economics – Page 10 – Pertinent Observations

Coase

In the wake of the passing of Ronald Coase, two incidents, both professional. The first was with an established company to whom I suggested a partnership – they are in a space where I don’t have much skill, but have access to companies who I would love to sell to, and they don’t have my skill and our skills are complementary. So I reached out to them (through common contacts) suggesting that we could work together. They came back to me saying they would love to work with me, but would want me to join them as an employee.

The second was an incoming lead. This was a rather small company doing something similar to what I’m doing but with bigger ideas. They want me to join this “innovation hub” they are trying to create. This is a loose federation they are creating including professionals from various fields. Nobody is obliged to work full time for the hub, but this gives people an opportunity to get together and work together on projects where their respective expertise can combine well.

As the more perceptive of you who would have read every Coase obituary in the last two weeks would have figured out, the piece of work that Coase is most well known for is about the theory of the firm. The question is rather simple – why should you and I get together and form a firm if we have to work together, if we can remain independent and just come together for projects. The answer lies in transaction costs.

The advantage of coming together as a firm is that you negotiate only once. Let us suppose you are a graphic designer and I’m a data scientist. If we decide to work together on a visualization project, how do we decide how much you get and how much I get? We will need to negotiate. Let’s say we negotiate and agree on a price. And complete a project and split the spoils. What would happen the next time we were to bid for a project? We will need to negotiate again on how we will share the spoils.

If on the other hand we were to form a partnership firm, then for every project that we do, our respective share is fixed! Thus we don’t have to negotiate before every single projects. Thus, firms exist so that you don’t have to repeatedly negotiate.

However, there is a downside to this. What if I form a firm with a graphic designer, and then we see a significant opportunity in projects that involve a lot of analysis but little visualization? In that case, I have no use of my partner, and would loathe to pay him his share of the profits. Or consider if I were to somehow become much better at my job, while my partner stagnates. There is little I can do, for we’ve been locked in into the financial arrangement.

These are only some of the complications that arise when you need to decide whether you want to become a firm. I just thought it is pertinent that I’m having some of these dilemmas (employee versus consultant versus partner versus member of federation) in the few weeks after Coase’s passing.

Levi’s Price Discrimination

So I’ve never managed to buy jeans on discount. Let me explain. Unlike most other people (if you go by what the store assistants tell you), I don’t like to wear faded jeans. It is perhaps an inherited hangover since my father used to consider jeans to be inherently dirty and would make me discard jeans as soon as they faded a little bit. It could also be more practical – since I sometimes like to wear jeans to official meetings, I want to wear jeans that look neat.

Now I’ve managed to drive my wife crazy with my shopping (and we’ve known each other for barely four years, shopped together for three maybe). She thinks I’m way too fussy about clothes, and can’t make up my mind easily. I’ve explained earlier on this blog why I take a long time over shoes (my sandals are now wearing out, so I’m getting ready for another ordeal). But the more fundamental differences that my wife and I have is with respect to jeans.

The problem is that we fundamentally disagree on what purpose jeans serve. I have traditionally looked at jeans as comfort wear. Trousers I’m absolutely comfortable in (I sometimes even sleep in my jeans), which I don’t need to wash too frequently, and which can be worn even after they get torn in non-strategic places. I’ve always bought “comfort fit” jeans, and after I graduated to branded jeans towards the end of my teens, my staple had been the comfort-fit Lee Chicago.

The problem is that my wife thinks of jeans as fashion-wear – things you need to necessarily look good in. Some of the jeans she owns are so skinny that sometimes she takes a really long time to change. She looks great in them, no doubt, but the problem is that she expects that I too wear such jeans. And so after some ten years, I have given up my loyalty towards Lee Chicago, and instead have to try out various skinny fits (as things stand now, I own only one pair of Lee Chicago, bought in 2009).

Ok all this is besides the point of this post (and the point of another post which I never wrote). Coming back to the point of this post, the deal is that nowadays I find it extremely hard to shop for jeans. Of course it doesn’t help that I don’t live in Kathriguppe (with its dozens of factory outlets) any more, and that in my part of town (Malleswaram-Rajajinagar) the only place you can find decent branded clothes is in malls, which are a pain. The bigger problem, though, is that it is very hard to find stores that stock my kind of jeans.

In the last couple of years, our strategy for shopping clothes has been to visit a multi-brand outlet in one of the two malls near our place, so that we have a wide variety of choice. Except that I have no choice. Because stores such as Lifestyle or Shopper’s Stop or Westside (which now mostly stocks private labels) or Central don’t stock my kind of jeans. At all. If you happen to locate a store clerk and ask him for “mid blue straight cut non-faded jeans” he will look at you as if you have just landed from another planet. He can be excused for giving you those looks, for his store simply doesn’t stock non-faded jeans, because of which he has never sold them!

So I happened to be on Brigade road over the weekend, and I had a small gap of about half an hour between two meetings, and thought I should visit the Levi’s flagship store there. I must mention that the salespeople there were definitely significantly more polite than I’ve ever seen at a multi=brand store. However, as soon as I repeated my mantra (mid blue straight cut non-faded jeans), the first thing the salesperson who approached me told me was “oh Sir, but there’s not discount on that!”.

It’s clever price discrimination by Levi’s, to not sell non-faded jeans on discount. For they know that people who buy non-faded jeans tend to be older (hey I’m only thirty), or will be buying them for office wear, and they are less price elastic than the typical college kid who buys faded stuff. So while the college kid needs discounts to be attracted during the “discount season”, the “formal jeans” buyer needs no such attractions, and will pay full price for his stuff.

It is interesting to note, however, that companies that make formal clothes (not Levi’s) also offer massive discounts during the “discount seassons” (one of which is on now). That, though, can be explained by the fact that most people need a few sets of formal clothes (even those that normally wear faded jeans), and discounts are necessary to attract customers.

Now I’m beginning to think that the market for “formal jeans” in India is extremely niche, and if I”m acting above my age because I prefer such jeans. I half-expect my wife to call me an “uncle” be cause of this.

What should we do about the falling rupee?

So the more perceptive of you would have realized that the rupee is falling. And fast. At the beginning of the year, fifty four rupees bought a dollar. Now you need over sixty rupees. That’s a fall of over ten percent in half a year.

People argue based on differences in interest rates and interest levels between India and the United States, and India’s current account deficit, that the rupee deserves to depreciate. Some argue that the rupee should actually trade even lower. That is correct. What makes the fall of the rupee worrying, however, is that it has happened so quickly. No theories on trade imbalance or rates imbalance or inflation can account for the fall of ten per cent in half a year.

The issue, of course as everyone knows, is to do with capital flows. While India has run a persistent current account deficit, the continuous inflow of foreign investment into the Indian markets (either direct or indirect) had ensured that the rupee was relatively stable over the years. With India maintaining a high growth rate in the GDP over the noughties, the inflow was persistent. Things aren’t so good now, however.

India’s GDP is slated to increase at a paltry 5% this financial year. The growth story is seemingly over. And that is not all. Things aren’t looking great in other parts of the world also. Due to this concept of margin financing, sometimes when some of your holdings lose value, you are forced to liquidate other holdings in order to comply with “margin requirements” (we will not go into the technical details here). So with markets around the world not doing great, and India’s growth not as spectacular as it used to be, and with the country’s muddled policies (check out how difficult the government has actually made it to invest in India – irrespective of your nationality), investors started exiting. With some investors exiting, asset values dropped and the rupee dropped. Consequently other investors exited. And so forth. It did not help that there was nothing inherent in India’s government policies to hold them here.

So that’s the story so far. Question is what we should do going forward. As I mentioned earlier, there are two levers that can help shore up the rupee – the capital account and the current account. Within the current account there are two components – imports and exports. What normally happens when a currency depreciates is that exports become more competitive and go up further. Imports become costlier and thus reduce. On the current account front, thus, we have what is called as “negative feedback”.

Notice that in the past whenever an economy staged a recovery, it was generally preceded by a devaluation of the local currency. So since our currency is already devalued the stage is set for recovery, right? Unfortunately it’s not so simple. While it is true that our exports are now likely to be more competitive, fact is that Indian industry is not well placed to capitalize on that. Investment bottlenecks, labour laws and bureaucracy means our entrepreneurs haven’t been able to move fast enough to take advantage of the falling rupee and up exports. This can be borne in the fact that the Reserve Bank of India, which normally shies away from controlling exchange rates (as long as they are not too volatile), has issued several public statements on this matter in the recent past, and taken steps to prevent further fall in the currency levels. That the Central Bank has had to step in to protect the currency shows that we are in extraordinary times. The natural corrector to a falling exchange rate (increase in exports) is absent.

Matters are not helped, of course, by the fact that one of our largest imports is an asset – gold. Thing with asset prices is that unlike prices of “normal goods”, the demand for assets increases with price. When asset prices increase, people see “momentum” in the asset and want to get on to the bandwagon. So there goes part of another natural corrector to a falling exchange rate (less competitive imports).

So coming back to where we started off with – what should the Government do? While this is going to be a time-consuming process, what the government needs to do is to ensure that exporters can exploit the falling rupee. Reforms in this direction are not easy of course – since they require significant efforts in removing bureaucracy and making it easier to do business – which means we need significant administrative reform. There is also the small matter of possibly having to reform labour laws (while on the matter of labour laws, check out this paper by Takshashila Scholar Hemal Shah, who presents some easily implementable reforms in the labour law). While these are difficult things to implement, the fact that there is a crisis gives the government an alibi to push ahead with the reforms. PV Narasimha Rao had done that once in 1991. The problem now is that the government may not have political will given that elections are less than a year away. In this context, it would be advantageous to have early elections, for a new government with a fresh mandate might be more prone to taking tough short-term measures.

Currently, the government is trying its best to shore up on the other levers. Gold import is being curbed – except that it will be hard to implement since they will simply get diverted to the black market. The Finance Minister is traveling the world putting up a roadshow to get investments to India. That, however, is akin to putting lipstick on a pig since there is little in India’s fundamentals and current economic scenario to attract foreign investors. Even if some of these measures succeed, they will only lead to temporary respite to the currency. Fact is that for sustainable improvement in currency, tough reforms are mandatory.

Inefficiency of Restaurant Reservations

Quartz reports that restaurant reservations have been taken over by bots in San Francisco. Certain restaurants in that city are incredibly hard to get reservations at, so people have started letting lose bots that check for availability every minute and grab the table as soon as it’s available. In fact, there are enough bots out there that at a particular restaurant which opens reservations at 4 am, all tables are taken by 4:01. Every day.

In Kannada, there is an idiom that says “gubbi mEle brahmAstra”, which means using the weapon of Brahma (widely recognized in Hindu epics are the most powerful weapon) to annihilate a sparrow. Using a bot for restaurant reservations is a solution that falls under this category. However, that someone had to think up of this solution shows that there is something wrong with the restaurant reservation market. And it is not just in San Francisco (I guess this solution was first implemented there thanks to the penetration of online restaurant reservations and the high number of techies in the city. Bangalore fails on the first count).

The problem with the way restaurant reservations currently work is that the option is priced at zero. And thus gets allocated on a first come first served basis. Suppose I want to go out on a date tonight but am not sure what cuisine my wife is craving today. Anticipating crowds, given that it is a Saturday, I will make reservations in four different restaurants serving four different cuisines. There is nothing that currently prevents me from doing that. And it costs me nothing (apart from the cost of four phone calls).

A restaurant reservation is essentially an option to occupy a table of a certain size at a certain restaurant in a particular time period. If you show up at the restaurant at the appointed time, the restaurant is obliged to offer you a table. However, the way it is currently implemented is that you are not obliged to show up at that restaurant at that particular time. If you don’t show up, the table the restaurant had “reserved” for you will go empty for that evening, thus resulting in loss of business.

How can a restaurant handle this? One idea is to overbook. If you have 10 tables, allow 12 people to make reservations, in the hope that on an average day, 10 or less will show up. While this may lead to higher occupancy, problem is when all 12 show up. You then run the reputational risk of making a reserved guest wait, or worse, turning them away. Another option is to book only a fraction of the tables. If you have 10 tables, give out reservations only for 8, and let people know that you are open to walkins (if someone calls after the 8 are taken, you can say “I’m sorry, but we can’t take any reservations. However, we have some unreserved tables. You can come and check it out. If you’re lucky you’ll get it”). That way, by keeping yourself open for walkins, you can prevent loss of inventory- except that if you are a high end restaurant you are unlikely to get too many walk in customers.

Another option (which I believe is a method online retailers in India use for cash-on-delivery customers) is to maintain a list of people who called you along with their phone numbers and whether they showed up. That way, you can deny habitual offenders a reservation. However, considering that if you are a high end restaurant people are unlikely to visit you very often this may not work either.

The ideal economic solution, of course, would be to charge for reservations. People pay a small deposit when they make a reservation. If they do show up, this amount gets adjusted against their bill. However, given that most reservations happen over the phone (except in SF), you have no way to charge for it. So is the solution that you move your reservations exclusively online, so that you can charge for it? Then you could lose out on customers who are uncomfortable with making reservations online.

Even if all your reservations were online (like in SF), there is a problem in charging for reservations – you wouldn’t want to be the first restaurant doing that. One thing high end restaurants pride themselves on is their reputation, and charging for reservations can make them appear “cheap”, and they wouldn’t want to do that unless it is the done thing.

So how are restaurants managing the situation now? My take is that they are adjusting for it in the price. They are not overbooking, but assuming the cost of empty tables (as a result of no shows) in their overall pricing. This way, customers who are honouring reservations are effectively subsidizing those that don’t. While the market “clears”, the implicit subsidy towards customers who don’t honour their reservations leads to dead weight loss. There is also moral hazard – since desirable customers (the ones who show up) are subsidizing the un-desirable (the ones that don’t).

Is there a solution to this? One way to look at this would be for restaurants to centralize their reservations. I’m surprised no one has done it yet. You can have a website and a call centre from which you can take reservations for a large number of restaurants. The restaurants will pay for it since it will mean that they don’t need to have someone by the phone taking and managing reservations. And given that the same call centre manages bookings for multiple restaurants, they can identify duplicate bookings and overbook accordingly. Customers can be incentivized to use the same ID for booking for multiple restaurants by introducing a multi-restaurant loyalty card. And then – once there is a large number of restaurants that have moved their reservations to this call centre, they can start thinking of collectively moving towards a system of penalizing for unfulfilled reservations.

There – I’m giving a business idea away for free!

Money De-laundering

A few months back I got my kitchen remodelled. It set me back by a couple of lakhs, and the guy who did the work for me insisted that I pay him fully in cash. I, who has had all cash inflows so far via bank transfers, was thus forced to withdraw (in several iterations) from the ATM perfectly white money and then hand it over to this guy and permanently convert it to black. Now that I think about it, I overpaid.

The key fact here is that people pay to get their money laundered. If you have Rs. 100 of unaccounted money in wads of cash, you are willing to give it to someone who puts Rs. 80 in your bank (the spread has been pulled out of thin air. Don’t go after me for that) and also some documentation to prove that you legally earned the Rs. 80.

So you have this bunch of people who want their money laundered. And then there are bank-only guys like me who sometimes have to produce wads of hard cash. Why isn’t there an exchange (illegal, of course, but who’s talking legality here? I’m only talking money) where money can be laundered and people with excess bank balances (and little hard cash) can be paid for it? For example, instead of paying Rs. 200000 in hard cash to my carpenter, I would have paid (say) Rs. 160000 to someone by cheque and got a receipt for it, and that person would have paid Rs. 200000 cash to my carpenter.

What does it say about the black economy that no such exchange exists? Does it mean that the market is skewed in a way that the demand for money laundering is much larger than its supply, because of which people who would otherwise have been intermediaries doing one side of the deal themselves? Or does an exchange like this actually exist but I’m not aware of it partly because it’s underground (for obvious legal reasons) and partly I’m seen as too small a fry to be accosted by the exchanges?

Next time I pay wads of hard cash, though, I’m going to try and see if I can get a discount.

Depression and Stimulus

Ok so this post has nothing to do with macroeconomics, though it borrows its concepts from there. As the more perceptive of you might have figured out by now (ha, i love that line!) I was diagnosed with clinical depression about a year back. Actually that was the second time I had been diagnosed with that diagnosis, the first being a full six months earlier, when I had suddenly stopped medication after I had lost trust in that psychiatrist.

For over a year now, I have been on anti-depressants. It started with 37.5 mg per day of Venlafaxine (brand name Veniz), which got slowly bumped up until at 187.5 mg per day I started going crazy and having crazy mood swings and had to be scaled back to 150 mg. I was at that level for over six months when I realized that I had plateaued – that there was no real improvement in my mental situation thanks to continuous intake of the drug and perhaps I should consider getting off.

I proposed this idea to the psychiatrist when I met her last month and amazingly she agreed without any hesitation and quickly drew up a plan on how I need to get off the drug (you need to decrease dosage slowly else you’ll have withdrawal symptoms which are pretty bad). I found it a little disconcerting that she so readily agreed to take me off the drug, given that she had herself not given any indication of wanting to take me off the drug. I was disconcerted that I had been taking the drug for much longer than necessary, perhaps.

The doctor, however, paired the paring of my anti-depressant with doubling the dosage of the stimulant that I have been taking for my ADHD for the last six months. As it happened, though, I went through a major bout of NED that evening, and didn’t muster the enthu to go to the one pharmacy that legally sells Methylphenidate (the ADHD drug, supposed to have similar chemical composition as cocaine) in Bangalore. That I managed to function pretty well the following one week, including the three days spent at my client’s office, meant that I probably didn’t need teh ADHD drug also. So as I write this I’m off all mind-altering substances (apart from my several-times-a-day doses of caffeine and occasional ingestion of ethanol).

Recently I met a friend who told me that I had been too generous in my praise of psychiatric drugs in my blog, and that I hadn’t taken into consideration their various side effects and addictive symptoms. I’ve heard this from other people also – that I probably wasn’t doing the right thing by taking anti-depressants. So do I now regret taking them, given that I’ve chosen to go off them? Probably not.

This is where the analogy of economic depression and clinical depression comes in. In an economic depression, there is a halt in economic activity thanks to which there isn’t much circulation of money. When people start earning less, they start spending less, which further depresses their income and the whole economy goes into a tailspin. Going by Keynes’s theory, letting the economy slowly repair itself would take an extraordinarily long time (in the course of which we will all be dead, as the joke goes), so it is recommended that the government steps in and spends heavily in order to “stimulate” the economy and break the vicious circle it was getting itself into.

When you suffer from clinical depression, there is a shortage of flow of this chemical compound called Seretonin in your brain. Thanks to that, your mental energy is at a much lower level and you get tired and stressed out easily. Moreover, depression also leads to a significant drop in your confidence levels. You start believing that you are useless and not capable of anything. But then, your lowered mental energy levels mean that it is tough for you to be good at work, and do things that are likely to give your confidence a boost. And this in turn leads to further lowering of confidence and there is no way out for you to break out of this vicious circle.

A number of people believe that depression can be conquered with “willpower”, but this is applicable only if you’ve recognized it in its early stages. In most cases though, you realize it only when it’s deep into the vicious circle, and your “willpower”, much like “normal economics” during an economic depression, will take way too long to break you out of the vicious circle, and by then half your productive life will be gone.

Hence, to draw the Keynesian analogy, you need a stimulus. You need some sort of an artificial stimulus that breaks you out of your vicious cycle of low self-esteem and low performance. Sometimes, there can be a fortuitous life event which by matter of chance gives you a sudden sense of achievement and helps you break out of the cycle (for example, I was quite depressed (most likely clinically) through most of my life at IIT, but success in CAT proved to be a good stimulant in helping me break out of that cycle). But then, most of the time, life is structured such that there are few opportunities for such positive black swans, especially when you are older and especially when your mental energy levels are in general quite low.

Under these circumstances, I believe, there is no way out but chemical stimulants to help you get out of your depressive state. Clinical researchers and psychiatrists over the years have found the answer to be this molecule called “SSRI” which slows down the rate of seretonin uptake into the brain, with the result that there is greater flow of seretonin in your nervous system (continuing our economic analogy this is like the government cutting taxes as a form of stimulus). Greater seretonin in the system means greater mental energy, and sometimes the difference in energy levels is itself enough to push up your self-esteem levels, and the new energy levels means you have given yourself a chance to perform, and the cycle breaks.

Keynes said, as part of his theory, that it is important that a stimulus is short and targeted, and that in good times a government needs to be fiscally conservative so that, if not anything else, it has the necessary firepower to deliver a stimulus when necessary. Similarly, it is important that you don’t get yourself addicted on these anti-depressants and that you don’t become immune to them. Which is why psychiatrists typically wean you off your anti-depressants six months to a year after you started on it. By then, they expect, and in my case it did, that the stimulus would have been delivered.

Khamir Rouge

I spent most of the last weekend at a workshop organized by this not-for-profit called Khamir somewhere near Bhuj in Kutch. It was a rather small-scale festival they had organized called the Desert Art and Music Festival (though the fees were anything but small scale, setting each participant back by seven and a half kilorupees). The art on display were crafts local to the Kutch region, and we were given hands-on training in various crafts by artisans that worked with Khamir. The music, sadly, wasn’t Kutchi, as two rather large bands had been imported from Rajasthan (from Bikaner and Jaisalmer) and local musicians only played the opening acts.

I’m not entirely convinced by Khamir’s business model. Ok that may not be an accurate statement since strictly speaking Khamir isn’t a business, but to put it in another way, I’m not convinced that Khamir’s contribution to the ecosystem of handicraft artisans in Kutch is entirely positive. It may not be possible to make a convincing economic argument right now, but my sense is that they are distorting the market for handicrafts.

Actually it may not even be their fault. In a rare conversation on economics with one of the artisans, I found that it is actually easier to start a not-for-profit than a for-profit. This artisan wanted to train youth in his village and surrounding areas, and had found that there was considerable demand abroad for what he made. When I asked him why he didn’t set up a for-profit company instead, the answer was that it was next to impossible for him to get a bank loan for one such venture. But he had found some means by which he had tied up a rather large no-questions-asked donation from the Government of Gujarat.

Coming back to Khamir, they are in the business (ok it’s impossible for me to think in a non-business sense) of promoting the crafts of Kutch. They have a number of “studios” where local artisans, who have been given raw material, work and they sell the products in their own local shop and also in the US and Canada. Apart from this, they procure stuff from other local artisans and sell it on. In that sense, they are just like any other middlemen – except that they are not for profit.

If you ask why this is a problem, I point you to the Indian airline industry. When one player in the market doesn’t have a strict profit motive (like Air India), they can work on wafer thin (or even negative) margins, a level at which their for-profit competitors cannot really compete. Sooner or later, the for-profit competitors get driven out of business (like Kingfisher Airlines, for example), and soon the market itself has disappeared!

While Khamir itself might be too small (their campus suggests they are rather well funded, but their scale of operations doesn’t seem commensurate), the fact that it is easier to get funding for not-for-profit than to start a for-profit business in this space (as the artisan alluded) raises the sceptre that there could soon be more such not-for-profit middlemen in this business, which might make a real dent in the business of Kutchi crafts.

The story of intermediation in this market is also interesting and deserves to be sold. Both the artisans we spoke to said they don’t prefer to do business with large for-profit middlemen such as FabIndia or Mother Earth since the latter demand a high degree of standardization, which is tough to achieve in a hand-craft environment. Rather than face high rejection rates at such middlemen, the artisans instead find it more profitable to peddle their wares at sundry craft exhibitions all over India, where they are more likely to sell their stuff, though with a higher risk in terms of profits and considerable hardship in terms of travel and sales.

The thing with handicrafts is that the market is rather fragmented and it is only really large-scale players such as FabIndia or Mother Earth who have cracked the model in terms of effective intermediation (the large scale is necessary given the fragmentation of the market). The “illiquidity” in the market means that inventory costs can get rather high, and thus a considerable retail margin needs to be allowed for to enable effective intermediation. In the face of this, organizations such as Khamir who “work to give as much money as possible to artisans” can get rather distortionary.

Two minutes was watching a weaver work at the Khamir facility drove me nuts (it was such a laborious process I wasn’t able to take it any longer). So there is this wooden piece that has to be tossed from one side of the loom to the other each time a thread is passed (and the thread has to be practically hammered in to the rest of the cloth) so even a full day of work by a skilled artisan can only produce a few meters of cloth. Watching the hand loom weavers work even made me wonder if promotion of such arts only serves to keep people poor.

So the problem is that handloom weaving is a rather laborious process, and extremely inefficient economically. The same kind of cloth when produced by a machine results in significantly lower cost, and by that logic, handloom weaving being an ineffective process should probably go extinct. While premium branding for handloom in certain circles has ensured higher prices that could possibly compensate the weavers, it is not unfathomable that machines will be soon able to make (if not already) cloth in a texture similar to what is produced by hand looms.

For someone with a short attention span and ADHD and for someone who is a computer programmer, it was unfathomable that people do a rather laborious task repeatedly through the course of the day, and over several days, to earn their living. We asked an artisan why he continued to make cloth by hand, and he replied that the handloom tag helped him earn a better margin. When I suggested to him that greater volumes would make up for the lesser margins that powered looms would offer, he talked about certain intricate designs that according to him only hand loom could create. I could only think of one thing at that moment – the CNC Lathe.

I find the entire ecosystem disturbing. That it is easier to find funding for a not-for-profit venture than for for-profit. That these funds are being used to keep alive trades that have no business to do business (given their inefficiencies). That these efforts put the artisans into a false lull that there actually exists demand for their produce, and at a level that can compensate for their inefficient processes. Which prevents creative destruction, and holds back innovation. And leads to the not-for-profits painting a rather romanticized picture of poverty and traditional rural crafts to get more funding. The cycle continues.

Given that the festival did not have sponsors, I would assume that a significant portion of the fee I paid would have gone into paying the musicians. For that level of fee, I expected a rather small and intimate concert. Instead what I got was two public concerts (where the general public got to watch for free) where there were more speeches than there was music, and one of which started so late into the night that I drifted off.

In the world of not-for-profits, I suspect that “value for money” is perhaps a dirty phrase.

Industry and agriculture’s contribution to GDP of Indian States

So you think India is an agricultural country? Maybe you are right in terms of the number of people employed in the sector. But that is not really the case in terms of output – the contribution to GDP to agriculture is a paltry 30% in most states and dropping sharply. The chart here (hope it works) shows how the contribution of agriculture and manufacturing to SGDP of various states in India.

[cf]indiagdp[/cf]

Farmers as businessmen

My association with the Takshashila Institution took me on a field trip today to trace the story of the not-so-humble potato. The journey actually started last night, as we checked out potato prices at retail stores near our respective homes. And we continued the journey this morning, in reverse order as we went first to the APMC Mandi in Bangalore and then to the potato growing areas near Arkalgud, in Hassan district. As an aside, today was the first time I visited (or rather passed through) my mother’s native place Holenarasipura (the H in her initials stood for that).

When we build narratives about farmers in India, we talk about the “humble farmer”, the “poor farmer”, the “farmer dying in Vidarbha”, the farmer exploited by zamindars, and of India itself as a “nation of farmers”. The one part of a farmer’s job that never makes it to the popular narratives is his role as a businessman and entrepreneur. A farmer we met at the APMC yard at Bangalore this morning had delayed his journey from Bettadapura by four days, only to realize a lower price than what he would have got on Tuesday. Another near Arkalgud had grown tobacco late in the season, not knowing the complications that could arise due to rainfall patterns.

Back in school when I studied Hindi, I read a story by Munshi Premchand about a young man who moves to a village because he wants to be a farmer. That story ends with him returning disgruntled to the city, claiming there is more to be done by the farmer in the city than just doing his job as a farmer. That story, which I remember as being beautifully written (though I don’t remember its name), is a good primer into how much of a business farming really is.

Consider the decisions that a farmer has to make, and decide if this is closer to being a businessman or being a tiller. First he has to decide what crop to plant. Next, he has to decide what exact variety to sow, and what variety of seeds to procure. Then comes the rather big decision about the timing of the sowing of the crop, comes as it does with dicey predictions and forecasts of rain which even the Met department can’t get right. That done, the farmer has to decide on the labour he needs to employ for the sowing season, and whether he needs to hire a tractor. Then towards the end of the season, there are decisions about hiring of labour with respect to harvest, decisions on where to sell and most importantly, timing the market right in order to realize the best possible price for his crop. And the farmer is his own salesman also, having to negotiate the price at which he sells.

Commenting on the pittance that the farmer stands to make (in terms of a profit) on what he grows, one of my colleagues on today’s field trip said it was a no-brainer – in the long line of businessmen who stand between a crop and the customer, he said, the farmer is the worst businessman, so it is no surprise that he is the one who gets squeezed the worst.

From a “corporate strategy” standpoint, the amount of management required in the farming profession suggests that it makes eminent sense to separate the roles of the farm manager (who plans inputs , labour hire, sales, crop mix, etc.) and the farmer (who does the day to day job of tending to the farm and looking after the crops). Unfortunately, the fragmented nature of land holdings in India doesn’t allow us this luxury. In fact, there is evidence to suggest that back in the days of unequal (and supposedly unfair) land-holdings, this was perhaps actually the case, with farm managers (zamindars) taking the risk and making the big decisions, while leaving the actual farming job to the specialist farmers. Unfortunately, supposedly pro-farmer initiatives such as the Land Reforms Acts and the “land to the tiller” movement served to defeat this separation of responsibilities.

The other big problem with farming is the amount of risk in the business. At one of the farms, we saw heaps of potatoes which had been cast aside because of blight (wasn’t that the same culprit that caused the Irish potato famine back in the 1800s?). In another farm, lack of timely rain had meant that potatoes hadn’t grown to the size to which they had been expected to grow, thus resulting in much lower realizations in terms of output. Even with the best possible management, exposure to the elements means there is always a significant amount of risk in farming. Current land holdings, though, don’t allow a farmer to diversify his risk by planting more than one crop.

Fragmented land holdings creates a further problem – the produce from one farm is usually way too small to make it viable to take it to the market 200 km away in Bangalore, where an auction at the “mandi” can help the farmer realize the best possible price (more on this auction in another post). Instead, the farmer is forced to sell to local aggregators and simply accept the price the latter is willing to offer (in small centers such as Arkalgud, there isn’t much choice the farmer has in who he sells to). We met a local farmer there with considerably bigger holdings than others in his area, and he told us that he had enough to make a trip to Bangalore viable, and there was no reason he would sell locally.

From a purely business perspective, the logical way forward for farming in India would be consolidation. Consolidation of land holdings would solve several of the problems that I’ve mentioned above, and also make it viable for the farms to appoint specialist managers. One possible way forward I see would be for a bunch of farmers with contiguous farms to get together and form a private limited company (with their respective shares being proportional to their land holdings). The farmers can continue managing their own pieces of farmland, while they appoint a professional manager to do business for them (think of it as being similar to geeks Sergey Brin and Larry Page bringing in professional CEO Eric Schmidt to run Google).

Yes, that paragraph might sound too grand and fantastical, but I don’t see any other way out for Indian farmers to do better. It is time that policymakers recognize the amount of management that goes into farming, and understand that keeping farm sizes small does no good for the lot of the farmer. A comparable example would be the Indian textile industry, where labour laws have served to keep manufacturers tiny, and has resulted in them losing out to larger competitors from the Far East (who have no such constraints, and are thus able to do better business).

So what policy interventions do we need to enable better management of Indian farming? Undoubtedly, the one decision that can potentially go the farthest in this direction is to make purchase and sale of farmland easier. So far, laws that have been designed to keep “evil capitalists” out of the noble farming profession have sought to make farm-holdings illiquid, and hard to purchase or sell (making farm land sales more liquid will also ease land acquisitions for industrial purposes and infrastructure projects). However, the fact of the matter is that there is a significant amount of management skills required to successfully run a farm, and the best way to achieve that would be to be inclusive of “evil capitalists”.

The narrative about the Indian farmer needs to change, and change in a way that recognizes him as being a businessman. The sooner our policymakers recognize the business aspect of farming, the easier it would be in making farming a viable profession in India.

Liquidity

In economic theory, outside of capital markets, “liquidity” is a topic that isn’t spoken about as much as it should. While I’m no academician to set this right in theoretical circles, I’ll make an attempt to help my readers what the fuss is all about.

Well past midnight, when you exit a mall after having just watched the “second show” of a movie, you will find a bunch of auto rickshaw drivers who accost you. Without exception, each of them is likely to quote an exorbitant price to take you home. As the night goes on, there is a reasonable chance that some of these drivers will have to move away from the mall, unable to have found a customer for the night.

Two months back, I was looking to purchase a high end laptop. I walked the high streets of Bangalore, going to every big and small computer store I came across. Each brand had a maximum of one laptop that fit my requirements. I ended up purchasing the laptop I’m typing this post on in the US (got a cousin to bring it in for me).

In London in 2005, a sandwich at Subway cost less than two pounds, while a Masala Dosa at a half-decent restaurant cost at least seven or eight pounds. In Bangalore today, a first rate Masala dosa won’t set you back by more than thirty rupees, while a standard unexceptional “sub of the day” at a subway costs over twice that amount.

All the above cases of pricing anomalies or market failures can be ascribed to “lack of liquidity”. In financial literature, liquidity is defined as an asset‘s ability to be sold without causing a significant movement in the price and with minimum loss of value (source: Wikipedia). From a practitioner’s standpoint, liquidity is positively correlated with the amount of activity that is happening in the market – the more the buyers and sellers for a particular security, the less the “transaction cost” you incur in selling it.

Auto rickshaws in the middle of the night, dosas in London, subs in Bangalore and high end laptops in India – they are all examples of markets that (by the above definition) are highly illiquid. In each of the above markets, the number of buyers and sellers at any point of time is low (relative to other comparable markets – such as auto rickshaws in the evening or dosas in Bangalore). Thanks to that, the “bid ask spread” (my apologies for continuing to use financial jargon. Bid ask spread refers to the price between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) is high, and consequently, buyers end up paying a high price, or in some cases, sellers end up not realizing a high enough price for their good.

Now, why should this happen? Doesn’t it sound counterintuitive if I say that “there isn’t much demand for subs in Bangalore, hence the price is high”? The fact is that when I say that “there isn’t much demand” I omit saying that there isn’t much supply also. This calls for further explanation.

Let us imagine a world where it is impossible for a buyer and a seller to interact directly to conduct a sale (this sounds like dystopia, but let us imagine a situation like that). In this world, there are a bunch of “specialists” called “market makers”, whose only job is to buy and sell goods. So if you are the seller of a particular good, instead of finding a buyer, you sell it to a market maker, who takes the risk of holding on to your good (carrying cost, possible damage, risk of sudden fall in value of that class of goods, etc.) until he has found a seller. Similarly, if you want to buy something, you only contact a market maker.

When there are a large number of buyers and a large number of sellers for a particular good, the costs of making markets is low. Due to the number of buyers, the average length of time a market maker has to hold on to the good is low, which automatically reduces the risk of making markets in this particular good. Since the cost of making markets in this good is low, more market makers will want to make markets for this particular good. Their competition lowers the bid-ask spread (refer to definition above), and thus both buyers and sellers will realize a price that is close to the true market clearing price.

Now what happens when there are few buyers and sellers for a good? Very few market makers will want to trade in this good, since the risk of holding on to these goods is significantly higher. Consequently, there is less competition among market makers and the bid ask spread remains high (while it is a fact that the cost of market making is also high for these goods, the lack of competition in market makers further pushes up the spread). As a seller, you now have much less choice in terms of buyers for your good, so you end up accepting a rate much lower than true market clearing price. Similarly, as a buyer, you end up paying exorbitant prices.

Now let us get back to the real world where buyers and sellers can actually interact. It can be seen as being similar to the above world, but with the change that buyers and sellers are their own market makers! The cost of making markets comes into play here. As a seller of auto rickshaw services outside a mall past midnight, you know there is a risk of not finding a buyer for your services. You try and price in this risk in the price you quote, and you end up asking for more than the market clearing rate, and there is a good chance there will be no takers for that rate, until you get desperate about finding a customer and quote something below the clearing rate. If you are looking to hail a rickshaw outside a mall past midnight, you are wary of being stranded there without a ride home, so you end up paying much more than the true clearing price.

Several examples of this nature abound. Like how real estate prices are “sticky”, and builders refuse to drop prices in the face of falling demand (note there that real estate brokers are not market makers – they don’t take on the risk of holding on to the asset). Like how I get suboptimal rent for the house that I own in Kathriguppe in Bangalore, only because there aren’t too many people who want to rent a 3BHK independent house. And how apple products are almost a fourth more expensive in India than in the US.

Moving briefly from micro to macro economics, GDP grows when there is more economic activity, or when there is more trade. One way of increasing GDP is to foster trade. However, a large number of goods and services that people need, or that people want to provide, are “illiquid” (that includes Quant consulting – which is what I do. There aren’t too many of my ilk around, and no too many organizations interested in buying these services). One way of fostering internal trade, and thus economic growth, is to reduce the cost of market making. When it comes to goods, VAT, in that sense is a step in the right direction since at each step it is charged only on the marginal value added – and thus the presence of an intermediary doesn’t increase the total cost by too much. Stamp duty on real estate, however, is a bad idea. By charging a full tax on every transaction, it dissuades market makers in the sector, and thus keeps markets illiquid and opaque. The worst of all, though, is Agricultural Marketing, where by law the APMCs have monopoly in making markets in agriculture. Now you know why the farmer continues to suffer even though retail prices of agricultural products have been going through the roof.

Ok I end this post with that digression into macroeconomics. However, I do hope that I’ve been able to explain to you why illiquid products are costlier (if you’re a buyer that is)! Let me know in case you have any questions.

Update

This post came about as a result of a twitter conversation earlier today with Dhiren and Pavan. Giving credit where it’s due