The Role Of Family In Good Education Is Really Important: James Heckman


Professor James J. Heckman is the Henry Schultz Distinguished Service Professor of Economics at the University of Chicago, where he also serves as Professor in the University of Chicago’s Law School and Harris School of Public Policy. In 2000, Professor Heckman won the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (more commonly referred to as the Nobel Prize in Economics). In this interview he speaks to Forbes India on various aspects of education.

In India we have launched the right to education where we are trying to put children from poor families into good schools run by the private sector. Do you think this kind of approach will work?
I think engaging the private sector is always a good idea but I also think that you have to make sure that the private sector is fully responsive to a particular question. We know from my own experience in US that the private sector in early childhood education programmes can help respond to cultural, social and parental religious values that would adapt programmes to be where the children and parents want to be. The private sector can also generate funds and support outside the government
. So not only can it communicate information about diverse groups interest but it can also help finance those programs and raise support and also kind of shape the agenda in a way that is fully responsive to different elements of the society.
In India the poor have shown an increasing preference for paying a higher fees and shifting their children to private schools and this is what prompted the government to say that private schools have to take in a huge diverse population from different background both at the early education stage and later. Is it a good approach when 90% of the schools are actually run by the state?
I don’t want to pretend to be an expert on the Indian education. But I have seen some of the studies and I don’t think if they completely control for the issue of selectivity, which is that children attending private schools have parents who are more motivated. That is a problem that runs throughout the world and not just in India. But it does seem like the private schools are doing a better job, at least superficially, but again I haven’t studied the problem in depth.
You talked about this problem running throughout the world…
Look one thing we have found in American education and education in Chile and other countries is that when the private sector and the public sector coexist, in many cases the private sector can help the public sector become more responsive to the children. And so they compete. In that sense competition can promote quality in both public and private sector. John Hicks the famous economist talked about the benefits of monopoly. He said that benefit of monopoly was that a monopolist can live a quiet life. The monopolist doesn’t have to compete and I think that is probably equally true in education as it is in steel or any other activity
When you spoke about selectivity you seem to think that private schools may or may not be necessarily better but the kind of students that self select themselves into these schools may be giving them better results. Is that what you are trying to say?
Oh yes. The motivated parents are the ones trying to achieve better results for their children. And we know that parenting is an important part of success of schools. Good parenting can be a very powerful factor leading to the success of the child and may be we attribute too much credit to the school attended by the child and probably underestimate the powerful role of the parent and the motivation of the parent.
As an aside, are you aware of the Amy Chua’s Tiger Mom concept. Do you think it has a huge impact in the kind of student performances of children coming from certain communities?
Yeah, I think it is. I know she goes to extremes in proving her theory. There is a difference that we make sometimes between an authoritarian mother and an authoritative mother. And I think tiger mom sounds a little too authoritarian. What you want is the mother to be informed and provide guidance to the child and I think that is an important distinction. If you look at Asian communities in the United States, for example Indian or Chinese communities, a lot of those children come from those homes that are very highly motivated.
Can you tell us a little bit more about that?
James Flynn talked about the Flynn effect, where each generation has a higher score and IQ than the previous one, sometimes by a substantial amount. He asked the question that why was it that Asian American children that included Japanese Americans, Indian Americans and Chinese Americans, were doing so well in school? The initial feeling was that there was some superiority in terms of IQ of the Asian population. But when Flynn looked at the data he found that these children were more motivated. They were working harder, were doing more homework, their parents co-operated with them and so forth. So I don’t know if they were tiger moms but they were families that were staying with the kids, motivating the kids and that is really part of what gave the culture. So the role of the family is really important. And I think some of the advantage of one culture or one ethnic group over another is precisely that.
What do you mean by that?
For example in the United States now, we have many children from Mexican-American families and for whatever reason the value placed on education is much lower. It is not uncommon to allow their children to drop out of school. They see the role of their child as following them, as doing a certain kind of manual labour. They don’t have any aspirations, may be because that they think there is no chance for their children in those other occupations. Hence, a part of the whole notion has been to educate those parents about the value of higher education.
How much does the quality of early education impact how well an individual does in life?
Let me tell you that I have seen from US data and I think this may be true in other countries, that the gap in achievement tests scores that is present when people leave secondary school, most of that gap is present when they enter school and kindergarten. So the early preschool years are playing a huge role. And you say, well maybe that is genetics, the family is smarter. There are more advantaged parents and they have more advantaged children, and better performing children and the gap you see in tests scores at age six or age five is may be a genetic gap. That is when the intervention studies come along and show that you can close a lot of that gap by essentially giving disadvantaged families some of the same advantages that advantaged children have. So it is not purely genetic. That’s an old idea, in fact there is lot of work showing that environment plays a big role. Genes play a role, but its not all set by the genes.
Should students be given exams from a
very young age? Is there some research on that?
I would say yes because you want to be able to monitor and measure children through out their life time. And the reason why it is useful is it guides teachers and the parents about where the child is behind and needs special effort. But having said that, we also need broader measures of what a child’s achievement is. So we want to go beyond just the notion of a test score or reading or writing, but to have a broader inventory of things like what is sometimes called non-cognitive or character skills. Character plays a very important role and we can shape characters, parents shape characters, schools shape characters, peers shape characters and we have a way to measure it.
How important is class size when it comes to delivering education? How small or big should a class be?
The younger the child, the smaller the class size should be. So when you get to these very young preschools, it seems like a ratio of three children per one teacher is about the right size. I am talking about kids one year of age who are very demanding, so you really cant supervise them. However, when you get to higher levels of education, class sizes can grow and there the evidence on class size is a little bit weaker. Schools in the north east of Brazil did not even have a roof over their heads. They imagined trees, they had no text books. So spending more money on those schools turned out to be a very good thing. They had a huge number of students and a very small number of teachers. So smaller classes and more resources played a huge role in increasing the Brazilian quality of schooling. But if you were to move that discussion to Sao Paulo, just go south into a more urban area, then large classrooms per say were not the problem, even resources per say weren’t the problem. It was typically what happened to the kids when they walked into the classroom from the aspect of student disciple and so on, that was the problem. So I think the focus in the past has been on the class size and that may have been overstated.
Can you elaborate on that?
Some 15 years back I did some calculations and what we suggested was that if you reduced the teacher pupil ratio by the amount suggested in certain influential studies, what happened was you boosted the incomes of the children. But if you ask that did it pay for itself in terms of what the increased teachers salaries were and the increased numbers of schools that came with reducing pupil teacher ratio, it did not. It was actually more efficient to give the children money and put it in the bank than it was to give the children few more teachers or have more classroom size. So, I would say the more important thing is creating efficiency within the school system than just having fewer students per teacher.
Just to shift the field, I think you have been a bit of a skeptic on the ability of the markets ultimately delivering the best results, even though you come from the Chicago School…
Be careful now. Suppose a child is born into a poor family. The resources available to that child are not to the same extent as to what some other child is getting. And that child who gets poor resources by what is basically a luck of the draw is very bright. He had a great future possibly but isn’t able to realise it. Then the question is that is there insurance against this kind of possibility? If there can be, you can literally imagine a market where fetuses would be buying insurance against having bad parents. But that market doesn’t exist and the point is that there is a kind of market failure which is related to the accidental birth and I think that is a very traditional Chicago argument that the parents play a big role and the child cannot control the families that they are born into.
That’s a very interesting way of putting it…
What I said is the result of what many people including my former colleague now deceased Milton Friedman, had to say. Friedman was a very strong believer in public education and that has been forgotten. As a very poor child, he was the beneficiary of public school education. The point you want to make a distinction on is that education provides a very basic framework for human capability. Adam Smith said that himself. So, this is not at odd with any things in economics. And the point is, very poor parents, somebody living in a very rural area in India or China for that South America, it may well be that the parent cant afford or doesn’t have the resources or even access to education for his children. So there is a role for government in providing resources. But having said that there is still a huge role for the private sector in making sure that the resources are used effectively.
In India, we are debating a law about the value of specific quotas especially in higher education, jobs and other thing,s as opposed to affirmative action where a company or a higher educational institution is expected to seek diversity rather than actually fill up quotas. What is the global experience on this front?
There was a similar debate in Brazil and I actually participated in that debate. In Brazil they started putting affirmative action in place, in the sense that blacks would be given privileges to go to medical school, professional schools and they worked. And what also happened is that Brazil had largely been racially unconscious in the sense that they were many poor blacks but there were many poor whites too. True, there were more blacks than probably white but there were awful lot of whites in poverty as well. Now, what happened is as you created a level of racial consciousness, it turned out that many people who looked very European, once the orders were given were actually trying to find out evidence if they had one thirty second black, so they could somehow claim credibility. So I worry, I definitely don’t like discrimination. And discrimination is a serious thing. It is very harmful, it just denies dignity to people. But I think reverse discrimination also denies dignity too.
Can you elaborate on that?
We want a society that doesn’t discriminate so I don’t know if tilting the scale in another direction is so good either. I think we want fairness. But I would say this that inequality starts really early in life and if we want any kind of affirmative action then it is probably helping the disadvantaged-white, black, high caste, low caste and so on. I think probably the idea of giving the skills and capabilities to people that allow them to flourish is probably a much better policy than kind of mandating equality in the face of gaps in skills. And I am afraid what happens in some case is that unqualified people are promoted at positions that they can not satisfy and that creates negative image which can actually undo the intentions.

 The article originally appeared in the Forbes India magazine edition 

Capitalism and the common good

thomas piketty

Thomas Piketty is a professor at the Paris School of Economics. Over the last few months he has become the most talked about economist globally with the release of the English edition of his book Capital in the Twenty-First Century (The Belknap Press of the Harvard University Press). The original was written in French.
Capital has been the second best-selling book on for a while now. This is a rarity for a book which is not exactly a bed time read and runs into 577 pages (without including the nearly 80 pages of notes). But that is not a surprise given the important issues the book tries to address. In this book Piketty deals in great detail about the “distribution of wealth”.
As he writes “The distribution of wealth is one of today’ most widely discussed and controversial issues. But what do we really know about its evolution over the long term? Do the dynamics of private capital accumulation inevitably lead to the concentration of wealth in fewer hands, as Karl Marx believed in the nineteenth century? Or do the balancing forces of growth, competition, and technological progress lead in later stages of development to reduced inequality and greater harmony among the classes…?”
In this interview he speaks to Vivek Kaul. Kaul is the author of the Easy Money trilogy which deals with the evolution of money and the financial system and how that led to the current financial crisis. The second book in the trilogy Easy Money—Evolution of the Global Financial System to the Great Bubble Burst releases in June 2014.


You write that “It is an illusion to think that something about the nature of the modern growth or the laws of the market economy ensures the inequality of wealth will decrease and harmonious stability will be achieved”. Why is that incorrect? Has capitalism failed the world? Capitalism and market forces are very good at producing new wealth. The problem is simply that they know no limit nor morality. They can sometime lead to a distribution of wealth that is so extremely concentrated that it threatens the working of democratic institutions. We need adequate policies, particularly in the educational and fiscal areas, to ensure that all groups in society benefit from globalisation and economic openness. We want capitalism to be the slave of democracy and the common good, not the opposite.
A major part of your book deals with how capitalism leads to inequality…
History tells us that there are powerful forces going in both directions — the reduction or the amplification of inequality. Which one will prevail depends on the institutions and policies that we will collectively adopt. Historically, the main equalizing force — both between and within countries — has been the diffusion of knowledge and skills. However, this virtuous process cannot work properly without inclusive educational institutions and continuous investment in skills. This is a major challenge for all countries in the century underway.
What is the central contradiction in capitalism? How does that lead to inequality?
In the very long run, one powerful force pushing in the direction of rising inequality is the tendency of the rate of return to capital rto exceed the rate of output growth g. That is, when rexceeds g, as it did in the 19th century and seems quite likely to do again in the 21st, initial wealth inequalities tend to amplify and to converge towards extreme levels. The top few percents of the wealth hierarchy tend to appropriate a very large share of national wealth, at the expense of the middle and lower classes. This is what happened in the past, and this could well happen again in the future. According to Forbes global billionaire rankings, top wealth holders have been rising more than three times faster than the size of the world economy between 1987 and 2013.
That clearly is a reason to worry. Why are you confident that in the years to come economic growth rate will be lower than the return on capital. What implications will that have on capitalism and the inequality that it breeds?
Nobody can be sure about the future values of the rate of return and the economy’s growth rate. I am just saying that with the decline of population growth in most parts of the world, total GDP (gross domestic product) growth rates are likely to fall. Also, as emerging economies catch up with developed economies, productivity growth rates are likely to resemble what we have always observed at the world technological frontier since the Industrial revolution, i.e. between 1 and 2% per year. With zero or negative population growth, this suggests that total GDP growth rates will fall much below 4-5%, which has been the typical value for the average rate of return to capital in the very long run.
So what is the point that you are trying to make?
My main point is not to make predictions, which by nature are highly uncertain. My main point is that we should have more democratic transparency about how the different income and wealth groups are doing, so that we can adjust our policies and tax rates to whatever we observe. As long as top groups grow at approximately the same speed as the rest of society, there is no problem with inequality per se. But if the top rises three times faster than the size of the economy, you need to worry about it.
Your book is being compared to Karl Marx’s Capital. How different is your work from his?
One obvious difference is that I believe in private property and markets. Not only are they necessary to achieve economic efficiency and development — they are also a condition of our personal freedom. The other difference is that my book is primarily about the history of income and wealth distribution. It contains a lot of historical evidence. With the help of Tony Atkinson, Emmanuel Saez, Abhijit Banerjee, Facundo Alvaredo, Gilles Postel-Vinay, Jean-Laurent Rosenthal, Gabriel Zucman and many other scholars, we have been able to collect a unique set of data covering three centuries and over 20 countries. This is by far the most extensive database available in regard to the historical evolution of income and wealth. This book proposes an interpretative synthesis based upon this collective data collection project.
Any other differences?
Finally, Marx’s main conclusion was about the falling rate of profit. My reading of the historical evidence is that there is no such tendency. The rate of return to capital can be permanently and substantially higher than the growth rate. This tends to lead to very high level of wealth inequality, which may raise democratic and political problems. But this does not raise economic problems per se.
One of the most interesting points in your book is about the rise of the supermanager in the US and large parts of the developed world and the huge salaries that these individuals earn. You term this as meritocratic extremism. How did this phenomenon also contribute to the financial crisis?
According to supermanagers, their supersalaries are justified by their performance. The problem is that you don’t see it the statistics. In the US, between two thirds and three quarters of primary income growth since 1980 has been absorbed by the top 10% income earners, and most of it by the top 1% income earners. If the economy’s growth rate had been very high, rising inequality would not have been such a big deal. But with a per capita GDP growth rate around 1.5%, if most of it goes to the top, then this is not a good deal for the middle class. This has clearly contributed to rising household debt and financial fragility.

 (Vivek Kaul can be reached at [email protected])

The interview originally appeared in The Corporate Dossier, The Economic Times on May 23, 2014 

For 250 Years, Strategy Has Been About How Much More We Can Sell: Niraj Dawar

Dawar-08_smNiraj Dawar, Professor at the Ivey Business School (Canada and Hong Kong), is a renowned marketing strategy expert who has also been on the faculty of leading business schools in Europe and Asia. He works with senior leadership in global companies and has executed assignments for BMW, HSBC, Microsoft, Cadbury, L’Oreal, and McCain on three continents, as well as with start-ups in the biotech and information space.  His publications have appeared in the Harvard Business Review, the M.I.T. Sloan Management Review and in the leading academic journals. Most recently he has authored Tilt: Shifting Your Strategy from Products to Customers (Harvard Business Review Press, Rs 1250). In this interview he tells Forbes India why the opportunities of capturing value in the downstream are relatively neglected and have huge payouts when they are recognised. 
Your follow up question to managers often is that why do your customers buy from you rather from your competitors. This is after you have asked them what business are you in. Why do you do that?
The reason I ask that question is to encourage managers to ask themselves that question because it really allows you to understand that the reasons that customers buy are related to the interaction between the firm and the customers. The reasons are often about reliability, trust, relationships, comfort, the ease of doing business and reputation. In fact, very rarely does the answer to this question has anything to do with better products or cheaper prices. The reasons are almost entirely between the softer aspects of the interaction between the buyers and the sellers.
What is the centre of gravity of a business as you talk about in your book Tilt?
If you look at the activities of a firm all the way from sourcing of their raw materials, transformation of those materials, production, innovation, and supply chains—then towards the downstream, customer acquisition, customer retention and customer satisfaction, those are all activities that the firm engages in. Not all of those activities contribute equally to the cost of the business. And not all those activities contribute equally to the value that the customer buys, sees, and pays for. And not all of those activities contribute equally to the competitive advantage of the company.
So what are you suggesting?
If we can answer the following three questions i.e. which of these activities accounts for the bulk of their cost? Which of those activities accounts for the value that the customer sees, pays for, comes back for, and becomes loyal for? And which of these activities accounts for the source of competitive advantage? If we can answer those three questions then we start to locate the centre of gravity of a business along the spectrum of value creation activities. And I believe that increasingly that the centre of gravity of successful firms is going to reside in the downstream activities, in the activities related to customer acquisition, customer retention and customer satisfaction.
Could you explain that through an example?
Imagine all Coca Cola’s assets i.e. there trucks, their supply chains, their factories, all their physical assets were to go up in flame overnight. How likely is it that they would be able get financing to start operations tomorrow? And the answer if you were to ask any reasonable manager would be that it is very likely that they would be able to get financing to start operations again tomorrow.
If you take the second half of the thought experiment and imagine that a colourless, odourless gas leaks out of a weapons research laboratory somewhere and it envelopes the world and seven billion consumers forget about the brand name Coca Cola and all of its associations. Now how likely is it that Coca Cola can get financing to start operations again tomorrow? The answer is quite unlikely. When you compare those two situations what you recognise is that sources of competitive advantage do not reside inside the four walls of the company but out there in the minds of the consumers. And they have to do with the brand and the reputation, and not the product. And that’s how a company’s centre of gravity can be assessed. So Coca Cola’s centre of gravity clearly resides in the market place.
Any other example?
If you take the entire pharmaceutical industry and map the companies according to their centre of gravity, the centre of gravity of some companies resides in the massive sales forces that they have, in the relationships they have with doctors, whereas for some other pharmaceutical companies their distinct advantage lies in the laboratory, in creating new molecules, in patenting them. The question I have is, which of these companies is in the driver’s seat? Who is acquiring whom? The answer is that the companies which have downstream assets i.e. the relationships with the doctors and the subscribers, are the ones acquiring those that have the patents. And not the other way around.
You talked about the centre of gravity of companies shifting downstream. Can you talk a little more about that?
Take Coca Cola once again. In most cities around the world you can buy a can of Coca Cola as a pack of 24 in a supermarket and it will cost you about 25 cents per can. Now consider an individual who is in a park on a hot sultry day and he has been out for two hours. He wants a Coke. He sees a vending machine and he can easily drop two dollars into the vending machine and get a can. The vending machine delivers to the customer a can of Coca Cola, at the point of thirst, in a single serve and chilled. For those reasons, single serve, at the point of thirst and chilled, the premium that is charged is 700%.
And the customer willingly pays for it…
Yes, there is a 700% price premium and the customer willingly pays that premium. Where does the value come from? The value came from a downstream activity of ‘how’ as opposed to ‘what’. It pays for the company to recognise these sources of value and to create ways of delivering and capturing that value. Many companies fail to recognise that. They build a product and they think that is the value they have created without recognising that there are opportunities around the product to develop offerings which are customised to the situation and the context of what the customer is looking for. Think about it this way, many companies spend a huge amount of money doing business process re-engineering, or reorganising their operations, or making their supply chain and operations more efficient. The result is a 2-5% cost saving,which might double their margins, which is huge. But think of the opportunities in the downstream where you capture 700% growth in value. If you compare these two, I believe that the opportunities of capturing value in the downstream are relatively neglected and have huge payouts when they are recognised.
Why are they neglected?
They are neglected because we have spent the last 250 years building factories, since Richard Arkwright, in the middle of the 18th century England, built the first one. Having built the factory one of the things he realised was that by streaming together all of the innovations in the textile industry like the spinning jenny, the flying shuttle, he reduced the cost of producing textiles by 90%. Even though he had reduced the per unit cost of production that came with the cost of leveraging. He had borrowed money to build these factories. So at the end of the month he had to pay interest regardless of whether he was able to sell or not. What happened was that his business became driven and obsessed with just one question, how much of this stuff can we sell. That was his obsession because everything else depended on that question.
And that’s carried on since then?
For 250 years strategy has been about how much more of this stuff can we sell. We have not asked the question what else do our customers need. We have not asked the question why do our customers buy from us and not from our competitors. These are downstream questions. The upstream question is how much more of this stuff can we sell or can we make a better product. We have had the factory at the centre of business. What I am arguing in Tilt is that the customer is at the centre of business.
So where does the title of your book Tilt fit into this?
Tilt is a shift in the centre of gravity from the upstream to the downstream. And I am arguing because costs, value and competitive advantage have shifted from the upstream to the downstream, management attention and strategy need to be focused on the downstream rather than the upstream. And that is why the title.
Do you see companies tilting?
I do see companies tilting. There are a lot of examples of things that companies can do to tilt. But I don’t see one single company doing all of those things. In other words, there are lots of opportunities even for companies that are doing one or two things well, to do the other things well. So Tilt is an incomplete project. It is happening but it is far from complete.
You also talk about some marketing myths in your book. Lets talk about some of those myths.
Does a better product always win?
No a better product does not always win. If you look at the innovation graveyard, it is full of better products. What matters is the ability of a company to change and influence the customer’s criteria of purchase. Let me give you an example. For the last 25 years everybody has known that Gillette’s next product will be a razor with one more cutting edge. Why is it then that competitors have not pre-empted Gillette and come up with the next cutting edge before Gillette? Introduce five cutting edges when Gillette only had four.
Why has that not happened?
The answer is that customers only find it credible when it comes from Gillette. So four blades are better than three only if Gillette says so. There is no value for competitors to develop a better product unless Gillette develops a better product. What is driving innovation is not the better product. It is consumer’s acceptance of the better product. So downstream reasons not upstream reasons drive innovation. So is a better product the answer? No. Understanding customer’s criteria of purchase is the answer. Influencing that criteria of purchase is the answer.
Any other examples? 
In case of mobile phones very recently the chip has become very important just like it became important in the PC industry during the 1990s. Now people are suddenly paying attention to questions like is it a single core or a dual coe? In fact, now we are upto quad core. Why are the cores important? There are technical reasons why they are important. For example, a mobile phone can shut down half the CPU if you are making a phone call rather than using graphics. Why is that important in a mobile phone? Because it saves battery life. And it allows you to have more functionalities with less battery life. You don’t have to recharge it as often. If you have a dual core it is a battery saving feature. If you have a quad core, it is an even better battery saving feature because you can shut-down three cylinders and run on only one cylinder when you don’t need the other three. When you need the other three they fire up quickly and you have all the four cylinders running. So its essentially that.
What is the point you are trying to make? 
Right now we are upto quad core. And everyone wants a quad core phone. In China there is a company called Meizu and it has just launched an octa core phone. Consumer acceptance for octa core phones, even though everyone knows that the next logical step is octa core, is not there unless Samsung or Apple introduce octa core phones. Then it will become a criteria. Exactly like the blades. So what is more important? Is it technology? Or is the consumer’s criteria of technology? The answer is marketing. It is the downstream not the upstream.
The next marketing myth I wanted to ask you about is does it make sense to listen to your customers? 
Not always. For a long time we were told that you needed to go and ask customers what they wanted. So you had focus groups. You ran surveys. You had questionnaires. All these were ways of finding out what does the customer want. That is really old technology. Today you find out what the customer wants primarily based on customer behaviour. What do they click on? Which products do they compare? Which pictures do they look for? How much do they pay today? How much are they going to pay tomorrow for same product? What is their price elasticity of demand? What is their cost elasticity of demand? You need to get deep into customer behaviour today simply by observing behaviour as opposed to asking.
Can you give us an example?
So Zara for example places products on the shelf. They will put 300 units in the store across 10-15 stores. If these units fly out of the shelf, then they put in 30,000. If they don’t sell, then they stop that product. They put in hundreds of new products every month. What flies they put in more of. What doesn’t fly, they cull. This approach is very different from asking the customer what he actually wants. In fact, it is cheaper and quicker for Zara to actually make the product and put it on the shelf and see if it actually sells, rather than ask the customer if you like the product.
But the thing with Zara maybe that it has a short turn around time, which may not be possible for other industries…
The answer is that it is becoming possible for more and more industries. In the textile business, the lead time used to be six months to a year. You had to plan the next winter season in January. And, showed that the model could be broken. They went down to a lead time of three weeks. I think there are many industries which are sitting ducks because of the long lead times that they have. They are still using the old technology of what do you think customers will want. And that is not viable.

 The article originally appeared in Forbes India edition dated March 7, 2014

The Complications of Easy Money

vivekAn Indian writer dives deep into the history of money and concludes that government interventions rarely end well

Although he is not by formal training an economist – and perhaps because he is not – Vivek Kaul has established a reputation as a provocative, clear-voiced economic commentator for Firstpost and other publications in India. One article about Kaul’s recently published history, “Easy Money: Evolution of Money from Robinson Crusoe to the First World War,” paid Kaul the compliment of being “readable.” In response, Kaul explained that he devotes considerable study to “break things down. If a child cannot understand what I am writing, it is pointless.”
Though perhaps understandable to the younger population, Kaul’s extensively researched, 300-page volume speaks to a very different, highly educated audience. He delves into the origins and evolution of monetary systems and finds in them pointed, cautionary lessons for the central bankers who manage the modern-day money supply and for policymakers concerned about the risks and stability of financial systems.
“One of the lessons from history is that money printing has never really ended well,” Kaul says in this recent interview conducted by Dr. Nupur Pavan Bang of the Insurance Information Bureau of India. “It has inevitably led to disaster. We don’t seem to have learned that lesson at all.”

Why is “Easy Money” your title?
I use the term ‘Easy Money’ in the context of money being created out of thin air by kings, queens, rulers, dictators, general secretaries and politicians. The practice was regularly resorted to by kings of Rome and has been abused ever since. As the Roman Empire spread, it needed more and more money to keep its huge army all over the world going. But gold and silver could not be created out of thin air. Also, as Romans grew richer, luxury and showing off became an important part of their lives. This also increased the demand for precious metals. This meant more plunder of the territories Rome had captured in battle. But plunder could not generate gold and silver beyond a point. Hence, the Roman kings resorted to debasement.
How did debasement work?
A metal like copper was mixed with the gold or silver in coins, while keeping their face value the same. So let’s say a coin which had a face value of 100 cents had silver worth 100 cents in it. After it was debased, it only had 80 cents worth of silver in it. The remaining 20 cents was pocketed by the ruler debasing the currency. Once the Romans started this, the rulers who followed also debased various forms of money regularly. And that is a practice that has continued to this day. These days, governments print paper money and pump it into the financial system by buying government bonds. Actually, most of this money is created digitally and resides in bank accounts, but “printing paper money” is a simple way to explain this.
How and where has that history repeated?
Governments at various points in history have worked toward destroying money and the financial system. The Romans under Nero were the first to do it systematically by lowering the silver content in the Denarius coin. The Mongols, Chinese, Spaniards, French, Americans and Germans followed, at various points of time. When gold and silver were money, the governments destroyed money by debasing it, i.e., lowering the content of precious metals in the coins they issued. When paper currency replaced precious metals as money, the governments destroyed it simply by printing more and more of it.
Today, in the U.K., for example, the government does not print money on its own. It sells securities to the central bank, which prints money to buy them. This started with the Bank of England being tricked into lending endless money to the government in the late 1790s by Prime Minister William Pitt. This allowed the government to borrow as much money from the Bank of England as it wanted to, without having to get clearance from the Parliament. Governments all over the world continue with this practice of borrowing unlimited amounts from their respective central banks. The practice has only increased over the last few years, since the advent of the financial crisis.
The first volume of your planned trilogy covers “from Robinson Crusoe to the First World War”. Do you think some earlier practices like barter were actually better?
Not at all. In fact, if barter was better, we would have probably stayed with it, and money and the financial system wouldn’t have evolved. Barter had two fundamental problems. The first was the mutual coincidence of wants. I have some eggs and I want to exchange them for salt. So, I need to find someone who has salt and, at the same time, wants to exchange it for eggs. What if the person who has the salt does not want eggs, and wants sugar instead? To complete the transaction, I need to find someone who has sugar and is ready to exchange it for eggs. A simple, straightforward transaction could become fairly complicated.
In a barter system that has four goods to be exchanged, there are six ratios of exchange. But imagine a situation where there are 1,000 goods to be exchanged under a barter system. There will be 499,500 exchange rates.
And the second problem with barter?
Indivisibility. Let us say I have a potter’s wheel and want to exchange it for some basic necessities like eggs, salt and wheat. One way would be to find someone who has these three things and is ready to do an exchange. If I am unable to find such a person, then barter does not work for me. That demonstrates the utility of money.
The evolution of the concept of money, where a standardized commodity could be used as a medium of exchange, did away with the problems of barter. Also, money allowed people to specialize in things they were good at. People can work in areas they feel they are most suited to without having to worry about how to go about getting the other things that they might require to live a decent life. This specialization, in turn, leads to discovery and invention. The concept of money is at the heart of human progress.
You write that gold, which historically backed the value of coins or currency, “is valuable, because it is useless”. Can you explain this oxymoron?
That may sound oxymoronic, but it is not. Gold is highly malleable (it can be beaten into sheets), ductile (can be easily drawn into wires), and the best conductor of electricity. Despite these qualities, gold does not have many industrial uses like other metals have. This is primarily because there is very little of it around. Also, pure gold is as soft as putty, making it practically useless for all purposes that need metal.
Now, why am I making this point? It is important to understand that when commodities are used as money, they are taken away from their primary use. If rice or wheat is used as money for daily transactions and to preserve wealth, then there are lesser amounts of rice and wheat in the market for people to buy and eat. This, in turn, would mean higher prices of grains, which are staple food in large portions of the world. If a metal like iron is used as money, it is not available for its primary use.
Why is gold different?
Given the fact that it is extremely expensive, and that it does not have many industrial uses, the mere act of hoarding gold does not hurt anyone or infringe their rights. That “uselessness” also helps it to retain value.
Silver has lots of industrial uses. If one owns silver during a recession, chances are that the price of silver, and thus its purchasing power, would fall, because there would be less demand for silver for its industrial uses. The same would be true for metals like platinum and palladium which are also used for industrial purposes. Gold would not be impacted. As analyst Dylan Grice wrote in “A Minskian Roadmap to the Next Gold Mania“ (2009), “The price of gold will be unaffected by any decline in industrial demand because there is no industrial demand!” Hence, gold is useful because it is useless. This is paradoxical, but true.
What determines currency values now, and what causes them to crash, as was the case in the South East Asian crisis of 1997?
Paper currencies inherently do not have any value. What makes them money is the backing by the government that has issued them. Hence their designation as fiat currencies. One paper currency’s value vis-à-vis another to a very large extent depends on the economic strength of the issuing country. Before the South East Asian crisis, the Thai baht was pegged against the U.S. dollar: one dollar was worth 25 baht. Thailand’s central bank ensured that this rate did not vary. Hence, it sold dollars and bought baht when there was a surfeit of baht in the market and vice versa.
Once economic trouble broke out in Thailand’s and other regional currencies, investors exited them en masse. They exchanged baht for dollars to repatriate their money. In the normal scheme of things, with a surfeit of baht in the market, the value of the baht would have fallen. But the baht was pegged to the dollar. The Thai central bank kept intervening by selling dollars and buying baht. But it could not create dollars out of thin air. It ran out of dollars, and the peg snapped.
The baht was a piece of paper before the crisis. And it continued to be a piece of paper after the crisis. What changed was the economic perception people had of Thailand. As a result, the baht rapidly depreciated in value against the dollar.
What is the relevance today?
Central banks around the world have been on a money-printing spree since the late 2008. Between then and early February 2013, the U.S. Federal Reserve System expanded its balance sheet by 220%. The Bank of England did even better, at 350%. The European Central Bank came to the money-printing party a little late and expanded its balance sheet by around 98%. The Bank of Japan has been relatively subdued, increasing its balance sheet by 30% over the four-year period. But it is now printing a lot of money, planning to inject nearly $1.5 trillion into the Japanese money market by April 2015. This is huge, given that the size of the Japanese economy is $5 trillion.
One of the lessons from history is that money printing has never really ended well. It has inevitably led to disaster. But we don’t seem to have learned that lesson at all.
In a past interview, Dr. Ishrat Husain, former governor of the Central Bank of Pakistan, pointed out that if shareholders’ equity in a bank amounts to 8% of deposits, then 92% belongs to depositors, ang although excessive risks are taken with the depositors’ money, the upside gains are captured by the shareholders and managers. But, if they lose money, taxpayers have to bail them out. This “asymmetric relationship in incurring risk and appropriation of reward makes the financial sector more vulnerable to exogenous shocks.”
I totally agree with Dr Husain. I talk about this in some detail in “Easy Money.” Walter Bagehot, the great editor of The Economist, wrote in Lombard Street,“The main source of profitableness of established banking is the smallness of requisite capital.” This book was published in 1873. So things haven’t changed for more than a century. The low shareholders’ equity of banks makes the entire financial system very risky.
What would it take to mitigate that riskiness?
Anant Admati and Martin Hellwig explain this point beautifully in “The Bankers’ New Clothes” (2013).Let us say a bank has shareholders’ equity of 2%, as some had between 2007 and 2009. If the value of the assets falls by 1%, half of its equity is wiped out. The bank cannot issue any new equity. So what does the bank need to do, if it wants to move its shareholders’ equity back to 2%? If the bank has assets worth $100, its shareholders’ equity earlier stood at $2. If the value of these assets fell by 1%, the bank’s assets are now worth $99. Its equity is also down to $1. To increase shareholders’ equity back to 2%, assets must fall to $50 – meaning $49 worth of assets must be sold.
In times of trouble, a lot of banks need to do this, leading to a rapid fall in the value of their assets. This tells us that if banks have a little more equity, then they will need to sell a smaller amount of assets, which will make for a more stable financial system during times of trouble.
Therefore, shareholders’ equity in banks needs to go up. This is a no-brainer, the influence of Wall Street notwithstanding. 

 The interview was first published by the Global Association for Risk Professionals on February 06th 2014 

Narrow your focus

al ries 2Al Ries
A rising tide lifts all boats. But a falling tide does the most damage to those boats that are poorly anchored.
In high-growth times, when things are going well, management ignores the marketing function. Why get involved when everything is upbeat?
When things are going bad, the first thing management does is to get involved in marketing activities. If sales are turning down, no CEO is going to ignore marketing.
This is the worst time for management to be involved in marketing. They don’t have the knowledge and experience to figure out what needs to be done.
In fact, their instincts are wrong. They know they need to increase sales in order to survive, so their first thought is to expand the brand.
That’s exactly the wrong approach. A downturn exposes the weakness of also-ran brands. In order to survive in a down economy, a company should narrow its focus in order to strengthen its brand, which ultimately can increase sales.
Great Wall Motor is a good example of this principle. In the year 2009, the company marketed trucks, passenger cars, minivans and SUVs, using nine different model names.
Then the company decided to focus their resources on a single model, Haval, using the strategy, “The most-economical SUV under 100,000 RMB.” (Roughly $13,000 at the time.)
Last year, Great Wall Motor sold more vehicles than any other Chinese automobile company. Furthermore, they made more net profits than the next four Chinese automobile companies combined.
The question is why does this happen? If you’re the CEO of a major corporation, chances are good you are a left brainer. Before you make a decision, you want to be supported by facts, figures, market data, consumer research. If you’ve a job in marketing, chances are good you are a right brainer. You often make decisions by “gut instinct” with little or no supporting evidence. It couldn’t be otherwise in a creative discipline like marketing.
A logical, analytical left-brainer generally won’t take a right-brainer seriously whether the economy is up or down. In China, for example, consumers saw passenger cars as “prestige” vehicles and trucks and SUVs as working vehicles for the lower class.
So if you are a logical thinker, you would want to focus on passenger cars. But a right-brainer is a holistic thinker. He or she sees the big picture. And the big picture in China back in 2009 was that every other automobile manufacturer was going to focus most of their resources on passenger cars. That’s why the better strategy for Great Wall was to do the opposite, focus on SUVs.
At the same time, low-growth times can actually benefit market leaders because it makes them relatively stronger than their weak competitors. Take the automobile industry in America. The recession of 2006 to 2008 bankrupted General Motors and severely damaged Ford. But it improved the position of imported brands like Toyota, Mercedes-Benz and BMW.
What should weaker competitors like General Motors have done? As a general principle, they should have narrowed the focus of their brands. General Motors’ leading brand, Chevrolet, has 18 different models. What’s a Chevrolet? It’s a large, small, cheap, expensive car or truck. That’s a weak position that can cause serious problems in low-growth times.
On the other hand, Toyota is the No.1 car brand in America. Mercedes-Benz is the “prestige” leader and BMW is the “driving” leader. They all did well in the downturn.
A weak brand may continue to exist in a rising economy. But not when the economy turns down. So marketing managers who manage a weak “also-ran” brand should “narrow the focus” of their brands in order to strengthen their positions.
As a starter, for example, Chevrolet should have divested itself of its truck business and concentrated on cars, preferably entry-level cars. General Motors has a truck brand called GMC that sells trucks only. That brand could be strengthened by the addition of the Chevrolet truck models as well as the Chevrolet model name for trucks, Silverado.
Look at the automobile market in Russia. Lada, the market leader, sells just six models yet has a market share of 17 percent. Chevrolet on the other hand markets 11 different models, but its market share is just 7 percent. Chevrolet’s leading model is Niva, an SUV made in Russia that has generated a lot of favorable interest. The model is often on back-order, with waits of two or three months.
If I were running Chevrolet in Russia, I would focus all my resources behind the Niva model, much like Volkswagen did with its Beetle model in the United States.
You are going to see the same things happen in smartphones. The rich will get richer (Samsung and Apple) and the poor will get poorer (BlackBerry, Motorola, Nokia and others) unless they do something dramatic like narrowing their focus to strengthen their brands.
Companies are like plants. Overtime, plants expand in every direction so a good gardener trims them back from time to time. Companies need to do the same. Keep cutting back on products and markets that are not performing well. Narrow the focus to both strengthen the core brands and increase their market share.
Look at the smartphone category. Apple basically markets one new model to replace an existing mode which is then discontinued. Yet the last time I checked, its competitor, BlackBerry, markets 15 different models. Which company is more successful?
But narrowing focus is easier said than done. Listen. Most CEOs we have dealt with take the position that they know what marketing strategies are best for their companies. They don’t want marketing managers to tell them what to do. They want marketing managers who will execute their strategies.
That’s why they seldom take the time to ask marketing managers for their advice and counsel. Most times, marketing managers have to force their way into boardrooms in order to present their ideas. I’ve been in those meetings. And it’s obvious that the chief executive and his or her staff has already made their minds up on what strategic directions to take. They just attend the meetings to placate marketing managers who often wind up frustrated.
Also, during low growth times, companies end up with metric madness. If you run a company by the numbers, you’ll eventually run the company into the ground. You might be successful in the short term, but never in the long term, as the financial crisis demonstrates.
The banking industry is a good example of an industry run by the numbers. And yet the banking industry was the one industry that did the worst in the recent recession. Left-brain managers are verbal, logical and analytical. Nothing wrong with that, as long as management also takes the remedy to counteract its overemphasis on mathematics.
Almost everything about marketing is the opposite of the typical manager’s approach to running a business. Marketing is illogical and definitely not analytical. Marketing is intuitive and holistic. We’re concerned, however, that this message is being ignored by the marketing community which seems to be drifting from right to left. From a right-brain approach to a left-brain approach. The hot topic among marketing managers today is ROI, return on investment.
Another mistake that some companies make during recessions or low-growth environment is that they introduce cheaper versions of their existing brands. Packard was the leading luxury car brand in America for many years. But during the depression in the 1930s, Packard started selling relatively inexpensive vehicles. Its major competitor, Cadillac, kept it prices relatively high, although selling far fewer vehicles than Packard. As a result, Packard is long gone and Cadillac is still alive.
I don’t know enough about Indian corporations to make specific suggestions, but as a general rule, if a company is losing market share or losing money, it needs to change its marketing strategy.
That runs counter to the normal thinking which is (1) The strategy is right, but (2) It’s the execution that is wrong. So chief executives tend to react to trouble by firing lower-level managers in charge of executing corporate strategy.
Then too, if a company changes its corporate strategy, it can reflect unfavourably on the chief executive. From an ego point of view, that’s a strong reason to focus on execution rather than strategy.
Also, there are few other things remembering. Does it make sense to launch new products in a low growth environment? Yes and no. Yes, it’s a good time to launch new markets for a market leader. Its competitors are weakened and are less likely to have a good response.
No. It’s a bad time to launch new products for a company that’s not a market leader. That drains resources from the company’s core business. Also, its worth remembering while launching new products that advertising today doesn’t have the credibility to launch new products. Only PR has that credibility. Regardless of the environment, companies should start with PR and then switch to advertising after the new product or brand has achieved some recognition among consumers. Our philosophy is: PR first, advertising second.
To conclude, the one message that marketers need to remember in times of low growth is to narrow your focus.

 (Al Ries is a marketing consultant who coined the term “positioning” and is the author of such marketing classics (along with Jack Trout) as The 22 Immutable Laws of Marketing and Positioning: The Battle for Your Mind. He is also the co-founder and chairman of the Atlanta-based consulting firm Ries & Ries with his partner and daughter Laura Ries. Along with Laura he has written bestsellers like War in the Boardroom and The Origin of Branding)
The article originally appeared in Business Today in the edition dated January 19, 2014
(As told to Vivek Kaul)