Frédéric Bastiat

The Unseen Effects of Banning Alcohol Along Highways

Bastiat

Sometime back the Supreme Court prohibited the sale of liquor within 500 metres of state highways and national highways. As it said in its second judgement on the issue: “India has a high rate of road accidents and fatal road accidents – one of the advisories states that it is the highest in the world with an accident occurring every four minutes.”

It further pointed out: “There is a high incidence of road accidents due to driving under the influence of alcohol… The existence of liquor vends on national highways is in the considered view of…expert authorities with domain knowledge—a cause for road accidents on national highways.”

The point being that people get drunk at shops and restaurants around highways, drive under the influence of alcohol and then cause accidents.

It is important to try and understand why people in India drink in shops and restaurants around highways. It’s not considered a good thing in India to be seen drinking with friends, colleagues and acquaintances. Hence, people like to drink outside the city near highways, so that they don’t get seen by the people whom they happen to know.

The question is will this banning of the sale of alcohol lead to a fewer accidents. Before I try and answer this question I will have to take a brief detour in order to introduce a 19th century French economist called Frédéric Bastiat.

In an essay titled That Which is Seen, and That Which is Not Seen, he wrote: “In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously—it is seen. The other unfold in succession—they are not seen: it is well for us if they are foreseen.”

In the case of the Supreme Court’s decision to ban alcohol along highways what is seen is that once shops and restaurants selling alcohol shutdown, it would lead to a major loss of taxes for the state governments. State governments earn taxes on the manufacture and sales of alcohol. If shops shutdown, then these earnings will fall.

This is something that the Supreme Court judgement has foreseen: “The states are free to realise revenues from liquor licences in the overwhelmingly large swathe of territories that lie outside the national and state highways and the buffer distance of 500 metres.”

Hence, the Supreme Court does not think that its decision would lead to lower taxes because the government could offer more licenses away from the highway. This is something that the government will eventually do. Meanwhile, what state governments have started to do in order to get around the decision is to denotify highways and have turned them into local, municipal or district roads, so that the sale of alcohol can continue. In many cases this is justified because highways are a part of the city and not outside it.

This has been done in order to ensure that the taxes from alcohol keep coming in. This is the unseen effect which Bastiat talked about and the Supreme Court decision did not foresee. In fact, the government of Maharashtra recently hiked the drought cess on petrol from Rs 6 to Rs 9, even when there is no drought in sight. This has been done to make up for the loss of revenue from shutting down of alcohol shops around highways.

Another unseen effect lies in the fact that those who used to go out of the city to drink in shops and restaurants along the highway, will now have to drink in the city. And if they drive after drinking, accidents will continue to happen. Given that they may not have to drive as long as they had to do in the past, the rate might fall.

Hence, the basic issue in this case is not drinking, but driving after drinking. And that cannot be solved by banning alcohol along highways. It can only be solved by better policing, in the city as well as on the highways.

 

The column originally appeared in the Bangalore Mirror on April 26, 2017

Is the 26 Week Maternity Benefit Really a Benefit?

Last week, the Parliament passed the Maternity Benefit Bill. Once the President gives his assent to the Bill and it becomes an Act, women will be entitled to a maternity leave of 26 weeks. Currently, it stands at 12 weeks.

The new law will apply to organisations employing 10 or more people. It will be available only for the first two children. Beyond that the leave will be limited to 12 weeks. The prime minister Narendra Modi called it “a landmark moment in our efforts towards women-led development”. The labour minister Bandaru Dattatreya said the new Bill was his humble gift to women.

Nevertheless, the question is, is this really a gift to women? Before I answer this, let’s try and understand a concept called the broken window fallacy. This concept was put forward by the nineteenth century French economist Frédéric Bastiat.

Bastiat basically talks about a shopkeeper’s careless son breaking a pane of a glass window. He then goes on to say that those present would say: “It is an ill wind that blows nobody good. Everybody must live, and what would become of glaziers if panes of glass were never broken.”

The point being that if windows weren’t broken, how would those repairing windows, the glaziers that is, ever make a living. This seems like a fair question to ask, but things aren’t as simple as that.

As Bastiat writes in Essays on Political Economy: “This form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.”

Bastiat then goes on to explain what exactly does he mean by this. Let’s say replacing the pane of the broken window costs 6 francs. This is the amount that the shopkeeper pays the glazier. If the shopkeeper’s son would not have broken the window there was no way that the glazier could have earned these six francs.

As Bastiat puts it: “The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.” This leads us to conclude that breaking windows is a good thing because it leads to money circulating and those who repair broken windows doing well in the process.

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

Now how does all this apply in case of the 26-week maternity benefit? Like the above case, there is a seen part to the benefit and an unseen part. The seen part of the benefit is very obvious. Women currently working in establishments with 10 or more people will get a 26 week maternity benefit during pregnancy. Of course, it is more than likely that this benefit will be limited to the organised sector. It is unlikely to benefit women working in the unorganised sector, which forms a bulk of the lot.

Further, this seen part comes with a cost attached to it. Small and big establishments will have to pay an employee for half a year her full salary, when she is not available at work. While, the big establishments will be able to manage this, the small ones won’t. Hence, the likely unseen impact of this is going to lead to managers not hiring women of child bearing age.

A newsreport in The Guardian points out: “A survey of 500 managers by law firm Slater & Gordon showed that more than 40% admitted they are generally wary of hiring a woman of childbearing age, while a similar number would be wary of hiring a woman who has already had a child or hiring a mother for a senior role.” This evidence is from the United Kingdom. Along similar lines, increasing the maternity benefit to 26 weeks is going to ensure that Indian managers will work along similar lines, not that they don’t already.

This is not to suggest that women should not be entitled to an extended leave post child-birth. Nevertheless, it is only fair to keep in mind that perfect is the enemy of good. The male-female ratio in most of corporate India is anyway lopsided to begin with. As an October 2015 report in The Economic Times points out: “The fairer sex comprises less than 2% of the workforce of marquee companies like Adani Ports, Bajaj Auto, Grasim, UltraTech and Hero MotoCorp.”  The 26-week maternity benefit is likely to make it worse and that is clearly not a good thing.

Further, this is in line with the Indian tendency to implement welfare measures much ahead of economic growth.

The other unseen impact of this move is that with a 26-week maternity leave, the mother is likely to become even more of a primary caregiver to the child, during the initial days. Hence, to that extent the extension of maternity benefit is patriarchal in nature. And that possibly cannot be a good thing.

The column originally appeared on Pragati.com on March 14, 2017

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

broken-windows

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The column originally appeared on Equitymaster on February 28, 2017

Govt Fixing Steel Prices: Is Make in India Just a Slogan?

make in india
On February 5, 2016, the directorate general of foreign trade imposed a minimum import price(MIP) on 173 steel products. The prices range from $352 per tonne to $752 per tonne of steel.

The MIP has been imposed in order to counter the dumping of cheap Chinese steel and should help the Indian steel companies. Also, the move should help public sector banks as well.

Why do I say that? As the RBI Financial Stability Report released in December 2015 points out: “A risk profile of select industries as at end September 2015 showed that iron and steel, construction and power industries had relatively high leverage as well as interest burden.”

The report further pointed out: “Five sub-sectors viz. mining, iron & steel, textiles,  infrastructure and aviation, which together constituted 24.2 per cent of the total advances of scheduled commercial banks as of June 2015, contributed to 53.0 per cent of the total stressed advances.”

What does this tell us? Steel companies have borrowed a lot of money from banks which they are now finding difficult to repay. The only way they can repay these loans is by ensuring that their sales and profits continue to grow. And that is not possible if cheap steel from China keeps hitting the Indian shores.

The government has tried to correct this by slapping an MIP on steel, in the process making imported steel more expensive. The idea is that anyone who needs steel within India, buys from Indian companies, instead of importing cheaper steel.

The question is does this make sense? It does for the steel companies. But not for the overall Indian economy as a whole. Before I get into explaining this, allow me to discuss what is known as the broken window fallacy. The French economist Frédéric Bastiat discusses this concept in his 1874 book That Which is Seen, and That Which is Not Seen.

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

The point being if window glasses were never broken what would glaziers ever do? As Basitat writes: “Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it, I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.”

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

What is Bastiat trying to tell us here? When we are analysing economic issues, we tend to look at that which is seen and tend to ignore that which is unseen. In the case of minimum import price being fixed on steel imports, it means looking only at the benefits that this would bring to the Indian steel companies.

Stock analysts have labelled this move of the government as a “gamechanger” for the steel companies and have recommended that investors buy these stocks.  Now that is the ‘seen’ part of it, if we were to apply Bastiat’s broken window fallacy to this situation. But what about the unseen?

As Henry Hazlitt writes in Economics in one Lesson: “The tariff has been described as a means of benefitting the producer at the expense of the consumer. In a sense this is correct. Those who favour it only think of the interests of the producers immediately benefited by the particular duties involved. They forget the interests of the consumers who are immediately injured by being forced to pay these duties.”

A tariff is essentially a tax or a duty that is paid on imports of exports. In the case of the minimum import price on steel imports, no duty has been fixed or tax has to be paid. But given that the minimum import price will force consumers of steel to buy steel at a higher price from Indian steel companies, it basically means that the companies are being forced to pay more than they would have, if this move had not been made. In that scenario they could have simply imported cheaper steel, which they cannot do now. Hence, to that extent even an MIP is basically a tariff.

Steel is an input into many different sectors from automobiles to real estate to engineering to construction and infrastructure. Hence, if the price of steel goes up, companies operating in these sectors need to pay more when they buy steel. And this in turn will impact the prices of the consumer goods that these companies produce and the physical infrastructure that they create. This is the unseen negative that people are not talking about.

Take the case of engineering goods, which is as of now, India’s number one export. As TS Bhasin, Chairman of EEPC India, an engineering goods exporters’ body, told The Hindu: “The MIP will raise the cost of raw materials for engineering products by about 6-10 per cent. This will severely hurt engineering exports that have already declined by 15 per cent in the first nine months of this fiscal.” How will Indian engineering companies compete globally in an environment of slow global economic growth, if steel is made expensive?

Further, this also leads to the question as to how serious is the government about “Make in India”. Is it just a slogan? Or is it more than a slogan? If it is more than a slogan then there is no way that the government should be fixing steel prices and in the process increasing the price the consumers of steel pay.

Also, why is the government just trying to protect steel producers. How about retail companies which have been bearing the onslaught of ecommerce companies selling goods at significantly lower prices, backed by foreign venture capital and private equity money?

As Anindya Banerjee, analyst at Kotak Securities puts it: “The offline retailers have been long complaining how ecommerce companies, funded by cheap dollars/euros/yen of yield hungry bubble vision private investors, is undercutting them in every consumer product. They claim that these ecommerce companies are destroying hard working mom and pop stores and their employees, by resorting to unsustainable discounts. So why is the government not imposing a minimum retail price(MRP) for all products sold online. This MRP should be set at a price which is above the offline retail price. I presume my fellow citizens won’t mind paying more for their stuff they buy. After all they are supporting the economy, aren’t they?”

Now that is something worth thinking about. And if something like that were to happen, we would be finally back to the eighties. My growing up years will  be back again.

The column originally appeared in The Five Minute Wraupup on Equitymaster on February 10, 2016

Of Jaitley, Fiscal Deficit and a 19th Century French Economist

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
Lawyers who become politicians are extremely eloquent speakers. But do they ‘really’ mean what they say? Or is it just something that sounds good at a given point of time, like a film dialogue?

The finance minister Arun Jaitley in his maiden budget speech in July 2014 had said: “We need to introduce fiscal prudence that will lead to fiscal consolidation and discipline. Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations. We cannot go on spending today which would be financed by taxation at a future date.”

Most governments spend more than what they earn. In order to bridge the gap, they borrow money by selling governments bonds. These bonds are repaid in the years to come. If the government borrows more today, the more it has to repay in the years to come.

This repayment is carried out of the money the government earns from taxing the future generations. This means that the benefits of borrowing are received by one generation but the debt is repaid by another. And this is why Jaitley talked about “considerations of inter-generational equity”. Or so it seemed.

The only way of respecting inter-generational equity is to borrow less today, so that the future generations don’t have to repay it, in the days to come. Borrowing less is only possible if the government is spending less today.

In his July 2014 budget speech Jaitley had talked about precisely this. He had said: “Difficult, as it may appear, I have decided to accept this target as a challenge. One fails only when one stops trying. My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent [of the gross domestic product (GDP)] for 2015-16 and 3 per cent for 2016-17.”

Fiscal deficit is the difference between what a government earns and what it spends. This difference is made up through borrowing money by selling government bonds. Hence, a lower fiscal deficit means lower borrowing and in the process the “considerations of inter-generational” equity is take into account.

In the budget speech Jaitley made in February 2015, the considerations of inter-generational equity took a slight backseat. He postponed the achievement of the fiscal deficit target of 3% of the GDP for 2016-2017, by a year.

As he said on that occasion: “Rushing into, or insisting on, a pre-set time-table for fiscal consolidation pro-cyclically would, in my opinion, not be pro-growth.  With the economy improving, the pressure for accelerated fiscal consolidation too has decreased.  In these circumstances, I will complete the journey to a fiscal deficit of 3% in 3 years, rather than the two years envisaged previously.  Thus, for the next three years, my targets are: 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18.  The additional fiscal space will go towards funding infrastructure investment.”

What the government had set out to achieve in a period of two financial years, Jaitley said would now be achieved in three years. This was in February 2015, when the budget for the current financial year 2015-2016 was presented.

In the recent past, there have been news-reports as well as statements which suggest that the government will again postpone, the fiscal deficit targets it had set for itself. “I am not particularly worried about the fiscal deficit target,” Jaitley said in early December.

A Reuters news-report quotes a senior finance ministry official as saying that the “the minister[i.e. Jaitley] has been advised to increase its fiscal deficit target to 3.7 or 3.9 per cent of gross domestic product (GDP) from 3.5 per cent.” “The economy is still suffering from slack demand…It needs a conducive fiscal and monetary policy,” the official added.

The industrial as well as consumer demand are seeing slow-growth and hence the government should be spending more, and in the process incurring a higher expenditure and a higher fiscal deficit. The higher government expenditure will push up economic growth. This is what the senior finance ministry official meant.

This is something Jaitley has also said recently: “Public investment has been stepped up in the last year and it will continue to remain stepped up… When you fight a global slowdown, public investment has to lead the way.”

In a year when the government will have to incur significantly extra expenditure to implement the recommendations of the Seventh Pay Commission, implement one rank one pension for the armed forces and pay pending, fertilizer and food subsidies, where is the money for public investment going to come from?

It is worth recounting here what the French economist Frédéric Bastiat had said in his 1874 book That Which is Seen, and That Which is Not Seen. “In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause–it is seen. The others unfold in succession—they are not seen. It is well for us if they are foreseen.”

When we talk about the government abandoning the fiscal deficit target and spending more, this is precisely how things are playing out. The immediate effect or that which is seen is that higher government expenditure will create economic growth in an environment where industrial and consumer demand growth continues to remain slow. This is the effect that is being ‘seen’.

But there are other effects which are not being seen. The entire issue about inter-generational equity that Jaitley had talked about in his July 2014, seems to have taken a backseat.

Let’s go back a few years in order to understand this point. In 2008-2009, the government spent 51% of what it earned in paying interest on its existing debt and repaying the debt that was maturing. In the aftermath of the financial crisis that started in September 2008, the government increased its expenditure and its fiscal deficit. When the government talked about increased government spending it was only in the context of economic growth. This effect was seen.

Nevertheless, increased government spending meant more borrowing. In 2015-2016, the government will spend around 60% of what it earns in paying interest on existing debt and repaying the debt that matures. The higher borrowing of 2008-2009 and the years that followed is now having an impact. This was the effect which was unseen or wasn’t foreseen in 2008-2009, when the government decided to spend more. This is what Jaitley meant when he talked about considerations of inter-generational equity.

When one government borrows more it leaves a problem for another government in years to come. Also, as more money goes towards debt servicing it leaves little money for other things, unless more money is borrowed.

Further, the government doesn’t have any separate access to borrowings. As economist M Govinda Rao wrote in a recent column in The Financial Express: “This year, the Union government’s deficit is set at 3.9%, and with the states together having a deficit of about 2.2%, the aggregate fiscal deficit of the government works out to 6.1%. It is reported that 21 distribution companies are likely to join the UDAY scheme and the deficit on that account could be about 1%.” If we were to add all this the real fiscal deficit of the government would come at 7.1% of the GDP. The household financial savings in 2014-2015 stood at 7.5% of GDP.

This means that if the government borrows more it will automatically lead to higher interest rates for everyone else who wants to borrow. When the finance minister talks about public investment and not being bothered about a higher fiscal deficit, these points also need to be ‘seen’. Currently, they are not being seen.

As Bastiat put it: “Between a good and a bad economist this constitutes the whole difference—the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee.”

Of course, politicians are in the business of winning elections not in the business of foreseeing or in the business of practicing good economics.

The column originally appeared on The Daily Reckoning on January 12, 2016