If you are smart, why aren’t you rich?

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We often attribute being rich to being smart. This is not to say that the rich are not smart. The likes of Bill Gates, Warren Buffett and NR Narayana Murthy, are exceptionally smart people. But not all rich are smart. Many rich are rich because of inheritance, or by being at the right place at the right time, or by simply being cronies to politicians.

Take what Gurcharan Das writes in about family owned businesses in his book India Unbound. As he writes: “Pulin Garg, the thoughtful professor at the Indian Institute of Management, Ahmedabad…used to say, “Haweli ki umar saatth saal [The life of a family owned business is sixty years].””

What does this tell us? It tells us that a family owned business typically lasts around 60 years or by the time the third generation takes over. By the time the third generation takes over, the family owned business starts to disintegrate due to various reasons.

As Das writes: “Thomas Mann expressed…in Buddenbrooks, arguably the finest book ever written about family business. It describes the saga of three generations: in the first generation the scruffy and astute patriarch works hard and makes money. Born into money, the second generation does not want more money. It wants power…Born into money and power, the third generation dedicates itself to art. So the aesthetic but physically weak grandson plays music. There is no one to look after the business and it is the end of the…family.” And then the family is no longer as rich as it used to be.

If the logic of, if you are smart, why aren’t you rich, was correct all the time, this would never have turned out to be the case. The rich would continue to be rich.

This basically explains why all rich people are not smart. But what about smart people being rich? Or to put it more specifically why aren’t all smart people rich?

Let’s take the example of Thales of Miletus, a Greek Philosopher, acknowledged as the father of Greek philosophy, by no one less than Aristotle himself. This is a point made by Mihir A Desai in his book The Wisdom of Finance—Discovering Humanity in the World of Risk and Return.

Miletus lived between 624BC and 546BC in what is modern day Turkey. He was also one of the seven sages of Greece. Other than being hailed as the father of Greek philosophy, he is also hailed as the first Greek mathematician, having been born before other such luminaries like Pythagoras and Euclid.

As Desai writes: “Thales earned his position… by pioneering the use of natural, instead of supernatural, explanations for phenomena, advocating hypothesis-driven thinking, and even managing to predict solar eclipses with the crudest of instruments.”

But Thales was poor and was taunted for the uselessness of his philosophy. He was basically being asked the question that I have raised above: “If you are smart, why aren’t you rich?”

Thales decided to redress this impression.

As Desai writes: “Thales decided to capitalize on his ability to forecast a good olive harvest. “He raised a small sum of money and paid round deposits of the olive-presses in Miletus and Chios, which he hired at a low rent as nobody was running him up; and when the reason arrived, there was a sudden demand for a number of presses at the same time, and by letting them out on what terms he liked he realised a large sum of money.”

Basically, Thales hired olive presses when there was no demand for them and let them out at a high price when there was a good demand for them. In the process, he essentially demonstrated that “it is easy for philosophers to be rich if they choose, but this is not what they care about.”

At a more generalised level, smart people can be rich if they want to and put their heart and soul to it, but that is not something that they care about.

The column originally appeared in the Bangalore Mirror on September 6, 2017.

The economics of Udta Punjab

udta punjab

The recent release Udta Punjab highlighted the problem of drug addiction in Punjab. While, drug addiction is a global problem, Punjab has nearly 3.3 times more drug addicts per lakh than the Indian national average.

And why is that the case? From the supply side, the state shares a border with Pakistan. Hence, drugs are easy to smuggle in. The demand side is a little more complicated to explain.

The state saw a Green revolution starting in the mid-1960s, with the agricultural yield exploding, thanks to C. Subramaniam, the food and agriculture minister back then.

Subramanian came to know of a form of wheat developed in Mexico which could rapidly raise output. As Gurcharan Das writes in India Unbound: “C. Subramaniam was a man in a hurry and he chartered several Boeing 707s and flew in 16,000 metric tons of seed of this miracle wheat…Punjabi farmers still speak lovingly of Mexico’s Lerma Rojo, one of the earliest varieties to take root in their soil.”

And thus started the green revolution in Punjab. In order to support this, the government also started to procure rice and wheat directly from the farmers through the Food Corporation of India and other state procurement agencies.

The higher yields along with assured procurement led to the farmers of Punjab progressing. While the procurement policy is supposed to be pan India, the procurement is limited largely to a few states. As the Economic Survey for 2015-2016 points out: In Punjab and Haryana, almost all paddy and wheat farmers are aware of the [procurement] policy.” In 2013-2014, Punjab produced 11.1 million tonnes of rice. Of this, 8.1 million tonnes was procured by the government. This is the highest in the country.

What also helped is that there is no tax on agricultural income. Also, free power is available for farming. All this, has helped the Punjabi farmer. The first generation worked hard to spread the green revolution. The second generation carried on the good work. And the third generation, born into money, is enjoying the spoils.

This is along the lines of what happens to a typical family owned business. As Das writes, taking the example of Buddenbrooks by Thomas Mann, which he feels is the finest book ever written about family business: “It describes the saga of three generations; in the first generation the scruffy and astute patriarch works hard and makes money. Born into money, the second generation does not want more money…The third generation dedicates itself to art. So the aesthetic but physical weak grandson plays music. There is no one to look after the business and it is the end of the Buddenbrook family.”

Something similar seems to have happened in Punjab, where some part of the third generation has moved away from farming and gotten into drugs, given the access to easy money they have, due to the hard work put in by their grandparents. Some evidence of this can easily be found in the kind of songs that Punjabi popstars sing these days. The word dope, weed etc., keep cropping up in these songs.

The other interesting thing is the number of super expensive brand names that these songs refer to and espouse. From Jaguar to Audi to Gucci to Armani, they seem to have it all. This seems to be a good indicator of the fact that some part of the third generation after the Green revolution started, has gone away from farming and gotten into other things.

No other state in India (except perhaps Haryana) has this kind of music. What has helped is the astonishing rise in the price of land in the state. Also, land acquisition in Punjab is easier compared to many other Indian states given that the average size of a landholding in Punjab is around 9.3 acres, which is much bigger than many Indian states. Hence, large parcels of land are easier to buy.

Land sale has also brought in a lot of easy money. And some of this seems to have leaked into drugs.

The column originally appeared in the Bangalore Mirror on June 29, 2016

 

Why India missed out on the industrial revolution and might miss it again

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The Prime Minister Narendra Modi met representatives of Indian business on September 8, 2015. The Indian businessmen as usual asked for lower interest rates, weaker rupee and so on, to get economic growth going.

Modi on the other hand emphasized on job creation and the role the private sector could play in it. A report in the Mint newspaper points out that Modi also prodded the banks to help small and medium enterprises in the so-called informal sector as “they have great potential for generating new jobs”.

As I have mentioned in previous newsletters of The Daily Reckoning, creating new jobs should be a top priority of the Modi government. This is primarily because 13 million Indians are entering the workforce every year.

Also, as I have mentioned in the past, the only way countries have gone from being developing to being developed is by unleashing a manufacturing/industrial revolution. Despite having a huge labour force and initiating economic reforms in 1991, India has missed out on the manufacturing revolution.

Why is that the case? As Sanjeev Sanyal writes in The Indian Renaissance—India’s Rise After a Thousand Years of Decline: “The country [i.e. India] appears to have shifted from farming to services without having gone through an industrial stage. This not only goes against conventional wisdom but also the experience of other fast-growing Asian economies particularly China.”

China and other Asian countries (Japan, Taiwan, South Korea and countries of South East Asia) essentially followed an export oriented manufacturing strategy to create economic growth. They started with low-end exports and then gradually started going up the value chain. “These economies usually started out by scaling up low-skill exports like making ready-made garments, toys, cheap household items and so on. With time, they all move up the value chain as wages rise and their workforce become more skilled. Exports shift to things like high-end electronics and automobiles,” writes Sanyal. The services sector becomes a driver of growth only later.

In the Indian case, nothing like that happened. After the 1991 economic reforms, we moved on to exporting complex automobile parts and pharmaceuticals. We also exported information technology and became a global hub of the business process outsourcing industry. India also saw a huge expansion in banking, hotels, airlines, cable television, telecom and so on. None of this was low-end, like was the case of Asian countries as well as China. Hence, we jumped from farming to services, without going through an industrial/manufacturing stage.

And this jump from farming to services, without going through an industrial stage, is counter-intuitive. In fact, India should have latched on to a low end export oriented manufacturing strategy much before the 1991 reforms. But that did not happen.

In order to understand why, we need to go back in history and talk about a gentleman called Prasanta Chandra Mahalanobis. Mahalanobis founded the Indian Statistical Institute in two rooms at the Presidency College in Calcutta (now Kolkata) in the early 1930s. He became close to Jawahar Lal Nehru, the first Prime Minister of India, and was appointed as the Honorary Statistical Advisor to the government of India.

As Gurcharan Das writes in India Unbound –From Independence to the Global Information Age “His biggest contribution was the draft plan frame for the Second Five Year Plan…In it he put into practice the socialist ideas of investment in a large public sector (at the expense of the private sector), with emphasis on heavy industry (at the expense of consumer goods) and a focus on import substitution (at the expense of export promotion).”

Hence, big heavy industry became the order of the day at the cost of small consumer goods. The alternative vision of encouraging the production of low-end consumer goods was put forward as well. As Das writes “It belonged to the Bombay [now Mumbai] economists CN Vakil and PR Brahmanand. It was neither glamourous nor as technically rigorous as Mahalnobis’s, but it was more suited to the underdeveloped Indian economy. Its starting point was that India lacked capital but had plenty of people…The thing to do was to put these people into productive work at the lowest capital cost.”

And how could this be done? “The Bombay economists suggested that we employ the surplus labour to produce “wage goods,” or simple consumer products – clothes, toys, shoes, snacks, radios, and bicycles. These low-capital, low-risk, business would attract loads of entrepreneurs, for they would yield quick output and rapid returns on investments. Labour would produce the goods it would eventually consume with the wages it earned in producing the goods,” writes Das.
Nevertheless, with the focus on the public sector, nothing like that happened.

But why did India miss out on a manufacturing/industrial revolution even after the process of liberalization started in 1991? India’s domestic savings through much of the 1990s stood at around 23% of the GDP. A major portion of these savings went into financing the government fiscal deficit. Given this, interest rates were high and “the country was forced to use capital sparingly,” writes Sanyal. Any industrial revolution needs a massive amount of capital, which wasn’t easily available in the Indian case.

Further, even with economic reforms many things on the ground did not change. As Sanyal writes: “The easing of big-picture impediments like industrial licensing and import tariffs did not get rid of the underlying framework of over-regulations, bureaucratic delays and erratic judicial enforcement. The country had built up a huge baggage off laws, by-laws and regulations at every layer of government during the half-century under socialism.” Much of this still remains to be dismantled.

Take the case of labour laws. There are more than fifty labour laws just at the central government level. As Jagdish Bhagwati and Arvind Panagariya write in India’s Tryst with Destiny: “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra (the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them.”

These laws prevent small Indian firms from growing bigger. They also prevent big Indian industrialists from entering sectors that can employ a huge amount of labour. Bhagwati and Panagariya recount a story told to them by the economist Ajay Shah. Shah, asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already backward integrated and made yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worthwhile only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”

If Narendra Modi wants Indian businesses to create jobs, he first needs to sort out the labour laws. And that will be easier said than done.

The column originally appeared on The Daily Reckoning on Sep 10, 2015

 

Note to Rahul: India sucks at producing rakhis and Ganeshas

rahul gandhi
Vivek Kaul
 
Economist Arvind Panagariya has  written an open letter to Rahul Gandhi, on the edit page of today’s edition of The Times of India. In this piece Panagariya answers Gandhi’s query to Indian industrialists, as to why India has to import ganeshas and rakhis from China and can’t produce them on its own.
Panagariya’s answer is very simple. India sucks at labour intensive manufacturing. As he writes “our top industry leaders are very comfortable doing what they do: invest in highly capital-intensive sectors such as automobiles, auto parts, two wheelers, engineering goods and chemicals or in skilled-labour-intensive goods such as software, telecommunications, pharmaceuticals and finance. The vast labour force of the nation stares them in the face but they look the other way.”
This is the major reason as to why India cannot compete with China in manufacturing rakhis and ganeshas. But some historical context also needs to be built in, in order to completely appreciate India’s lack of competitiveness on this front.
Prasanta Chandra Mahalanobis founded the Indian Statistical Institute in two rooms at the Presidency College in Calcutta (now Kolkata) in the early 1930s. He became close to Jawahar Lal Nehru, the first prime minister of India, and was appointed as the Honorary Statistical Advisor to the government of India.
As Gurcharan Das writes in 
India Unbound –From Independence to the Global Information Age “Mahalanobis had a profound effect on Nehru’s thinking, although he held no offcial position. His title, “Honorary Statistical Advisor to the Government of India,” certainly did not reflect the extent of his influence. His biggest contribution was the draft plan frame for the Second Five Year Plan…In it he put into practice the socialist ideas of investment in a large public sector (at the expense of the private sector), with emphasis on heavy industry (at the expense of consumer goods) and a focus on import substitution(at the expense of export promotion).”
Hence, big heavy industry became the order of the day at the cost of small consumer goods. The alternative vision of encouraging the production of consumer goods was put forward as well. As Das writes “It belonged to the Bombay (now Mumbai) economists CN Vakil and PR Brahmanand. It was neither glamourous nor as technically rigorous as Mahalnobis’s, but it was more suited to the underdeveloped Indian economy. Its starting point was that India lacked capital but had plenty of people…The thing to do was to put these people into productive work at the lowest capital cost. The Bombay economists suggested that we employ the surplus labour to produce “wage goods,” or simple consumer products – clothes, toys, shoes, snacks, radios, and bicycles. These low-capital, low-risk, business would attract loads of entreprenurs, for they would yield quick output and rapid returns on investments. Labour would produce the goods it would eventually consume with the wages it earned in producing the goods.”
But Mahalanobis’s vision of an industrialisted India sounded a lot sexier to the politicians led by Nehru who ran this country and hence, won in the end.
The Indian industrialists had done their cause no good by drafting and accepting the Bombay Plan in 1944. “In 1944, India’s leading capitalists had come together in Bombay and crystalllized their vision for a modern, independent India. They inclued the giants of Indian business – JRD Tata, GD Birla, Lala Shri Ram, Kasturbhai Lallabhai, Purshotamdas Thakurdas, AD Shroff and John Mathai – they produced what came to be known as the Bombay Plan,” writes Das.
The Bombay Plan put forward the idea of rapid and self reliant industrialisation of business in India. At the same time the businesses were willing to accept “import limitations on the freedom of private enterprise”. “Even more disastrous was their acceptance of a vast area of state control – in fixing prices, limiting dividends, controlling foregin trade and foreign exchange, in licensing production, and in allocating capital goods and distributing consumer goods. Without realising it, the Indian capitalists had dug their graves,” writes Das.
Hence, the government became the 
mai baap sarkar which gave out licenses for everything. And the Indian businessman if he had to survive had to become a crony capitalist to get these licenses. This was initiated during the regime of Jawahar Lal Nehru and perfected during the rule of his daughter Indira Gandhi.
The orientation of the Indian government was towards setting up big industries. What they did not want to set up themselves, they would give licenses to the private sector. And in order to get licenses a businessman had to be close to the government.
This ensured that both the government as well as the private sector set up and continue to set up capital intensive businesses. This is reflected in the slow growth of the number of workers working in private sector etablishemnts with ten or more people. As Jagdish Bhagwati and Arvind Panagariya write in their book 
India’s Tryst with Destiny – Debunking Myths that Undermine Progress and Addressing New Challenges. “The number of workers in all private-sector establishments with ten or more workers rose from 7.7 million in 1990-91 to just 9.8 million in 2007-2008. Employment in private- sector manufacturing establishments of ten workers or more, however, rose from 4.5 million to only 5 million over the same period. This small change has taken place against the backdrop of a much larger number of more than 10 million workers joining the workforce every year.”
Hence, an average Indian business starts off small and continues to want to remain small. “An astonishing 84 per cent of the workers in all manufacturing in India were employed in firms with forty-nine or less workers in 2005. Large firms, defined as those employing 200 or more workers, accounted for only 10.5 percent of manufacturing workforce. In contrast, small- and large-scale firms employed 25 and 52 per cent of the workers respectively in China in the same year,” write Bhagwati and Panagariya.
What is true about manufacturing as a whole is also true about apparels in particular, a very high labour intensive sector. Nearly 92.4% of the workers in this sector, work with small firms which have 49 or less workers. In comparison, large and medium firms make up around 87.7% of the employment in the apparel sector in China.
The labour intensive firms in China ensure that they have huge economies of scale. This drives down costs and explains to a large extent why India imports ganesha idols and rakhis from China. Everyone wants a good deal. And China is the country providing the good deals and not India.
A major reason for Indian firms choosing to remain small is the fact that the country has too many labour laws. Since labour is under the Concurrent list of the Indian constitution, both the state government as well as the central government can formulate laws on it. As Bhagwati and Panagariya point out “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra(the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them.”
This explains to a large extent why Indian businesses do not like to become labour intensive and choose to stay small. The costs of following these laws are huge. As Bhagwati and Panagariya write “As the firm size rises from six regular workers towards 100, at no point between these two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra cost of satisfying the laws.”
In fact, Bhagwati and Panagariya narrate an interesting anecdote told to them by economist Ajay Shah. Shah, it seems asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already making yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worth while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”
This is the answer to Rahul Gandhi’s question of why India imports rakhis and ganeshas from China. Like is the case with almost every big problem in this country, even this is a problem created by his ancestors.

 
The article originally appeared on www.firstpost.com on November 18, 2013
 
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Falling rural wages punches holes in UPA’s NREGA claims

india-wheat-2011-5-5-8-51-9Vivek Kaul  
One of the so called successes of the Congress led United Progressive Alliance (UPA) government has been the increase in rural incomes. As Ashok Gulati, Surbhi Jain and Nidhi Satija of the Commission for Agricultural Costs and Prices (CACP) of the Ministry of Agriculture point out in a research paper titled Rising Farm Wages in India “During the Eleventh Five year Plan (2007‐12), nominal farm wages in India increased by 17.5 per cent per annum (p.a), and real farm wages by 6.8 per cent p.a., registering the fastest growth since economic reforms began in 1991.”
Hence, rural incomes have been growing at a very fast rate through much of the second term of the UPA government. And the UPA politicians have pointed this out time and again. Yes, urban India is feeling the heat, but that is the price we need to pay to ensure that rural India is in a better situation than it was in the past, is an argument we have been made to hear time and again.
But looks like time has run out for this argument as well. Rural wages after adjusting for inflation fell in August 2013. As Sonal Varma of Nomura points out in a note dated October 24, 2013 “Growth in the average daily wage rate for agricultural labourers moderated to 13.1% y-o-y in August 2013, significantly slower than 18.5% y-o-y in 2012 and 23.4% in 2011. After adjusting for inflation, the decline was even more stark: real rural wage growth moderated to -0.1% y-o-y in August from 9.3% y-o-y in 2012 and 13.4% in 2011.” (y-o-y = year on year)
A real rural wage growth of -0.1% basically means that the income is growing just about at the same speed so as to match inflation. And this can’t be a good sign for sure.
One of the major reasons for an increase in rural wages has been Mahatma Gandhi National Rural Employment Guarantee Act(MGNREGA). As the CACP authors point out “The argument forwarded is that MGNREGA has ‘pushed’ up the average wage of casual workers, distorted the rural labour markets by diverting them to non‐farm rural jobs, thus creating an artificial labour shortage.” And this shortage has in turn pushed up rural wages to a large extent.
As Varma points out “Several factors, including the government’s employment guarantee scheme(which is MGNREGA) and indexing rural wages to CPI inflation, have boosted rural wage growth and shifted the terms of trade in favour of the rural sector.”
MGNREGA was launched in 200 of the most backward districts of the country on February 2, 2006. It was extended to all rural districts from April 1, 2008. The scheme aims at providing at least 100 days of guaranteed employment in a financial year to every household whose adults are willing to do unskilled manual work.
The payments made under MGNREGA vary from Rs 120 to Rs 179 per day, depending on the state. As mentioned earlier these wages are indexed to inflation. “At the national level, with the average nominal wage paid under the scheme increasing from Rs 65 in FY 2006‐07 to Rs 115 in FY 2011‐12… It has set a base price for labour in rural areas, improved the bargaining power of labourers and has led to a widespread increase in the cost of unskilled and temporary labour including agricultural labour,” write the authors of the CACP report.
So far so good. If MGNREGA was creating useful assets then all this money would have been well spent. The trouble is it isn’t. T H Chowdhary provided an excellent example of why MGNREGA does not work 
in a column he wrote for The Hindu Business Line in December 2011 “Villages cannot sustain so many unskilled labourers and not-so-literate labour. By creating useless “work” we are promoting dependency among the unfortunate rural, illiterate and unskilled population…An example of the village Angaluru in Krishna district will illustrate how good money is being thrown away for bad results. Out of 1,000 families, 800 had registered themselves as BPL, seeking work under NREGA. So far, it was 100 days at Rs. 100 per day. Even at this, 80,000 mandays of useful work in a year is impossible in a village and that too, year after year.”
What this tells us is that the very structure of MGNREGA does not make sense (and we are not even talking about all the corruption that comes with such schemes). What is true about one Angaluru village in Andhra Pradesh is true about most of the other villages all across the country as well.
Hence, the government is effectively giving away money free to people who have registered under MGNREGA. As Chowdhary puts it “Those who are registered for NREGA are mustered just for attendance and since there is no work to be done they go home, thus paid for no or little work.”
When people get paid for doing no work it is but natural that they will demand much more money for working. This has led to a substantial increase in rural wages over the last few years.
And high wages have led to high inflation in turn, specially food inflation, as a higher amount of money chased the same amount of goods and services. Over the last few years, the wages had been rising at a much faster rate than inflation, but now inflation has finally caught up.
This will now have an impact on rural demand which has remained robust over the last few years, even though the overall economic growth has slowed down considerably. As Varma of Nomura puts it “Over the last few years, rising real rural wages have…supported rural demand… A moderation in real rural wages should cause rural demand to moderate.” This, in turn, will slowdown economic growth further in the time to come. On a positive note, a slowdown in rural demand will also lead to medium term inflationary pressures moderating.
The basic point is simple. Sustainable economic growth cannot be created by simply distributing money or as some economists like to put it by “dropping money from a helicopter”. Gurcharan Das summarises the situation best in 
India Grows At Night. As he writes “We need to be humbler in our ambition and our ability to re-engineer society…If the state could only enable access to good schools and health care, equity would follow.”
The article originally appeared on www.firstpost.com on October 25, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)