Broken Window Fallacy: What Falling Vegetable Prices Tell Us About Notebandi


The negative effects of demonetisation have now reached a stage wherein there is enough data available to discuss the concept of the broken window fallacy. This fallacy explains beautifully the ill-effects of demonetisation or notebandi in a very simple and straightforward way.

The French economist Frédéric Bastiat discusses this fallacy in his 1874 book That Which is Seen, and That Which is Not Seen. He talks about the anger of a good shopkeeper whose careless son has happened to break a pane of a glass window.

As Basitat writes: “If you have been present at such a scene, you will most assuredly bear witness to the fact, that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation-“It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”

The point being if window glasses were never broken what would glaziers ever do? A glazier is essentially person who fits glass into windows and doors. Without broken window glasses, there would be almost no work for glaziers.

As Basitat writes: “Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade-that it encourages that trade to the amount of six francs-I grant it, I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.”

But what about that which is not seen? “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented,” writes Bastiat.

So how does all this apply to demonetisation? The phrases to mark in the above paragraphs are that which is seen and that which is not seen. As economist Jim Walker of Asianomics put it in a recent research note: “It is likely that the demonetisation exercise will throw up very little, and certainly transient, weaknesses in measurements of the formal economy. It will be claimed, because it can be seen, that the pain was small and transient.”

This is clearly seen in the post demonetisation revised GDP estimates (or to put it simply economic growth estimates). Most economists have cut their economic growth estimates by less than 100 basis points. One basis point is one hundredth of a percentage.

Take the case of the National Council of Applied Economic Research. It recently cut the Indian economic growth forecast by 70 basis points to 6.9 per cent. Earlier it had forecast an economic growth of 7.6 per cent for 2016-2017.

Or take the case of Moody’s Investors Service. It recently cut the Indian economic growth forecast by 40 basis points to 7.1 per cent, from the earlier 7.5 per cent. The Reserve Bank of India has cut the growth forecast by 70 basis points to 6.9 per cent, from the earlier 7.6 per cent.

Hence, India is widely expected to grow by around 7 per cent in the current financial year. Before demonetisation was announced, it was expected to grow by around 7.6 per cent. Hence, that is a drop of around 60 basis points. Given this small fall, those in favour of demonetisation will claim that the negative impact of demonetisation hasn’t been much.

But this is what Bastiat called that which can be seen. The problem is with the unseen part, which is India’s huge informal economy. As Walker puts it: “Since by definition it is not measured, the detrimental and potentially lasting effects on the informal economy are impossible to observe, precisely because it is not measured.”

This is a point I have made in few of my recent columns. (You can read them here and here). This point is made in the latest Economic Survey as well, a document published by the ministry of finance. As the Survey pointed out: “It is clear that recorded GDP growth in the second half of FY2017 [October 2016 to March 2017] will understate the overall impact because the most affected parts of the economy-informal and cash based-are either not captured in the national income accounts [basically the gross domestic product].”

Hence, a large part of the damage because of demonetisation will remain unseen. This will happen because of two reasons, one because a lot of it will remain unmeasured and two, because a lot of it won’t make it to the national media, which primarily operates out of New Delhi.

Take the case of vegetable prices. Take a look at Figure 1. It shows the vegetable price inflation since November 2015, using the wholesale price index (WPI) data.

Figure 1:
As is clear from Figure 1, the vegetable price inflation was at around 28.5 per cent in July 2016. Since then it has been falling and has been in negative territory since September 2016, with a major fall coming in after demonetisation in November 2016. In December 2016, wholesale vegetable prices fell by a third in comparison to a year earlier. In January 2017, the situation continued.

This damage has primarily happened because the vegetable supply chain in the country works primarily on cash. As analysts Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital write in a research note: “The core theme which was discernible across India was that the prices of perishables, such as vegetable, have crashed as farmers are unable to sell their produce as their supply chains are entirely cash driven. For instance, cauliflower and pea farmers in a village in Haryana (near Panipat) told us that they had to trash their produce entirely as there were no buyers.”

With not enough cash going around, transactions for buying and selling of vegetables could not be carried out in the same volume as was the case before notebandi. This has led to a situation where the farmers have had to trash their produce. This is the unseen damage of demonetisation that will never be talked about.

Also, this damage will have a multiplier effect. Given that farmers producing vegetables are ending up with a lot of waste despite a bumper crop, it means that they will not earn as much money as they were hoping to. This will have an impact on their consumption as well. As I had written sometime back, two-wheeler sales have already crashed big time.

The analysts also add: “Whilst farmers were confident that as the cash comes back into the system the situation will improve, they lamented about the fact that the bumper vegetable season was destroyed because of demonetisation.”

How soon the situation improves is not unseen, but it remains to be seen.

The column originally appeared on Equitymaster on February 28, 2017

Why Bill Gates is Right About Robots Paying Taxes


In the recent past, there have been a spate of predictions about robots taking over human jobs.  One such prediction was made on October 3, 2016, by the World Bank President Jim Yong Kim, when he said in a speech: “Research based on World Bank data has predicted that the proportion of jobs threatened by automation in India is 69 percent, 77 percent in China and as high as 85 percent in Ethiopia.”[i]

As per predictions being made, it is not only jobs in the developing countries that are at risk. As Rutger Bergman writes in Utopia for Realists: “Scholars at Oxford University estimate that no less than 47 per cent of all American jobs and 54 per cent of those in Europe are at the high risk of being usurped by machines. And not in a hundred years or so, but in next twenty years.” He then quotes a New York university professor as saying: “The only real difference between enthusiasts and skeptics is a time frame.”[ii]

I have view which is different from robots destroying human jobs and I wrote about it in late January 2017. The fear of robots or automation destroying human jobs is not a new one and has been around for a while. So, what is it that makes this fear so believable this time around?

As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “This is not an entirely new question. Ever since the Industrial Revolution erupted, people feared that mechanisation [which is what robots are after all about] might cause mass unemployment. This never happened, because as old professions became obsolete, new professions evolved, and there was always something humans could do better than machines. Yet this is not a law of nature and nothing guarantees it will continue to be like that in the future.”[iii]

The question is: What has changed this time around?

Human beings essentially have two kinds of abilities: a) physical ability b) cognitive abilities i.e., the ability to think, understand, reason, analyse, remember, etc. As Harari writes: “As long as machines competed with us merely in physical abilities, you could always find cognitive tasks that humans do better. So machines took over purely manual jobs, while humans focussed on jobs requiring at least some cognitive skills. Yet what will happen once algorithms outperform us in remembering, analysing and recognising patterns?

And given this, robots will takeover human jobs is the conclusion being drawn. This conclusion has one basic problem—it assumes that human beings will sit around doing nothing and let robots take over their jobs. Now that is a very simplistic thing to believe in. Hence, if and when, it seems likely that robots are really look like taking over human jobs, it is stupid to assume that the governments will sit around doing nothing. There will be huge pressure on them to react and make it difficult for companies to replace human beings with robots.

Over and above this, governments will lose out on tax. When an individual works, he earns an income and then pays an income tax on it to the government. Income tax is a direct tax. Over and above this, in India, when he spends this money, he pays other kind of other taxes, which are largely indirect taxes, like excise duty, service tax, etc. A similar structure works all over the world.

Now let’s say this individual paying taxes gets replaced by a robot. So, the government does not get the income tax that it was getting in the past. Over and above this, the individual who has lost his job, will not spend as much as he was in the past. He will go slow on spending in order to ensure that his savings last for a longer period of time, or at least until he finds another job. If a substantial number of individuals lose their jobs to robots, in this scenario, the government will lose out on a portion of indirect taxes that it was earning earlier. It will also lose out on direct taxes.

So, what is the way out of this?

In a recent interview to, Bill Gates, the founder of Microsoft, said: “Certainly there will be taxes that relate to automation. Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed and you get income tax, social security tax, all those things. If a robot comes in to do the same thing, you’d think that we’d tax the robot at a similar level.

Basically, taxing the robot means, taxing the company which owns that robot. And how will this help? It will help the government to finance other jobs. As Gates put it: “And what the world wants is to take this opportunity to make all the goods and services we have today, and free up labor, let us do a better job of reaching out to the elderly, having smaller class sizes, helping kids with special needs. You know, all of those are things where human empathy and understanding are still very, very unique. And we still deal with an immense shortage of people to help out there… So if you can take the labor that used to do the thing automation replaces, and financially and training-wise and fulfillment-wise have that person go off and do these other things, then you’re net ahead.”

What Gates has explained is perhaps a solution to the problem that too much automation or too many robots are going to create. There is a basic law in economics which goes against the entire idea of robots destroying human jobs. It’s called the Say’s Law. One of my favourite books in economics is John Kenneth Galbraith’s A History of Economics—The Past as the Present. In A History of Economics, Galbraith writes about the Say’s Law.

This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. As Galbraith writes: “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced.”

Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”

What does this mean in the context of robots destroying human jobs? If robots destroy too many human jobs, many people won’t have a regular income. If these people do not have a regular income, how are they going to buy all the products that robots are going to produce? And if they are not going to buy the products that robots are producing, how are these companies driven by robots going to survive?

Gates has offered a solution where he says that the government taxes the companies using robots, more. That money can then be used to retrain people and deploy them in areas where people are still needed.

This means that such people will be paid by the government. And when they are paid by the government they will pay income tax as well. Over and above this, these workers will also spend that money and pay several indirect taxes to the government. Hence, the government will use the money generated from taxing robots to generate more taxes for itself.

Gates suggestion is also in line with what I had said earlier about the fact that once automation becomes a real danger to human jobs, the governments will not just sit and wait it out, but will do something about it, given that there will be tremendous pressure on them from people who elected them. It will also work towards protecting its tax revenues. Hence, any government taxing the output of robots, will be in line with this.

Gates suggestion depends on several assumptions. First and foremost is that people who lose their jobs to robots will be trained for other professions. While, this sounds simple enough, it clearly isn’t. Second, it expects the governments to do the right thing. That as we all know, is easier said than done. Third, it assumes that companies will willingly pay tax on their robots and not look at loopholes to avoid making these payments.

Having said that, Gates’ suggestion still shows one way of getting through the economic mess that the robots are likely to create.

To conclude, if my job doesn’t get replaced by a robot as well, I hopefully will be around to keep writing about this trend in the months and the years to come.

Watch this space!

[i] Speech by World Bank President Jim Yong Kim: The World Bank Group’s Mission: To End Extreme Poverty, October 3, 2016

[ii] R.Bergman, Utopia for Realists—The Case for a Universal Basic Income, Open Borders and a 15-Hour Workweek, The Correspondent, 2016

[iii] Y.N.Harari, Homo Deus—A Brief History of Tomorrow, Harper, 2016

The column originally appeared in Equitymaster on February 23, 2017

Will Chinese Jobs Come to India?


One of the themes that I have regularly explored in the Diary is the fact that one million individuals are entering the workforce every month and there aren’t enough jobs going around for them. This basically means that around 12 million or 1.2 crore youth enter the Indian workforce, every year.

And how many jobs are available for them? As a recent newsreport in the Business Word magazine points out: “According to the Labour Bureau of India, only 1.35 lakh jobs were created in 2015 and 4.93 lakh in 2014 across eight sectors.” Hence, there are barely any jobs being created for those entering the workforce.

Given the fact that so many individuals are entering the workforce every year, India needs a large burst of economic activity in labour intensive sectors which can employ India’s largely low-skill, semi-skilled and unskilled workforce. Only then will the country be able to put its so called demographic dividend to good use.

So, which are these labour intensive sectors that have the potential to employ India’s burgeoning workforce? The apparel sector and the leather and footwear sector are two such sectors. As the Economic Survey of 2016-2017 points out: “The data show that the apparel sector is the most labour-intensive, followed by footwear. Apparels are 80-fold more labour-intensive than autos and 240-fold more jobs than steel. The comparable numbers for leather goods are 33 and 100, respectively. Note that these attributes apply to the apparel not the textile sector and to leather goods and footwear not necessarily to tanning.”

Take a look at Figure 1.

Figure 1: Jobs to Investment Ratio for Select Industries

Figure 1 tells us that the apparel sector creates close to 24 jobs per lakh of investment. For a similar investment, the steel sector creates almost no jobs. On the other hand, the leather and footwear sector create around seven jobs per lakh of investment. Hence, these sectors have a great potential to create jobs, given that they don’t need a lot of investment to create jobs. Also, they have a huge potential to create jobs for women.

As mentioned earlier, it is estimated that nearly one million Indians are entering the workforce every month. This number is based on the assumption of a very low female labour participation rate. The men make up for a bulk of the Indian workforce, with women forming a small part.

Nevertheless, the thing is that more and more women are likely to join the workforce in the years to come. And if that turns out to be true, then the estimate of one million Indians entering the workforce every month, will turn out to be an underestimate. In this scenario, if the sectors like apparel and leather and footwear expand, they are likely to create the required jobs.

Over and above this, as the Economic Survey points out: “The opportunity created for women implies that these sectors could be vehicles for social transformation… In Bangladesh, female education, total fertility rates, and women’s labour force participation moved positively due to the expansion of the apparel sector.”

The interesting thing is that there is an immediate opportunity here. In the last two decades, China has seen an explosion of economic growth. In this scenario, the per capita income in the country has gone up many times over. In 1995, the per-capita income had stood at $610 (current US $, World Bank data). By 2015, this had exploded more than 13 times to $8,028.

This tells us that the labour costs in China have gone up. Some of the goods that it used to produce earlier, and on which a lot of economic prosperity was built, it is no longer competitive in. As far as labour cost goes, India is well -positioned to cash in on this. If labour cost was the only concern, businesses which produce apparel, leather and footwear, should have been moving their manufacturing from China to India.

This becomes clear from Figure 2. The minimum wages for semi-skilled labour in most Indian states are lower than Vietnam, China and Indonesia. Despite this, the space being vacated by China is not being taken over by India.

Figure 2: Minimum Wages for semi-skilled workers

As the Economic Survey points out: “The space vacated by China is fast being taken over by Bangladesh and Vietnam in case of apparels; Vietnam and Indonesia in case of leather and footwear. Indian apparel and leather firms are relocating to Bangladesh, Vietnam, Myanmar, and even Ethiopia.”

If India firms are leaving India and setting up apparel and leather firms in other countries, it is not surprising that the space being vacated in China is moving to other countries and not India.

This is a point I make in my new book India’s Big Government-The Intrusive State and How It is Hurting Us: “In fact, if we look at the cost factor, India has the second lowest manufacturing cost (Indonesia is lower) among the top 25 exporting countries in the world. Nevertheless, it is important to realise here that companies set up a manufacturing base in China not just because of the low cost, but also because of the very good infrastructure that was available. And such an infrastructure is clearly not available in India right now. Indeed, almost all countries in East Asia offer an easier working environment than what is available in India.”

Hence, when it comes to capturing the space being vacated by China, two major factors are holding India back, logistics and labour laws. India’s labour laws essentially ensure that Indian firms continue to remain small and in the process they lack economies of scale to compete internationally.

As the Economic Survey points out: “One symptom of labour market problems is that Indian apparel and leather firms are smaller compared to firms in say China, Bangladesh and Vietnam. An estimated 78 per cent of firms in India employ less than 50 workers with 10 per cent employing more than 500. In China, the comparable numbers are about 15 per cent and 28 per cent respectively.”

Take a look at Figure 3. It shows the logistic costs of different countries. India comes right at the bottom. In fact, the logistics cost of India and Vietnam is the same. Nevertheless, it takes lesser time to deliver stuff from Vietnam to the US East Coast, than it takes from India. This works in favour of Vietnam.

Figure 3:To conclude, the window of opportunity to capture the space being vacated by China is narrowing. And India needs to get its act right quickly, if it wants to capture the space being vacated.

The column was originally published on Equitymaster on February 22, 2017

Why Crime and Muscle Rule Indian Politics


Several state assembly and municipal elections are currently on. And given this, it is common to see stories in the newspapers and the digital media talk about the fact that many candidates contesting these elections have criminal cases filed against them.

Just having criminal cases being filed against an individual is not a big deal in Indian politics. The politics of protest as well ingrained as it is in the Indian political system, leads to a situation where many minor charges like unlawful assembly or trespassing, get filed against any individual trying to make a mark. Hence, minor charges are par for the course.

But then there are many other charges like murder, attempt to murder, kidnapping, physical assault and crimes against women, which have nothing to do with an individual practising to become a politician. Let’s take the case of the current Lok Sabha, elections for which happened in 2014.

As per research carried out by the Association for Democratic Reforms: “Out of the 542 winners analysed, 185(34 per cent) winners have declared criminal cases against themselves.” In the 2009 Lok Sabha, 158 winners (30 per cent). The figure has clearly gone up.

How do things look when we look at MPs with serious criminal charges, which as I said earlier in the column, is what we should really be looking at? AS the ADR report points out: “112 (21%) winners have declared serious criminal cases including cases related to murder, attempt to murder, communal disharmony, kidnapping, crimes against women etc.” This number had stood at 77(15 per cent) out of the 521 winners that ADR had analysed in 2009.

As is obvious, many MPs have serious criminal charges filed against them. And this is true largely at state assembly levels and municipal levels as well. Of course, the proportion varies across different parts of the country.

Having said that, individuals with serious crime charges against them, get elected because political parties give them electoral tickets in the first place. So, the question is why do political parties give them tickets? The simple answer is that candidates with serious criminal charges have a better chance at winning.

Milan Vaishnav has crunched the numbers and calculated the probabilities of winning in his new book When Crime Pays—Money and Muscle in Indian Politics.  When it comes to Lok Sabha elections, the win rate of clean candidates is 6 per cent. The win rate for candidates facing a criminal charge of any type is 17 per cent. And the win rate for candidates facing criminal charge of serious nature is 18 per cent.

How do things look at the state assembly level? Clean candidates have a 9.5 per cent chance of winning. The probability increases to 19 per cent for candidates with minor cases. For candidates with serious criminal charges the probability shoots up to 23 per cent.

The point being that political parties give tickets to those with criminal charges against them, simply because these individuals stand a better chance at winning. Over and above this, such candidates tend to bring their own money when it comes to financing the elections. And that really helps.

As Vaishnav writes: “The key factor motivating parties to select candidates with serious criminal records comes down to cold, hard cash. In a context of costly elections, weakly institutionalised parties, and an ineffectual election finance regime, parties are likely to prioritise self-financing candidates who do not represent a drain on finite party coffers.”

What this means is that candidates with criminal cases against them tend to bring in their own money in order to finance electoral expenses. This essentially helps the political parties because it frees up resources for others including party elites.

As Vaishnav summarises: “Parties place a premium on muscle because it often brings with it the added benefit of money… Data drawn from nearly 70,000 aspirant candidates in India over the last decade substantiate the claim that money and muscle are inexorably linked.”

And that is something we need to worry about.

The column originally appeared on February 22, 2017, in Bangalore Mirror

What Vehicle Sales Tell Us About Notebandi


A few days back I got an email from a reader. This email essentially said that the world had moved on from demonetisation/notebandi and it was time that I did as well.

Well, people do get bored. So, does the media.

And in the process, they stop following issues that they did once. As fatigue sets in, this essentially leads to a situation that issues do not get followed to their logical conclusion.

It’s like a daily soap opera which keeps undergoing multiple changes in plots, depending on what the viewers want. Or rather depending on what the managers running the show think the viewers want.

The trouble is that my writing is not like that. Also, now we have some data points to properly analyse notebandi and its impact on the Indian economy.

And it would be rather stupid of me to stop writing on the issue right now. Hence, my writing on notebandi is likely to continue in the months to come and who knows, possibly even years.

So, dear reader, that was that. Let’s now cut to today’s edition of the Diary.

Take a look at Figure 1. It shows the two-wheeler sales over the last five months.

Figure 1: 

Figure 1 clearly shows that there has been a downward trend in two-wheeler sales since September 2016. Notebandi only accentuated this trend. Having said that there has been some recovery in sales in January 2017.

Two-wheeler sales are a very important data point. They show the spending potential of many Indians. They also have a very high correlation with India’s informal economy, which doesn’t get captured very well in the gross domestic product(GDP) numbers.

As Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital write in a recent research note: “History suggests that there exists a strong correlation between the nominal GDP generated by the informal sector and… two-wheeler sales data.” And given that two-wheeler sales have shown a largely downward trend lately, what can be said? As Mukherjee and Shekhar point out: “The latest data… shows a marked deterioration underway in the informal sector of the economy.”

As mentioned earlier, the informal sector is not captured well enough in the GDP numbers. As the Economic Survey of 2016-2017 points out: “It is clear that recorded GDP growth in the second half of FY2017 [October 2016 to March 2017] will understate the overall impact because the most affected parts of the economy-informal and cash based-are either not captured in the national income accounts or to the extent they are, their measurement is based on formal sector indicators. For example, informal manufacturing is proxied by the Index of Industrial Production, which includes mostly large establishments. So, on the production or supply side, the effect on economic activity will be underestimated.”

Given this, data points like two-wheeler sales become very important in gauging the real impact of notebandi on the Indian economy. Let’s see how the data for the remaining two months (February and March 2017) comes out. But from four months of data that is available for the second half of this financial year, it can safely be said that things aren’t looking good on this front. And this should be a huge reason to worry. As per Mukherjee and Shekhar, “The informal sector accounts for ~40% of India’s GDP and employs close to ~75% of the Indian labour force.”

Now let’s look at domestic passenger car sales between September 2016 and January 2017. Take a look at Figure 2.

Figure 2:As Figure 2 shows, the domestic passenger car sales have recovered much more quickly than two-wheeler sales, in the aftermath of demonetisation. The January sales were only 4.5 per cent lower than the September sales. In case of two-wheelers, the January sales were still 30.6 per cent lower than the September sales.

What does this tell us? It tells us very clearly that rural India was impacted much more by demonetisation. It tells us that the not so well off have been more impacted much more by demonetisation than the well off. As writer Amit Varma put it in a recent speech: “In all this, the rich got away… You see a reflection of this in automobile sales. They have plummeted for two-wheelers and three-wheelers, but SUV sales are steady. The rich got away.”

And that is something worth thinking about.

The column was originally published on Equitymaster on February 20, 2017