Month: October 2015 | Page 3

20 October, 2015

India’s Great Delay: From Son of India to Make in India

The great filmmaker Mehboob Khan’s last film release was Son of India. The movie released in 1962 and Khan died in 1964.

The movie is now more or less forgotten except for the song: “nanha munna rahi hoon desh ka sipahi hoon”. The song was a regular feature during the propaganda driven days when Doordarshan was the only TV channel in town and Chitrahaar one of the few entertaining shows that one could watch during the course of a week.

The song was shown regularly on Chitrahaar and given that, perhaps a whole generation grew up listening to it. One of the lines in the song is: “naya hai zamana nayi hai dagar, desh ko banaoonga machino ka nagar”. Loosely translated this means that “in this new world we will make India a nation of machines and factories”.

Fifty two years after the 1962 release of Son of India, Narendra Modi was elected as the prime minister of India in May 2014. Modi gave the call of Make in India in August 2014, echoing sentiments of the nanha munna rahi hoon The Make in India website when it was first launched defined it as “a major new national program designed to transform Indiainto a global manufacturing hub.” (I can’t find this line on the website anymore).

The question to ask here is what went wrong during the intervening period between 1962 and 2014? Why are we still talking about aiming to build factories and a vibrant manufacturing sector more than half a century later?

TN Ninan has an answer in his excellent new book The Turn of the Tortoise—The Challenge and Promise of India’s Future. As he writes: “Size helps preserve India as a democracy—it is too big and too complex for any person to so dominate the whole land as to render the law and institutions ineffective, or at least to do so for any length of time.”

While size has helped Indian democracy it has also led to policy errors, which shouldn’t have been made. As Ninan points out: “Successful small countries find it easy, indeed necessary, to focus on export markets because their internal markets are too small to support scale production. But India is big enough to offer the potential of a large domestic market; inevitably, that became the focus of policy.”

The countries of South East Asia also started with import substitution (or producing only for the domestic market) but quickly moved their focus towards exports.

India continued to favour import substitution for much longer and this had its repercussions. “The difference between exporting units and those with a domestic market orientation is that the former have to be competitive, the latter not necessarily so. In India’s case, the inward focus became so pronounced that the country became an economic prison, functioning behind high protective walls. It is therefore evolved into a market for mostly shoddy, usually overpriced goods that would not sell anywhere except countries that were similarly starved of quality goods, such as the Soviet Union, which at one stage was India’s largest trading partner,” writes Ninan.

This put us back in the manufacturing race. And we are still trying to get the manufacturing revolution going. In fact, one of the visions of the Make in India programme is “enhancing the global competitiveness of the Indian manufacturing sector.”

What this tells us is that India is trying to come to the manufacturing party a little too late in the day. Nevertheless, this perhaps remains the only formula for pulling out India’s poor from poverty. And this is only going to happen if the ease of doing business is improved and the inspector raj is done away with, in the days to come.

As Mihir Sharma writes in Restart—The Last Chance for the Indian Economy: “The Indian state is run for its nice, kindly Inspectors, and not for workers or entrepreneurs”. And this needs to be corrected.

The rules and regulations that any manufacturer needs to follow are simply humongous. As Ninan writes: “A policy statement issued in 2011(two full decades after 1991) recognized that the average manufacturing company has to comply with seventy laws, face multiple inspections and file as many as 100 returns in a year. Bear in mind that these returns were being filed (or not filed) by small and medium enterprises that accounted for 45 per cent of manufacturing output and 40 per cent of merchandize exports.”

This is something that the Modi government has improved on after coming to power last year, by introducing self-certification, nonetheless a lot remains to be done on this front.

To conclude, the ball is now in Modi’s court. It took India nearly 70 years to decisively vote for a non-Congress party to power. Modi has the majority to get things done. If he doesn’t, chances are the Congress might be voted back to power. And there can be no bigger tragedy than that.

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

The column originally appeared on Firstpost on Oct 20, 2015

16 October, 2015

One-rank one-pension – An economic analysis of an emotional issue

I have been quoting a lot from the writings of British economist John Kay in my recent columns. The reason for that is very straightforward. I have read two very good books (Other People’s Money – Masters of the Universe or Servants of the People and Everlasting Light Bulbs – How Economics Illuminates the World) written by him over the last two weeks. A lot of what Kay writes is very relevant for the times that we live in. And given that I have ended up quoting him over and over again. Today will be no different as well.

In an essay called A Fetish for Manufacturing which is a part of Everlasting Light Bulbs, Kay talks about an article he wrote in 1980. In this article he predicted that the British manufacturing would decline due the growth of North Sea oil production. Kay doesn’t explain the reason behind his prediction in the essay I am talking about and honestly, it is not important, given the point I am trying to make.

After the article was published there was a lot of controversy around it. As Kay writes: “Few critics focussed on the weakness in the argument. They claimed instead that what I was saying ought not to be true or, if it was true, ought not to be said.”

After a point, Kay started to understand “that for many people the role of manufacturing industry was an emotional issue rather than an economic one.” The phrase I want you pay attention on is that, “it was an emotional issue rather than an economic one”.

Something similar is playing out in India right now – the issue of one-rank one-pension for India’s armed forces. When an individual retires from the armed forces, he gets a pension. The pension amount depends on the date of retirement. Up until very recently, there was no ‘one-rank one-pension’ in the armed forces. This essentially meant that individuals who retired at the same rank and had served similar number of years, did not receive the same pension, if they retired at different points of time.

Given this, an individual retiring in 2004 would get a lower pension than the one retiring in 2006, despite having retired at the same level and having served for a similar number of years.

It also needs to be mentioned here that a bunch of armed force personnel retire in their mid to late 30s and unlike the general segment of the population do not get benefits of a full-pay until the retirement age of 58 to 60.

The armed force veterans have been demanding one-rank one-pension for a while now. It was one of the key promises that Narendra Modi made during the campaign for the last year’s Lok Sabha elections.

On September 5, 2015, the ministry of defence announced one-rank pension for the armed forces. As the press release said: “In simple terms, one-rank one-pension implies that uniform pension be paid to the Armed Forces personnel retiring in the same rank with the same length of service, regardless of their date of retirement. Future enhancements in the rates of pension would be automatically passed on to the past pensioners. This implies bridging the gap between the rate of pension of current and past pensioners at periodic intervals.”

And given that it took close to sixteen months for the Modi government to come up with anything concrete on the issue, it is not surprising that the issue has turned into an emotional one. Individuals who defend the borders of India, need to be treated better, is an oft-repeated argument.

The government estimates that “to implement OROP, the estimated cost to the exchequer would be Rs. 8,000 to 10,000 crore at present, and will increase further in future.”

The question is can the government afford this? Let me make a slight deviation before getting back to the question.

I have been reading through this interesting book called The Challenge of Things—Thinking Through Troubled Times, written by the British philosopher AC Grayling. In one of the essays in the book titled Does the Government Know Best, Grayling writes: “Much of the debate about levels of welfare spending concern how much security should be provided, not whether or not it should be provided. The consensus in question is that the state has welfare responsibilities; the arguments are almost always about how much should be spent in discharging them.”

So this brings us back to the question whether the government can afford this? And if yes, how much should it spend on it? The total budgeted expenditure of the government for the current financial year stands at Rs 17,774,77 crore. Rs 8000-10,000 crore is around 0.45-0.56% of that expenditure. Hence, if looked at in isolation, one-rank one-pension is clearly affordable for the government.

Nevertheless, the thing is that it won’t stop at just armed forces. As a report in The Asian Age points out, the Central paramilitary forces also want one-rank one-pension. This includes the Border Security Force, the Central Reserve Police Force, the Central Industrial Security Force, the Indo-Tibetan Border Police and Sashastra Seema Bal.

These forces are responsible for our borders as well as security within the country. They tackle the naxal threat as well in large parts of the country. So how can they be left out of one-rank one-pension? I think that is a fair question.

The Asian Age reports that the Central paramilitary forces have a strength of nearly nine lakh serving personnel and six lakh retired personnel. I haven’t come across any clear thinking by the government on this issue.

It doesn’t stop here. The PTI reports that the railwaymen also want one-rank one-pension. As the newsreport points out: “Railway employees are now asking for similar pension benefit, arguing that their duties too are “hazardous, risky and complex”. In a letter to Prime Minister Narendra Modi, National Federation of Indian Railwaymen has demanded uniform pension policy for railway employees. “On an average, 800 railway employees get killed per year in the course of duty and nearly 3,000 sustain injuries at work,” M Raghavaiah, general secretary of NFIR, said.”

Saurabh Mukherjea and Sumit Shekhar of Ambit point out in a research note that the “cost of salaries/pensions for railway employees is 2.7 times the cost of salaries/pensions of the armed forces”. Railways currently employs nearly has 13 lakh individuals.

Once all these factors are taken into account one-rank one-pension suddenly starts to look like an expensive proposition.

The question is will the government be able to stop after the armed forces? I don’t think so. And how will they finance this?

As John Kay (Oops I am quoting him again) writes in an essay titled How We Decide which is a part of Everlasting Light Bubbles: “Big decisions in politics and businesses are the result of political horse-trading, and are based on partial information, visions and prejudices, hopes and fears.”

The feeling I get is that people in decision making positions haven’t thought through the issue at the level they should have. In the years to come other government agencies will also demand one-rank one-pension and they are more than likely to get it.

Rest assured, you will hear more about one-rank one-pension in the years to come.

Watch this space.

The column originally appeared on The Daily Reckoning on Oct 16, 2015

15 October, 2015

Real estate prices are not just about corruption; they are also about affordability

Last week, Suraj Parmar, a leading Thane builder committed suicide. In his suicide note Parmar talked about the corruption in the system. A report in The Indian Express quoted V V Laxminaryan, the joint commissioner of police of Thane, as saying: “The suicide note speaks of several problems that Parmar was facing, including difficulties in obtaining approvals and the stop-work notices issued to him. The note goes on to say that several people were repeatedly demanding bribes, that he had already paid them a lot in the past but that their demands were still continuing and it had become too much for him to deal with.”

Corruption in real estate at the government level has always been an issue. But now if builders are to be believed it has reached never before seen levels. As Niranjan Hiranandani, director of Hiranandani Group told NDTV.com, after Parmar’s suicide: “In the last couple of years, I think corruption is over but extortion has started. So, I think what was unbearable to the builder was the fact that there was no corruption in that sense of the term, but it had gone far beyond corruption levels that have ever happened.”

A June 2011 news-report in The Economic Times gets into the details of the issue. In Maharashtra, which happens to be the biggest real estate market in the country, a builder typically needs around 60 approvals to construct a property. Of this, 50 approvals need to be taken from the municipal corporation where the property is being built.

The Economic Times report then goes on to quote Pune builder Kumar Gera, as saying: “These clearances should not take more than three months…But in most states, it takes anywhere between one year and four years. And they add 20-30 % to a builder’s project cost.”

This is, in turn, passed on to consumers who want to buy homes. As a report in the Daily News and Analysis points out: “At every step, there is a price to be paid to obtain necessary clearances. The ‘Golden Gang’, a group of corporators and civic officials, calls the shots and builders are bound to cough up exorbitant sums to avoid harassment. This expenditure, so to speak, is then passed on to home buyers. That explains why real estate in Mumbai, Thane and Navi Mumbai is so prohibitively expensive.”

In fact, as a real estate consultant told The Economic Times: “Builders don’t just pass it on…They often add to it big time.” So builders add their own corruption premium to the price of homes they sell.

Most builders use corruption in government and increasing input costs to explain that the price of homes won’t fall anytime in the near future. Take the case of cement, a major input into building homes. As a recent newsreport in The Economic Times points out: “Cement prices have jumped 20-40 per cent over the past two months in top cities despite demand from the real estate industry, which is its largest buyer, being low.”

In this scenario the price of homes won’t fall, say builders. But this logic just takes into account the supply side of the equation. It only talks about the builders who supply homes and the costs they have to incur. What about the end consumers who want to buy these homes?

As John Kay writes in an essay titled Guess Who’s Come to Dinner which is a part of the book Everlasting Light Bulbs – How Economics Illuminates the World: “But surely people can’t spend an increasing proportion of their incomes on housing.” The affordability of homes also needs to be taken into account.

Also, owning a house is just not about putting up a down-payment, taking a home loan and paying the builder. There are other costs involved as well. Hence, as Kay puts it, it is important “to focus on the costs of house ownership rather than the cost of houses.”

Given this, affordability isn’t just being able to pay the price of the house. There is more to it than that. As Kay writes: “Mortgage repayments [home loan EMIs basically] are only a…part of the cost of buying a house: you have to pay for repairs and maintenance, heat and light, property taxes.” Then there is the cost of moving in, the cost of setting up the place, and so on.

In a scenario where home prices are anyway high all these costs make the entire cost of owning a home even more expensive. So, the point that builders make about their inability to cut prices doesn’t have any meaning. They can build homes and sell them at prices they think are right, but the question is will there be any takers at that price? And the answer is clearly no.

In any market there are always two sides – demand and supply. And that is a basic point that our builders need to remember. So, they can continue holding on to their prices, but at those prices there will be not much demand for homes. As Kay writes in another essay titled A Fetish for Manufacturing: “The rewards of different activities [are] detached from their position in the hierarchy of needs. You only [get] paid for producing goods that people [want].”

Kay makes another interesting point, which I would like to talk about here. As he writes: “In classic bubbles – from tulip mania to the dot.com frenzy – people bought things, not for their intrinsic worth, but to sell on to others at a higher price. That rarely happens with houses.”

This is not true in the Indian context. Homes in India have “not” always been bought “for their intrinsic worth” but they have also been bought “to sell on to others at a higher price”. And that clearly is not happening anymore. Over the last few years you would have been better off letting your money sit idle in a savings bank account rather than investing in real estate. Given this, the interest in owning real estate has come down. That is clearly visible from the huge number of unsold homes across cities as well as fall in the launch of new projects.

As Kay writes: “As in every asset market, short term price movements are driven by beliefs, not underlying realities.” The underlying reality is that at these prices it does not make any sense to invest in real estate. But the belief that real estate prices always go up is still reasonably strong. The question is for how long will the belief remain strong?

I think we are half way there.

The column originally appeared in The Daily Reckoning on October 15, 2015.

14 October, 2015

Of prisoner’s dilemma and the discounting wars of Indian e-commerce

This week the ecommerce companies operating in India are at war.

Snapdeal had its electronic Monday sale on October 12, 2015.

Fllipkart has The Big Billion Days Sale between October 13 and October 17, 2015. This sale is limited to its smartphone app.

Amazon has the Great Indian Festival Sale during the same period. Amazon’s sale isn’t limited to its app, like Flipkart’s. Nevertheless, the company is offering higher discounts on the app.

Over the next few days you will see reports in the business press with senior executives of these companies saying that they have managed to sell this much and sell that much.

The trouble is everyone will talk about revenue numbers. No one will tell you that they are losing money on each product they sell and the more they sell the more money they will lose.

In fact, the business press is already talking about the positive impact of these sales. As Rahul Taneja of Snapdeal told the Mint newspaper: “We are well on track to reach $100 million sales on our Electronics Monday Sale.”

Nevertheless, things are not as simplistic as they are being out to be. The Indian ecommerce scene should be viewed from the lens of the prisoner’s dilemma.

The dilemma was first put forward by Polish mathematician Melvin Dresher while he was working at the Rand Corporation in the United States in 1950. It was given its name by Canadian Mathematician Albert Tucker.

And this is how the dilemma goes. There are two people who are suspected of a major crime. They are apprehended during the course of carrying out a minor offense and put in jail.

As John Allen Paulos writes in A Mathematician Plays the Stock Market: “They’re then interrogated separately, and each is given the choice of confessing to the major crime and thereby implicating his partner or remaining silent. If they both remain silent they’ll get one year in prison. If one confesses and the other doesn’t, the one who confesses will be rewarded by being set free, while the other one will get a five-year term. If they both confess, they can expect to spend three years in prison.”

The best solution here is for both individuals to remain quiet and get a prison sentence of one year. But the individuals are being interrogated separately and hence, one doesn’t know how the other will react. So what happens?

As Paulos writes: “Given…human psychology, the most likely outcome is for both to confess; the best outcome for the pair as a pair is for both to remain silent; the best outcome for each prisoner as an individual is to confess and have one’s partner remain silent.”

So even though the best outcome is for both to remain silent and spend one year in prison, the most possible outcome is that both of them will confess in the hope that they will get away free. In the process they land up in jail for three years.

Now how is this linked to what we started with i.e. the discount wars of Indian ecommerce? As Paulos writes: “The charm of the dilemma has nothing to do with any interest that one might have in prisoner’s rights…Rather, it provides the logical skeleton for many situations we face in everyday life. Whether we’re negotiators in business, spouses in a marriage, or nations in dispute…If both (all) parties pursue their own interests exclusively and do not cooperate, the outcome is worse for both (all) of them; yet in any given situation, any given party is better off not cooperating.”

Economist Dani Rodrik explains the situation of prisoner’s dilemma in the context of advertising carried out by competing companies in his new book Economics Rules—Why Economics Works, When It Fails and How to Tell the Difference.

As he writes: “Assume that two competing firms must decide whether to have a big advertising budget. Advertising would allow one firm to steal some of the other’s customers. But when they both advertise, the effects of customer demand cancel out. The firms end up having spent money needlessly.”

What is happening here? As Rodrik writes: “When the firms make their choices independently and they care only about their own profits, each one has an incentive to advertise, regardless of what the other firm does: When the other firm does not advertise, you can steal customers from it if you do advertise; when the other firm does advertise, you have to advertise to prevent loss of customers. So the two firms end up in bad equilibrium in which both have to waste resources.”

Now replace the word advertise in the above paragraph with the sales that are currently on and the situation is very similar. Let’s say Flipkart (or Amazon or Snapdeal, it doesn’t really matter) announces a big sale over five days to acquire new customers as well as sell more to existing ones. It makes tremendous sense for Flipkart to do that as long as it is the only company doing it.

If Amazon and Snapdeal (and other similar ecommerce websites and aps) decide to ignore the Flipkart sale, they will lose out on their customers. So they need to announce their sales as well to prevent Flipkart from stealing their customers and retain their customers.

The moment they do this, Flipkart loses out on the advantage it would have had if it was the only sale in town. The vice versa is also true.

Now Amazon and Snapdeal also have a sale on just to ensure that they don’t lose out on their customers. A classic prisoner’s dilemma.

Also, each company now has to offer greater discounts on their products, to make it look like a sale. This means accumulating more losses than they currently are. The Indian ecommerce players don’t mind doing this given that they are currently looking to drive up their revenue.

The higher the revenue number they are able to generate, the higher the valuation they get. And this helps them raise more money from investors. This, in turn, helps them keep running the show given that their current operations are loss-making.

Akhilesh Tilotia of Kotak Institutional Equities in a report titled .com 2.0 – Value versus Valuation makes a very interesting point. As he writes: “It will be instructive to note that the proportion of people who have purchasing power in India is limited to the top 10% or so of the population.” So the number of people that Indian ecommerce companies can tap is limited and is nowhere near as is typically made out to be.

And this has important repercussions. As Tilotia writes: “It is important to consider whether India’s e-commerce GMVs[Gross Merchandise Values] and volumes are going to come from (1) a larger number of users doing more transactions or (2) a smaller base of consumers (say the top-end 100 million or so users) driving all the volume. If it is going to be the latter, customer engagement and retention will be more important than customer acquisition.”

If customer retention is more important than customer acquisition then any one company launching a sale will lead to others having to join in, in order to retain their customers, even though they may not want to do the same. The prisoner’s dilemma is at work.

As John Allen Paulos writes in Beyond Numeracy: “The parties involved will be generally better off as a pair if each resists the temptation to double-cross the other and instead cooperates…If both parties pursue their own interests exclusively, the outcome is worse for both of them than if they cooperate.”

But that’s not going to happen because that is what competition is all about. And it does work at some places.

The column originally appeared on The Daily Reckoning on October 14, 2015

14 October, 2015

Aarushi Talwar and the myth of common sense

Aarushi_Talwar_300-250x300

I saw the movie Talvar on the day it was released. The movie is based on the Aarushi Talwar murder case. The names of the lead characters in the movie have been changed, with Aarushi Talwar becoming Shruti Tandon.

But as the movie unfolds, anyone who has followed the murder case closely would know that there is nothing fictional about it. Vishal Bhardwaj’s script is based on solid research. The movie tries to show two sides of the story, with a portrayal which suggests that Aarushi’s parents, Nupur and Rajesh Talwar, got a raw deal, and they got caught up in the rigmarole of the Indian police and justice system.

Along with Talvar if you have happened to read journalist Avirook Sen’s book Aarushi, you will come to the same conclusion.

Given this, the question here is why almost everyone was convinced for a long time (and some still are) that the parents killed Aarushi, and it was a case of honour killing. In fact, while coming out of the cinema theatre, I overheard two women talking and one of them was telling the other, that the filmmaker must have taken money to show a sympathetic portrayal of Aarushi’s parents. This logic has also been offered to me by a few journalist friends.

Why are people so convinced that the parents murdered Aarushi? I think their common sense is at work. One reason offered is that Nupur Talwar did not cry when she was interviewed by NDTV. Which mother would not have cried if she was giving an interview after her daughter’s murder? This question is often put forward as a reason to explain that the parents murdered Aarushi.

Nevertheless, as TV journalist Sonia Singh, who interviewed Nupur Talwar, recently wrote in a column: “I want to shout this from the rooftops. Nupur Talwar cried; in fact, she cried copiously! Her mistake – she did it off camera; my mistake – I didn’t keep the cameras rolling to record what I felt was a private moment of heartbreak.”

So Nupur Talwar did cry. It’s just that people never came to know about it.

While trying to explain things to themselves most people tend to use what they call “common sense”. Nevertheless there are problems with this approach. As Duncan J. Watts writes in Everything is Obvious—Once You Know the Answer: “Because we only try to explain things that strike us as sufficiently interesting, our explanations account for a tiny fraction even of the things that do happen. The result is that what appear to us to be causal explanations are in fact just stories…Nevertheless, because these stories have the form of causal explanations, we treat them as if they have predictive power.”

A similar phenomenon has been at play in the Aarushi murder case. Another reason offered in favour of why parents killed Aarushi is that how could the parents not hear anything while their daughter was being murdered in the next room. The parents said that the AC in their room was making too much noise and hence, they could not hear anything. This was later tested and found to be true (there is a long scene in the movie as well).

But this sort of reasoning is beyond our common sense. As Duncan writes: “The basic problem is that whenever people get together in groups…they interact with one another, sharing information, spreading rumours, passing along recommendations…learning from each other’s perspectives and generally influencing each other about what is good and bad, cheap and expensive, right and wrong.”

So people were convinced that the Talwars were guilty and the story spread. As Duncan writes: “The net result is that common sense is wonderful at making sense of the world, but not necessarily understanding it.”

And that is something worth thinking about.

The column originally appeared in the Bangalore Mirror on Oct 14, 2015

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