Books

Labour reforms: What Modi’s ‘Make in India’ call can learn from the Bolsheviks

narendra_modiVivek Kaul

I was just joking to a friend during the course of a discussion in early August that soon we will start talking about the Rajasthan model of development. And that seems to have happened sooner than I had estimated.
The Business Standard in an editorial titled The Rajasthan Model today (August 19,2014) writes that Vasundra Raje, the chief minister of Rajasthan “is single-handedly creating a “Rajasthan model” of development.” This model, the paper goes on to write, differs from other models like the “Bihar model” and the “Gujarat model” in putting “liberal economic reform at the centre of the development strategy”.
Labour reforms are a key part of what seems to be emerging as the “Rajasthan model”. It is well worth mentioning here that the size of the organised work force in India is only around 15.8% of the total workforce (Source: What’s Holding Back India’s Labour Market Environment? Part 1, Morgan Stanley, August 12, 2014). And this work force which is highly unionised and tends to punch over its weight, has held back the growth of the Indian manufacturing sector.
Before we go any further let’s go back a little in history. Nicholas II, the last Tsar of Russia abdicated(i.e. relinquished) his throne in early 1917, after a massive revolt broke out. As Alan Beattie writes in False Economy—A Surprising Economic History of the World “Undermined by Russia’s dismal military failure on the Eastern Front of the First World War, the Tsar abdicated in February 1917 after a massive rolling revolt grew in Petrograd [known as St Petersburg till 1914, changed to Leningrad in 1924 and back to St Petersburg in 1991]…Starting with industrial workers, the rebellion then progressed to thousands of mutinying soldiers. This was a popular uprising but not a communist uprising.”
In fact, the communists were caught napping around the time of the popular uprising. “The ‘Bolshevik’ political grouping led by Vladimir Lenin and Leon Trotsky, which would eight months later take control of the country and become the Communist Party of the Soviet Union, was taken by surprise. Many of its key members were not even in Russia at the time, giving rise to the faintly comic spectacle of a bunch of revolutionaries hurrying home to catch up with a revolution,” writes Beattie.
Over and above that the Bolsheviks did not have support of people across the length and breadth of Russia. The Socialist Revolutionaries had that support. Nevertheless the Bolsheviks still managed to seize power. What worked in favour of the Bolsheviks was their “increasing control over Petrograd’s ‘soviet’, or workers’ organization, through the months that followed.”
As Beattie writes “They [i.e. the Bolsheviks] watched their rivals punch themselves out and exhaust local popular support by trying to run a provisional government after the February revolution. Amid mounting discontent with the [First World] war, which was still continuing, the Bolsheviks’ October revolution was a special forces assassination of a tottering government, not a pitched battle against the commanding heights of a functioning state.”
In fact, more people were accidentally killed when director Sergei Eisenstein was making a movie on the October revolution than were killed “during the event itself”. The Bolsheviks managed to punch way above their weight because their support was concentrated around Petrograd where the seat of power was, in comparison, the support of the Socialist Revolutionaries was spread across Russia’s vast interior. And given this, as Beattie writes “The Bolsheviks found it amazingly easy simply to dismiss the Constituent Assembly which was supposed to take power and in which the Socialist Revolutionaries had a clear majority, and take control themselves.”
The Indian labour market is similarly placed. The organised labour tends to punch above its weight like the Bolsheviks, primarily because labour laws are rigged in its favour. It is also unionised and the unions ensure that any prospect of labour reform which is beneficial to the overall labour force and not to organised labour, is vociferously opposed.

If genuine labour reform has to happen, it is this ability of the organised labour force to punch above its weight, that needs to be controlled. Let’s take the case of the Industrial Disputes Act 1947. According to this Act any factory employing more than 100 workers needs the permission of the state government, if it decides to lay off a worker. The permission to lay off employees if the situation demands so is difficult to get.
This has led to a situation where firms continue to remain small even when they have an opportunity to grow. It also explains why a country like Bangaldesh manages to export more apparel than India. Economist Arvind Panagariya in an open letter to Rahul Gandhi in November 2013 wrote that “India exported less apparel than much smaller Bangaldesh and less than one-tenth that by China.” Most Indian apparel firms start small and continue to remain small.
This leads to a situation where they cannot benefit from the economies of scale and hence, cannot compete in the export market. In their book India’s Tryst with Destiny, Jagdish Bhagwati and Panagariya point out that 92.4% of the workers in this sector work with small firms which have forty-nine or less workers. Now compare this to China where large and medium firms make up around 87.7% of the emplo
yment in the apparel sector.
Given this, the smallness of the Indian apparel sector, the economies of scale never come into play. As Panagariya wrote in the Business Standard recently “It is astonishing that Indian laws view a factory of 100 workers as a large, corporate firm. In the United States, any firm with fewer than 250 workers is classified as “small”, while a firm with 250 to 500 workers is classified as “medium”. Even the World Bank, a development institution, defines a firm with 50 to 300 workers as being of medium size, and not large.” This ensures that a firm that starts small, continues to remain small. And this ultimately has an impact on job creation. As Chetan Ahya and Upasana Chachra of Morgan Stanley point out in a research note titled What’s Holding Back India’s Labour Market Environment? Part 1 “All of these ultimately lead to lower job growth. Indeed, the manufacturing sector accounts for only 12.9% of GDP in India (2013) vs. 31.8% in China (as of 2011), 23.7% in Indonesia, 20.5% in the Philippines, and 14.8% in Brazil.”
History tells us that the creation of a strong and robust manufacturing sector is very important for robust economic growth. But in India’s case the system as it stands is rigged in favour of the incumbent large firms and organised labour.
The Industrial Disputes Act also requires the firm to take consent from the workers before modifying an existing job description. “This creates additional rigidities in the use of labour in response to changing market conditions,” write Ahya and Chachra.
Another tricky point is the fact that only 10% of the workforce is required to start a trade union. As the Trade Unions (Amendment) Act, 2001 points out “No trade union of workmen shall be registered unless at least 10% or 100, whichever is less, subject to a minimum of 7 workmen engaged or employed in the establishment or industry.”
This leads to a situation where there is “scope for multiple trade unions in a single factory”. As Ahya and Chachra point out in a note titled What’s Holding Back India’s Labour Market Environment? Part II dated August 18, 2014, “A company with 700 workers can have 70 trade unions. In most other countries, the requirements for minimum membership for trade unions to be recognized are higher than those in India, reducing the scope for multiplicity of unions.”
In Pakistan at least 20% of the workmen are required for the trade union to be registered. In Bangaldesh the number stands at 30%. Sri Lanka requires a minimum of seven employees for a trade union, but collective bargaining is only allowed if the trade union represents a minimum of 40% of the total employees.
Then there are multiplicity of laws to cope up with. This is primarily because labour law is a concurrent subject and both the central and state governments can legislate on it. As Ahya and Chachra point out “This has resulted in multiplicity of laws, at times with overlapping jurisdictions. Currently there are 44 central laws and about 160 state laws on the subject (ILO, 2013).” It is not rocket science to conclude that it is very difficult for any entrepreneur to follow all these laws. As Reuters columnist Andy Mukherjee wrote in a recent column “As a textile businessman recently tweeted, if small and mid-sized companies in India followed all existing rules, “your underwear will cost what your jeans cost today”.”
The Rajasthan government has begun chipping away at these laws. One of the changes proposed is that a firm needs to approach the state government when laying off workers only if it employes three hundred or more workers. These are state level changes being made to central government regulation, and hence, they need the assent of the president.
But Rajasthan is just a small part of the overall puzzle. Labour market reforms are needed at the central government level especially if Narendra Modi’s recent “Make in India” call needs to be taken seriously.
Currently, China accounts for 17.5% of the total global manufacturing exports. India in comparison stands only at 1.6%. Labour markets reforms at the central government level are needed if that number has to go up.

The article originally appeared on www.Firstbiz.com on August 20, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Nigerian frauds decoded: Why the success of scamsters lies in their dumbness

think like a freak

The following email just popped into my mailbox. Have you ever received a similar email?

My Dearest Friend,
I am MR. PAUL ARUNA, The chief auditor in bank of Africa (boa) Burkina Faso West African, One of our customers, with his entire family was among the victims of plane crash and before his death, he has an account with us valued at $27.2million us dollars(twenty-seven million two hundred thousand us dollars) in our bank and according to the Burkina Faso law, at the expiration of Ten years if nobody applies to claim the funds a grace of one year also will be given before the money will revert to the ownership of the Burkina Faso government.
My proposals is that i will like you as a foreigner to stand in as the next of kin or distant cousin for us to claim this money, so that the fruits of this old man’s labour will not get into the hands of some corrupt government officials who will later use the money to sponsor war in Africa and kill innocent citizens in the search for political power.
As a foreign partner which this money will be transfer into your account, you are entitle to 40% of the total money while 55% will be for me as the moderator of this transaction and 5% will be mapped out for any expenditure that may be incur during the course of this transaction. Please note that there will be no problem as my bank has made all effort through to reach for any of his relation but all was fruitless.
My position as the chief auditor in this bank guarantees the successful execution of this (deal) transaction.
Please send the following:
1) Your full name…..
2) Sex…..
3) Age…..
4) Country…..
5) Passport or photo…..
6) Occupation…..
7) Personal Mobile number…..
8) Personal fax number…..
9) Home & office address…..
Thanks.
MR. PAUL ARUNA.

Chances are you receive an email along these lines almost everyday or maybe even more than one a day. Instead of a chief auditor, as is the case with the above email, you might get an email from the widow of a billionaire or a deposed prince. While the details might change, the overall theme of such emails continues to remain the same.
As Steven D Levitt and Stephen J Dubner write in Think Like a Freak—How to Think Smarter About Almost Everything “In each case, the author[of the email] has rights to millions of dollars but needs help extracting it from a rigid bureaucracy or uncooperative bank.”
And this is where you come in. You will need to share your bank-account information along with other personal information. This will help the sender of the email “to park the money in your account until everything is straightened out”. As Levitt and Dubner write “There is a chance you will need to travel to Africa to handle the sensitive paperwork. You may also need to advance a few thousand dollars to cover up some up-front fees. You will of course be richly rewarded for your trouble.”
Does any of this tempt you to reply to your email? Most of us delete such an email as soon as we see the subject of the email. We don’t even bother to read it, before it goes into the junk box of our email account. This fraud is known as the Nigerian letter fraud (even though the email that I share at the beginning of this article has come from Burkina Faso.)
In fact, this is a scam that has survived the test of time. “An early version was known as the Spanish Prisoner. The scammer pretended to be a wealthy person who’d been wrongly jailed and cut off from his riches. A huge reward awaited the hero who would pay for his release. In the old days, the con was played via a postal letter or face-to-face meetings; today it lives primarily on the Internet,” write Levitt and Dubner.
Since the advent of the internet, the Nigerian scam has taken on a life of its own. But the question is all these years later, when the scam is pretty well known, do people really fall for it? Further, why haven’t these scammers gone around fine tuning their story? Why does almost everyone who uses an email continue to get emails with the same basic “sob” story when it comes to the Nigerian scam? And why does almost every scammer who sends out an email claim to be from Nigeria or some other West African country?
Cormac Herley of Microsoft Research decided to investigate this question. As he asks it in a research paper titled Why do Nigerian Scammers Say They are from Nigeria? “An examination of a web-site that catalogs scam emails shows that 51% mention Nigeria as the source of funds, with a further 34% mentioning Cˆote d’Ivoire, Burkina Faso, Ghana, Senegal or some other West African country…Why so little imagination? Why don’t Nigerian scammers claim to be from Turkey, or Portugal or Switzerland or New Jersey?”
Stupidity can’t be an answer. As Herley puts it “Stupidity is an unsatisfactory answer: the scam requires skill in manipulation, considerable inventiveness and mastery of a language that is non-native for a majority of Nigerians. It would seem odd that after lying about his gender, stolen millions, corrupt officials, wicked in-laws, near-death escapes and secret safety deposit boxes that it would fail to occur to the scammer to lie also about his location. That the collection point for the money is constrained to be in Nigeria doesn’t seem a plausible reason either. If the scam goes well, and the user is willing to send money, a collection point outside of Nigeria is surely not a problem if the amount is large enough.”
So what can possibly explain this? The Nigerian (or any other West African for that matter) scammer carrying out this fraud needs to send out many emails initially. Hence, the cost of contacting a possible victim is very low. But at the same time his chances of getting hold of a possible victim who he can engage in a conversation over email, are also very low.
“An email with tales of fabulous amounts of money and West African corruption will strike all but the most gullible as bizarre. It will be recognized and ignored by anyone who has been using the Internet long enough to have seen it several times. It will be figured out by anyone savvy enough to use a search engine and follow up on the auto-complete suggestions…It won’t be pursued by anyone who consults sensible family or fiends, or who reads any of the advice banks and money transfer agencies make available,” writes Herley.
That being the case why go through so much trouble? The Nigerian sending the email cannot know in advance “who is gullible who is not?”. As Levitt and Dubner put it “Gullibility is in this case an unobservable trait.” So what explains this?
Herley provides the answer. As he writes “Those who remain are the scammers ideal targets. They represent a tiny subset of the overall population…The initial email is effectively the attacker’s classifier: it determines who responds, and thus who the scammer attacks (i.e., enters into email conversation with). The goal of the email is not so much to attract viable users as to repel the non-viable ones, who greatly outnumber them.”
To put it in simple English, the scammer essentially wants to identify individual(s) who haven’t heard o
f the Nigerian scam. As Herley told Levitt and Dubner “The scammer wants to find the guy who hasn’t heard of it…Anybody who doesn’t fall off their chair laughing is exactly who he wants to talk to.”
Such a gullible individual is most likely to send across thousands of dollars to someone he does not know based just on an email about a lost fortune. And this is why the Nigerian scam continues to look so do dumb. Its dumbness is what makes it so successful.
As Herley puts it in his research paper “A less outlandish wording that did not mention Nigeria would almost certainly gather more total responses and more viable responses, but would yield lower overall profit. Recall, that viability requires that the scammer actually extract money from the victim: those who are fooled for a while, but then figure it out, or who balk at the last hurdle are precisely the expensive false positives that the scammer must deter.”

The article appeared on www.firstbiz.com on August 17, 2014

 

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

 

The power of context

Vivek Kaul

We live in an era of instant coffee and analysis.
Even before something has happened, the analysis on why it has happened is ready. Given this, it leads to situations where we analyse using what we think is “common sense”.
But common sense does not always work. The simplest answer is not always the right one. Life can get a little more complicated than that.
Consider the story of a woman who the economists Abhijit V Banerjee and Esther Duflo met in the slums of Hyderabad. The economists recount this story in their book Poor Economics-Rethinking Poverty & the Ways to End It: “A woman we met in a slum in Hyderabad told us that she had borrowed Rs 10,000 from Spandana and immediately deposited the proceeds of the loan in a savings bank account. Thus, she was paying a 24 percent annual interest rate to Spandana, while earning about 4 percent on her savings account.” Spandana is a micro-finance institution.
Common sense tells us that anyone in their right mind wouldn’t do anything like this. But the economists soon found out that there was a method to the madness, once they saw the context in which the woman was operating.
As they write: “When we asked her why this made sense, she explained that her daughter, now 16, would need to get married in about two years. That Rs 10,000 was the beginning of her dowry. When we asked why she had not opted to simply put the money she was paying to Spandana for the loan into her savings bank account directly every week, she explained that it was simply not possible: other things would keep coming up…The point, as we eventually figured out, is that the obligation to pay what you owe to Spandana – which is well enforced -imposes a discipline that the borrowers might not manage on their own.”
Once viewed in this context the story makes immense sense. The woman was borrowing at 24% and investing it at 4% in order to build a savings kitty for her daughter’s dowry. Of course, prima facie this wouldn’t have seemed obvious at all. As Nicholas Epley writes in Mindwise: How We Understand What Others Think, Believe, Feel, and Want “The mistakes we make when reasoning about the minds of others all have the same central outcome: underestimating their complexity, depth, detail, and richness. When we’re indifferent to others, it’s easy to overlook their minds altogether, treating such people as relatively mindless animals or objects than as fully mindful persons.”
Epley gives a brilliant example of people who chose to stay back in in New Orleans when Hurricane Katrina hit the city in August 2005. The experts were at it with their instant analysis. As ABC News put it, “It’s hard to understand the mind-set of those who ignored evacuation orders.” Michael Chertoff, the Chief of Homeland Security said that those who stayed back made a “mistake on their part”. Psychiatrists suggested that there was a “certain amount of denial involved” on part of those who had chosen to stay back in New Orleans, given that they believed that they could handle the storm.
All these explanations sound pretty convincing, “but it does not resonate as well with the actual experience of most who left and stayed, because the broader context is not quite as easy to see.” It is simple to come to the conclusion that anyone choosing to stay back and take on a category 5 hurricane was not right in the head. But anyone who came to that conclusion ignored the context in which the people who had chosen to stay back, were operating.
As Epley writes “Compared to those who left, those who stayed were disproportionately poor, had geographically narrower social network, had larger families (both children and extended members), had less access to reliable news, and were considerably less likely to own a car.” And given this it was not easy for these people to just pack up and leave.
“If you had money to pay for an extended hotel stay, relatively small family to move, a car to get all of you there, or had far-away friends to stay with, you could choose to leave. If you had no money for an extended hotel stay, no car to get you out, a large family to move and no long distance-friends to stay with, what choice did you have?” asks Epley.
Of course, people who analysed the situation did not understand this broader context. Given this, before passing judgements it is important to understand the context in which people are operating. People who chose to stay back when Katrina hit New Orleans, did not need convincing to leave the city, what they needed was a bus. As Epley puts it “Many who stayed wanted to desperately to leave but couldn’t. They didn’t need convincing, they needed a bus.”
And what about the woman who borrowed money at 24% and invested it at 4%? What it clearly tells us is that there is a need for a savings solution which allows the poor to save on a daily basis. If they can discipline themselves to pay back micro-finance institutions every week, they can easily discipline themselves to save small amounts on a daily basis. Of course, there are financial institutions which cater to this market, but most of them are of dubious nature. Hence, there is a clear market out there for anyone who is willing to take the risk.

The article originally appeared in the Wealth Insight magazine August 2014

(Vivek Kaul is the author of Easy Money: Evolution of the Global Financial System to the Great Bubble Burst. He can be reached at [email protected])

Global market bubbles: Raghuram Rajan will have the last laugh second time around

ARTS RAJAN

Vivek Kaul

The Federal Reserve Bank of Kansas City is one of the 12 Federal Reserve banks in the United States. Every year in August it organizes a symposium at Jackson Hole in the state of Wyoming. The conference of 2005 was to be the last conference attended by Alan Greenspan, the then Chairman of the Federal Reserve of the United States, the American central bank.
The theme of the symposium was the legacy of the Greenspan era. Those were the days when Greenspan was god, and hence, the economists who had turned up at the conference, were expected to say good things about him and his time as the Chairman of the Federal Reserve of United States, which had lasted close to two decades.
One of the economists attending the conference was Raghuram Rajan, who at that point of time was the Chief Economist of the International Monetary Fund. Rajan presented a paper titled “Has Financial Development Made the World Riskier?” at the conference. 
As Neil Irwin writes in The Alchemists—Inside the Secret World of Central Bankers “Raghuram Rajan presented a rare moment of clarity at the 2005 conference. Rajan indeed had an astute understanding of the ways in which the financial industry, with misguided compensation policies that encouraged risk-taking, was making the world a more dangerous place: Bankers were paid big bonuses for making money in the short run even if they were betting poorly in the long run.”

Rajan in his speech also suggested that banks were not in the best shape as was being made out to be. As he put it “The bottom line is that banks are certainly not any less risky than the past despite their better capitalization, and may well be riskier. Moreover, banks now bear only the tip of the iceberg of financial sector risks…the interbank market could freeze up, and one could well have a full-blown financial crisis.”
In the last paragraph of his speech Rajan said that “One source of concern is housing prices that are at elevated levels around the globe.” Rajan’s speech did not go down well with people at the conference. This is not what they wanted to hear.
Rajan recounts the situation in his book Fault Lines – How Hidden Fractures Still Threaten the World Economy: “I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions. As I walked away from the podium after being roundly criticized by a number of luminaries (with a few notable exceptions), I felt some unease. It was not caused by the criticism itself…Rather it was because the critics seemed to be ignoring what going on before their eyes.”
Rajan’s prediction turned out to be right in the end and a little over three years later in September 2008, the world was in the midst of a full-blown financial crisis, the impact of which is still being felt, almost six years later. Banks and financial institutions about the go bust had to be rescued by governments all over the Western world. Also, in the aftermath of the crisis, Western governments and their central banks decided to print trillions of dollars in order to get their economies up and running again.
Now Rajan has sounded a warning again.
In an interview to the Central Banking Journal which was published a few days back Rajan said “The problems arising are not so much from credit growth, which is relatively tepid in the industrial markets and has been much stronger in emerging markets, but from asset prices due to financial risk-taking and so on. Unfortunately, a number of macroeconomists have not fully learned the lessons of the great financial crisis. They still do not pay enough attention – en passant – to the financial sector. Financial sector crises are not as predictable. The risks build up until, wham, it hits you. So it is not like economic growth, where unemployment offers a more continuous indicator.”
What Rajan is essentially saying here is that all the money printed and pumped into the financial system by the American and other Western governments has led to financial market bubbles all over the world. And these bubbles when they burst will lead to another financial crisis. As Rajan put it “We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost.”
Rajan went on to suggest that central banks have had a role to play in creating financial market bubbles all across the world. As he put it “The kind of language we hear is akin to gaming. Investors say, ‘we will stay with the trade because central banks are willing to provide easy money a
nd I can see that easy money continuing into the foreseeable future’. It’s the same old story. They add ‘I will get out before everyone else gets out’.”
In another interview to the Time magazine published on August 11, 2014, Rajan said “A number of years over which we, as central bankers, have convinced markets that we continuously come to their rescue and that we will keep rates really low for long — that we do all kinds of ways of infusing liquidity into the markets — has created markets that tend to push asset prices probably significantly beyond fundamentals, in some cases, and make markets much more vulnerable to adverse news.”
One of the reasons for the bubbles is the fact that compensation structures which encourage high financial risk-taking are back on Wall Street. The following table makes for a very interesting reading.bonus to profit ratio


Source: The Office of New York State Comptroller

In 2007 and 2008, the Wall Street firms faced huge losses. But their employees still got their bonuses. In fact, in 2007, the total bonus had stood at $33 billion. This, when firms had faced losses of $11.3 billion.
In the year 2009, the Wall Street firms made a profit of $61.4 billion because of all the bailout money given by the government. Even during the heydays of the bull run between 2003 and 2006, the firms had not made that kind of money.
Interestingly, if one looks at the bonus-to-profit ratio between 2003 and 2006, it stands at 1.55. For the period after the financial crisis, between 2010 and 2013, the ratio stands at 1.48. There is not much material difference between the two ratios.
What this clearly tells us is that the bonus paid as a proportion of profits continues to remain high among Wall Street firms. Hence, the “risk” that these high bonuses built into the American financial system continues. As Michael Lewis writes in Flashboys: “Once the very smart people are paid huge sums of money to exploit the flaws in the financial system, they have the spectacularly destructive incentive to screw the system further, or to remain silent as they watch it being screwed by others.”
What Rajan had warned about in 2005 continues unabated and that has led to financial market bubbles all over the world. The real estate bubbles which played a major role in the financial crisis which started in September 2008, are also back with a bang. As Albert Edwards of Societe Generale wrote in a research note titled Here we go again…and once again no-one is listening “We are in the midst of the mother of all housing bubbles.
The economist Nouriel Roubini wrote in a November 2013 column “Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil.”
Over and above this the stock market in the United States continues to rise. As investment newsletter writer Gary Dorsch puts it in a June 2014 column “The “Least Loved” Bull market is still running on steroids, even at 63-months old. The median lifetime of the Top-12 Bull markets is 55-months. So it’s lasted 8-months beyond its mid-life. A -10% correction hasn’t happened for the past 34-months, far beyond the average of 18-months between corrections.”
And when these bubbles start bursting all over again, as they are bound to do, there will be trouble along the lines Rajan has been talking about. He might have the “last laugh” second time around as well. Though until that happens he may still be the “early Christian who [has] wandered into a convention of half-starved lions”.

The article was originally published on www.Firstbiz.com on August 14, 2014

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

Investing lessons from football penalties

goalkeeperVivek Kaul 

By the time you get around to reading this, the football World Cup would have already started. And hopefully the referees would have awarded a few penalty kicks by then as well.
A penalty kick is by far the easiest way to score a goal in football. As Steven D. Levitt and Stephen J. Dubner write in Think Like a Freak “75 percent of penalty kicks at the elite level are successful.”
In fact, the goalkeeper cannot wait for the footballer taking the penalty to kick the ball. The ball takes around 0.2 seconds to reach the goal after it is kicked. Hence, this does not give enough time to goalkeeper to figure out the direction in which the ball is kicked. He has to take a guess in which direction the ball will be kicked and jump (either to his right or his left). If he gets the direction wrong, then the chances of a goal being scored “rise to about 90 percent”.
Given this, which direction do goalkeepers jump in? As Levitt and Dubner write “If you are a right-footed kicker, as most players are, going left is your “strong” side. That translates to more power and accuracy—but of course the keeper knows this too. That’s why keepers jump toward the kicker’s left corner 57 percent of time, and to the right only 41 percent.”
What does this mean? It means that they stay in the centre only 2 percent of the time. Hence, the for a footballer taking the penalty it makes immense sense to aim for the centre of the goal. He is more likely to succeed in scoring a goal. But only 17 percent of kicks are aimed for the centre of the goal.
Now why is that the case? Why don’t kickers hit the ball towards the centre of the goal where the chances of scoring the goal are the highest? A simple reason is kickers want to maintain some mystery instead of doing the same thing all the time (i.e. aim towards the centre of the goal). If every kicker started kicking the ball towards the centre of the goal all the time, goalkeepers would soon figure out what is happening and factor that in.
But there is a more important reason than just trying to be unpredictable. As Levitt and Dubner point out “Picture yourself standing over the ball. You have just mentally committed to aiming for the center. But wait a minute—what if the goalkeeper doesn’t dive? What if for some reason he stays at home and you kick the ball straight into his gut and he saves [the goal]…without even having to budge? How pathetic will you seem!”
So you decide to take the “traditional route” and aim for one corner of the goal. If the goalkeeper saves the goal, then so be it. At least you won’t seem pathetic and be accused of doing a dumb thing.
At a more general level what this means is that people feel more comfortable being a part of a “herd” and doing things that everybody else around them seems to be doing. And this applies to the investment industry as well.
An excellent example of this comes from the dot-com bubble. By the end of 1999, even though the stock market had reached astonishingly high levels, the Wall Street analysts were still recommending that investors should continue to buy stocks. According to data from Zack Investment Research, only about one percent of the recommendations on some 6,000 companies were sell recommendations. The remaining 99 percent was divided between 69.5 percent buy recommendations and 29.9 percent hold recommendations (i.e., don’t buy more shares but don’t sell what you already own). The dot-com bubble started losing steam March 2000 onwards.
Bob Swarup explains this phenomenon in Money Mania in the context of investment managers.As he writes “Don’t stick your head above the parapet. Run with the pack. There is safety in numbers, especially in bad times. It may not the rational human’s choice but it is the sensible human’s choice.”
Running with the herd is a sensible human’s choice due to two reasons. “First, the notion of inclusivity is powerful and can create perverse economic incentives that encourage crowding. Second, having decided to go with the flow, we are good at convincing ourselves that there are strong rational bases for what is essential a primal urge to belong and conform.”
An excellent recent example of this phenomenon is the current upgrading of the Sensex/Nifty targets by almost all stock brokerages. Targets as high as the Sensex reaching 35,000 points by December 2015, have been bandied around. This is not to say that the Sensex will not reach the target. It may. It may not. That time will tell and I really don’t know.
But the point is that there is not one stock brokerage out there which has a different point of view. How is that possible? Every stock brokerage is telling us that the economic problems of this country are over because a new government which “seems” to be reform oriented will deliver and set everything right. And happy days will be here again.
But as we all know, hope as an investment strategy, can be a pretty dangerous thing. Shouldn’t at least one brokerage be discounting for that? But they are not. As Swarup explains “no financial institution wants to be an outlier.”
Further, it needs to be pointed out here that investment managers are not the only ones who like to move in a herd. Economists do that as well, specially the ones who work on the policy side with the government. Given this, it limits their ability to spot bubbles and financial crises. In order to that they need to move against the herd. And that is a huge risk to take.
As Alan Greenspan writes in The Map and the Territory —Risk, Human Nature and the Future of Forecasting “In my experience, if policy makers are in a minority and wrong, they are politically pilloried. If they are in a majority, and wrong, they are tolerated and the political consequences are far less dire.”
To conclude, John Maynard Keynes explained this phenomenon brilliantly when he said “Worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally.”
The article originally appeared in the Mutual Fund Insight magazine July 2014  

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])