- How much black money is in cash
- Efficiency of the laundering channels that will develop (The more efficient the channel, the quicker the economy will recover)
- How much of the remonetized cash will be sucked back into storing black money
- How’s quickly the Banking system can be remonetized with the new notes.
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.
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)
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.
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.
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.
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.
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.
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.
Dilip D’Souza does not read The Examined Life. In the course of not reading my blog, he runs across a comment by me on my blog saying that I cheered the demolition of the Babri Masjid.
The Babri Masjid, if you recollect, was demolished in 1992. At the risk certainty of giving away my age, I was 17 years old at that time. The comment itself makes it clear that I have reconsidered my view since. A person who, at the age of 40, admired a psycopathic mass-murderer should not be throwing stones at people aged 17, especially since stones can’t do time travel yet. A sane man would have, on reflection, passed by the chance to pick up the stone. But we are talking of Dilip D’Souza. So out comes a post. I am apparently an “economist” and a libertarian who was “delighted” by the demolition of the Masjid. The characterization delights me, as I am not really a trained economist. I just did a couple of courses as part of my MBA. And I had written “cheered”, not “delighted”, but it is close enough.
Having done this of course, the problem is to get back plausible deniability. Dilip needs to get back to not reading my blog. The SOP so far is to claim that though he does not read the blog, one of my posse of admirers (or detractors) sent the link to him. But this time, it is a slightly different. This time, he adds a postscript. Apparently, the economist/libertarian has written to him and remains delighted that the Babri Masjid was demolished. Ingenious, isn’t it? If I protest that I did not in fact write to him, it will turn out that it was someone else, not me. In March 2009, an epidemic broke out among economist libertarians wherein they all confessed their teenage delight when the Babri Masjid was demolished to whoever was within reach. If I don’t protest, the insinuation that I remain delighted with the demolition of the Masjid stays. If only Dilip D’Souza were smarter, he would have been a valuable asset in India’s psychops.
It turns out that the UPA government, which presided over the boom phase of the business cycle has ended its term with an incredibly high fiscal deficit. It got away with its legal responsibility to keep the budget within limits by keeping them within limits on paper and simply spending more than it was allowed. Chidambaram’s response to those who pointed out that he had not actually provided funding for the NREGA was, in effect “Trust me. Do you think I am so stupid as to not provide funds for such an important scheme?” Now, we will enter the bust phase of the cycle burdened with a huge deficit. For some reason, I am reminded of the discussion I got into here.
I have been remiss in pointing out that George W Bush too has caught on to what I have been pointing out. It is the prosperity of the middle class that causes inflation. If you have a few rich people and lots of poor people, the poor would be free of inflation. It is the middle class in India and China that causes the problem. Ajay Shah explains better.