Category Archives: economics

Cost of the Free Lunch

The party between the banks and the wilful defaulters – How much did it cost us?

 

Read here…

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Paying for the Free Lunch: Indian Public Sector Banks

Just how bad is the Indian public sector banking mess? How to check wilful defaults and improve bank governance? Can Privatization and Bankruptcy code help?

Full article here

Fourth Industrial Revolution: How should India React?

Hello guys!

I wrote a draft policy discussion paper on the impact of forthcoming technologies like robotics and artificial intelligence on the economy. Please read it at your leisure. Any critical comments are more than welcome so that I can make incorporate them and make it better.

The questions addressed are: will the upcoming industrial revolution (robotics, AI) be good for mankind like the previous ones or will it take away all our jobs? Will it create a winner take all economy and increase inequality? Or will, like the previous ones, economy will adjust itself and create better lives for all? Will history be repeated or will it be different this time?

What does basic economic logic say about the impact of these technologies? Will the unemployment so caused only be temporary? If so under what conditions can it become sticky? Can India really avoid Fourth Revolution by banning the new technologies? If so what will be the consequences? What should it do to better prepare itself for the coming Revolution.

https://papers.ssrn.com/…/D…/SSRN_ID3084256_code2854981.pdf…

#AI, #Robotics, #Unemployment, #ClassicalEconomics

Indian Economy: Budget Discussion

This budget has presented a lot of data… Fiscal deficit, current account, inflation, gdp growth, manufacturing and what not… And it has presented a rather rosy picture before us. Fiscal deficit would be reined in at 4.6% (below even the targeted 4.8%), current account deficit is down to below $40 billion (vs estimates of over $90 billion in the beginning), inflation has come down and growth is picking up (expected to be 4.9% this year vs 4.5% in the last).

In this article, we intend to decode all these numbers, take a stock of the situation and analyse the true state of the economy. We will look at each of the major indicators of the economy – current account, fiscal deficit, inflation, investment and manufacturing – analyze how we did in 2013-14 and see what lies ahead.

Current Account Situation – Is the crisis over?

We began the year 2013-14 with gloomy current accout deficit (CAD) predictions of over $90 billion. CAD was easily the biggest macroeconomic threat we faced then which could derail our entire growth story and render us vulnerable to an ASEAN like shock during 1997. We desperately needed capital inflows to finance this gap. And then came the talks of US QE tapering. All the capital inflows stopped and the result was a major selloff in rupee. The situation became so grim that talks of an IMF bailout as in 1991 were in the air.

Compared to that we are clearly in a much better position now. Now the CAD is only expected to be $45 billion for the year. Our goods exports during the period April 13 – Jan 14 have grown at a healthy (when compared to rest of the world) rate of +5.7% over previous year to $257 billion while imports have fallen for the firt time in many years by -7.8% to $377 billion. Thus the goods trade deficit has come down to $120 billion in this period compared to $166 billion during April 12 – Jan 13.

The pickup in exports is a really welcome sign for the future. In fact, the growth rate in exports was in double digits from July 13 – October 13. It looks like the rupee depreciation and revival of growth in US are finally translating into higher export orders for us which is good for the future as these factors are likely to sustain.

However, everybody knows that this compression of CAD is basically an import compression story for India and that too largely gold. Various steps have led to a virtual halt in import of gold in India. But this gold import supression is not sustainable as gold smuggling will rise.

Also, another big factor behind this import compression was a sharp drop in import of capital goods (power plants etc.) and coal. But this is not a healthy sign. Capital goods and coal imports have not gone down because our production has increased. They have gone down because our fresh investments have stalled due to various structural problems (land acquisition, multiple delayed clearances etc.). So this compression is not any cause to cheer but a symptom of a bigger underlying problem which the new government needs to address with urgency.

Finally, a large part of our import bill i.e. oil imports remained constant (only +1.2% growth) simply because the oil prices remained constant because US didn’t attack Syria and a nuclear deal with Iran is on the cards. These positive factors are likely to sustain over the near horizon but they are out of our control and so we need to have some backup plan in case things go wrong.

Concluding, yes the crisis is over and will not return in near future. There are positive signs which are likely to sustain in near future. At the same time, we cannot afford to be complacent and must address the structural problems which have brought fresh investments to a screeching halt in our economy.

Fiscal Deficit: The 4.6% magic

A reduction in the headline fiscal deficit number to 4.6% may appear to many as a welcome sign and may indicate that the economy is on a sounder footing. But the real issue is the QUALITY of this fiscal deficit reduction. If the deficit is reduced by an increase in taxes or decrease in wasteful spending, then it is a welcome sign. But if it is reduced by merely postponing the expenditures to next fiscal and beyond and relying on one time revenue measures, it doesn’t present a good report card.

This cut in fiscal deficit headline number has been achieved mainly by the following measures:

– On the revenue side, the regular tax revenues have been disappointing. The last budget had estimated tax revenues to grow by 19% as our economy would have grown by 6%. But the real growth in economy was only 4.9% (that too estimated) and hence tax revenues growth only 12%. The actual tax to GDP ratio has declined from 10.9% to 10.2% this year. Similarly the disinvestment proceeds too were dismal at Rs. 15K crores vs estimated Rs. 40K crore in the last budget. However the successful 2G auction which raised Rs. 67K crore vs estimated Rs. 40K crore has given a partial relief. Also the government has resorted to extraordinary dividends from PSUs to fill up the revenue shortfall. But the questions to ask is whether the 2G revenues would be available next year also? And can we endlessly squeeze the PSUs to pay huge extraordinary dividends year after year? Clearly no… the revenue situation is definitely not good.

– The expenditure side presents an even more unconvincing picture. The real amount of subsidies has greatly exceeded the amount predicted in the last year’s budget and so while presenting this budget, the excess amount has simply been pushed over to be paid during the next year. This is possible because the government recognizes expenses when it actually pays the cash and not when they are incurred. For ex. if I buy a car today, i incur an expense of Rs. 10 lac today. It should appear as an expense in my accounts as of today. But in government accounting, an expense is recognized when the cash is paid for the car. So if the government decides to pay for the car in April instead of today, the expense would be shown in next year’s budget and not this year’s! So this means that the finance minister can simply decide not to pay the subsidy bills for say January – March this year and thus reduce expense for this year and hence the fiscal deficit. But bills are bills and have to be paid. So they would be paid in April and would show up as a huge expense next year. Independent experts have estimated that large amounts of fuel and fertilizers subsidies have been pushed to next year this way.

– Government expenditure is of 2 types – one which creates assets which would be used in future and one which is used to meet present expenses. The latter forms a part of the revenue deficit while overall expenses form part of fiscal deficit. Headline fiscal deficit has come down to 4.6% but revenue deficit has remained sticky at around 3%. This means what? That the expenditure being reduced is not the present expenses but the capital creating investment! In fact, this year such capital creating investment has been reduced by Rs. 91K crores! This is very bad for the economy. Because if we don’t create capital assets today, how will we pay our debts tomorrow? If we don’t invest today, where will the growth come from? This indicates weakening of economy. Question now arises why we are reducing the capital investment expenditure which shouldn’t be reduced and not reducing the current expenses expenditure (subsidy etc.) which should be reduced? This is because reducing subsidies costs votes while no one cares about the capital expenditure.

– Finally a comment on assumptions for next year which the budget makes in order to achieve the target of 4.1% fiscal deficit for the next year.
– On the revenue side, it assumes a 19% growth in tax revenues again. It had the same assumption last year as well @ 6% growth but with the growth remaining below 5%, the actual revenue growth turned out to be only 12%. This year the assumption of 19% is at a nominal growth rate of 13% (6% growth assumption last year was real growth rate not nominal). Nominal growth rate is real growth + inflation. Now either we are assuming that growth this year will bounce back to 6% or higher or we are assuming a very high inflation of 8% and above. The former doesn’t look likely (we will examine it later). Also when we account for the 2% reduction in excise duty, the cridibility of the 19% revenue growth assumption goes down even further.
– For the disinvestment, again the target has been set to Rs. 36K crores. It was Rs. 40K crores last year vs Rs. 15K crores only achieved.
– On the expenditure side, first we take a look at the subsidies. As mentioned earlier, large amounts of fuel and fertilizers subsidies have been pushed to be paid this year. But the budget doesn’t make any additional provisions for it. Fuel subsidies provided for this year are Rs. 65K crore only out of which Rs. 35K crores are from last year. Also it seems that the increase in burden due to roll back of cap on subsidised gas cylinders and Aadhar linked transfers for LPG subsidy have not been accounted for.
– Similarly fertilizers subsidies allocated for next year have remained largely same at Rs. 67K crore. But the government has recently increase gas prices (which would incidentally greatly benefit Lord Ambani). Increased gas prices would mean increased subsidy burden on fertilizers since fertilizers use gas as an input (80% of fertilizer costs are gas only). But no provision seems to have been made for this in the budget.
– Food subsidy has been pegged at Rs. 115K crores. However, the combined expenditure on all food subsidies this year was Rs. 125K crores. With all the food inflation and the Food Security Act, it is difficult to imagine how will the food expenditure come down!

Overall, commenting, the quality of fiscal consolidation this year has been poor. And the prospects for the next year too look poor. This is not good for the economy. It needs better economics, not imaginative accounting.

Savings and Investment

– Without commenting on the claims and counter claims on policy paralysis, one thing is clear. Private sector investment is just not happening. Government and PSUs are doing that but that can happen only till a particular limit. To restart the growth engine, it is the private investments which have to flow in. But from the peak, our savings rate has declined from 38% to 30% and fixed capital formation rate (or the investment rate roughly) from 36% to 28.5% today.

GDP Growth

The budget has cleverly steered clear from projecting any real growth rate for GDP next year. But it has assumed a growth rate of 4.9% for 2013-14. Given the growth rate for the first 2 quarters was 4.5%, this translates into a growth rate assumption of 5.2% for the last 2 quarters. However, recently released figures for Q3 put its growth at 4.7% only. The message is clear, there is still no recovery which we have ben hearing about from at least the past 2 years.

Inflation

The budget tells us that ‘inflation is moderating’. This familiar phrase we have been hearing for last so many years. But the truth is that only the January inflation data showed a downtick (CPI down to 8% and WPI to 5%). But if we look at the average CPI inflation in this year so far, it has been well into double digits. I am not saying that inflation is not moderating. But we need more than just 1 downtick to establish say it is a trend!

Manufacturing

The story of manufacturing captures in a very fine way everything that has gone wrong in India in the past few years. During the boom years of 2004-2008, manufacturing growth in India was well over 15-16%. Articles had even started appearing speculating if India would become the new manufacturing powerhouse of the world shadowing China !!

Fast forward to 2012-13 manufacturing grew at an anemic 1.1% and we thought things could go no worse. This reminds me of my story during the college days. In 2nd year, I hardly studied anything, didn’t attend most of the classes and got a CGPA of 6.8 / 10. I thought this is my bottom. This is my ‘zero effort’ CGPA. What could go worse. Next semester, I flunked in 2 courses and got 3.6 / 10! Manufacturing growth so far this year has been – 0.2%.

Situation is desperate in manufacturing, but thankfully the budget has taken a significant rescue step in reducing the excise duty on automobile sector and various capital goods and machinery industries.

Conclusion

We have definitely come out of the crisis situation. CAD no longer poses the explosive threat it posed last year. We have also taken important steps to save the manufacturing sector from dying. We can also hold our breath and wait for the next few inflation numbers with anticipation. But in order to really see our economy stable and healthy again, we have to improve the quality of our fiscal correction and restart the private investments. Let us hope better times lie ahead.

Growth vs Entitlements: Impact of PDS on Poverty Reduction

one of the most scholarly paper i ve come across so far on pds and growth vs entitlement issue. and unusually unbiased as well in terms of data and conclusions (despite the occasional rhetoric here and there which is unavoidable considering they are jnu profs… but at least the academic integrity has been maintained). authors are himanshu n abhijit sen (planning commission)… read from section 1 though may require some background, hence putting the gist below

The paper aims to decode how much of poverty reduction in recent years has been due to “growth” and how much due to “entitlements” (they have measured only PDS and mid day meal only and not included NREGA and others).

poverty reduction from 1999-00 to 2004-05 was ~0.85% points per annum. This jumped to ~1.3% points per annum between 2004-05 and 2009-10 and ~2.2% pts per annum between 2004-05 and 2011-12.

In the official poverty calculations, PDS grains which are provided at say 1 re (whereas the market price is say 10 rs) are valued at 1 re only. So say if a household consumed 5kg of PDS grain and 5kg of non pds, our records will show he consumed a total of 10 kg at Rs. 55 (5 * 1 + 5 * 10). Let our poverty line basket be 10 kg of grain only then in money terms too our poverty line would be Rs. 55.

What the authors do now is to value this PDS grain consumption at market prices both in poverty line calculation and household consumption. So new poverty line would be 10 * 10 = Rs. 100. Our poor household’s expenditure too would be now Rs. 100. Now the authors see how many of the households will have an expenditure < Rs. 100 if we assume they don't get any PDS grain i.e. people who would have been poor if there were no state assistance. The difference in the number of poor calculated using this approach and official number of poor would give us the number of poor who were lifted out of poverty because of PDS (and mid day meal). If we compare across time, we can get how many people were lifted out of poverty due to growth in incomes (non pds consumption) which we can assume comes entirely from growth (not entirely true as part of it would come from NREGA) and how many due to PDS.

The authors conclude that:

a) between 1993-94 to 2004-05, out of 0.85 %point poverty reduction p.a. 0.73%pt was due to income growth and rest PDS + MDM. between 2004-05 to 2009-10, out of 1.28 %point poverty reduction p.a., income component was 0.87 %point only while rest all came from PDS and MDM. This shows the importance of PDS and MDM extension in accelerating rate of poverty reduction.

b) however, 2009-10 was a severe drought year where incomes were highly depressed. If we look from 2004-05 to 2011-12 where poverty reduction was 2.2 %point p.a., 1.6% points came from income growth and remaining 0.6% points from PDS. This means nearly 30% of poverty reduction happened because of PDS and MDM (despite all the leakages). Poverty ratios would be ~4.8% points higher (i.e. close to 27% instead of 22%) if there were no PDS and MDM.

c) The impact of PDS and MDM on poverty reduction has become more important compared to earlier period. This is because of PDS reforms in many states, shift away from TPDS and near universalization of MDM in this period. Also the impact of PDS is increasing with moves to universalise PDS show that PDS is becoming less leaky with extension – contrary to the fear highlighted by food security critics.

d) Everyone knows the wonder story of Bihar in poverty reduction between 2004-05 to 2011-12. It was considered worst on PDS performance. The authors say the following about it,

“But the NSS 68th round reports that 43% of Bihar households accessed PDS cereals in 2011-12, up from only 14% in 2009-10 and less than 2% in 2004-05. This expansion, unnoticed so far, is remarkable because it went hand in hand with two other features: Bihar climbed to the top of the poverty reduction league in 2011-12 from being a laggard so far. Much more significantly, Bihar’s PDS grain leakages (i e, what NSS does not capture as PDS consumption out of official offtake figures) reduced to about 20% in 2011-12 from 65% in 2009-10 and 97% in 2004-05.”

Click Here to download the paper.

For the love of left or right

One of the biggest lessons (learnt rather rudely though and still not perfectly) of my trading days was that conviction behind a trade is essential. But being in love with it is suicidal. For the love of the trade often makes one blind even to the clearest of writings on the wall. Today I trade no more, but I read various economists – both leftists and rightists… And I see many of them making the same mistake, falling in love with their ideologies to the point of making arguments which simply run contrary to the basic principles of economics.

I would take up here 3 recent proposed reforms… (1) Direct Cash / Benefits Transfer. (2) Abolishing Securities Transaction Tax. (3) Port Charges Reforms. While each of these have many points in favor or against of them, I would simply confine myself here to the points which I think are against basic economics.

1. Direct Cash / Benefits Transfer
This means giving money directly to the people in lieu of say food subsidy. Currently food is supplied at highly subsidized rates through PDS or ration shops. Now our leftist economists criticize the change saying it would fuel inflation. Their reasoning is simple – more money in the hands of poor means more demand and hence higher inflation. Higher prices of food all around again meaning higher inflation.

I don’t think this makes sense. Why? Because the total amount of subsidy doesn’t change! Earlier the government was paying the wheat traders say Rs. 100 per kg. Then assume it sold the wheat to the poor free of cost. So the subsidy, and hence the fiscal deficit was Rs. 100. This deficit fueled inflation to the extent of Rs. 100 in the economy. Now in the new system, the government will again pay the wheat trader Rs. 100. So a deficit of Rs. 100 arises. Next, it sells the wheat to the poor at Rs. 100. So it gets back Rs. 100 and now deficit becomes Rs. 0. Finally it transfers this Rs. 100 in the bank account of poor directly. So deficit again becomes Rs. 100. Thus the deficit remains unchanged and hence no inflation.

Consider the argument that now there will be additional demand from poor in the market and hence higher food inflation. Agree the demand of food at market rates would increase. But so would the supply! For earlier what was sold ‘off-market’ to the poor by the government, would now come in the market. And thus the increase in demand and supply will match out each other. Where is the additional inflation?

2. Abolishing Securities Transaction Tax (STT)
This time the rightist economists like Ila Patnaik propose that we should abolish this tax. Simply put, STT is a tax imposed when one buys / sells a share in the stock market. They argue that due to this tax, trading Nifty in India will become more expensive. So foreign investors would instead begin to trade Nifty futures (a kind of derivative) in Singapore. So India’s business will go abroad and India would lose. Now consider this…

Lets say STT is 10%. Now a foreigner wants to buy Nifty which is at say 1000. If he buys in India, he will have to pay 1000 + 100 = 1100. But if he buys Nifty in Singapore, he doesn’t have to pay this tax, so he would have to pay only 1000. Naturally he would prefer to buy in Singapore, correct? But here is a problem… He can buy in Singapore only if there is someone in Singapore to sell it! Now typically what happens is that there are people who would be willing to provide the other side of the trade i.e. they would be willing to sell Nifty in Singapore. And to offset their risk, they would buy Nifty in India. They are called arbitrageurs and because of their operations liquidity is maintained in Singapore. If they were not there, Nifty market in Singapore would become too illiquid to trade. Now in our example, for our arbitrageur to not to lose money, Singapore Nifty has to be at least at 1100! Why? Because he would sell Singapore Nifty at 1100 and buy India Nifty at 1000 to offset his risk … but he would also have to pay tax of 100 in India and thus total he has to pay 1100 in India. So if Singapore Nifty is anything below 1100, he would not do the transaction. And if he doesn’t do this transaction, there will be no liquidity. If there is no liquidity, there is no risk of ‘India losing its business to Singapore’.

Now in market there are always people trying to buy and sell. Singapore Nifty cannot go above 1100 otherwise the arbitrageurs will sell Singapore Nifty and buy India Nifty. Similarly Singapore Nifty cannot go below 900 because then the arbitrageurs will buy Singapore Nifty and sell India Nifty. So Singapore Nifty will oscillate between this large range. And within this range, arbitrageurs will not operate and hence no liquidity! Thus instead of losing business, higher STT will only bring more business to India, keeping all other things constant. (Of course I am aware that a higher tax will reduce the overall market and in the final analysis India’s market share may reduce. But the point is that the argument of India losing market to Singapore is wrong.)

3. Port Charges Reforms
India needs to develop its ports. But government doesn’t have money. So it needs private participation via PPP. But the private player would only invest if he can make money. He can make money by charging a ‘port fee’ to all the users of the ports (exporters and importers). Currently this port fee is fixed by the government. Obviously it is less and hence no incentive for private players to invest. So the rightists propose (and the shipping department has agreed) to let the private port developers decide the port fee. They can then charge a higher port fee and make money and so will be eager to invest now. Fair enough?

But here comes the problem. Ports are a monopoly! An exporter in Bombay has no choice but to export his stuff through the Bombay port. True he can ship it out through Chennai port if the charges at Bombay port are too heavy, but shipping stuff to Chennai will entail higher costs. So so long as charges in Bombay port are lower than charges in Chennai port + the transport costs from Bombay to Chennai, the Bombay port is a monopoly. And basic economics tells us that monopolies lead to market failures. And so the government must intervene to correct this market failure.

Agree, the current fixed port fee regime is counterproductive. But by letting the port developer fix the fee, we are simply moving from one type of market failure to the other. Why can’t we seek a solution somewhere in the middle? Say in the bidding process for the development of the port, why can’t we award the project to the private party who agrees to charge the lowest? This would take care of the monopoly part assuming the bidding is competitive and so the lowest bidder would win and thus any monopoly profits would be wiped out. Of course I don’t know the details of the process, but in principle, something like this should work.

Funny enough, in its defence in the coal scam the government took the opposite position. It said a competitive bidding would only mean coal prices would go up and thus the electricity prices. That is why it went ahead to give away the mines for free. But there too why couldn’t we have a competitive bidding where the coal mine would be allocated to the person who would be willing to sell the coal (or the electricity) at the cheapest price?

Anyways, the love of ideology has made these economists blind to the extent they forget basic economics.

The Economics of a Girl Child

After Amir Khan talked about it on his show Satyamev Jayate the issue of saving the girl child caught the public imagination. The government machinery swung into action and within no time numerous advertisements were issued by the governments in newspapers. An example of such advertisements is shown below.

Many facebook pages came up like this using particularly touching pictographic material.

What do we infer from such advertisements / initiatives apart from the fact that obviously the girl child is in danger? These advertisements / initiatives seek to ‘increase the awareness’. They want to make people aware of how important the girl child is. However, the point to be noted here is that they depict the importance of the girl child to the society in general and not to the particular parent. It is this dynamics of the importance of the girl child to the society vis a vis the parent which we will explore in greater detail here. Then the government initiatives largely end here i.e. with the advertisements. True there are many schemes seeking to incentivise the birth of a girl child and laws penalising foeticide, but these are simply haphazard in planning and lax in implementation. Is this sufficient or is there an inherent drawback in this strategy?

Let us examine this issue in greater detail.

The Society versus the Individual

The girl child in current context is clearly a valuable asset to the society. Its simple, we need more girls to restore the gender balance. The other reasons – I needn’t even go into them as they are so well known.

Anyways, the point however is that to a parent, a girl child is a cost. She has to be fed (and hopefully educated) through her childhood and when the time comes to reap the benefits of this investment, she has to be married off and sent away. Her benefits flow to some other family. And not to mention the steep costs of the marriage. Thus to an individual parent couple, a girl child is a loss making proposition.

In other words, the girl child has large positive externalities. (A positive externality is a situation when the benefits of a commodity overflow to the society and can’t be limited to the buyer only. So the buyer derives less benefits and hence pays less. So the production will always be less than the socially desirable level.) In such a condition, left to its own, the society will never produce enough girl children (because producing a girl child is a loss making proposition for the parents so why should they produce a girl child). This is a classic case of market failure and hence we need the government to step in.

Returning to the spreading awareness initiatives, we can now question the effectiveness of this strategy. Are girls being killed really because people don’t know how important they are to the society? No sir no, even if all of us are educated to the highest levels, we will still never produce girl children to the socially needed level. Because the economics of a girl child simply doesn’t make any sense.

Then will reducing the expenses of marriage and dowry address the problem? Well it will certainly increase the number of girls (because the costs of a girl child are now less) but it will never produce the socially needed number of girls.

Will increasing penalties for pre natal sex determination tests help? Certainly it has the potential to correct the imbalance. But that will require a very high level of surveillance. Its biggest weakness is that it is a coercive method and tries to solve the problem without correcting the underlying market economics which gives birth to the problem in the first place.

This brings us to the question that what will work… The economics of the girl child is wrong and clearly we must correct the economics if we are to make any headway. In case of a girl child, marriage and subsequent migration is inevitable. So either we try to change the culture where traditionally the parents can’t live on the daughter’s earnings and daughters start to live with their parents only instead of migrating like the sons or we try to enhance the ‘earning power’ of the girls before they get married.

Changing the former may be a very slow process.. So the government must intervene to enhance the pre-marriage earning power of the girls instead of merely try to ‘spread awareness’. A very good case here is that of Bangladesh where each school attending girl is allowed to carry a bag of rice home every month. And believe it or not, Bangladesh performs better than India on almost all gender related indices. So enough of talk or giving fifty rupees as incentive to BPL citizens on each girl born. We need to correct the economics here.

A Funny Chutukla …

Click here to download pdf

***
Let me tell you a short ‘chutukla’ a dear friend once told me.

***

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. 

If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing. 
The fifth would pay $1. 
The sixth would pay $3. 
The seventh would pay $7.
The eighth would pay $12. 
The ninth would pay $18. 
The tenth man (the richest) would pay $59. 


So, that’s what they decided to do.. 

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner offered “Since you are all such good customers, I’m will reduce the charge of your daily beer by $20″. Drinks for the ten men would now cost just $80. 

The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still drink for free. But what about the other six men? How could they divide the $20 windfall so that everyone would get his fair share?


They realized that $20 divided by 6 is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by a higher percentage the poorer he was, to follow the principle of the tax system they had been using, and he proceeded to work out the amounts he suggested that each should now pay.
And so the fifth man, like the first four, now paid nothing (100% saving). 
The sixth now paid $2 instead of $3 (33% saving). 
The seventh now paid $5 instead of $7 (28% saving). 
The eighth now paid $9 instead of $12 (25% saving). 
The ninth now paid $14 instead of $18 (22% saving). 
The tenth now paid $49 instead of $59 (16% saving). 



Each of the six was better off than before. And the first four continued to drink for free. But, once outside the bar, the men began to compare their savings.
”I only got a dollar out of the $20,” declared the sixth man. He pointed to the tenth man,”but he got $10!” 

”Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar too. It’s unfair that he got ten times more benefit than me!” 

”That’s true!” shouted the seventh man. “Why should he get $10 back, when I got only $2? The wealthy get all the breaks!” 

”Wait a minute,” yelled the first four men in unison, “we didn’t get anything at all. This new tax system exploits the poor!”


The nine men surrounded the tenth and beat him up.
The next night the tenth man didn’t show up for drinks, so the nine sat down and had their beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill! 



(Never mind all the math, the gist of the chutukla is that rich are overburdened with taxation in our taxation system which suffers from a ‘socialist’ mindset.)

***
And that is how our tax system works. The people who already pay the highest taxes will naturally get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas, where the atmosphere is friendlier.

But does this tell us the complete story when applied to the real life? Let me tell you another chutukla…

***

To save the argument of the chutukla, let me reframe it. Let 1 beer every day be essential for a man to survive. Now obviously poor are poor. They can’t afford even 1 beer. Let us now add weight to the argument of the chutukla. Lets say there is only 1 rich man, 2 middle class men and rest 7 are poor. The rich man has the money to pay for 10 beers, middle class to pay for 1 beer each and the poor have zero money.

Lets say richest man goes in a bar alone and drinks his beer there from his own money. Now when he comes out, our other 7 poor guys and the 2 middle class men ask him to go back in and pay for their beer as well. Now in this second visit the richest man doesn’t drink, only the 7 poor and 2 middle class drink and the rich man pays the entire bill (for all 9) happily. Let this be our initial taxation system (even more unfair to the rich man than the initial chutukla, ain’t it?).

Now enter the real life. In real life, the rich man is never happy paying the bill for the other 9 men’s beers. So he goes and tells the government, “I ll pay you 1 beer (for your election spending or whatever purposes) so that you give me an exemption from paying for say 2 beers.” Now both the middle class men will have to buy their own beers (in best case)… less equity but still acceptable. But it doesn’t stop here. Our rich man now goes and tells the government, “I ll pay you 2 beers so that u exempt me from paying for 4 beers.”… Now what? In the best possible case also, 2 poor men will have to die (or be deprived of ‘minimum needed’ economic resources).

***

In real life, it is obvious that the rich man has all the incentive in the world (except should he be otherwise persuaded by a dissenting conscience) to bribe the government to save his taxes… and the government will have all the incentives in the world to accept the bribe since its overriding objective is to win elections. So in all likelihood the second chutukla is going to prevail. At least 2 poor are going to die, the rich man will invest the saved beer in a say beer refinery and produce 5 more beers tomorrow. GDP will grow and we will call this development. Funny…

The poor are worse off in the system. But they are in majority. So how does the system survive in a democracy like ours? Consider this…
***

Lets multiply everything by 2 now and let us assume that 1 beer is essential for physical survival and 1 for other basic needs like education, health, environment etc. which are otherwise essential to lead a minimum “meaningful” life. Now lets eliminate the middle class and club them with poor so that there are 9 poor. Say our rich fellow now bribes the government 4.5 beers so as to save on 9 beers in tax. Now every poor will have his 1 beer of physical survival but thats it. Election time comes and government distributes the 4 beers among the poor (read “populist” fiscal sops or alcohol, cash, mixers etc.), the poor are happy and vote for the government.
***

The rich are happy (they got to save 4.5 beers), the government is happy (it got reelected and also saved 0.5 beers), the poor are happy (they got election time sops). But the poor are still the losers for now they have been condemned to poverty in perpetuity. The poor – they never knew they had a chance of a better life… think of that child who has no future in our society now and yet he finds unparalleled joy in laying his hands upon a kite or playing with dustbin in a park riding it as if it were a horse….

The question we must then ask ourselves is whether in a civilized society (which we claim to be) can we condemn the unfortunate to live lives in perpetual “unfreedoms” (borrowing the term from Sen) given that they may find joy in small things (but which in no way can enable them to overcome their unfreedoms)? Lets not forget that men (and of course women) are human beings and not just a factor called labor used in the process of producing economic goods and services and its only the “accident of birth” which determines whether a man will be poor or rich in an overwhelming majority of cases in a real world society like India. (If you are considering of negating this then I implore you to impartially consider the probability of you being what you are today had you suffered from the “accident” of taking birth in any poor household. In fact at the risk of diverging from the current discussion, I would go to the extent of saying that the only difference between a feudal society and what we have today is that while in a feudal society there was legal sanction to the discrimination based on the accident of birth whereas now we have no such legal sanction but in 90-95% cases, our social and economic construct ensures such a discrimination prevails.)

So what can we do? The most compelling way I think is to “awaken” and “empower” people. Think of this… for 60 years since our independence the state had been providing all social goods to the poor (at least that was the declared aim). I am sure 450 years ago, Akbar would have been doing the same and some 2300 years ago, Asoka would have tried the same… yet none of it worked (or let me claim “could have” worked)… this is because the truth of all such efforts, however praiseworthy was that they were “acts of generosity by the state”. If you are a poor and the state is providing you with food, health and education, it was state’s “generosity”. It wasn’t your right… So if you happened to get nothing there was nothing which you could possibly do to redress the situation. However, if we are to really eliminate deprivation, it should be a matter of “right” for the poor to claim such benefits. Just because they happen to exist, they should have the right to have proper food, proper education and proper health… and if they don’t get it they could take action against the state…

MGNREGA (the national employment guarantee scheme) was implemented on this philosophy by making employment a right and not an act of generosity and dare I say it has been one of the most meaningful and successful schemes ever (true, there are defects but dude, we don’t live in a bookish world. In real world everything has defects).

P.S. A good read on MGNREGS here… http://www.indiawaterportal.org/sites/indiawaterportal.org/files/mgnrega_sameeksha.pdf

How does India estimate its poor?

The purpose of this one is not to take any sides in the ongoing debate over the (ill) famed Rs. 26 (and subsequently lowered to 22 point something) poverty line. I just intend here to present in simple words the poverty estimation procedure in India to everybody so that (s)he can form an informed opinion on the matter.

Since professor Ahluwalia has time and again tried to deflect the blame on late professor Tendulkar (who recommended the current poverty line) I think the most appropriate place to begin would be the Tendulkar Poverty Line. Then we will briefly go into its merits and demerits.

How did Tendulkar come up with that Rs. 26 line?

Ok, initially in India the poverty line was 2400 kcal (kilo calories – a measure of energy) in rural areas and 2200 kcal in urban areas. This means that if your expenditure is such that you buy enough food which gives you more than this amount of calories, you are not poor. They have a list of amount of calories one kg of rice, wheat, bajra etc. gives. An agency called NSSO conducts surveys (every 5 years) in which they ask people how much they spent and on what (in last ‘few’ days). From this data you can find out how many people were able to buy that minimum nutrition or more and those who couldn’t are your poor. So (roughly) what Planning Commission did was it took 1973-74 NSSO data, arranged the expenditure (from lowest to highest), took the cutoff which met the 2400 kcal criteria and saw what items the person consumed. The basket of these items became the Poverty Line Basket (PLB) and it remained the same till Prof Tendulkar.

Now comes Prof. Tendulkar. Following is what he did:

1. Change in poverty line basket (PLB): He said (perhaps rightly) that the Poverty Line Basket is too old. While economy has grown, the consumption basket of poor has remained unchanged from 1973-74! So let us use the basket as revealed by the 2004-05 data (this was the year of the latest survey Prof. Tendulkar had).

2. Departure from calorie based poverty line: Then he argued that the nutritional status based on NSSO data set didn’t correlate well with the nutritional outcomes of more specialized surveys (for instance if the malnutrition survey reveals that 42% population is suffering from malnutrition then logically they ought to be poor so NSSO data should capture them as poor. But it didn’t.). Also the new consumption basket of poor in 2004-05 was no more dominated by food items. It includes manufactured goods, education, fuel, rent etc. as well. So calorie approach is not suitable. (Now comes the most controversial part!)

3. Continuity with earlier poverty line: He makes a subjective decision and says, “There was lot of controversy over rural poverty line of 2004-05 (which was given by the earlier method). But there was less controversy over urban poverty line. So in the new approach, I am going to keep the urban poverty line same and change only the rural line accordingly.” This means that if earlier urban poverty line said 25.7% of urban people were poor, the new line would also keep 25.7% of urban people as poor. But note the Poverty Line Baskets have changed (earlier line used 1973-74 basket and the new line uses 2004-05 basket). We already have the basket for 1973-74. We need to find out the corresponding basket for 2004-05 which leaves 25.7% urban people as poor. The committee decided to arrange expenditure data (of 2004-05) of urban consumers in ascending order and found the basket which corresponded to 25.7% poor. Thus urban poverty was kept same. Next, for rural poverty, the same urban basket (2004-05) was used since it was believed that urban consumption basket is superior to the rural basket (i.e. urbanites consume more lavishly than rural people) .

4. Updating poverty line after 2004-05: In the years when NSSO conducts the survey again (2009-10, 2014-15, 2019-20) prices per unit can be calculated from NSSO data itself (it contains total quantity consumed as well as total expenditure on it. So divide them to get unit prices). Such prices can be applied on same basket to arrive at new poverty lines. In years when there is no NSSO data, use disaggregated inflation indices (if lets say inflation index tells us wheat prices have gone up by 10% and weight of wheat in poverty line basket (not the inflation index basket!) was 50% then multiply 10% by 50%).

Why what Prof. Tendulkar did was not all bad?

1. We have a Public Distribution System (PDS): Rs. 26 sounds ridiculous, can’t deny that. I don’t know probably it can’t even buy 1 kg of wheat (apologies, I really don’t know and I may be ridiculously wrong here)? Prof. Ahluwalia is supposed to know it however and its his duty not to make such ridiculous mistakes. But wait… what if the poor get wheat at Rs. 2 per kg, what if their children study in a school which charges only Rs. 10 per month and what if the fuel they use is not the Rs. 361 per cylinder LPG but is free of cost wood or Rs. 2 per litre kerosene? If that is so, their expenditure data itself will show lower expenses! (He will say I spent Rs. 20 per on wheat, Rs. 5 on sugar, Rs. 15 on fuel per month and was able to buy enough food to give me 2400 kcal. I am not poor.) In India PDS gives cheap stuff and if 25.7% of urbanites make use of PDS, their expenditure will rank as the lowest 25.7% and the poverty line so fixed will be (ridiculously according to most of us) low – no one can deny it. Perfectly acceptable, can’t blame Prof. Tendulkar or Prof. Ahluwalia. Where is the problem? We will cover in the next section.

2. If its low its not his fault: I can’t think of any way Prof. Tendulkar tried to lower the poverty line. One (livable) argument I can think – he used same urban and rural poverty baskets, urban baskets may contain stuff like fuel and rent which is free of cost in villages and hence village poverty line may come lower. But remember he decided to keep the number of urban poor as same from earlier poverty line? So this means that if the earlier poverty line underestimated poverty than that error would be propagated in Prof. Tendulkar’s line as well. So while one can’t fault him for “keeping the line so low” one can definitely fault him for not using the opportunity to correct “all errors” in the earlier line. (I haven’t been able to go through the earlier methodologies so far, if anything interesting comes up will post it here.)

3. As a sanity check, Prof. Tendulkar worked out hoe many calories these new lines correspond to? He found its 1776 kcal in urban areas which is close to what Food and Agriculture Organization (UNO agency) has recommended for India (1770 kcal). So its ok.

What were the bad things Prof. Tendulkar did?

1. Question of how to account for cheap PDS stuff: As we discussed earlier that if lets say the state is giving cheap food then expenditure data for people who are covered will show that a lower expenditure is sufficient to get adequate nutrition. But this is very harsh on people who get excluded! Because they don’t buy wheat @ Rs. 2 per kg, they have to buy it @ Rs. 26 per kg (?). Given the state of errors and corruption in public distribution system, this error is a serious error.
2. Change in baskets / consumption patterns: Prof. Tendulkar said if people are consuming less food in 2004-05 then we should respect their choice. Fine, but a part of this change is non voluntary as disguised employment and unemployment will lead to less demand for calories. But the less calorie intake in such a situation doesn’t reduce the poverty!

3. FAO argument: I personally think FAO argument was most ridiculous (close to a fraud). FAO norms he mentioned correspond to that of sedentary work for a 50 kg man and a 45 kg woman. Poor don’t do sedentary work (meaning office work – sitting idle). If instead we take norms for moderate work it is some 500 kcal higher and if we take heavy work it is 1200 kcal higher. For a 60 kg man doing moderate work average requirement is 2800 kcal and for heavy work it is 3500 kcal (according to FAO only). Poor people lift loads they don’t type on a computer.

Hope the above helps!