The Magic of Markets

pencilIn the early 1990s, the Soviet Union broke up and started making a transition from being a communist economy to a more market focused economy. At this point of time, a British economist named Paul Seabright came visiting.

He had a very interesting experience which Felix Martin recounts in Money—The Unauthorised Biography. The director of bread production of the city of St. Petersburg asked Seabright a very interesting question.

This gentleman was trying to understand how the new system (i.e. a more market focussed economy, which wasn’t like the old system) worked. He asked Seabright, “Please understand that we are keen to move toward a market system … but we need to understand how such a system works. Tell me, for example who is in charge of the supply of bread to the population of London?”

Now anyone who understands how a market works would know that nobody is really in-charge. It works because of the efforts of multiple people trying to further their own interest. As Adam Smith, the original economist, wrote: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

And this best explains how a product is made and makes it to the market. In fact, even the simplest product involves many people working towards their interest and is beyond one individual. As Matt Ridley writes in The Evolution of Everything: “Among the myriad of people who contribute to the manufacture of a simple pencil, from graphite miners and lumberjacks to assembly-line workers and managers, not to mention those who grow coffee that each of these drinks, there is not only person who knows how to make a pencil from scratch.”

A pencil gets made because of the selfish interests as well as cooperation and knowledge of many people. Or let’s take the example of something as simple as ink. As Donald J Boudreaux writes in The Essential Hayek: “Consider the ink. Where does it come from? Its colour comes from a dye made from chemicals that were extracted from roots, berries, or bark. Who found those roots, berries or bark? That person had to know which specific roots, berries or barks to find. Most roots, berries, and bark won’t work. And just how are the colouring chemicals extracted from vegetation? Today the extraction is done through a complex process involving a mix of industrial chemicals and complicated machinery. The dye is then mixed with water, resins, polymers, stabilizers and preservatives.”

This is just one set of expertise required to make ink. Then you require people who can run machines who can extract the colourings. Another group of people to mix the extracted chemicals with other ingredients. Machines run on electricity, so you need electricians to equip the factory with electrical wiring. And so on.

The point being making even simple things is essentially a complicated thing beyond the capabilities of a single individual. As Bordeaux writes: “To make even one vial of the simplest and least-expensive modern ink requires the knowledge and efforts of many, many people…No single person knows more than a tiny fraction of all that there is to know about how to make ink.”

Many people specialise in many areas for a product to be made. And this specialisation leads to economic prosperity as well as innovation. As Ridley writes: “Specialisation, accompanied by exchange, is the source of economic prosperity…Leave people free to exchange ideas and back hunches, and innovation will follow. So too will scientific insight.”

The trouble is most governments do not understand this, given that it is not in their control. And they try to do too many things to create economic prosperity given that governments are meant to do things. What they do not do is to allow specialisation, exchange and innovation, to flourish.

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

The column appeared in Bangalore Mirror on April 20, 2016

Mr Modi, govts can’t do everything

Various Indian governments over the years have tried to run many businesses but have been unsuccessful at doing the same. In fact, the trend continues even now, despite the fact that one of the key promises made by Narendra Modi in the run up to the Lok Sabha elections last year was “minimum government maximum governance”. But this promise like a few others now seems to have taken a backseat, around eighteen months after Modi was sworn in as the prime minister of the country.

Like the previous governments, the Modi government also wants to do many things. But is that possible? As veteran journalist TN Ninan writes in The Turn of the Tortoise—The Challenge and Promise of India’s Future: “Governments have tried to do great many things, from running watch and scooter factories to making shoes—all unsuccessfully. They continue to try and run airlines, telecom companies, hotels and banks—all of which have found it difficult to compete with private competitors, losing ground to the latter when they come on the scene.”

There is a fundamental problem in the government trying to run businesses. The economist Friedrich Hayek called it the knowledge problem. He explained it in a seminal article called The Use of Knowledge in Society which was published in the September 1945 issue of the American Economic Review.
In this article Hayek wrote: “The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.”

Hayek further wrote: “The economic problem of society…is a problem of the utilization of knowledge which is not given to anyone in its totality.”

What does this mean in simple English in the context of governments usually being bad at business? The knowledge required to run a business successfully is dispersed among many individuals and not concentrated with a central authority like a government. As Matt Ridely writes in The Evolution of Everything: “The knowledge required to organise human society is bafflingly voluminous. It cannot be held in a single human head”.

This is a basic point that governments tend to forget when they decide to be present in all kinds of businesses, like is the case in India. And whenever this happens, businesses lose money and need to be subsidised by the government.

Take the case of Mahanagar Telephone Nigam Ltd which offers internet and telephone services in Mumbai and Delhi. For the financial year ending March 31, 2015, the company’s income was at Rs 3,400 crore. Its expenditure on the other hand stood at a much higher Rs 5,284 crore.

Or take the case of the government owned airline Air India. The company has accumulated losses of Rs 20,000 crore. Every year, we hear that the airline is planning to turn profitable over the next few years and gets more money from the government in the process.

More than the money losses, these companies are distractions for the government. They get more government attention than they deserve and in the process other more important things tend to get ignored.

As Ninan writes: “There is too little of government attention paid to core areas like law and order, education and health—too few judges, too few teachers who teach, too few hospital beds; also too few trade negotiators and too few policemen, especially those with proper training. It should be obvious that there are many things that the state does inadequately or badly, and many tasks that the state has needlessly taken on itself.”

The tragedy is that no Indian politician seems to believe in focussing on the few important things and leaving out the rest. And this includes Narendra Modi as well. His promise of “minimum government and maximum governance,” like a few other things that he had promised, is turning out to be an electoral jumla at the very best.

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

The column originally appeared in the Bangalore Mirror on Nov 18, 2015