicts with the Central legislation provided the Presidential assent is given to such legislation. The States are thus fully empowered to amend the 2013 Land Law and seek Presidential assent before the amendment can be effected.”

What this means that states can bring in their own land acquisition laws from now on. As per the 2013 Act, for rural areas the minimum compensation promised is anywhere between two to four times the market value of land along with the value of the assets on that land. For urban areas the minimum compensation promised is two times the market value of land along with the value of the assets on that land. Hence, the compensation offered by the 2013 Act should become a floor price for the compensation that states will offer under their own Acts.

What further helps is the fact that the BJP is currently in power in 11 states, which are likely to come up with their own land acquisition laws, in line with the Modi government’s ordinance than the 2013 Act. In fact, Tamil Nadu, where the AIADMK is in power, a party closer to the BJP than the Congress at this point of time, has already done that.

As Mukherjee and Shekhar write in their research report: “Tamil Nadu was the first and only state to seek and receive Presidential assent to exempt three major categories from the purview of the Land Acquisition, Rehabilitation and Resettlement Act. In particular, land acquisition done under the Tamil Nadu Highways Act, 2001; the Tamil Nadu Acquisition of Land for Industrial Purposes Act, 1997 and the Tamil Nadu Acquisition of Land for Harijan Welfare Schemes Act, 1978 is outside the purview of the consent clause and Social Impact Assessment clause.”

Around four-fifths of the land acquired in Tamil Nadu is acquired under the three acts mentioned above. Hence, given that the Tamil Nadu government has totally managed to work around the binding provisions of the 2013 Act.

The social impact assessment clause and the consent clause are at the heart of the 2013 Act. While the clauses are necessary in order to protect the interest of the people who own land, at the same time one needs to keep in mind the fact that 13 million Indians are entering the workforce every year. And jobs need to be created for these individuals. For jobs to be created more industry needs to set up. And that requires land. This is a point those opposing the dilution of the 2013 Act need to keep in mind.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Sep 3, 2015

3 September, 2015

Does Janet Yellen know Bahl and Bansal of Indian ecommerce?

On August 31, 2015, The Economic Times, the largest read business newspaper in the country carried an interview with Kunal Bahl, the chief executive officer of Snapdeal. In this interview Bahl claimed that: “The one thing I am very , very clear about right now is that I think we’re going to be No. 1 (in terms of sales) by March 2016….I think we’re going to beat Flipkart by then.”

Two days later on September 2, 2015 (i.e. yesterday), Mukesh Bansal, the head of commerce at Flipkart, responded in the same paper by saying: “Flipkart will sell goods worth $10 billion (Rs 65,000 crore) during fiscal 2016, and “nobody will be even half of that”…There is not a shred of doubt based on all the market numbers we have today.”

When was the last time you saw a CEO or a CXO of a brick and mortar company talk like this? Where does this confidence of Bahl and Bansal come from?
There is a basic advantage that ecommerce companies have, which the brick and mortar crowd does not. Consumers can buy many things through a single transaction. I can buy a geyser, a book case and several books, all at the same time and pay for it all at once sitting at home (or in office for that matter). I don’t have to visit different shops to buy these things.

As economist Alvin E. Roth writes in Who Gets What and Why—The Hidden World of Matchmaking and Market Design: “It looks to me like a single transaction, even though I may have bought each item from a different seller that subscribes to Amazon’s marketplace services.” Now replace the word Amazon with Flipkart or Snapdeal and the logic remains the same.

Plus, there is something called “thickness” at work here as well. As Roth writes: “The thickness of the Amazon marketplace—the ready availability of so many buyers and sellers—is self-reinforcing. More sellers will be attracted by all those potential buyers, and more buyers will come to this market place because of ever-expanding variety of sellers.”

And as I said earlier, what works in case of Amazon in the United States, also works in case of Flipkart and Snapdeal. But there is also something else that needs to be pointed out here.

Typically, the tendency is to look at India as one big market given the huge population of more than 120 crore people. But the more important question is –how many people are digitally proficient to be able to carry out ecommerce transactions on computers as well as smart phones.

And this is where things get interesting. Analyst Akhilesh Tilotia of Kotak Institutional Equities in a recent research report titled How many internet literates in India? points out some very interesting data based on the 71st round of the National Sample Survey Organization (NSSO).

As Tilotia writes: “We note that 48.9% of the youth in urban India in the age range of 14-29 can operate a computer; this proportion falls to 18.3% in rural India. We also note that digital literacy among women trails men’s by 10 percentage-points. Even more interesting, only a quarter of those in urban Indian in the age range of 30-45 years can operate a computer, this percentage is 4% in rural India.”

It needs to be pointed out that in the NSSO survey on which this data is based, “any of the devices such as desktops, laptops, notebooks, netbooks, palmtops, smartphones, etc. were considered as computers.”

In fact, digital proficiency is significantly lower than digital literacy. As Tilotia writes: “Only around one in seven Indians can do any meaningful activity with their computers/smartphones. Urban India is better off with between a fourth and a third of its populace having dexterity to work on their digital devices; less than one in 12 rural Indians have such skills. It is quite possible to be communicative on social media without having email-writing skills or Googling skills.”

This is not the kind of data which the Indian e-commerce companies would want to take a look at.

The NSSO survey on which these numbers are based was carried out between January and June 2014. While things would have definitely improved on the digital proficiency front since then, the improvement couldn’t have been very significant.

So, given this low level of digital proficiency among Indians there has to be a limit to the size of the ecommerce market in India. But individuals who run these companies clearly don’t think that way. As Bansal of Flipkart told The Economic Times: “Flipkart is aiming to sell goods worth $100 billion in 5-7 years.”

The way things are currently going, the kind of valuations the ecommerce companies seem are getting, leads one to conclude that the investors who invest in these companies believe that Indian ecommerce companies will continue to grow at a rapid rate in the time to come.

There are regular news-reports on the front pages of business newspapers of millions of dollars of investment going into Indian ecommerce companies. But none of these news-reports ever seems to talk about the profitability of these companies.

As I have written in the past, almost all the Indian ecommerce companies are losing money big time. Most of these companies have been able to attract buyers by offering discounts on products that they sell. The only thing that has kept them going in spite of making massive losses, is the endless rounds funding that keep coming in, from venture capital and private equity firms, as well as hedge funds. And with every round of funding, the valuation of these firms also goes up.

All this money coming into Indian ecommerce is essentially because of extremely low interest rates that prevail through much of the Western world. In the aftermath of the financial crisis that started in September 2008, the Western central banks started to print money and drove interest rates to very low levels, in the hope of initiating an economic recovery. Leading the way was Ben Bernanke, the Chairman of the Federal Reserve of the United States, the American central bank. He was succeeded by Janet Yellen in 2014.

The private equity and the venture capital firms have borrowed and invested this money into Indian ecommerce companies. And it is this “easy money” from the West that has kept the loss making Indian e-commerce companies selling things on discounts, going.

The question is till when will this money keep coming in? Until very recently most economists were of the opinion that the Federal Reserve would raise interest rates from September 2015 on. Now with the massive fall in stock markets all over the world that seems unlikely.

Nevertheless, the Indian ecommerce companies are totally dependent on this “easy money” borrowed at very low interest rates. And it is this money that has kept them going. And it is this money that will keep them going. In fact, I am even tempted to ask, does Janet Yellen know Bahl and Bansal of Indian ecommerce?

The column appeared originally in The Daily Reckoning on Sep 3, 2015

2 September, 2015

Why ‘good’ restaurants make you wait

A few weekends back I met a friend, who wanted to study economics, but ended up becoming an engineer under parental pressure. As the story often goes in such cases, he was told by this father that nobody studies “Arts” in our family.

Most Indian universities offer an economics degree under their “Arts” course. Would fathers look at their children wanting to study economics differently, if universities offered a BSc in economics rather a B.A.? I really don’t know and that is really not the subject of this column as well.

I and my friend, met for dinner at a popular restaurant in the Western suburbs of Mumbai. As usual there was a waiting time of 15-20 minutes. Given his passion for economics, this friend has the habit of asking the most unusual questions at the most unlikely places.

So, here we were standing almost on the road, waiting for a table to eat, and he asked me: “Why do restaurants make you wait?” I didn’t understand what he was really trying to ask and replied: “Well, because there is only so much space that they have and if more people turn up on a given day, someone has to wait.”

“You are not getting my point,” he replied. “What I mean is that the restaurant doesn’t benefit in any way, when more people turn up than it has space for. People waiting doesn’t benefit them in any direct way.”

“Yes. So?” I asked.

“I mean, why not just raise prices and make more money in the process. I am sure enough people would be ready to pay more, if they don’t have to wait. And those who don’t want to pay more, will drop out and go somewhere else. Simple,” he said. “Higher prices will lead to no waiting.”

We couldn’t continue the conversation because our turn to eat came and there are better things to talk about while eating than economics. Nevertheless, the question stayed with me and a few days later, I luckily discovered the answer, while reading a book by a Nobel Prize winning economist Alvin E. Roth. In Who Gets What and Why—The Hidden World of Matchmaking and Market Design, Roth provides the answer to the restaurant question.

As he writes: “Restaurants don’t just rely on ads to signal how tasty their food is, since any eating establishment can advertise that it serves good food. It’s also a part of the reason restaurants sometimes have prices low enough that long lines form outside.” And how does this help?

When a customer waits for his turn to eat he is essentially wasting time and this doesn’t help the restaurant either, as my friend had suggested. So why not just raise prices and make more money in the process? And by not raising prices why is the restaurant letting go of the money it could easily make?

As Roth explains: “That long line sends a signal that the restaurant across the street with empty tables can’t easily mimic—that is, a lot of people think this is a good restaurant, worth waiting for, and if you haven’t tried it, maybe you should get at the end of the line instead of going across the street.”

So, long lines go a long way in building the story around any restaurant.

This also possibly explains why some restaurants survive the test of time despite a fall in quality standards over the years. The lines at the door ensure that people keep coming and convince themselves that the “food” continues to be as good as it was in the past.

Further, the lesson here is that next time there is a long line at your favourite restaurant, it might just make sense to hop on to some other place in the vicinity. Chances are that the food might not be that bad. It’s just that the restaurant may have never had the benefit of long lines forming in front of it.

The column originally appeared in the Bangalore Mirror on Sep 2, 2015