Economics and I

Economics and I:

Can’t say we are “one for all & all for one” but yes, we do manage.

A busy Sunday indeed! Had an assignment to submit – some patchy write up on Current scenarios of Indian IT industry – threats & opportunities and why they should go towards “moving up” the value chain and blah blah blah … Well, submitted something.

Then we were supposed to attend two lectures by Dr. C Rangarajan on Macroeconomics & Policy Instruments (4 hours on a Sunday!!!). Was mentally ready for some heavy dose of eco but not this heavy !!! But, overall I liked the lecture. Doc is a great speaker and obviously knows what he is talking about.

Something about him – for those who don’t know who I am talking about (probably the innocent majority!!!). So, here it goes. Dr. Rangarajan is a PhD in economics from Wharton Business School. He was then involved with IIMA as faculty for quite some time before he was appointed by the P V Narsimha Rao government as the RBI Governor in 1992 – at the peak of the economic reforms (so, here was a man who had seen it all and done it all). Subsequently, he held numerous posts including the Governor of Andhra Pradesh, Chairman of the Finance Commission & finally he was appointed the Chief Economic Advisor to the Prime Minister (no wonder he teaches on Sundays!!!!).

So, now back to the sessions. The sessions were primarily to discuss Policy interventions – the basic questions being the Why & the How. For the layman, Policy interventions are instruments to change the behaviour of the economy. By behaviour I mean, the direction of growth of the economy.

There are basically three issues that any government is bothered about (or should be bothered about!!). They are – the level of output (or growth in output), employment & inflation. By level of output, we basically refer to something called as business cycles. In brief, business cycles are periods of growth & stagnation in any economy. Any policy making authority of a country is bothered about both the absolute growth of the economy & the stability of the growth. Governments of developing economies are more concerned about growth than stability while it is the reverse for developed economies. In terms of employment, the government is concerned about whether the growth in the economy is creating an equivalent number of jobs or not. Inflation is I guess fairly clear to all – the rapid increase in price levels in the economy.

Dr. Rangarajan attempted to discuss the need to study Macroeconomics (deals with groups) – especially since we also study Microeconomics (deals with individuals). He expressed it as something called as: “Fallacy of composition”. It is defined as – “what is true of an individual need not be true for the aggregate”. I will attempt to explain in simple terms. If you are standing as a part of a crowd, none of you can see clearly ahead (as every body’s vision is equally blocked). However, if you decide to stand on a chair, you will obviously be able to see well. Now, if everybody decides to emulate you (copy you) then will everybody be able to see better? Obviously no!! Because now you all are again equally handicapped!!! So, what was good for one (you alone) is no good when considering the aggregate.

He then went on to discuss the differences between the Socialist & Capitalist systems & the tradeoffs. I will not go into those details here. The conclusion is something that bothers most people though and so I will touch upon that. Dr. Rangarajan suggested that (& I tend to agree) in the early stages of the economy, it is required to meet the basic needs of the people (roti, kapda aur makan !!!!) and so the central planner knows enough about the economy and so the socialist system works well. However, when the basic needs are already satisfied, higher needs assume importance (aka Maslow’s hierarchy – in case you don’t know – wait, I will cover it some other time) and now it is a matter of choice. For eg., which kind of car to produce or which shade of red to produce? These decisions are any day made more efficiently by the market. This was the primary reason why the Soviet economy could no longer be sustained on central planning. In fact, the Indian system of a Mixed economy is the most popular form of economy in the world. Even the US is not entirely capitalistic & the government plays a major role as a spender (consumer).

However, what should be whose role is obviously a subject of debate. People often wonder as to why can’t economists ever concur. Dr. Rangarajan had a simple answer. He said that if you put five economists together, you will end up with six views on the same issue. The sixth came because one of them decided to revise his view point!!!

We went on to discuss the various theories that make up modern economics book of knowledge – primarily the Keynesian view & the Classical view. An interesting read is the “Marginal propensity to consumption” & its impact on the economy – through its multiplier effect. The marginal propensity represents the proportion of our increased income that we decide to consume!!! Say, your salary goes up by 100 Rs and your marginal propensity to consumption is 80%. So, you save 20 & consume 80. This 80 is actually somebody’s income & suppose he too consumes 80% of it (64 Rs). This in turn goes to the next person who too consumes 80% of his income & so on. We see that this is actually a decreasing geometric progression and results in overall increase in wealth of the economy (far greater than the initial 100). The assumption is that the actual production level of the economy also went up by the exact amount – or else the 100 would only be the saving. Ok. For those who didn’t follow a word – your increased income becomes somebody else’s income when you spend it and somebody else’s when he / she spends it and so on. This is the multiplier effect.

Keynesian’s used to believe that government policies should be ensure that its actions result in something opposite to that happening in the economy – counter cyclical steps. When the economy is growing rapidly, reduce govt. expenditure & when economy is stagnating, increase govt. expenditure. This is something that we have seen countless number of times in India. Of course, it doesn’t work. It is only tax payer’s money down the drain.

The other option with the government is to increase the money supply. This it does by reducing the interest rates for the banks. If money supply goes up, availability of money for borrowing goes up and so interest rates, which are the cost of borrowing, have to go down. This is bound to increase investments by companies & thus increase the total output level of the economy & thus stimulate growth. How ever, all these ideas hold truw only if the economy is not expecting the govt. to reduce interest rates or it will have already factored it in!! This is referred to as the “Theory of Rational expectation”.

He then went on to discuss the major roles of the government in an economy. They are – producer of marketable goods (commanding heights of the economy), a regulator & a provider of public goods / merit goods. The first role (existing in India) is on the wane while the other two will always remain. Govt. regulation is required in industries where the failure of one institution can affect many others (eg. Bank). While, merit goods are marketable goods where the social benefit is more than the private benefit (eg. Schools). The modern view is that where ever markets can do better, they should be left alone to do so. The government’s ultimate role is to ensure that a competitive environment is maintained in the economy – by means of legislations & proactive measures (eg. Anti – trust legislations).

In short – more market does not mean less government. It means a better government in a market complementary role.

Another important discussion that he had was on “money”. The fundamental question is – what is money? Money is a medium of exchange & storage of value. Something can serve as a medium for exchange only if it is scarce – for eg. Gold. If it is freely available, then anybody can easily make it and use it (& its value would drop to zero).

Doc spoke about a doctor as an example of the role of money. A doctor had successfully treated a lady. When she got well, she went to him to thank him and was at a loss of words to do so. She kept saying she didn’t know how to thank him. The doctor replied curtly – “Your problem was solved the day money was invented”!! For those who didn’t get the joke – don’t worry!!!

He then went on to discuss the elements of the monetary policy. In between he paused to define the differences between recession (the opposite of inflation) & depression (acute & chronic recession). As usual, he had an easy way of defining it. He said that – “if your neighbor is unemployed then we are probably going through a recession and if you are unemployed then we are definitely doing through a depression”. So much for economics definitions!!

That’s all for today I guess. I will discuss the monetary policy & functions of the Central Bank in greater detail in the next entry. Before I sign out though, I will leave you all with a basic definition of the role of the RBI Governor. The predecessor to Dr. Rangarajan (I distinctly don’t remember his name) was once traveling by train to some where & he had a particularly nosy person sitting close by. This man kept on pestering him with questions on who he was & what he did for a living, etc etc. This governor obviously did not want to disclose as to who he really was and so gave the following simple answer – “I am a writer. I write a short note & then sign it. It is widely circulated in the whole of India”.

So, with that note I bid good night.