December 2009
Global Financial Crisis and economic recession was in full grip by December 2008. Continued State interventions in the financial, commodities, trade and exchange rate markets by various countries including the US and China ultimately caused the crisis. The Governments are now bailing out the credibility of the political institution called Legislature and Government through massive Quantitative Easing, fiscal stimulus and near-zero interest rate policy to revive, of all things, the market mechanism that was earlier distorted by prodding imprudence in the name of homeownership to all, employment through production of cheaper goods sold abroad on easy credit (massive trade surpluses and arbitrarily fixed exchange rates) and piling up petro-dollar State coffers through production controls. It will probably take the entire 2009 before the efforts of different governments cause markets return to normalcy. There is every possibility however that the States (Governments) will soon get into protectionism and delay the return of normal market operation, the much needed development of properly regulated, transparent markets for contracts against contingencies to enhance the efficiency and effectiveness of market mechanism, and the economic recovery.
Meanwhile, cross-border terrorism driven out from the West is spreading fast in some countries in the East that chose to remain backward on terrorism-control technology and management, as part of their soft stance that encouraged the terrorists.
Hopefully, more determined efforts to eliminate terrorism from the Planet will get momentum in the East. That would be necessary for early economic revival and eradication of poverty. Corporate managements would be looking for opportunities to add value to terrorism-control economic activities and help protect and create wealth for the human civilization.
If 2008 had been a year of distress, 2009 may ultimately bring the signs of economic revival and peace throughout the World.
Tuesday, April 7, 2009
Amusement Economics 001
[This serial is essential a dialogue between a Guru and Student where the student
speaks more than the Guru. As usual the content may appear close to being
non-sense. But that’s the way the World is and therefore so funny, interesting and
enjoyably entertaining. The serial will continue for some time]
G: We discussed a few economics issues as illustration of Stochastic
Destiny Principle. But today we explore economics as a source of amusement.
S: Yes, people deal with what is referred to as Economics in interesting ways. We
are destined to use knowledge of economics often to yield fun and entertainment.
G: That applies to all knowledge. Knowledge allows man to create and enjoy fun and
entertainment.
Inclusive Economics
S: True. But Economics is special. It offers unlimited scope for fun and entertainment even
when we do not want to use Economics for fun and entertainment (rather, even when
we believes that we are using the knowledge of economics for serious and meaningful
purposes).
G: You need to illustrate this.
S: That is the whole purpose of today’s discussion. As we go along, we will use illustrations
and examples.
G: Let us start with some preliminaries. First, let us try to find out what is economics and who
are the economists?
S: Suggest some definition please.
G: Economics is the study of mankind in ordinary business life.
S: So, as part of economics, one can study anything about mankind so long it is nothing
non-business or extra-ordinary business. That is as good as studying everything on earth.
There is hardly anything that the mankind does is not either as part of ordinary business
life or that is without any impact or influence on ordinary business life.
G: There is another definition. Economics deals with allocation of scarce resources to
alternative, competing uses to maximize satisfaction of man or society.
S: It means so long as scarcity of resources exits and multiple uses of the same resources are
possible, economics is applicable. Is there anything that mankind does that does not
involve dealing with scarcity and choice among alternative means and uses? So, economics
seems applicable in all spheres of life. All knowledge is therefore linked to economics.
G: But does economics have so much content?
S: Yes, it does and it is always expanding its scope. Earlier academic economists used to talk
about Principles of Economics in the context of specific economic problems/ phenomenon.
The classification in economics was based on schools of thought: classical economics,
neo-classical economics, marginalist school, Kenesian economics and so on. Later on area of
interest developed new classification, micro-economics, macro-economics, monetary
economics, international trade, welfare economics, mathematical economics, public
economics, and so on. Now, you get to hear about specialization in specializations that together cover
practically everything: health economics, economics of education, engineering economics,
environmental economics, managerial economics, financial economics, economics
of intellectual property, urban/ rural economics, agricultural economics, housing economics,
infrastructure economics, petroleum economics, energy economics, behavioral economics,
development economics, economics of poverty, transport economics, and so on.
G: Let us grant all pervasive and inclusive characteristic of economics for the sake of argument. Now, lets find
out the economists.
The Economist Being
S: Almost every individual is an economist. Everyone deals with scarcity of resources, alternative
uses of resources and choices. So everyone is a practicing economist of sort.
G: Doesn’t such a definition apply to physics, chemistry, engineering, geography, philosophy,
mathematics, medicine, politics and other fields of knowledge. Almost all individuals are
physicists, chemists, engineer, mathematicians, geographer, philosopher, political analyst,
accountant, doctor and so on?
S: Not really. It is difficult to become a physicist without being strong in mathematics or a
formal training or education in physics. Many may observe doctors prescribing medicine
to different patients over time. On that basis, they may even offer medical advice to friends.
They may be acting like pseudo-doctors. But they are never regarded as doctors and they
would seldom believe that they have really any knowledge of medicine. No one can serve
as an engineer without acquiring formal training in engineering.
G: What is different for economists?
S: To be an economist, one need not have to have a formal training or education in economics
or any other discipline. Indiviuals have to act as economists and most people consider
themselves as economists of some sort, irrespective of the extent of their knowledge and
education in economics.
G: Why do individuals need to do so?
S: There are a number of reasons. First, individuals are now increasingly realizing that
economics is some sort of a mix of natural and artificial system. So long most people
believed that individuals economic condition depended on the pious intentions and honest
efforts of the State (Govt. / Ruler/ King/ Dictator). But recent events have shown how corrupt and
inefficient the State most often is. People has realized how incompetent the State can be in
dealing with the economic problems faced by the individuals and households. People are
increasingly finding the State helpless and powerless against economic events adversely
or favourably affecting the economic conditions of the individuals.
G: Is that true? Are people in general aware?
S: Certainly most people are not in full realisation of the truth of powerlessness of the State.
They are only observing the instances of the hapless tiger position of the State and still
need the protection of a belief, however illusive and false, that the State must be all powerful
like the God almighty as projected by the devotees of the God. Many who believe in God
and pray to Him continue to cling to the God despite going through hardships that seem
unending. They do so merely because they feel miserable without a belief in someone all
powerful who can rescue them from their sufferings. Similarly, most individuals still believe
in almighty State because without such a belief they feel helpless and miserable.
G: In that case what are individuals doing?
S: They are increasingly getting afraid that the artificial institution called Govt. is corrupt,
dishonest, incompetent and above all really powerless to control economic events or
bring about the desired economic results they expect the State to produce. They still
nurish a hope that the State may become less corrupt, more honest, more capable and
develop power to control economic events or their impacts. But in their hearts they see
the writing on the wall.
G: How is this happening now?
S: Because of the progress of technology, increasing cross border relationships among people
of different countries and the differences in economic conditions of people in different
countries. The TV and the internet have made individuals to develop an international
perspective. The Press and the Media covers the entire World as if everything is local news.
People are traveling abroad and making cross border economic and financial transactions.
People are not only using domestic currencies and bank accounts, they are becoming
familiar with foreign currencies, goods, banks. They have become conscious of the economic
conditions and change in various countries, thanks to the Media.
G: What is the result of all this?
S: People have come to know that there is strong interdependence of economic conditions and
economic events across the World and the State has no power to control what happens
elsewhere. Even they are witnessing the continuous failure of the State even to control what
happens within a country in the economic sphere.
G: How are they responding to these findings and realizations?
S: They are trying to make them more competent and capable in dealing with the economic
problems individually and in groups. They are learning how to enhance their interest by
being smarter than the paper-tiger State. Earlier the individuals depended on the State. Now
they are trying to use the institution of the State in their own self-interest. To do so they need
to become economist or rather the rational economic being.
G: How are ordinary people trying to become the Economic Beings or the Economist?
S: Common people are simply asking questions that academoc economists have been long
trying to answer. Common people are trying to know what has been the domain of academic
and professional economists.
G: Without formal education and training in economics, how will they know the answers?
S: That is an important but separate issue. But they are trying to know and form their own
opinions about what could be the truth. Today, young people in the richest countries
are asking whether we are slaves of the economy or we can control the behaviour of the
economy in a desired direction. They are asking why jobs have started shifting from one
country to another. Why some currencies are becoming stronger and why others are
becoming weaker? Why some countries can keep their currencies pegged? Why foreigners
from poor countries are allowed to work in the rich countries? Why are some 1% of the
population is so wealthy and why poverty afflicts poor nations? How does the spending
millions of dollars by a few wealthy persons on space trip affect the common peoples’ lives?
Why interest rates change and cannot remain constant? Why should the values of their
homes they are most unlikely to sell rise rapidly and then crash?
G: Why should they ask such questions? What is their motivation to know?
S: Because they suspect that answers to these questions will help them understand
whether and how far their economic conditions and life are related to these issues. They
want to know whether the someone can control the behaviour of economic variables
to protect them from adverse effects of such movements in economic variables.
G: But these simple questions are so simple to answer. Nor are the answers easy to
comprehend.
S: You are right. But they feel the need to know and indeed they really need to know instead of
being fooled by false promises and explanations of politicians, columnists and economic
administrators and getting confused by the rigorous analytics of the academic economists
and economic policy experts. It would never be easy to decipher the truth. But it would be easy to
G: Maybe at this stage, we should examine some examples for a better appreciation of
these thoughts.
Govt. As Employment Generator
S: You are right. Let us take the case of employment.
Since the days of the Marxism-baked Soviet Economic Planning, Roosevelt’s New
Deal program after the Great Depression in the USA and the emergence of Keynesian
Multiplier theory, the economist in being have been brought up in the faith that the Govt.
can lift employment level in the country through macro-economic policies. And, this
belief continues in the face of failure of Govt.s to create productive and sustainable
employment and the emergence of employment opportunities from sources that are far
removed from Govts.’ power and activity.
G: How can that be a belief among the academic economists and economic administrators?
S: But that is the truth. Govts. can raise taxes and use he proceeds to dole out income to
people who get employed without any productive job to do. But real employment is
generated and destroyed by the natural economic forces. The govts. and economic
administrators just take credit when employment increases and announces grandiose
plans when unemployment rate rises. This is true of all countries. It is the funniest but highly
profitable business that Govts. and economic administrators have developed. People needs
to believe that Govt. can and do create employment. This want is satisfied by the Govts. and
economic administrators for which they get fabulously paid.
G: I am sure you are joking. After all India has been implementing Five year Plans during the
last 55 years to increase employment and employment has been increasing. All advanced
countries use fiscal and monetary policies to ensure emplyment and output growth.
Are they fooling us?
S: We have a great desire to be fooled in this area. We cannot feel comfortable with the truth
that the creation and the level of employment is not within the control of human beings
and in particular these cannot be impacted by Govts’ effeorts. We derive considerable
satisfaction from the cultivation of the belief in Govts’ power to reduce unemployment. The
Govts. just deliver us that satisfaction by running a mechanism even if they really have no
such powers. This is the make believe world of fantasy without which people cannot live in
the modern day of uncertain economic conditions.
G: You seem to suggest that all this is fiction that modern human societies need to be
entertained with.
S: You are absolutely right. In India we have seen very rapid growth
of both high paying IT sector jobs as well as not so high paying ITES sector jobs. In USA
we have seen many ITES firms closing down and offshoring these business elsewhere
including in India. Both the US Govt. and the Indian Govt. could do nothing to stop this
economic phenomenon.
G: What has the Economist Individual observing and concluding from this?
S: Let us first talk about the US. Common Americans feel bad that jobs of on-line, real-time
cleint servicing, medical transcription, accounting entries and also software development for
American companies. For them it is disgraceful to American and most important a cause for
reduced employment and income opportunities for Americans. They want to know why this
could happen and why this could not have been stopped.
G: How will they know this? Even economic experts and academeics have different views
on this subject. Can layman understand all this?
S: But the layman need to know first whether they can rely on experts? Whether the
American companies are to blame for outsourcing? Whether Govt. could have stopped this
trend of outsourcing? And, whether outsourcing was really bad for the Americans?
G: What did they come to know?
S: They have come to know that outsourcing is good from American consumers point of view.
That it does not make economic sense to produce the outsourced services any more locally
in America. Just like America imports cheap clothing for their use, it is better to buy cheaper
ITES services from India. American labour is too expensive to produce these low value
added services any longer. That American labour can continue to maintain their standards
of living only if they can re-deploy themselves in relatively high value added industries.
G: How does this knowledge help them?
S: In many ways. They now have come out of the phobia of blaming American companies. They
are no more under the illusion that outsourcing was bad for Americans. They no more waste
much of their time and energy in pursuing with the believe that the American State/ Govt. can
stall outsourcing. They do no longer dream that the American Govt. is capable of finding
economic policies that would stall outsourcing without hurting the interests of American
consumers and workers. They are seeing the writing on the wall and preparing themselves for
alternative employment and income opportunities. They are becoming independent and
formulating their own individual strategies to protect their income and employment through
transition to newer areas of work. Politicians will now find it difficult to fool them that the Govt.
can and should stop outsourcing. This is emancipation from the clutches of politicians and
columnists.
G: Do all Americans have this understanding?
S: Surely not. But they have started suspecting that outsourcing is not bad and that it is
Better that the Govt. does not interfere with the decisions of the American enterprise to
outsource. It was great fun and entertainment that they have witnessed through the debates
among the columnists and politicians on both sides of the issue of outsourcing. They know
that the Truth lies somewhere else.
G: What fun and entertainment are the Indians enjoying?
S: Since Independence and particularly after central economic planning was introduced in India
in 1951, Indians have been brain-washed that they can do much to improve their economic
lot and it is only the Government of India along with the State-level Governments who
can only cause economic uplift of Indians. And, the Govts. would provide employment to all
through the mechanism of economic planning and control over economic activities.
G: And, Indian economy got into the quagmire created by this belief in the Govt.’s and
politicians’ super natural power to control economic conditions. For decades we continued
to give away more and more power and resources to the State and our econmy remained
slow moving and we remained among the poorest in the World. The entire savings of the
people of India in the form of bank deposits were deployed only as per the wishes of
the State and the State owned and manmaged 80% of industrial and infrastructure activities.
The State decided what to produce, how to produce, where to produce, how to distribute
the output and at what prices. And, yet year after year, the State failed to deliver rapid
economic growth and reduce the intensity of under-employment and unemployment. All
of a sudden as the software and others ITES sector demand from abroad created a
tremendous employment growth, thanks to the purely private entrepreneurial effort of some
non-resident Indians who returned home. This sector surged before the State could control
and thereby constrain rapid growth of employment and income in this sector. Today, the
govts. may try to take credit for this but everyone knows that this employment came because
the Americans and the Europeans gave this employment opportunity to Indians and other
Asians because that was economic for them and their Govts. had no real power to control this.
G: Fine but what is amusing in all this?
S: It is amusing that the people continue to believe that Govts. can create employment for
people with their economic, administrative and legislative powers while this is not what
really happened. How blind is the faith in Govts as economic magicians!. This is true of
both Indians and American.
G: And, this continues not because people are not aware of the economic laws but
because everyone thinks that he or she is a good economist. Even they criticize
standard economic theories that according to them fail to explain their own behaviour
of dependence on Govt. as the God to fulfill their economic aspirations. It is surprising
that the standard economic theories failed to explain the power of the wish
“ Govt. bless you” as the source of economic growth, development and prosperity.
Only if the Govt. blesses people, people will get employed or get their employment
secured/ protectected.This is an amazingly strong belief that most economist citizens
share across the Globe. What can be more amusing!
S: Economics is such a wonderful source of fun and entertainment when you leave standard
Positive economic theories out and everyone becomes a Normative economists. Jobs get
Allocated between Americans and Indians as per the laws of positive economics, but
economist citizens in both countries thank or blame the Govt. for getting/ losing jobs.
speaks more than the Guru. As usual the content may appear close to being
non-sense. But that’s the way the World is and therefore so funny, interesting and
enjoyably entertaining. The serial will continue for some time]
G: We discussed a few economics issues as illustration of Stochastic
Destiny Principle. But today we explore economics as a source of amusement.
S: Yes, people deal with what is referred to as Economics in interesting ways. We
are destined to use knowledge of economics often to yield fun and entertainment.
G: That applies to all knowledge. Knowledge allows man to create and enjoy fun and
entertainment.
Inclusive Economics
S: True. But Economics is special. It offers unlimited scope for fun and entertainment even
when we do not want to use Economics for fun and entertainment (rather, even when
we believes that we are using the knowledge of economics for serious and meaningful
purposes).
G: You need to illustrate this.
S: That is the whole purpose of today’s discussion. As we go along, we will use illustrations
and examples.
G: Let us start with some preliminaries. First, let us try to find out what is economics and who
are the economists?
S: Suggest some definition please.
G: Economics is the study of mankind in ordinary business life.
S: So, as part of economics, one can study anything about mankind so long it is nothing
non-business or extra-ordinary business. That is as good as studying everything on earth.
There is hardly anything that the mankind does is not either as part of ordinary business
life or that is without any impact or influence on ordinary business life.
G: There is another definition. Economics deals with allocation of scarce resources to
alternative, competing uses to maximize satisfaction of man or society.
S: It means so long as scarcity of resources exits and multiple uses of the same resources are
possible, economics is applicable. Is there anything that mankind does that does not
involve dealing with scarcity and choice among alternative means and uses? So, economics
seems applicable in all spheres of life. All knowledge is therefore linked to economics.
G: But does economics have so much content?
S: Yes, it does and it is always expanding its scope. Earlier academic economists used to talk
about Principles of Economics in the context of specific economic problems/ phenomenon.
The classification in economics was based on schools of thought: classical economics,
neo-classical economics, marginalist school, Kenesian economics and so on. Later on area of
interest developed new classification, micro-economics, macro-economics, monetary
economics, international trade, welfare economics, mathematical economics, public
economics, and so on. Now, you get to hear about specialization in specializations that together cover
practically everything: health economics, economics of education, engineering economics,
environmental economics, managerial economics, financial economics, economics
of intellectual property, urban/ rural economics, agricultural economics, housing economics,
infrastructure economics, petroleum economics, energy economics, behavioral economics,
development economics, economics of poverty, transport economics, and so on.
G: Let us grant all pervasive and inclusive characteristic of economics for the sake of argument. Now, lets find
out the economists.
The Economist Being
S: Almost every individual is an economist. Everyone deals with scarcity of resources, alternative
uses of resources and choices. So everyone is a practicing economist of sort.
G: Doesn’t such a definition apply to physics, chemistry, engineering, geography, philosophy,
mathematics, medicine, politics and other fields of knowledge. Almost all individuals are
physicists, chemists, engineer, mathematicians, geographer, philosopher, political analyst,
accountant, doctor and so on?
S: Not really. It is difficult to become a physicist without being strong in mathematics or a
formal training or education in physics. Many may observe doctors prescribing medicine
to different patients over time. On that basis, they may even offer medical advice to friends.
They may be acting like pseudo-doctors. But they are never regarded as doctors and they
would seldom believe that they have really any knowledge of medicine. No one can serve
as an engineer without acquiring formal training in engineering.
G: What is different for economists?
S: To be an economist, one need not have to have a formal training or education in economics
or any other discipline. Indiviuals have to act as economists and most people consider
themselves as economists of some sort, irrespective of the extent of their knowledge and
education in economics.
G: Why do individuals need to do so?
S: There are a number of reasons. First, individuals are now increasingly realizing that
economics is some sort of a mix of natural and artificial system. So long most people
believed that individuals economic condition depended on the pious intentions and honest
efforts of the State (Govt. / Ruler/ King/ Dictator). But recent events have shown how corrupt and
inefficient the State most often is. People has realized how incompetent the State can be in
dealing with the economic problems faced by the individuals and households. People are
increasingly finding the State helpless and powerless against economic events adversely
or favourably affecting the economic conditions of the individuals.
G: Is that true? Are people in general aware?
S: Certainly most people are not in full realisation of the truth of powerlessness of the State.
They are only observing the instances of the hapless tiger position of the State and still
need the protection of a belief, however illusive and false, that the State must be all powerful
like the God almighty as projected by the devotees of the God. Many who believe in God
and pray to Him continue to cling to the God despite going through hardships that seem
unending. They do so merely because they feel miserable without a belief in someone all
powerful who can rescue them from their sufferings. Similarly, most individuals still believe
in almighty State because without such a belief they feel helpless and miserable.
G: In that case what are individuals doing?
S: They are increasingly getting afraid that the artificial institution called Govt. is corrupt,
dishonest, incompetent and above all really powerless to control economic events or
bring about the desired economic results they expect the State to produce. They still
nurish a hope that the State may become less corrupt, more honest, more capable and
develop power to control economic events or their impacts. But in their hearts they see
the writing on the wall.
G: How is this happening now?
S: Because of the progress of technology, increasing cross border relationships among people
of different countries and the differences in economic conditions of people in different
countries. The TV and the internet have made individuals to develop an international
perspective. The Press and the Media covers the entire World as if everything is local news.
People are traveling abroad and making cross border economic and financial transactions.
People are not only using domestic currencies and bank accounts, they are becoming
familiar with foreign currencies, goods, banks. They have become conscious of the economic
conditions and change in various countries, thanks to the Media.
G: What is the result of all this?
S: People have come to know that there is strong interdependence of economic conditions and
economic events across the World and the State has no power to control what happens
elsewhere. Even they are witnessing the continuous failure of the State even to control what
happens within a country in the economic sphere.
G: How are they responding to these findings and realizations?
S: They are trying to make them more competent and capable in dealing with the economic
problems individually and in groups. They are learning how to enhance their interest by
being smarter than the paper-tiger State. Earlier the individuals depended on the State. Now
they are trying to use the institution of the State in their own self-interest. To do so they need
to become economist or rather the rational economic being.
G: How are ordinary people trying to become the Economic Beings or the Economist?
S: Common people are simply asking questions that academoc economists have been long
trying to answer. Common people are trying to know what has been the domain of academic
and professional economists.
G: Without formal education and training in economics, how will they know the answers?
S: That is an important but separate issue. But they are trying to know and form their own
opinions about what could be the truth. Today, young people in the richest countries
are asking whether we are slaves of the economy or we can control the behaviour of the
economy in a desired direction. They are asking why jobs have started shifting from one
country to another. Why some currencies are becoming stronger and why others are
becoming weaker? Why some countries can keep their currencies pegged? Why foreigners
from poor countries are allowed to work in the rich countries? Why are some 1% of the
population is so wealthy and why poverty afflicts poor nations? How does the spending
millions of dollars by a few wealthy persons on space trip affect the common peoples’ lives?
Why interest rates change and cannot remain constant? Why should the values of their
homes they are most unlikely to sell rise rapidly and then crash?
G: Why should they ask such questions? What is their motivation to know?
S: Because they suspect that answers to these questions will help them understand
whether and how far their economic conditions and life are related to these issues. They
want to know whether the someone can control the behaviour of economic variables
to protect them from adverse effects of such movements in economic variables.
G: But these simple questions are so simple to answer. Nor are the answers easy to
comprehend.
S: You are right. But they feel the need to know and indeed they really need to know instead of
being fooled by false promises and explanations of politicians, columnists and economic
administrators and getting confused by the rigorous analytics of the academic economists
and economic policy experts. It would never be easy to decipher the truth. But it would be easy to
G: Maybe at this stage, we should examine some examples for a better appreciation of
these thoughts.
Govt. As Employment Generator
S: You are right. Let us take the case of employment.
Since the days of the Marxism-baked Soviet Economic Planning, Roosevelt’s New
Deal program after the Great Depression in the USA and the emergence of Keynesian
Multiplier theory, the economist in being have been brought up in the faith that the Govt.
can lift employment level in the country through macro-economic policies. And, this
belief continues in the face of failure of Govt.s to create productive and sustainable
employment and the emergence of employment opportunities from sources that are far
removed from Govts.’ power and activity.
G: How can that be a belief among the academic economists and economic administrators?
S: But that is the truth. Govts. can raise taxes and use he proceeds to dole out income to
people who get employed without any productive job to do. But real employment is
generated and destroyed by the natural economic forces. The govts. and economic
administrators just take credit when employment increases and announces grandiose
plans when unemployment rate rises. This is true of all countries. It is the funniest but highly
profitable business that Govts. and economic administrators have developed. People needs
to believe that Govt. can and do create employment. This want is satisfied by the Govts. and
economic administrators for which they get fabulously paid.
G: I am sure you are joking. After all India has been implementing Five year Plans during the
last 55 years to increase employment and employment has been increasing. All advanced
countries use fiscal and monetary policies to ensure emplyment and output growth.
Are they fooling us?
S: We have a great desire to be fooled in this area. We cannot feel comfortable with the truth
that the creation and the level of employment is not within the control of human beings
and in particular these cannot be impacted by Govts’ effeorts. We derive considerable
satisfaction from the cultivation of the belief in Govts’ power to reduce unemployment. The
Govts. just deliver us that satisfaction by running a mechanism even if they really have no
such powers. This is the make believe world of fantasy without which people cannot live in
the modern day of uncertain economic conditions.
G: You seem to suggest that all this is fiction that modern human societies need to be
entertained with.
S: You are absolutely right. In India we have seen very rapid growth
of both high paying IT sector jobs as well as not so high paying ITES sector jobs. In USA
we have seen many ITES firms closing down and offshoring these business elsewhere
including in India. Both the US Govt. and the Indian Govt. could do nothing to stop this
economic phenomenon.
G: What has the Economist Individual observing and concluding from this?
S: Let us first talk about the US. Common Americans feel bad that jobs of on-line, real-time
cleint servicing, medical transcription, accounting entries and also software development for
American companies. For them it is disgraceful to American and most important a cause for
reduced employment and income opportunities for Americans. They want to know why this
could happen and why this could not have been stopped.
G: How will they know this? Even economic experts and academeics have different views
on this subject. Can layman understand all this?
S: But the layman need to know first whether they can rely on experts? Whether the
American companies are to blame for outsourcing? Whether Govt. could have stopped this
trend of outsourcing? And, whether outsourcing was really bad for the Americans?
G: What did they come to know?
S: They have come to know that outsourcing is good from American consumers point of view.
That it does not make economic sense to produce the outsourced services any more locally
in America. Just like America imports cheap clothing for their use, it is better to buy cheaper
ITES services from India. American labour is too expensive to produce these low value
added services any longer. That American labour can continue to maintain their standards
of living only if they can re-deploy themselves in relatively high value added industries.
G: How does this knowledge help them?
S: In many ways. They now have come out of the phobia of blaming American companies. They
are no more under the illusion that outsourcing was bad for Americans. They no more waste
much of their time and energy in pursuing with the believe that the American State/ Govt. can
stall outsourcing. They do no longer dream that the American Govt. is capable of finding
economic policies that would stall outsourcing without hurting the interests of American
consumers and workers. They are seeing the writing on the wall and preparing themselves for
alternative employment and income opportunities. They are becoming independent and
formulating their own individual strategies to protect their income and employment through
transition to newer areas of work. Politicians will now find it difficult to fool them that the Govt.
can and should stop outsourcing. This is emancipation from the clutches of politicians and
columnists.
G: Do all Americans have this understanding?
S: Surely not. But they have started suspecting that outsourcing is not bad and that it is
Better that the Govt. does not interfere with the decisions of the American enterprise to
outsource. It was great fun and entertainment that they have witnessed through the debates
among the columnists and politicians on both sides of the issue of outsourcing. They know
that the Truth lies somewhere else.
G: What fun and entertainment are the Indians enjoying?
S: Since Independence and particularly after central economic planning was introduced in India
in 1951, Indians have been brain-washed that they can do much to improve their economic
lot and it is only the Government of India along with the State-level Governments who
can only cause economic uplift of Indians. And, the Govts. would provide employment to all
through the mechanism of economic planning and control over economic activities.
G: And, Indian economy got into the quagmire created by this belief in the Govt.’s and
politicians’ super natural power to control economic conditions. For decades we continued
to give away more and more power and resources to the State and our econmy remained
slow moving and we remained among the poorest in the World. The entire savings of the
people of India in the form of bank deposits were deployed only as per the wishes of
the State and the State owned and manmaged 80% of industrial and infrastructure activities.
The State decided what to produce, how to produce, where to produce, how to distribute
the output and at what prices. And, yet year after year, the State failed to deliver rapid
economic growth and reduce the intensity of under-employment and unemployment. All
of a sudden as the software and others ITES sector demand from abroad created a
tremendous employment growth, thanks to the purely private entrepreneurial effort of some
non-resident Indians who returned home. This sector surged before the State could control
and thereby constrain rapid growth of employment and income in this sector. Today, the
govts. may try to take credit for this but everyone knows that this employment came because
the Americans and the Europeans gave this employment opportunity to Indians and other
Asians because that was economic for them and their Govts. had no real power to control this.
G: Fine but what is amusing in all this?
S: It is amusing that the people continue to believe that Govts. can create employment for
people with their economic, administrative and legislative powers while this is not what
really happened. How blind is the faith in Govts as economic magicians!. This is true of
both Indians and American.
G: And, this continues not because people are not aware of the economic laws but
because everyone thinks that he or she is a good economist. Even they criticize
standard economic theories that according to them fail to explain their own behaviour
of dependence on Govt. as the God to fulfill their economic aspirations. It is surprising
that the standard economic theories failed to explain the power of the wish
“ Govt. bless you” as the source of economic growth, development and prosperity.
Only if the Govt. blesses people, people will get employed or get their employment
secured/ protectected.This is an amazingly strong belief that most economist citizens
share across the Globe. What can be more amusing!
S: Economics is such a wonderful source of fun and entertainment when you leave standard
Positive economic theories out and everyone becomes a Normative economists. Jobs get
Allocated between Americans and Indians as per the laws of positive economics, but
economist citizens in both countries thank or blame the Govt. for getting/ losing jobs.
Friday, January 23, 2009
Amusement Economics 002
[This is the second in the serial that began in August 2007 continuing the dialogue between
Guru and Student who lectures more and communicates close to weird ideas. But that’s
the way the World is and therefore so funny, interesting and enjoyably entertaining.]
G: Can we discuss the illusion of economics regarding the power of the Govt. a little more?
S: Sure. All the people want to be economist because they need to understand things that
affect their economic lives. But hardly a few have the put in the hard work required
to acquire knowledge. So, they accept economic ideas unverified provided they feel
comfortable with the idea and dump other ideas with which they are not comfortable
treating them as wrong. The truth or the theory is established by majority belief as in
democracy. That is how popular economics is what has developed in modern economies.
G: And, one of the theorems of popular economics is “ the government can and do change
the economic destiny of country and its people”.
S: You are right. This theorem is proved democratically i.e. most people vote for the
theorem. No other proof is required. And, no scientific, logical or empirical proof is
available so far. So, we go by the strength of the belief in the theorem in terms of
popular acceptance. And, popular acceptance is guaranteed. Just like medical or health
insurance or more appropriately life insurance, each person needs a protection from the
risks of the economy working in a manner that adversely affect employment or income
or wealth of a person. The concept and the acceptance of the theorem is such a kind of
insurance, though incomplete and largely illusive.
G: But economists and policy makers talk about macro-economic policies for economic
growth, inflation control, etc.
S: Yes, they do. Their business is to do that and satisfy the psychological need of the
people apprehensive of uncertain economy behavior. Even in free market advanced
economies, individuals from a quite early age get anxious about the stability of
income earning employment and sudden shocks of loss of current jobs due to
sudden recession, technological obsolescence, shift of consumer demand pattern and
international competition. They start feeling that they individually become the slaves
of something called ‘economy’. They seek a master of the economy. The Govt. fills in
this vacancy even if the govt. fails to dictate the economy.
G: Is it not possible to design a societal system that removes this uncertainty?
S: This is what Man wants to achieve: to become the master of the economy through the
institution of government. The progress of human civilization is all about trying to
become the Master of Nature and Master of the Economy. By trying to become does
not make you the Master. Scientific knowledge has helped Man to evolve technologies
to manage various risks originating in the Nature, but we are far from being Master of
the Nature.
G: You seem to suggest that the same is true of the struggle of Man against the Economy.
Those who are tonally afraid of fighting within the free market mechanism and individual
liberty, designed socialism, communism, state ownership of all resources, state led
economic planning, and so on. These concepts appeared to succeed for a while but their
grand failures for most of the time are now part of recorded history of economic
development of countries in Asia and Russia. Those who wished to fight within the free
market, so-called capitalist systems evolved the concepts of business cycles, aggregate
demand, insurance, welfare payments (unemployment doles), insurance, pensions,
fair labor laws, Keynesian income/ employment multipliers, macroeconomic management
through monetary and fiscal policies of the Govt., international economic cooperation
and economic aid. But even with all the long past experience in economy management,
Govts. in these economies are nowhere near of being in charge/ control of their
economies. But the effort at occupying the position of Master of the economy must
continue to maintain the illusion of certainty protection through Government and look
away from the inconvenient reality.
S: But the Govts. in modern economies do exercise tremendous power and dominance of
economic activities!
S: Yes, by exploiting the fear of uncertainty by individuals in general, the govts.
have acquired this great and dominating power only to do things
(implementing economic policies) but their power to yield real
results in terms of economic growth, economic stabilization, better
income and wealth distribution and most importantly in
raising economic efficiency, productivity and technological progress
has been very negligible. The economic growth, economic stability,
improved income distribution, rise in economic efficiency,
per capita income and productivity in the last 100 years are due mostly
to efforts and decisions of individuals and very little due to govt.
plans, policies and efforts. Govt. has just become another player in
the economy, a player of increasing great size but very little positive
net impact of the behavior of the economy.
G: You really mean that macro-economic policies of govts. or State
controlled economic planning had negligible impact.
S: Yes. Net impact has hardly been positive. One must remember that
when Govts. take certain measures, individuals respond to them in
various ways and not exactly in the way govt. assumes and
wants people to respond. The response of individual and
non-govt. economic entities interact with govt. response to produce
the actual results. Even a monopoly producer may not fulfill its
desire: it all depends on the response of large number of buyers.
In the case of Govt. policies, the response of the individuals may
be overt or covert and changes over time.
G: Are you talking of things like changes in inflationary expectations,
money illusion or effect of taxes on work effort that influence the
outcome of govt. policies?
S: Yes. But I am also referring to how talented, creative scientists
and technologists respond to govt. policies, systems and structures.
I am referring to individuals’ urge for doing things in their own
Ways rather than in govt. dictated ways. I am referring to withdrawal
by the most talented to commonweal just because of govt. dictates.
Individuals may have their own concept of sovereignty just like nations
Profess to have. You must have heard about the story of a king ordering/
Appealing to all households to contribute a mug of milk to the artificial
milk pond he has been constructing. He got few people pour milk, some
abstaining and some pouring water or water mixed with milk.
G: But after the Indian govt. changed the economic policies from those linked
to a closed, public sector dominated and bureaucracy-dominated,
non-competitive administratively controlled mechanism to those linked to
liberalized competitive market, open economy environment, India has
recorded very rapid economic growth. One must give credit to govt.
economic policies for this success.
S: Yes, the new policies have delivered for which if we give credit to Govt.,
we must be prepared to accept the great discredit to govt. that failed
with its economic policies for the 40 years 1951-1991. The period of
success is small compared with the 40 year period of grand failure that
led to bankruptcy of the Indian economy. More importantly, the Govt.
did not change its economic policies. In fact, they were most reluctant
to change. The change occurred because the Govt. did not know what to
do: so, they left doing what they were doing earlier. It is the natural forces
economics that brought the change. There is no way we can give credit to
Govt. had to do because they had no other choice.
G: So, you do not support the idea that Govts. and central banks implement
macro-economic, monetary and fiscal policies or State economic planning.
S: The issue is not about supporting the idea. The idea has evolved naturally
to solve the human need for security against economic risks to individuals.
There is no way you can stop this idea from being implemented if the
human civilization has to continue. However illusory and false, the govt.
guaranteed security against risks to individual/ family income and employment
is what the market (voters) demands and therefore gets. But I know that this is illusion.
All debates about what the govt. could do or should do to raise economic
growth, ensure stability, control inflation and reduce economic disparities
are intellectually stimulating and at the same time a source of amusement
because govt. policies and efforts are inefficient and ineffective in delivering
promised/ intended results most of the time. The risks remain despite the govt.
and often increases because of the govt. meddling in economic affairs.
G: I understand what you mean by amusement economics now. So why not
have some examples now.
S: Good idea. You know what common man economist think about the Keynesian
theory of multipliers.
G: Yes, it says if the Govt. increases spending, economy can expand and
grow by a multiple of that spending. For example if Govt. spends additional
X amount of money, income of the people in general increase by
an aggregate amount that is a few times of the amount of increase in govt.
spending. And this expansion results in additional employment.
S: How much does the National Income increase if the Govt. makes additional
spending of say $one billion?
G: That depends on the marginal propensity to consume (mpc) by households
and others. If mpc is 0.75, the multiplier under the simplest economic model
is 1/ (1- 0.75) or 4. The National Income would increase by $4 billion.
S: So, why doesn’t the Govt. increase its spending by say $ 100 trillion and
Increase National Income by $4 trillion every year?
G: I really do not know why Govts. do not employ this easy policy to economic growth.
Probably govt. needs to finance its extra-spending by printing money or taking loans
from the public or raise additional taxes. And, there may be difficulty here,
S: So, govt. is not as powerful as simple Keynesian economics suggests or the
economist in the common man would like to believe.
G: There are other economic theories which says too much printing of money may
cause high inflation, too much borrowing by Govt. may raise interest rates and
reduce private sector investments.
S: Fine, why not raise taxes to fund additional Govt. spending?
G: That can be done but increasing taxes will have a negative multiplier effect
on National Income.
S: Will that totally offset the positive multiplier effect of Govt. spending?
G: In terms of the simple Keynesian Income determination model, it will not.
A billion dollar increase in Govt. expenditure will increase income by $ 4 billion
and a S1 billion additional taxes will reduce income by 0.75/ (1-0.75) billion or
$ 3 billion. So the net effect of equal amount of increase in Govt. spending and
Taxes will increase income by $1 billion. Thus the balanced budget (Govt. spending
exactly matches Taxes) multiplier is always1.
S: That is excellent. Tax all incomes at 100% and spend the entire money back. You will
Continuously increase National Income.
G: You are joking! In such a situation what is the use of generating income if people
cannot consume anything, paying the entire income as taxes?
S: Ah, you are right. Then just tax all incomes at 75%. Still you will have continuous
income growth. It seems that is what the Communist or dictatorial regimes seem to do.
G: But, too high a level of taxation may hurt household
expenditure. People in democracies may object.
S: So, one popular economic policy of spending faces another unpopular policy. And,
The Govt. has to make a package that makes best selling to the people even if the
package finally delivers nothing. However, in state controlled dictatorships this does
not matter: nor does the people and their economic conditions matter much.
G: Yes, the same economic policy packages supported by ruling politicians at any time
are almost always opposed by the opposition parties.
S: This is because economics has two hands: While on the one hand, an economic policy
packages are popularly correct; on the other hand the same thing is popularly incorrect.
Is this not amusement?
G: How can you call this amusement? Economics is a complex subject and it is not so easy
to formulate the most appropriate economic policies.
S: Yes, such complex things are debated by people who have no formal training in
Economics and in any case by those whose credentials as students of economics is
highly suspect. And, decisions on complex economic matters are taken based on votes.
This is really interesting entertainment democratic nations engage in and pay
a high price for that without even knowing.
G: Economics is not like physical sciences and therefore one has to go by democratic
majority rule for deciding what are right and what is wrong.
S: Unfortunately, the results from economic policies are not chosen by votes or
democratic majority rule. But coming back to your multiplier
example. Why do not we make the mpc close to the number one? Then, even with a
small increase in govt. expenditure, one can get nearly infinite increase in national
income.
G: If mpc equals 1, then the multiplier becomes infinity. So a $1 billion increase in Govt.
spending will increase national income by infinite times. But, you cannot force people
to consume all of the incremental income. They will need to save for the future. So,
mpc cannot be equal to 1.
S: Ok. Then why not have mpc of 0.99? This will lead to increase in income by 100 times
of the Govt. expenditure. So you need not have a high Govt. expenditure and yet the
people will have considerable amount of savings because of a much higher level of
income despite a low savings rate of 1%.
G: You are in a joking mood. The Keynesian model is not so simple as you are trying to
make out. There are many underlying realistic assumptions we have to consider.
S: I understand that Economics is very complex subject. But the way the common
people, politicians and economic administrators discuss and come to conclusions
about appropriate macro-economic policies, the multiplier theory looks so simple.
And, that is why economics is a great source of amusement.
G: The general conclusion is that higher the mpc, higher is the multiplier.
S: That is interesting, the more people consume the higher is the income growth
produced per $ of govt. spending. But isn’t there another economic growth model
that emphasizes savings - something called Harrod-Domar Model that is Keynesian
in nature.
G: Yes. The lesson from Harrod Domar growth model is that national income growth
rate is equal to savings rate divided by the incremental capital output ratio (ICOR).
S: So, if the savings rate is higher, income growth rate becomes higher. If the savings
rate is 32% and the ICOR is 3.2, the income growth rate is 10%
G: If the savings rate increases to 38.4%, income growth rate will rise to 12%.
S: Here we find higher savings rate yielding higher income growth while in the
Multiplier Example we found higher consumption rate and lower savings rate yield
higher income growth. Economics is really amusing.
G: No, you are being mischievous somewhere! Both consumption and savings are
important. The ultimate objective however is consumption now or later: savings is
the bridge to transfer consumption from now to later.
S: The amusement offered by Keynesian Economics as practiced by the common
economist and politicians is enormous. We take up that again at appropriate time.
Let us stop today to keep something for the later..
Amusement Economics 002
[This is the second in the serial that began in August 2007 continuing the dialogue between
Guru and Student who lectures more and communicates close to weird ideas. But that’s
the way the World is and therefore so funny, interesting and enjoyably entertaining.]
G: Can we discuss the illusion of economics regarding the power of the Govt. a little more?
S: Sure. All the people want to be economist because they need to understand things that
affect their economic lives. But hardly a few have the put in the hard work required
to acquire knowledge. So, they accept economic ideas unverified provided they feel
comfortable with the idea and dump other ideas with which they are not comfortable
treating them as wrong. The truth or the theory is established by majority belief as in
democracy. That is how popular economics is what has developed in modern economies.
G: And, one of the theorems of popular economics is “ the government can and do change
the economic destiny of country and its people”.
S: You are right. This theorem is proved democratically i.e. most people vote for the
theorem. No other proof is required. And, no scientific, logical or empirical proof is
available so far. So, we go by the strength of the belief in the theorem in terms of
popular acceptance. And, popular acceptance is guaranteed. Just like medical or health
insurance or more appropriately life insurance, each person needs a protection from the
risks of the economy working in a manner that adversely affect employment or income
or wealth of a person. The concept and the acceptance of the theorem is such a kind of
insurance, though incomplete and largely illusive.
G: But economists and policy makers talk about macro-economic policies for economic
growth, inflation control, etc.
S: Yes, they do. Their business is to do that and satisfy the psychological need of the
people apprehensive of uncertain economy behavior. Even in free market advanced
economies, individuals from a quite early age get anxious about the stability of
income earning employment and sudden shocks of loss of current jobs due to
sudden recession, technological obsolescence, shift of consumer demand pattern and
international competition. They start feeling that they individually become the slaves
of something called ‘economy’. They seek a master of the economy. The Govt. fills in
this vacancy even if the govt. fails to dictate the economy.
G: Is it not possible to design a societal system that removes this uncertainty?
S: This is what Man wants to achieve: to become the master of the economy through the
institution of government. The progress of human civilization is all about trying to
become the Master of Nature and Master of the Economy. By trying to become does
not make you the Master. Scientific knowledge has helped Man to evolve technologies
to manage various risks originating in the Nature, but we are far from being Master of
the Nature.
G: You seem to suggest that the same is true of the struggle of Man against the Economy.
Those who are tonally afraid of fighting within the free market mechanism and individual
liberty, designed socialism, communism, state ownership of all resources, state led
economic planning, and so on. These concepts appeared to succeed for a while but their
grand failures for most of the time are now part of recorded history of economic
development of countries in Asia and Russia. Those who wished to fight within the free
market, so-called capitalist systems evolved the concepts of business cycles, aggregate
demand, insurance, welfare payments (unemployment doles), insurance, pensions,
fair labor laws, Keynesian income/ employment multipliers, macroeconomic management
through monetary and fiscal policies of the Govt., international economic cooperation
and economic aid. But even with all the long past experience in economy management,
Govts. in these economies are nowhere near of being in charge/ control of their
economies. But the effort at occupying the position of Master of the economy must
continue to maintain the illusion of certainty protection through Government and look
away from the inconvenient reality.
S: But the Govts. in modern economies do exercise tremendous power and dominance of
economic activities!
S: Yes, by exploiting the fear of uncertainty by individuals in general, the govts.
have acquired this great and dominating power only to do things
(implementing economic policies) but their power to yield real
results in terms of economic growth, economic stabilization, better
income and wealth distribution and most importantly in
raising economic efficiency, productivity and technological progress
has been very negligible. The economic growth, economic stability,
improved income distribution, rise in economic efficiency,
per capita income and productivity in the last 100 years are due mostly
to efforts and decisions of individuals and very little due to govt.
plans, policies and efforts. Govt. has just become another player in
the economy, a player of increasing great size but very little positive
net impact of the behavior of the economy.
G: You really mean that macro-economic policies of govts. or State
controlled economic planning had negligible impact.
S: Yes. Net impact has hardly been positive. One must remember that
when Govts. take certain measures, individuals respond to them in
various ways and not exactly in the way govt. assumes and
wants people to respond. The response of individual and
non-govt. economic entities interact with govt. response to produce
the actual results. Even a monopoly producer may not fulfill its
desire: it all depends on the response of large number of buyers.
In the case of Govt. policies, the response of the individuals may
be overt or covert and changes over time.
G: Are you talking of things like changes in inflationary expectations,
money illusion or effect of taxes on work effort that influence the
outcome of govt. policies?
S: Yes. But I am also referring to how talented, creative scientists
and technologists respond to govt. policies, systems and structures.
I am referring to individuals’ urge for doing things in their own
Ways rather than in govt. dictated ways. I am referring to withdrawal
by the most talented to commonweal just because of govt. dictates.
Individuals may have their own concept of sovereignty just like nations
Profess to have. You must have heard about the story of a king ordering/
Appealing to all households to contribute a mug of milk to the artificial
milk pond he has been constructing. He got few people pour milk, some
abstaining and some pouring water or water mixed with milk.
G: But after the Indian govt. changed the economic policies from those linked
to a closed, public sector dominated and bureaucracy-dominated,
non-competitive administratively controlled mechanism to those linked to
liberalized competitive market, open economy environment, India has
recorded very rapid economic growth. One must give credit to govt.
economic policies for this success.
S: Yes, the new policies have delivered for which if we give credit to Govt.,
we must be prepared to accept the great discredit to govt. that failed
with its economic policies for the 40 years 1951-1991. The period of
success is small compared with the 40 year period of grand failure that
led to bankruptcy of the Indian economy. More importantly, the Govt.
did not change its economic policies. In fact, they were most reluctant
to change. The change occurred because the Govt. did not know what to
do: so, they left doing what they were doing earlier. It is the natural forces
economics that brought the change. There is no way we can give credit to
Govt. had to do because they had no other choice.
G: So, you do not support the idea that Govts. and central banks implement
macro-economic, monetary and fiscal policies or State economic planning.
S: The issue is not about supporting the idea. The idea has evolved naturally
to solve the human need for security against economic risks to individuals.
There is no way you can stop this idea from being implemented if the
human civilization has to continue. However illusory and false, the govt.
guaranteed security against risks to individual/ family income and employment
is what the market (voters) demands and therefore gets. But I know that this is illusion.
All debates about what the govt. could do or should do to raise economic
growth, ensure stability, control inflation and reduce economic disparities
are intellectually stimulating and at the same time a source of amusement
because govt. policies and efforts are inefficient and ineffective in delivering
promised/ intended results most of the time. The risks remain despite the govt.
and often increases because of the govt. meddling in economic affairs.
G: I understand what you mean by amusement economics now. So why not
have some examples now.
S: Good idea. You know what common man economist think about the Keynesian
theory of multipliers.
G: Yes, it says if the Govt. increases spending, economy can expand and
grow by a multiple of that spending. For example if Govt. spends additional
X amount of money, income of the people in general increase by
an aggregate amount that is a few times of the amount of increase in govt.
spending. And this expansion results in additional employment.
S: How much does the National Income increase if the Govt. makes additional
spending of say $one billion?
G: That depends on the marginal propensity to consume (mpc) by households
and others. If mpc is 0.75, the multiplier under the simplest economic model
is 1/ (1- 0.75) or 4. The National Income would increase by $4 billion.
S: So, why doesn’t the Govt. increase its spending by say $ 100 trillion and
Increase National Income by $4 trillion every year?
G: I really do not know why Govts. do not employ this easy policy to economic growth.
Probably govt. needs to finance its extra-spending by printing money or taking loans
from the public or raise additional taxes. And, there may be difficulty here,
S: So, govt. is not as powerful as simple Keynesian economics suggests or the
economist in the common man would like to believe.
G: There are other economic theories which says too much printing of money may
cause high inflation, too much borrowing by Govt. may raise interest rates and
reduce private sector investments.
S: Fine, why not raise taxes to fund additional Govt. spending?
G: That can be done but increasing taxes will have a negative multiplier effect
on National Income.
S: Will that totally offset the positive multiplier effect of Govt. spending?
G: In terms of the simple Keynesian Income determination model, it will not.
A billion dollar increase in Govt. expenditure will increase income by $ 4 billion
and a S1 billion additional taxes will reduce income by 0.75/ (1-0.75) billion or
$ 3 billion. So the net effect of equal amount of increase in Govt. spending and
Taxes will increase income by $1 billion. Thus the balanced budget (Govt. spending
exactly matches Taxes) multiplier is always1.
S: That is excellent. Tax all incomes at 100% and spend the entire money back. You will
Continuously increase National Income.
G: You are joking! In such a situation what is the use of generating income if people
cannot consume anything, paying the entire income as taxes?
S: Ah, you are right. Then just tax all incomes at 75%. Still you will have continuous
income growth. It seems that is what the Communist or dictatorial regimes seem to do.
G: But, too high a level of taxation may hurt household
expenditure. People in democracies may object.
S: So, one popular economic policy of spending faces another unpopular policy. And,
The Govt. has to make a package that makes best selling to the people even if the
package finally delivers nothing. However, in state controlled dictatorships this does
not matter: nor does the people and their economic conditions matter much.
G: Yes, the same economic policy packages supported by ruling politicians at any time
are almost always opposed by the opposition parties.
S: This is because economics has two hands: While on the one hand, an economic policy
packages are popularly correct; on the other hand the same thing is popularly incorrect.
Is this not amusement?
G: How can you call this amusement? Economics is a complex subject and it is not so easy
to formulate the most appropriate economic policies.
S: Yes, such complex things are debated by people who have no formal training in
Economics and in any case by those whose credentials as students of economics is
highly suspect. And, decisions on complex economic matters are taken based on votes.
This is really interesting entertainment democratic nations engage in and pay
a high price for that without even knowing.
G: Economics is not like physical sciences and therefore one has to go by democratic
majority rule for deciding what are right and what is wrong.
S: Unfortunately, the results from economic policies are not chosen by votes or
democratic majority rule. But coming back to your multiplier
example. Why do not we make the mpc close to the number one? Then, even with a
small increase in govt. expenditure, one can get nearly infinite increase in national
income.
G: If mpc equals 1, then the multiplier becomes infinity. So a $1 billion increase in Govt.
spending will increase national income by infinite times. But, you cannot force people
to consume all of the incremental income. They will need to save for the future. So,
mpc cannot be equal to 1.
S: Ok. Then why not have mpc of 0.99? This will lead to increase in income by 100 times
of the Govt. expenditure. So you need not have a high Govt. expenditure and yet the
people will have considerable amount of savings because of a much higher level of
income despite a low savings rate of 1%.
G: You are in a joking mood. The Keynesian model is not so simple as you are trying to
make out. There are many underlying realistic assumptions we have to consider.
S: I understand that Economics is very complex subject. But the way the common
people, politicians and economic administrators discuss and come to conclusions
about appropriate macro-economic policies, the multiplier theory looks so simple.
And, that is why economics is a great source of amusement.
G: The general conclusion is that higher the mpc, higher is the multiplier.
S: That is interesting, the more people consume the higher is the income growth
produced per $ of govt. spending. But isn’t there another economic growth model
that emphasizes savings - something called Harrod-Domar Model that is Keynesian
in nature.
G: Yes. The lesson from Harrod Domar growth model is that national income growth
rate is equal to savings rate divided by the incremental capital output ratio (ICOR).
S: So, if the savings rate is higher, income growth rate becomes higher. If the savings
rate is 32% and the ICOR is 3.2, the income growth rate is 10%
G: If the savings rate increases to 38.4%, income growth rate will rise to 12%.
S: Here we find higher savings rate yielding higher income growth while in the
Multiplier Example we found higher consumption rate and lower savings rate yield
higher income growth. Economics is really amusing.
G: No, you are being mischievous somewhere! Both consumption and savings are
important. The ultimate objective however is consumption now or later: savings is
the bridge to transfer consumption from now to later.
S: The amusement offered by Keynesian Economics as practiced by the common
economist and politicians is enormous. We take up that again at appropriate time.
Let us stop today to keep something for the later..
Global Economic and Financial Crises
December 2008
The Current Global Economic and Financial Crisis is really a Two-in-One State-created Market-distortion Induced Crisis. There are two crises that merged into one:
A. Unsustainable Trade Imbalances and Market Distortions created by State/ Governments that dominate their economies finally bursting, and
B. Financial crisis emerging out of State policy-led distortions in financial market mechanism in the US.
Together A and B accentuating each other form a formidable Crisis.
Unsustainable Trade Imbalances & Market Distortions
Over a decade poor nation provided subsidized credit/ investment funding to profligate rich nation’s spending for consumption. China ran continuous trade deficit with the US. China grew fast economically and provided employment to millions by producing low value added consumer goods giving low wages to labor and sold them cheap to the US, investing the surplus dollar earnings in low interest bearing US Treasury bills and helping US keep the inflation rate low. Such abnormal economic situation can never sustain it had to burst. Chinese policy of controlling the exchange rate of its currency, Yuan, to neutralize the adverse effect of its huge and growing trade and current account surplus on its export competitiveness had to burst. At the same time, energy market imbalances accentuates with rapid economic growth of populous, poor nations. Energy prices soared, energy profits and petro-dollars aggravated asset inflation and also funded/ sponsored- terrorism business. Distortions rose to alarming proportions in energy, exchange rate, commodity, labor and weapons markets. Such unsustainable market distortions can get corrected only through thru’ economic Recession / Slowdown
Financial crisis - Crisis of Confidence
Populist dreams were sold by political regime through market interventions. This sowed the seed of the financial crisis. How? Just go through a rewind of the sequence of events.
Currently (Time Zero), all Political Regimes are in Coordinated
Bailout, Fiscal Stimulus and Monetary/ Qantitative Easing Actions throughout the World. These actions include:
a. Raising and expanding Deposit Insurance
b. Buying illiquid, impaired housing and other loan assets
c. Guaranteeing inter-bank lending
d. Infusing capital
e.Relaxing Marked to market capital adequacy and provisioning and market price based financial reporting, etc.
What happened before that? Follow the events chronology in reverse: here BC means Before Crisis or Bailing out of Crisis.
BC1: US Banks flushed with funds but not lending amongst themselves and to others. They were flush with funds because
BC2: US Fed pumped liquidity to encourage bank lending because
BC3: Banks stopped inter-bank and other lending because
BC4: There were Run on US banks because the fear spread that banks are insolvent and people started withdrawing deposits. This happened when the Political Regime Lost in the Woods of Economic Greenery they were trying to exploit without knowledge and responsibility. When they had lost their minds under pressure of economic forces they allowed
BC5: Fall of Lehman Brothers as the political regime got trapped between the need to contain systemic risk by rescuing Lehman Brothers and their propaganda tht financial firms failed because of their and their executives’ greed that led to imprudent behavior. The electorate wanted the greedy people to be punished rather than being bailed out by Government money.
Therefore, the political regime tried to play safe against common people’s verdict against bailing out the people who caused the crisis by their greedy and imprudent act. The political regime had to come clear out of the
BC6: Uncertain Political Stance on Pvt. Cos./ executives Bailout as elections were coming up soon and the electorate was agitated over this issue because earlier
BC7: The political Regime rescue of AIG, Freddie Mac and Fannie Mac from going into bankruptcy after giving an impression to the electorate that the political regime would not support failing financial firms and followed a policy of
BC8: No Rescue of failing Small banks and firms like Merrill Lunch and others in grave trouble after the political regime came into criticism by organizing
BC9: Rescue of Bears Stern, after a long period of inaction and ignoring the signals given by the market on the problems in the financial sector. During this period
BC10: Rating agencies issued downgrade calls on Investment banks/ financial institutions exposed to housing mortgages.
BC11: Bond prices fell sharply as mortgage defaults soared under ne the impact of rising interest rates from 1% to 5% (homeowner liability increased 40% with every 2%-point rise in interest rates) Interest rates were raised as anti inflationary measures with rising oil prices, growing budget deficits and current account deficits caused inflation to rise.
BC12: Signs of Mortgages defaults and house price downturn were evident as early as in 2005 with the emergence of excess supply in the housing market leading to higher price and leveraging risk of financiers who needed to operate under marked-to-market and prudent income recognition regulation regime.
The period of ignoring the signals of emerging problems was a natural sequence to the previous period of when Political Regime was baskig in glory over its great achievements:
BC14: Surging Housing boom leading to fasy employment expansion and high economic growth (house price to income ratio crosses 190% in 2002 and crosses 200% in 2004 and about 25% of house purchases were for speculation y people who already owned homes)
BC15: The initial successes in the War on Terrorism, growth impulses released by increased defense spending and higher Budget Deficits, thus neutralizing the adverse economic slowdown potential of the Dot.com sector bust and the 9/11 terror strike.
BC16: Interest rates were continuously reduced over successive quarters by about 4% points n three years despite bulging trade deficit, current account deficits and budget deficits. The interest rate reduction was the regulatory contribution to initiate the housing market growth need to effectively sell the pseudo-socialist political product: American Dream of homeownership for every household.
There was no shortage of dwellings, but 40% households were not homeowners, as they were not expected to earn enough to become creditworthy for loans to buy homes whose prices were to rise if their demand to purchase homes impacted the housing market as they would. The political regime wanted that all households must own homes that would live irrespective of the insufficiency of their current and future income levels and interest rates to borrow as much as was necessary to purchase their dream homes. To achieve this it would be necessary to:
a. Use Govt. control and influence over banks, Freddie, Fannie, investment banks, insurance companies and regulators
b. Encourage players and regulators to neglect prudence and norms (instead of building transparent market, the State was thought to be entitled to deliberately distort market mechanism)
c. Encourage Sub-prime home lending
d. Remove Mandatory 20% down payment
e. Prod Freddie/Fanny to make home ownership affordable to the poor
f. Encourage Investment bankers and unregulated high leverage so that they raise greater amount of financial resources from the market to fund the great homeownership revolution
g. Encourage Discount mortgage innovation: Variable/ Adjustable Mortgages
h. Allow high leverage and housing portfolio concentration
i. Continue Regulatory ambiguity to enable political influence to keep at bay standard risk management in financial sector (Commodity Futures Modernization Act, 2000)
j. Arrange credit default insurance market growth by removing laws against such insurance
k. Attract foreign investors with implicit State Guarantee
To summarize the Political Regime started acting God and believed in the prudence of State distorting markets to sell political dream, and in the process benefit politically-influential house builders (buy land cheap and realize profit by transferring risk at the earliest to banks/ financial institutions), leaving economy imbalances unattended, using housing construction for employment and income expansion at the cost of raising the prices of house beyond te repayment capacity of the low income borrowers, prodding and implicitly protecting pliable players and regulators, ignoring the signs of breakdown and hiding the Truth and thereby allowing the problems to compound, and acting hesitatingly in containing systemic risks from engulfing the US and the word economy.
Ultimately however the God conceded defeat to market mechanism when the latter forced the Truth out. When the costly crisis started hurting the people and payment system was about to come to a halt, the political regime blamed regulators and private sector executives and investors. In response, regulators pleaded ignorance and incompetence: Alan Greenspan expressed shock at lending institutions’ ignorance of their self-interest, admitted knowing about sub-prime mortgages only in 2005, and blamed securitization, foreigners’ demand to invest in US housing-related securities and Freddie-Fannie involvement for the debacle. Shareholders and bondholders shouted each time a bailout was arranged as the value of their investments in these and other companies/ assets tumbled to near zero levels from great heights. The common people and the electorate got really concerned as job losses started mounting with no hopes from a lame duck government and political representative bodies. Public confidence on political regime slumped. Te political regime had then to act to bail itself in.
Bail the political regime out.
People took time to understand the fallout of the politically sponsored American Dream of home ownership:
National Debt at 68% GDP;
Current Account Deficit at 6.5% of GDP;
30% drop in the value of housing assets owned by the common people with further fall likely;
Rising Inequality and prospect of long period of high unemployment;
Huge dent in the international confidence in US economy and the US dollar.
Record high indebtedness – credit to GDP ratio crossed 3.5 (2.7)
Looking Ahead
Economic Crisis would be corrected by the markets; faster, if the Current Big Keynesian-ism is consistent with market corrections and slower, if that is conflicting with market corrections. But consequences of both market corrections and Keynesian-ism will not be same for all countries and all sections of people. This may in turn cause conflicts that would cause recovery to delay. Hopefully, the large Fiscal stimulus/ bailout would help recovery starting in 18 months, i.e by July 2008. Hopefully, th peak unemployment rate in the US will settle at less than 11%.
Posted by Basudeb Sen at 11:49 AM 0 comments
Labels: Markets and the Political Gods
The Current Global Economic and Financial Crisis is really a Two-in-One State-created Market-distortion Induced Crisis. There are two crises that merged into one:
A. Unsustainable Trade Imbalances and Market Distortions created by State/ Governments that dominate their economies finally bursting, and
B. Financial crisis emerging out of State policy-led distortions in financial market mechanism in the US.
Together A and B accentuating each other form a formidable Crisis.
Unsustainable Trade Imbalances & Market Distortions
Over a decade poor nation provided subsidized credit/ investment funding to profligate rich nation’s spending for consumption. China ran continuous trade deficit with the US. China grew fast economically and provided employment to millions by producing low value added consumer goods giving low wages to labor and sold them cheap to the US, investing the surplus dollar earnings in low interest bearing US Treasury bills and helping US keep the inflation rate low. Such abnormal economic situation can never sustain it had to burst. Chinese policy of controlling the exchange rate of its currency, Yuan, to neutralize the adverse effect of its huge and growing trade and current account surplus on its export competitiveness had to burst. At the same time, energy market imbalances accentuates with rapid economic growth of populous, poor nations. Energy prices soared, energy profits and petro-dollars aggravated asset inflation and also funded/ sponsored- terrorism business. Distortions rose to alarming proportions in energy, exchange rate, commodity, labor and weapons markets. Such unsustainable market distortions can get corrected only through thru’ economic Recession / Slowdown
Financial crisis - Crisis of Confidence
Populist dreams were sold by political regime through market interventions. This sowed the seed of the financial crisis. How? Just go through a rewind of the sequence of events.
Currently (Time Zero), all Political Regimes are in Coordinated
Bailout, Fiscal Stimulus and Monetary/ Qantitative Easing Actions throughout the World. These actions include:
a. Raising and expanding Deposit Insurance
b. Buying illiquid, impaired housing and other loan assets
c. Guaranteeing inter-bank lending
d. Infusing capital
e.Relaxing Marked to market capital adequacy and provisioning and market price based financial reporting, etc.
What happened before that? Follow the events chronology in reverse: here BC means Before Crisis or Bailing out of Crisis.
BC1: US Banks flushed with funds but not lending amongst themselves and to others. They were flush with funds because
BC2: US Fed pumped liquidity to encourage bank lending because
BC3: Banks stopped inter-bank and other lending because
BC4: There were Run on US banks because the fear spread that banks are insolvent and people started withdrawing deposits. This happened when the Political Regime Lost in the Woods of Economic Greenery they were trying to exploit without knowledge and responsibility. When they had lost their minds under pressure of economic forces they allowed
BC5: Fall of Lehman Brothers as the political regime got trapped between the need to contain systemic risk by rescuing Lehman Brothers and their propaganda tht financial firms failed because of their and their executives’ greed that led to imprudent behavior. The electorate wanted the greedy people to be punished rather than being bailed out by Government money.
Therefore, the political regime tried to play safe against common people’s verdict against bailing out the people who caused the crisis by their greedy and imprudent act. The political regime had to come clear out of the
BC6: Uncertain Political Stance on Pvt. Cos./ executives Bailout as elections were coming up soon and the electorate was agitated over this issue because earlier
BC7: The political Regime rescue of AIG, Freddie Mac and Fannie Mac from going into bankruptcy after giving an impression to the electorate that the political regime would not support failing financial firms and followed a policy of
BC8: No Rescue of failing Small banks and firms like Merrill Lunch and others in grave trouble after the political regime came into criticism by organizing
BC9: Rescue of Bears Stern, after a long period of inaction and ignoring the signals given by the market on the problems in the financial sector. During this period
BC10: Rating agencies issued downgrade calls on Investment banks/ financial institutions exposed to housing mortgages.
BC11: Bond prices fell sharply as mortgage defaults soared under ne the impact of rising interest rates from 1% to 5% (homeowner liability increased 40% with every 2%-point rise in interest rates) Interest rates were raised as anti inflationary measures with rising oil prices, growing budget deficits and current account deficits caused inflation to rise.
BC12: Signs of Mortgages defaults and house price downturn were evident as early as in 2005 with the emergence of excess supply in the housing market leading to higher price and leveraging risk of financiers who needed to operate under marked-to-market and prudent income recognition regulation regime.
The period of ignoring the signals of emerging problems was a natural sequence to the previous period of when Political Regime was baskig in glory over its great achievements:
BC14: Surging Housing boom leading to fasy employment expansion and high economic growth (house price to income ratio crosses 190% in 2002 and crosses 200% in 2004 and about 25% of house purchases were for speculation y people who already owned homes)
BC15: The initial successes in the War on Terrorism, growth impulses released by increased defense spending and higher Budget Deficits, thus neutralizing the adverse economic slowdown potential of the Dot.com sector bust and the 9/11 terror strike.
BC16: Interest rates were continuously reduced over successive quarters by about 4% points n three years despite bulging trade deficit, current account deficits and budget deficits. The interest rate reduction was the regulatory contribution to initiate the housing market growth need to effectively sell the pseudo-socialist political product: American Dream of homeownership for every household.
There was no shortage of dwellings, but 40% households were not homeowners, as they were not expected to earn enough to become creditworthy for loans to buy homes whose prices were to rise if their demand to purchase homes impacted the housing market as they would. The political regime wanted that all households must own homes that would live irrespective of the insufficiency of their current and future income levels and interest rates to borrow as much as was necessary to purchase their dream homes. To achieve this it would be necessary to:
a. Use Govt. control and influence over banks, Freddie, Fannie, investment banks, insurance companies and regulators
b. Encourage players and regulators to neglect prudence and norms (instead of building transparent market, the State was thought to be entitled to deliberately distort market mechanism)
c. Encourage Sub-prime home lending
d. Remove Mandatory 20% down payment
e. Prod Freddie/Fanny to make home ownership affordable to the poor
f. Encourage Investment bankers and unregulated high leverage so that they raise greater amount of financial resources from the market to fund the great homeownership revolution
g. Encourage Discount mortgage innovation: Variable/ Adjustable Mortgages
h. Allow high leverage and housing portfolio concentration
i. Continue Regulatory ambiguity to enable political influence to keep at bay standard risk management in financial sector (Commodity Futures Modernization Act, 2000)
j. Arrange credit default insurance market growth by removing laws against such insurance
k. Attract foreign investors with implicit State Guarantee
To summarize the Political Regime started acting God and believed in the prudence of State distorting markets to sell political dream, and in the process benefit politically-influential house builders (buy land cheap and realize profit by transferring risk at the earliest to banks/ financial institutions), leaving economy imbalances unattended, using housing construction for employment and income expansion at the cost of raising the prices of house beyond te repayment capacity of the low income borrowers, prodding and implicitly protecting pliable players and regulators, ignoring the signs of breakdown and hiding the Truth and thereby allowing the problems to compound, and acting hesitatingly in containing systemic risks from engulfing the US and the word economy.
Ultimately however the God conceded defeat to market mechanism when the latter forced the Truth out. When the costly crisis started hurting the people and payment system was about to come to a halt, the political regime blamed regulators and private sector executives and investors. In response, regulators pleaded ignorance and incompetence: Alan Greenspan expressed shock at lending institutions’ ignorance of their self-interest, admitted knowing about sub-prime mortgages only in 2005, and blamed securitization, foreigners’ demand to invest in US housing-related securities and Freddie-Fannie involvement for the debacle. Shareholders and bondholders shouted each time a bailout was arranged as the value of their investments in these and other companies/ assets tumbled to near zero levels from great heights. The common people and the electorate got really concerned as job losses started mounting with no hopes from a lame duck government and political representative bodies. Public confidence on political regime slumped. Te political regime had then to act to bail itself in.
Bail the political regime out.
People took time to understand the fallout of the politically sponsored American Dream of home ownership:
National Debt at 68% GDP;
Current Account Deficit at 6.5% of GDP;
30% drop in the value of housing assets owned by the common people with further fall likely;
Rising Inequality and prospect of long period of high unemployment;
Huge dent in the international confidence in US economy and the US dollar.
Record high indebtedness – credit to GDP ratio crossed 3.5 (2.7)
Looking Ahead
Economic Crisis would be corrected by the markets; faster, if the Current Big Keynesian-ism is consistent with market corrections and slower, if that is conflicting with market corrections. But consequences of both market corrections and Keynesian-ism will not be same for all countries and all sections of people. This may in turn cause conflicts that would cause recovery to delay. Hopefully, the large Fiscal stimulus/ bailout would help recovery starting in 18 months, i.e by July 2008. Hopefully, th peak unemployment rate in the US will settle at less than 11%.
Posted by Basudeb Sen at 11:49 AM 0 comments
Labels: Markets and the Political Gods
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