What went wrong with Game of Thrones

Long back, during Doordarshan’s golden era, I watched an episode of a TV series, one those where every episode was a short story. This particular episode told the story  of a novelist who was getting his novel serialized in a magazine. A fan of the novelist comes to meet him and begins discussions about turning this novel into a TV series (or movie, I don’t remember which). As the discussion progresses, it turns out that she is particularly interested in the fate of one particular character and is distraught to learn from the novelist that she was going to die. She pleads with the novelist, asking for the character’s life to be saved, but the novelist refuses, saying “It is not I who is killing her. It’s the logic of the story that is!” The fan and the novelist have more meetings where she continues to implore him to change the course of his story, till finally the novelist relents. He tells her that he had found a way to save his character’s life, but the story would have to be crafted in a particular way and that the producers of the show would have to promise not to deviate from the script. She gladly accedes to the request. The twist at the end was that it turned out that the TV series was just a ruse. In reality, the fan was so interested in the character arc because the character’s story was magically getting turned into the story of her own life, and she naturally did not want to die. 

I remember being fascinated by the idea that the story of a novel is not something that the novelist creates or controls, but something that has a life of its own. I remembered this story in the context of Game of Thrones because it struck me that the essential problem with the series was that there was really no way to end it in a  satisfactory way. 

Game of Thrones is the Mahabharata of Kali Yuga. It is said that the Mahabharata, unlike the Ramayana, prefers realism to idealism. Characters have grey areas, make and morally ambiguous choices. In the Ramayana, Good triumphs over Evil and the story ends in Rama Rajya. The Mahabharata culminates in a great war and the end of the epic marks the beginning of the Age of Kali. This denouement is logical, because unlike in a simple story where good triumphs over evil, in the real world, it is difficult to tie up all the loose ends and come to a tidy conclusion.  There are actually no endings in the real world. A victory in one battle leads to a reaction from someone somewhere. Kill one person and someone from his clan is out there plotting revenge. Get all people in a room and agree on something, and at least one person goes out from the room intending to break the agreement as soon soon as he is in a position to do so. 

Game of Thrones exceeds the Mahabharata in its realism, as befits an epic set in Kali Yuga. It is morally ambiguous. Good people die because of their goodness. Ned Stark got killed because he did the honourable thing. Rob Stark got killed because he married for love. These morally ambiguous events added to the complexity of the story, which branched off in many different directions, making it tougher and tougher to bring them all together. But if Game of Thrones is the Mahabharata of our age, the end of the story must also end Kali Yuga. After the cycle of four yugas is complete, Krta (or Satya) Yuga, the first yuga where righteousness prevails must begin again. The complete inability of the showrunners (and I suspect, Martin as well) to direct the arc of the story towards this ending where Kali Yuga ends and Truth and Righteousness prevails at the end leads me to suspect that the end of Kali Yuga is still far away. 

While the series had many themes and failed to bring any of them to a satisfactory conclusion, the one theme that was of most interest to me was Danerys’ desire to “break the wheel”.  I am not sure how many people noticed the parallel between her desire and Joffrey’s outburst back in season 2 or 3, where, in a conversation with his mother, he expressed frustration that he had to work on the painstaking task of building alliances with all the lords of Westeros if he wanted to assemble an army. It was all so primitive, he exclaimed. Why couldn’t he have an army of his own, answerable only to him? 

The answer to Joffrey’s question is that the medieval economy did not allow such a setup. A medieval monarch faced two choices about where to maintain his army. Should he keep it close, in the capital, or should it be distributed throughout the kingdom? If he opted for the former, maintaining control over the periphery would be difficult. If he chose the latter, given the tyranny of distance in medieval times, maintaining effective central command over the army was difficult. He would have to distribute command by giving autonomy to local leaders. But the latter option meant that the soldiers would be loyal to the local leaders, not to him. 

Modern states maintain large standing armies. A medieval state that tried to maintain a large standing army would face famine because moving young men off farm to the army meant that the fields lay fallow – this would be especially true if it kept this standing army concentrated at some place for purposes of control. A modern state needs a much smaller proportion of its population in agriculture . It can also, because of modern weaponry, maintain a monopoly on use of force with a much smaller and more centralized army.  

For a medieval state, maintaining effective monopoly on use of force was pretty much impossible.  Other than the limit on size of the army, entry barriers to someone else raising an army were non-existent. Raising a modern army requires sophisticated machine guns, tanks and other artillery. In modern day India, if someone began to acquire such weaponry, the state would notice pretty quickly. In a medieval state, if someone decided to acquire spears, bows and arrows and cannon, there’s a good chance that they’d be able to do it without the state noticing.  

If medieval states did not have monopoly on the use of force, how did they maintain political stability? For most part, they did not. There was always palace intrigue, rebellion brewing in the peripheral regions or a foreign invasion going on. To the extent that stability existed, it was built and maintained by the king negotiating coalitions with the various lords and satraps throughout the kingdom. It was the need to do this that so frustrated Joffrey. The need to maintain these coalitions constrained the medieval monarch, preventing him from turning into an absolute ruler.

The more successful states embedded these constraints into customs and traditions that carried on over generations – Game of Thrones was at its best when it depicted this delicate balance in Westeros. The formalization of these customs and traditions, the codification of them in writing (for example, via the Magna Carta), was one of the ways in which democracy began.   

But while medieval kings were not absolute rulers, the economic and social conditions of those times did not actually permit an evolution to real democracy. In a parliamentary system, we know the challenges of having to build coalitions and and governing with the support of many small parties. Imagine having to do that, but with the difference that those parties are not accountable to the people and have armies of their own.  Your attempt to govern for the benefit of the people will be hampered by the fact that your coalition partners want absolute rule over their own jagirs and may want you to run the government for their benefit rather than their subjects’. Your attempt to bring about the rule of law will be stymied by the fact that the government is constrained, not by laws, but by balance of power, and as the balance changes, your coalition partners will want to renegotiate the rules. 

 So here is the paradox. The journey towards democracy may begin with the codification of customs and traditions that constrained kings, but to actually achieve a modern democracy, you need a centralized army with the ability to exercise monopoly over power. One way to achieve democracy is to evolve towards it, slowly changing the rules towards greater and greater participation of the people. The other way, which was Danerys’ preferred way, was to break the wheel – to bring about revolutionary change that blows away the existing power structures in the kingdom. It did help that she had access to the three dragons that, through their awesome firepower, would be able to subdue any opposition to their monopoly. But if you seize power by destroying the existing power structures, you have also destroyed the customary constraints on the autocrat’s power, and now what will stop the military monopoly from sliding into tyranny? 

It is clear that Game of Thrones wanted to conclude the series by coming out in favour of evolutionary over revolutionary social change, but because of the incompetence of the writers and because the showrunners were in a hurry to end the series, they went about it in the dumbest way possible. The worst scene of the worst episode of the worst season of the series is the one that takes place at the dragon pit after Jon Snow has killed Danerys Targaryen. There, the lords and ladies  have gathered to elect the new monarch, and Sam Tarly rather timidly suggests broadening the franchise to include commoners. His suggestion is scoffed at, with the gathered lords arguing that they might as well include dogs in the vote. Quite clearly, this was meant to signal that the socio-techno-economic conditions of the time did not permit a drastic transition to full liberal democracy. 

But the point about evolutionary change is that each step in the evolution needs to be sustainable, possibly over many generations till conditions are ripe for the next steps. The finale of Thrones was a masterclass in papering over the obvious cracks. The surviving dragon, has for some reason, flown away to an unknown location, conveniently doing away with the problem of civilian control of dragonry. But how is this new setup supposed to maintain political stability in its absence? The capital has been destroyed, most of the army has been killed, the military force that conquered the kingdom has been pensioned off, and the one person who is a competent military commander has been sent off to guard against a non-existent threat. Worst of all, the kingdom has installed as ruler a philosopher king who is more philosopher than king, and the philosophy in question being more of the mystic variety than of the kind that will provide guidance in this world. At least, if at the end it had been revealed that Bran the broken intended to use his warging abilities to exercise surveillance over the entire kingdom and use his information asymmetry as power, the series would have been slightly salvaged, but this ending is an unmitigated disaster. 

It’s quite clear that the producers of the series knew that the ending was stupid and that they were airbrushing visuals of loose ends from the picture – Yara Greyjoy, for example, makes some noises about she being still loyal to her old queen, and before she could set out to lead a rebellion to extract vengeance, she is asked to shut up, presumably because the producers were in a hurry to end the series.  This hurry has been visible right from season 6, when they started using their their various dei ex machina to eliminate the complexities in the story. Till that season, all the unexpected twists – the death of Ned Stark, the Red Wedding or the poisoning of Joffrey – had increased the complexity in the story. But when Cersei blew up the Great Sept using wildfire – yes, it led to Olenna Tyrell plotting revenge and joining Danerys, but you have to wonder about the High Sparrow and the Faith Militant. Was there no fallout from eliminating them? Did they not have a following in Kings Landing? Did killing them all not cause any kind of unrest?  In the same season, Dany uses her dragons to burn the slavers’ ships and destroys their fleet. No fallout from that? No one left to plot revenge?  

Evidently, the showrunners were incompetent at plotting the course of the series when unmoored from George R R Martin’s guidance. But Martin himself has been unable to finish writing his books, and while he is good at fleshing out the complexity of the real world, I don’t see any evidence that he has the ability to resolve the complexity and bring the series to a satisfactory conclusion. Which is just as well. A satisfactory conclusion to the series will bring about the end of the cycle of the four yugas, result in Pralaya, and the start of a new cycle. I don’t think we are ready for that yet.  

Thoughts on the GST

Much reporting on the GST is about how tax rates have changed after the rollout. You may have read that a good or service was taxed at, say15% earlier, but will be at 18% now. I suspect that these reports are comparing on the basis of sales tax and VAT in the case of goods and service tax in the case of services. Such reporting displays a lack of understanding of the fact that GST replaces many other taxes, as also of the value added nature of the tax.

Suppose that you run a shop. You have been buying a widget that incurred excise at 10%. The cost to the manufacturer, ex tax, was Rs50. With tax, you bought it for 55 rupees. Your value addition and profit came to Rs45; with a 15% sales tax on Rs 100, the widget retailed for Rs115. The tax incidence on the widget was 20/95, or 21%.

Now, the GST at 18% has been introduced, replacing all other taxes. In a perfect world that adjusts to the GST immediately, you would receive an invoice for the widget from your supplier showing a price of Rs50 and the GST of Rs9 as separate line items. This GST would not figure in your pricing decisions because you would claim it as input tax credit. Your value addition and profit would still be 45 rupees, so your widget would be priced at Rs95 pre-tax. With a GST of 18%, your widget would be priced at Rs112.1. In other words, in our perfect world, it is perfectly possible that replacing sales tax of 15% with a GST of 18% results in a reduction in price.

The real world differs from the perfect world in several crucial ways.

First, the widget in question is imaginary and I have made up the tax rates. I have only a dim understanding of what taxes used to apply at what stage, and I have no idea what the tax rates were on different products. The government has claimed that the tax rates were aimed at achieving revenue neutrality. If they are right and if they have done a perfect job of being revenue neutral on every product and service, retail prices should not change at all. Of course, it is unrealistic to expect that kind of perfection. It will take significant analysis to figure out how good or bad a job they have done on this count, and whether they have erred on the side of higher or lower revenues. But the point to note is that revenue neutrality can only be achieved if the GST is higher than or equal to the current sales or service tax.

Second, the example assumes that the shop will instantly respond to a fall in input prices with a reduction in price. In reality, it’s just as likely to keep its listed price the same and slap the 18% on top of it, and try to pocket the profits as long as market forces let it.

Third, even if the shop does want to adjust prices in response to the GST, it is unlikely to have full visibility into prices along the entire supply chain. The example of the widget was a deliberately simplified one. The more realistic scenario is a complex supply chain with multiple stages involved in the conversion of raw materials to finished goods. Each participant in the supply chain faced a certain set of taxes earlier and is faced with GST and input tax credits now. Getting all the costs worked out and the prices renegotiated is going to take time.

Fourth, one of the avowed aims of the GST rollout is increased tax compliance. While that is a good thing, if it succeeds in achieving this goal, it means that taxes that weren’t being paid earlier are now being paid. If that happens, it means an increase in prices.

In other words, any claim you read about how the GST is going to increase or reduce prices should be taken with a pinch of salt. Unless there is evidence that those who are making the claim have done rigorous studies taking into consideration the above factors, they are probably just pulling numbers out of their ass.

A partial exception to this principle of scepticism can probably be made for services. Unlike goods, there is no supply chain to deal with, so it’s more likely that replacing a 15% service tax with GST at 18% results in a straightforward increase in price. Of course, a hairdresser’s shop does deal with raw material like shampoos and hair dyes, while for a financial services firm, the tax credit on office stationery and on ISP payments will probably not compensate for the higher GST rate.

The point of all this is that calculating the impact of the GST on prices even in the short to medium run is difficult. In the long run, the GST is supposed to bring about a whole bunch of structural changes in the economy, like speedier transport of goods, economies of scale in warehousing, more rational decision-making on the question of where to locate factories, etc. All of these should contribute to economic growth and should also have a positive impact on inflation. Calculating that impact is a different story.

In Defence of the GDP

The GDP as a measure has well-known limitations – in fact, I learnt about these limitations in the same chapter of the introductory Economics textbook that taught me how the GDP is calculated. The most glaring among these limitations is that voluntary and unpaid labour is not taken into account in its calculations. This tends to devalue women’s work. A woman cooking for her family in her own kitchen does not add to the GDP, but if the family hires a cook, the payment to the cook does. Likewise, as Alan Greenspan pointed out, a natural breeze does not show up in the GDP, but air conditioning does. Other things being equal, a society naturally endowed with pleasant weather is better off than one that has to keep the A.C. on all the time, no matter what the GDP says.

There are other criticisms that I am sympathetic to from the moral point of view. Purchase of cigarettes adds to the GDP, but a cigarette reduces the well-being of a smoker. The GDP has no way of knowing that. As far as it is concerned, a rupee spent on a cigarette or a prostitute’s services is as good as a rupee spent on buying healthy snacks for the children. This shortcoming has led some to argue that we must junk the GDP as a measure. Apparently, one of them is Lorenzo Fioramonti, who has written The World After GDP. I haven’t read the book, but I learnt of it by reading this broadly unsympathetic review in the FT (The FT article is subscription-only, so you should probably not bother clicking that link, and you should continue to read this blog post)

Now, as a non-smoker who abhors cigarette smoke, I am willing to lend a sympathetic ear to any method of GDP calculation that would lead to us not counting cigarette purchases while measuring the GDP. But is it really fair to say that the GDP is a top-down measure which takes society in the direction that it would not prefer to if it didn’t have GDP growth as a target? The argument that it is is not convincing.

First off, the GDP isn’t top down. It is a bottom up measure. In a market economy, a nation’s GDP is what it is because of the individual purchasing decisions of individual citizens. In fact, it is precisely because it is a bottom up measure that it ends up measuring things that some of us find abhorrent.

My friend is a smoker who smokes two cigarettes a day. Were you to ask him if his smoking makes him happy, his answer would be an empathetic no.  He claims to have cut down his smoking from his earlier quota of three a day and periodically claims that he is planning to quit altogether, but rather dubiously explains that quitting all at once is not recommended. He used to carry two cigarettes with him to work every day, but he’s stopped that. Now he walks down to the cigarette shack to buy his fix. The shack is 500 metres away from the office block, and his hope is that the prospect of doing the 1km trek twice a day will, at some point,  discourage him from going. It hasn’t so far. He takes his two breaks right after lunch and at around 4pm each day.

Peak temperatures these days in Hyderabad hit 42 degrees Celsius; I get dehydrated just looking out of the window. My friend pays for the cigarettes, not only in money, but also in sweat, quite literally. He is also quite willing to spend an hour of his time each day. Only the money he spends shows up in the GDP. Going by what he spends on it, the value added by those cigarettes to the national economy is actually much more.

Wait a minute! Didn’t we start from the premise that my friend’s smoking should be excluded from the GDP,  because when you ask him, he says that he does not like smoking and wants to quit? The problem is, if I tell the GDP: “Exclude my friend’s smoking when you get calculated. He says he doesn’t actually like smoking”, GDP will answer: “Look, first of all, it is very common for people to say one thing and do the other. That is why economists have a term called ‘Revealed Preference’. Words are cheap. People can say what they want, but the best way to find out if they get value from something is to check if they are willing to give away something they worked hard for, for it.

“Second of all, it’s not just a question of your friend. There are millions of smokers in this world, and it would be impractical to hand out a questionnaire with every cigarette that asks the smoker ‘Are you smoking this cigarette because you get utility out of it or are you just hopelessly addicted and trying to quit?’ And if you want me exclude smoking from my calculation because of a few people’s opinion that smoking does not add value to the smoker, well, that is not what I’d call a bottom-up way to measure me.”

OK, so the argument that the GDP is a top-down measure is unconvincing. What about the argument that the GDP as a top-down target leads us in the wrong direction? Well, that is even less convincing. When you get to work each morning, do you do it because you want to do your patriotic duty to your country by increasing its GDP or do you do it to earn money to buy the things you and your family want?  Or perhaps you are highly competitive and you enjoy the sense of achievement, you like winning the rat race, or you just enjoy having a lot of money. People have different motivations for doing things that contribute to the GDP, but “I want to increase the nation’s GDP” is rarely one of them.

The same goes for companies and businesses. They often do boast of how much they contribute to the nation’s economy, but surely primary motivation of those who run businesses is the growth of their business’s bottomline. This motivation would be unaffected if the government’s statisticians stopped reporting the GDP.

Does the GDP as a target take government policies in the wrong direction? Politicians want to get reelected, and the policies they pursue are the ones that will help them with that goal. While they may think of the GDP or the economy as a useful shorthand for the things that voters want, they must surely be aware that what the voters want is not the GDP in the abstract, but tangible things like jobs, roads, education for their children. These things tend to be correlated with the GDP, but voters will not stop wanting the tangible things they want just because the government stops reporting the GDP. In fact we know that governments do implement policies like protectionism even when they reduce the GDP. They do it because they care more for tangible things like saving jobs than the GDP in the abstract.

Given all this, I am just not convinced that giving up on, or even modifying the calculation of the GDP is worth the bother. If you are concerned about the untrammeled pursuit of material wealth, the problem is human nature. We aren’t doing it because the GDP tells us to, and we won’t stop if the GDP tells us to stop.

Black Money and Chaos

The chaos created by demonetization is not because of a failure in implementation. It could not have been avoided by calibrating ATMs on time. It is a function of how much of India’s black money is held in cash.
To understand this, consider a thought experiment. Suppose that there was no cash black money in India, and yet the government, for some vague reason, announced demonetization. Would there have been a similar level of chaos?
Or consider another thought experiment. Suppose that the government announced demonetization, but also announced that the 500 and 1000 rupee notes could be exchanged at the bank without limit, no questions asked. Would a similar panic have spread through the economy?
My answer to both questions is no, and it would stay no even if you told me that in both thought experiments, the government was as unprepared with the task of ATM calibration as in the real world. That is because in both those situations, shops would continue to take the demonetized notes even though it would be illegal to take them.
In the real world, shops are refusing to take those notes, not because it would be against the law (we aren’t a very law-abiding society), but because of the difficulty of converting them to legal tender. This difficulty is because of the existence and quantum of cash black money (thought experiment 1) and the difficulty of laundering it (thought experiment 2).
Because of these two factors, the demonetized notes are trading at a discount. Because of this discount, there is a huge impact on the economy. Remember that the black economy is also a part of the economy, and a hit on the black economy is necessarily an attack on the economy, and the people affected aren’t necessarily, or even primarily the holders of black money.
Another way to say the same thing is to note that the discount on the demonetized notes affects everyone, not just those who hold unaccounted money. It affects daily wage labourers, it affects the supply chain for food, everything.
My initial reaction to demonetization was that it was a mildly positive move, but ultimately more of a PR stunt rather than one that would have a large impact one way or the other. That is because my thinking ran on the lines of ” Who keeps their black money in cash?” I thought was that people mostly maintained only their working capital in cash, and as a great believer in the efficacy of markets, I thought that money laundering channels would quickly take care of the black money that was in cash. The net result would be a PR victory for Modi, a one-time shock to the cash economy and a net cash transfer to the poor, as it would be the poor whose Jan dhan accounts would be used to launder all the black money.
From the chaos that is occurring, it appears that I was wrong about how much black money is stored in cash. Of course, I don’t have a baseline level of how much chaos was expected to compare the current level with. But the point is that if you believed that a lot of black money is stored in cash (as against circulated as working capital and laundered before storage) you should have expected a much higher level of chaos.
A full model of how much chaos to expect from the demonetization would consider:
  1. How much black money is in cash
  2. Efficiency of the laundering channels that will develop (The more efficient the channel, the quicker the economy will recover)
  3. How much of the remonetized cash will be sucked back into storing black money
  4. How’s quickly the Banking system can be remonetized with the new notes.
It looks like Modi has a similar mental model of demonetization. The government has flipped and flopped multiple times, but it has been consistent in one thing, which is that it had imposed ever tighter restrictions on changing money over the counter.
This makes no sense if you believe that the folks changing old 500 notes are the unbanked poor, but makes complete sense if you believe that it’s a channel to launder demonetized notes into remonetized ones AND if you believe that those notes will go back to black money storage. The problem though is that anything that hurts black money storage (#3) will also hurt the circulation of black money (#2) and this puts pressure on #4 even more.
I don’t know if this experiment will succeed. As I write this, it is the end of November and the ATMs around me are empty. If people are unable to withdraw money when they get their salaries in the first week of December, I expect hell to break loose.
But what this experiment has taught us is not, as one article put it, how much India runs on cash, but how much of India’s unaccounted money is stored in cash.

The Gatekeepers to India

It is said that our country is divided into an India and a Bharat. I hate this terminology because it is unnecessarily pejorative towards “Bharat”, but let’s go with it for now.  These two nations are often identified with Urban and Rural India respectively, but sometimes the borders are not so clearly geographical. Some people say that the border is in fact between the rich and the poor. I believe that there are in fact two nations, but the line of separation is different from what is commonly assumed.  On one side is India, a nation that exists in spite of government hindrance.  On the other side is Bharat,  a country that would not have existed in its current state without the overbearing presence of government.

Guarding the frontier between the two countries are the Gatekeepers. They are a loose coalition of politicians, government offiicials, NGOs and other activists, caste and community leaders, local strongmen, industrialists, and the like. The Gatekeepers may have access to the levers of government, the capability for violence, or both, to achieve their end.  The Gatekeepers guard both countries against each other. To the Indians, they say that they are protecting them against the hordes from Bharat. To the Bharatiyas, they say that they are preventing the evil Indians from encroaching on their domain, and ensuring that the wealth created in India is equitably distributed.

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Tipping Point

I am rather amused to hear opinions that argue that tipping to waiters is an act of generosity, and a barometer for how we treat those less fortunate than we are.

From a first order economic perspective, tipping shouldn’t matter. What you are willing to pay at the restaurant table depends on the economics of dining, and what the restaurateur pays his staff depends on the vagaries of the labour market.

 An economist would point out that a tip comes out of your pocket as much as the rest of the  bill does, and if you are in a society where a 15% or 20% tip is customary, you will factor that into your dining decisions. In other words, when deciding whether to eat out or not, or when deciding whether to eat at a particular place or not, you should mentally translate an expected bill of Rs1,000 to Rs1,200 ( assuming a 20% tip) and decide on that basis.

 Likewise, when a waiter’s salary is negotiated, the tips that he can expect must surely be taken into account. How can it not be? A restaurateur  will certainly tell a candidate for the post of waiter: “Look, your official salary is X, but you can expect tips of Y per month, so your take home is actually X+Y.”

 So, at first glance, it must seem that the custom of tipping should make no difference. If there were to exist two cities that were identical in all respects except  that Stingy City has a culture that tips 5% and Generous City has a culture that tips 20%, the menu prices and waiter salaries in the two cities must adjust themselves so that diners pay out approximately the same amount to the restaurant and the waiters take home around the same amount in both cities.

 As I have taken care to mention, all this is the first order perspective. What about when we look more closely? This is where things get a little more interesting.

 Suppose that you have a culture where tipping up to 20%  is customary, but any tip in the range of 0 to 20 is acceptable, depending on how much you think you can afford, and how much you liked the service. What will happen then?

 First, from the perspective of economics, this increases flexibility, which is a good thing. One of the biggest problems that economies face is that wages and prices are rigid. Actually, it is worse than that – wages are rigid downwards (i.e. it is difficult to reduce wages) while prices aren’t very rigid, but to the extent that they are, they are rigid upwards – i.e. it is difficult to raise prices. This makes it difficult for economies to get out of a downturn, because you can’t reduce people’s salaries when faced with reducing profits. So you hold on to employees, and when you can’t do that, you lay them off (or if labour laws make it difficult to do even that, you struggle for a bit and close down the company)

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Rules and Principles

Kunal and Gaurav are right. In this post, I was talking of the trade-off between rules and principles in policy enforcement.  Actually, when you think of it, rules vs. principles is not a simple dichotomy, but a spectrum of choices.

Imagine that these choices are spread from left to right. At the left end of the spectrum is automation. Rules are enforced automatically, without anyone having the responsibility of enforcing them. The best example  of automation in my stories was actually the turnstile – it automated the task of checking for tickets, leaving very little scope for discretion.

Another example is the jugad “automation” that the Hyderabad police enforced. Blocking off the right turn doesn’t seem like an example of automation, but for our purposes, it is, because it enforced the rules without the police having to intervene.

To the right of automation come rules – clear and transparent rules that leave no scope of discretion to the enforcers. But then, whether to follow the rule or not is still a choice – and ensuring that officials enforce the rule depends on the existence of procedural mechanisms.

As you move further to the right,  you find that the rules have more and more discretion embedded in them. For example, consider the difference between enforcing a red light and ticketing someone for rash driving. The former is easier to enforce fairly than the latter.

At the extreme right of the spectrum is the idea of “principles-based regulation”.  This distinction  between rule-based regulation and principles-based regulation is used most often in the financial sector, so let me use an example from Banking to illustrate.

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A Rant About Poverty Numbers

The good Pragmatic Desi asked me to write about the release of the latest poverty numbers from NSSO. I do want to write a follow up post to my Pragati article. But the bad news is that I have accumulated a lot of heavy reading material in preparation for that follow up post which I need to read. The good news is that a long weekend is coming up, and I hope to get the reading and the post out by then.

But in the mean time, here is a rant.

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Poverty in Pragati

As promised, I have an updated and expanded version of my post on The Poverty Numbers at Pragati. From my blog post, I have subtracted some things in the interest of space – the discussion on the recall period being most prominent. More importantly, I have added some things, so you should read the Pragati piece even if you’ve read my post.

I have referred to some papers in the Pragati article. Here are the original links to those:

  • The Tendulkar Report on the methodology on estimation of poverty.  Suresh Tendulkar, by the way, was an excellent free market economist.
  • Angus Deaton’s 2008 paper on why Indians are consuming fewer calories is here (PDF link). Look at pages 53 onwards for discussion on the calorie decline.
  • Deaton’s other paper on how the divergence between the NSS data and the CPI affected poverty numbers is here.
  • All of Deaton’s work on poverty can be viewed here.

The Scrap Over Poverty Statistics

What should we make of the latest scrap over the Tendulkar committee report? Here are some thoughts.

 Poverty isn’t a binary variable. There is no switch that, when turned on, defines a household as poor vs.  non-poor.  There are various degrees of deprivation, and we have differing intuitions about at what level of deprivation we should classify a family as poor. Part of the root of the outrage over the seemingly low household income (Rs. 26 per day per person in villages to Rs. 32 per person per day in cities)  comes from the fact that our intuition about what constitutes poverty has changed.

 My uncle started his career after completing his graduation in the mid-70s in Bombay’s weather office. He was single and lived alone then, but he’d send part of his salary home to his family. Towards the end of the month, his money would run out, and the last few days of the month, he’d be able to cook and eat only one meal a day.

 Then, as now, if you were a graduate and you were earning an entry level salary in a government firm, you would be categorized into the middle-class – lower middle-class to be sure, but middle-class nonetheless. When did you last hear of a middle-class person lacking for food in India? But that’s how things were till the 70s, and my uncle’s situation wouldn’t excite comment then.  One can only imagine the situation of the others who were poorer than my uncle.

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What Just Happened?

I have tried in the past, with some success, to explain how economies work with the help of The Model Village, so let me try again.  This time I will try to explain how the American Economy got into the situation it is in. These, by the way, are the fundamental reasons that I will be explaining. There are many, equally valid and mutually consistent ways of looking at the situation. I will be explaining just one aspect of it, which I hope, cuts to the heart of the matter.
So, in The Model Village, there was a huge Zamindari. By huge, I mean really huge. It was a mini-economy by itself. Many crops grew on its lands, it had cattle, goats and chicken. It also had small factories that processed the produce of its land into finished goods that could be sold outside.

Of course, this Zamindari, while enormously productive, did not produce everything it needed. What it did not, it would buy from the traders of The Model Village. And while the Zamindari was extremely rich, it still needed credit to smooth out its consumption cycle – it needed to borrow early during the planting cycle and repay when the harvest came in. Also, the Zamindar was focused on making improvements in his lands and factories, and he needed credit for that.

The way the Zamindari got credit was to issue IOUs in return for whatever they needed, and those IOUs could later be redeemed for fixed quantities of wheat, rice, etc. (And oh – by the way – this was a primitive model village, so no one had bothered to issue currency yet. They were still using barter.) But the IOUs suited the traders just fine. They knew that they’d get something of value later in return for those IOUs, so they applied the time value of money to calculate how much they could offer in return now. The Zamindari was extremely well-run, so its IOU was seen as extremely stable. It would soon perform the function of money. People in The Model Village traded Zamindari IOUs among themselves, their savings consisted of these IOUs, and so on.
After a time, the Zamindar announced a change. He said that these IOUs would no longer be redeemable against fixed quantities of wheat or rice. Instead, the Zamindari would buy whatever it wanted against the IOUs, and when it came to redeeming the IOUs, he’d auction the produce of his estate, and the price, in IOUs, would be determined by the results of the auction. When asked why he was introducing this change, the Zamindar gave an honest answer – he needed the flexibility to print IOUs to finance his estate’s expansion, and he found the constant need to worry about making sure that the IOUs were good constraining. But surely, the traders did not need to worry about? In any case, the IOUs were backed by the good credit of the Zamindari, and as long as the Zamindari’s lands were fertile and its people hardworking,  there was no need to worry – after all, if the Zamindari was too reckless in issuing IOUs,  it would not be in a position to buy what it needed next time round.

The traders saw the logic of this – and in any case, they had no choice. The Zamindari was the biggest deal in The Model Village, and not trading with it was not an option.

Things went fine for a while. The Zamindari continued to be well-managed, and the Zamindar was prudent in issuing IOUs. The IOUs continued to strengthen their position as the de facto currency of The Model Village. Its value began to be determined less by what the Zamindari could pay for it and more by what other traders would. Traders in turn began to measure their success by the number of IOUs they could accumulate.  The rest of The Model Village got prosperous and began to produce a lot of stuff, much of which was sold to the Zamindari in return for IOUs.

The prosperity of The Model Village grew so much that very few took notice of the fact that the output of the Zamindari was in fact slowing down. The old Zamindar had died and his son had taken over. The new Zamindar was, compared to his father, a reckless man, and he had not failed to notice that the traders’ willingness to accept his IOUs was rather out of proportion to his ability to repay. His lands were turning infertile and his workers older, and he needed to keep issuing IOUs to keep up the expenses of his Zamindari, and so he did.

From the point of view of the traders, they were behaving prudently.   While they intellectually understood the views of those who pointed out that this was a classic bubble, the fact was that they were working hard, making sales, making money (they no longer thought of it as IOUs) and saving. Everything they were doing was exactly what their wise men had told them to do. How could that be wrong?

But of course, things were bound to go wrong. Very, very wrong. It was just a question of how.

By now, most of you would have understood the elements of the allegory. The Zamindari is the United States of America.  The IOUs are dollars. The Zamindar’s decision to cease setting the value of his IOUs is analogous to Nixon’s decision to take the dollar off the gold standard. The traders are those countries who, over the past few decades, have run an export surplus with the US – Japan, China, India, to name a few.

You will notice that it is rather difficult to fix the blame here. Was going off the Gold standard the mistake? Perhaps, but it also presents advantages – and which other country is on the Gold Standard? Was the Zamindar too reckless? Well yes, he was, but not too much. He issued the IOUs because there were always greater fools to buy them. Were the traders at fault? Yes, but it isn’t easy to notice at first glance, because, after all, they are doing what they should be doing – selling stuff, making “money” and saving it – the problem of course is that they shouldn’t have treated those IOUs as money.

You will also notice that this edition of The Model Village was not particularly difficult to understand. It is  not even very controversial. In many bubbles, you will find many sensible people disagreeing over whether  we are in fact in a bubble – if there weren’t such people, we wouldn’t have bubbles. But you won’t find that to be the case here. If you stop two mainstream economists who are vehemently arguing over the Debt ceiling debate and ask them if they, in essence, agree that the parable of the Zamindari is a valid model of the US economy, they will agree before moving on to argue over the specifics of how long  the bubble will last, whether the bubble will burst or slowly lose steam and how to deflate it. And yet, we ended up here.

The Hackneyed Man From the Past

Gaurav non-Sabnis thinks that  the use of the man-from-the-past technique in my Pragati editorial ”The Case for Freedom” was hackneyed.  He is free to think so. He also thinks that my introduction was inaccurate. He is free to think so too as long as he doesn’t mind being mistaken.

Gaurav makes two errors - a misinterpretation and a factual error. The misinterpretation is this: He says that “mismatch between supply and demand must be as old as beginning of trade”. Well, duh. Obviously, a famine is a severe mismatch between the demand for food and the supply of food. If I had said that there is now a greater mismatch than before, it would have been an extremely stupid statement.

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