Perspectives on the global economic meltdown- (Nov 28 2010)

[somnath]

About the only mutual benefit I see is that BoA- Merrill will probably get some more banking business from RIL and Mukesh will gain further in terms of global stature.

Not possible...On the contrary, if anything, there will be more restrictions on the amount of businss BofA can get out of RIL now - there are very strong regs both in the US and in India around conflicts of interest with independent shareholders...these appointments are mostly signllaing tools - so BofA is signalling to the Indian establishment how seriouls it is about its India plans, and plus Mukesh A can certainly add value to most boards even otherwise..

The basis of policy, apart from pragmatism, also has to be principle. In this case, 'reciprocity' as a core principle. How many of our desi banks have branches in the TFTA west? Our very own SBI's application for an overseas NY branch to service NRI accounts has been sat upon for 3 decades now close to. Why are TFTA banks being allowed in at all? That is anything should be the start of our negotiating position only.

Dont know about the specific SBI case in NY, but India generally does a very good job of maintaining reciprocity in banking and fianncial services...The total # of branch licenses given every year to foreign banks is capped @ 12, and RBI maintains that zealously most of the time...

About Indian banks setting up ops in the US, I would actually be very surprised if the demand was that high...Why would any Indian bank spend a lot of money and scarce capital to set up ops in a market growing @1%, when their home market is growing @ 9%? Some niche areas, yes..But as a macro business opportunity, the game is in India, not in the US....

[somnath]

Some more of the same - Jayant Sinha and Ashutosh Varshney describes Indian billionaires as "robber barons"...
http://www.ft.com/cms/s/0/635c59e6-19cd ... z1H336YCfa

India has 6.9 per cent of the world’s 1,000 or so billionaires, while its gross domestic product is only 2.1 per cent of world GDP. The total wealth of Indian billionaires is more than a fifth of the nation’s GDP, equalled only by Russia. By comparison, the wealth of China’s billionaires is less than 3 per cent of its GDP.
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like the barons of America’s Gilded Age, most of India’s billionaires have used three methods to tilt the playing field to their advantage: securing rich natural resources such as mines and land; ensuring favourable regulations in various industries; and restraining the entry of foreign competition wherever possible

[ramana]

There is plan to create enough wealthy Indians before letting the foreigners in. In 80s new technology industry was encouraged to create green field wealthy. However 2000 onwards found they are same as old money!

[Arjun]

Some more of the same - Jayant Sinha and Ashutosh Varshney describes Indian billionaires as "robber barons"...

A standard hit piece from a known anti-India rag. Coming from a nation whose pinnacle in business achievement was the British East India Company - I see this as an attempt by the original barons of thievery to tar Indian business talent with the same brush. Presumably these are among the last flailings of this nation of shopkeepers, as they get used to the idea of being colonised by Indian business magnates.

Note the usage of the phrase 'restraining foreign competition wherever possible' - which makes the agenda of this piece quite clear ! Sinha & Varshney might have been commissioned on this job - but I don't see why BR should give space to this piece.

India has 6.9 per cent of the world’s 1,000 or so billionaires, while its gross domestic product is only 2.1 per cent of world GDP. The total wealth of Indian billionaires is more than a fifth of the nation’s GDP, equalled only by Russia. By comparison, the wealth of China’s billionaires is less than 3 per cent of its GDP.

The statistics are as outdated as the one from Raghuram. Note that this was done before the latest Forbes list came out...

As per the latest list, India has 4.5% of the world's billionaires while India's GDP is 2.8% of global GDP. In comparison, the US has 34% of the world's billionaires while accounting for only 24% of global GDP.

Indian billionaires total wealth stands at 14% of GDP, while that of the US is 9%. Yes its greater - but nowhere close to the extent as portrayed in the statistics above.

Like the barons of America’s Gilded Age, most of India’s billionaires have used three methods to tilt the playing field to their advantage: securing rich natural resources such as mines and land; ensuring favourable regulations in various industries; and restraining the entry of foreign competition wherever possible

'Most' of India's billionaires have done this - thats BS ! Why don't you list out all the billionaires who you believe are guilty of this and lets compute the ratio. As noted earlier, the agenda of this hit-piece becomes patently obvious based on usage of the last phrase- 'and restraining the entry of foreign competition whenever possible'.

[somnath]

Arjun-ji, we have discussed this enough, I posted this only because I came across an interview of Jayant Sinha in Outlook on the same topic and was reminded of the article...

Beyond a point, these things are subjective - so cant really be defined objectively...But examples of crony capitalism abound with gay abandon, no point diregarding that..

'Most' of India's billionaires have done this - thats BS ! Why don't you list out all the billionaires who you believe are guilty of this and lets compute the ratio.

Many of them, in fact perhaps most of them in the list...For good reasons or bad...A small example - Bajaj Auto - Rahul Bajaj goes on and on sanctimoniously on every thing under the son...How come Bajaj Auto redeemed its full investment (~500 crores I think) in UTI US 64 just before (in fact a day or two) the entire scam unravelled? Going out at the 'gteed NAV while the rest of the retail investors had to be bailed out by the govt at much much lower levels as the scheme imploded...Savvy investment management?

there is a lot of it - the 2G scam is living example of that...So we need to be careful, and get strong regulators in (like RBI) - thats the limited point...

[akashganga]

http://financialsense.com/contributors/ ... ull-market

The "permanent Bull market" engineered by the constant intervention of banking and political authorities has a problem: the duration of each cycle is getting shorter.

[Arjun]

Many of them, in fact perhaps most of them in the list...For good reasons or bad...A small example - Bajaj Auto - Rahul Bajaj goes on and on sanctimoniously on every thing under the son...How come Bajaj Auto redeemed its full investment (~500 crores I think) in UTI US 64 just before (in fact a day or two) the entire scam unravelled? Going out at the 'gteed NAV while the rest of the retail investors had to be bailed out by the govt at much much lower levels as the scheme imploded...Savvy investment management?

At best this can be an example of insider trading. What seems to have happened is that some folks at the top of the UTI management probably tipped off a few of the largest corporate unit-holders - so that UTI did not lose out on their confidence and money for future schemes - I would blame the insiders in UTI more than Bajaj....

And this is not even one of the points listed in Sinha's article! If you are going to look for alleged misdemeanors against industrialists - rest assured you will find mounds of examples, as you will in the US where every large firm at any point in time will have several litigation cases filed against it. Once you become a key part of the economy there is no escaping this aspect.

Regulation is an imperative but I would question your need for selectively tarring only Indian business in order to justify the need for regulation.

[Arjun]

http://financialsense.com/contributors/ ... ull-market

The "permanent Bull market" engineered by the constant intervention of banking and political authorities has a problem: the duration of each cycle is getting shorter.

Maybe the Austrians should come out with a new formula that says all stock prices everywhere are a monetary phenomenon !!

How do the Austrians explain the 99-2000 market boom? And why are commodity markets exempt from these cycles - are they not part of the Fed-driven bonanza?

[Hari Seldon]

^^^ Good point, Arjun.

Austrian economics, it seems, is also only half-right (a little better than that perhaps), just like the other schools.

However, it does have at its heart certain identities that are almost self-evident in their simplicity. Such as for instance, that expenses > income is not sustainable in the long term regardless of how complex the economic system is.

Sure, its not always practical, this Austrian school thing but it does give a useful benchmark to measure against - like the 'first best' outcome in economics that ain't always achievable but is useful to see how efficient/effective the 'second best' outcome is etc.

IMO, deflation play will have to play out before genuine recovery and repair can happen - whether in proxies for economic health like stock prices or in socio-economic indicators like median wages and access to healthcare. There is no doubt that the Fed and assorted central banks have been desperately trying to stave off deflation by pump over-priming liquidity into a fin system already suffering from indigestion of debt gone bad form the past binge. IOW, no use only. BoJ shows amply why central banks are powerless in the face of a deflationary outcome. Fiscal stimulus might help take on deflation but I see little appetite for that right now. We'll see, time will tell.

[ldev]

Self del

[Arjun]

However, it does have at its heart certain identities that are almost self-evident in their simplicity. Such as for instance, that expenses > income is not sustainable in the long term regardless of how complex the economic system is.

My understanding is that the Austrian school is against all intervention by government in financial markets, whether through monetary or fiscal policy. On the monetary side they use arguments like the Fed exacerbates cycles rather than smoothens them, and that fiat money results in inflation - on the fiscal side I presume they are using the argument of expenses > income not sustainable to argue against any fiscal intervention or deficit.

First of all, I do think there is validity in having a school of thought that does not agree with the principle of government intervention. In the absence of any real-life examples though- it becomes difficult to be completely certain of the pros and cons of any such approach. Which is why I had suggested earlier having a country (maybe a small one) that actually implements this so we know the practicability of the Austrian school.

Sure, its not always practical, this Austrian school thing but it does give a useful benchmark to measure against - like the 'first best' outcome in economics that ain't always achievable but is useful to see how efficient/effective the 'second best' outcome is etc.

Am not aware of this one...will have to google it up, or if you have any good literature, happy to update my knowledge.

IMO, deflation play will have to play out before genuine recovery and repair can happen - whether in proxies for economic health like stock prices or in socio-economic indicators like median wages and access to healthcare. There is no doubt that the Fed and assorted central banks have been desperately trying to stave off deflation by pump over-priming liquidity into a fin system already suffering from indigestion of debt gone bad form the past binge. IOW, no use only. BoJ shows amply why central banks are powerless in the face of a deflationary outcome. Fiscal stimulus might help take on deflation but I see little appetite for that right now. We'll see, time will tell.

I found this to be a good article on understanding the whole inflation/deflation / hyperinflation debate: Thoughts on Inflation & Hyperinflation

From this article - paper currencies since 1948 have NEVER had any episode of deflation as long as they had an independent central bank (there was only one exception ever of Japan in late eighties). On the other hand, the gold standard period preceding it was marked by alternate periods of inflation and deflation. It therefore seems to me, that central banks are not really concerned about deflation as a serious threat today. But the Fed and others believe that a certain amount of inflation is good for the economy (the URL I enclosed talks of aiming at 4% as a good target) - so they are actually trying to boost inflation to this benchmark. Of course, the liquidity overhang in an economy where interest rates are close to zero is debatable....esp when there is no matching investment to mop up the cash infusion.

[Arjun]

Xposting from Global Economy thread...

IMF Addresses Big Economic Questions

http://blogs.wsj.com/economics/2011/03/ ... questions/

A summary of the main conclusions from this event, from Olivier Blanchard (Future of Macroeconomic Policy)

The Future of Macroeconomic Policy: Nine Tentative Conclusions

The global economic crisis taught us to question our most cherished beliefs about the way we conduct macroeconomic policy. Earlier I had put forward some ideas to help guide conversations as we reexamine these beliefs. I was heartened by the wide online debate and the excellent discussions at a conference on post-crisis macroeconomic policy here in Washington last week. At the end of the conference, I organized my concluding thoughts around nine points. Let me go through them and see whether you agree or not.

1. We’ve entered a brave new world in the wake of the crisis; a very different world in terms of policy making and we just have to accept it.

2. In the age-old discussion of the relative roles of markets and the state, the pendulum has swung—at least a bit—toward the state.

3. The crisis made it clear that there are many distortions relevant for macroeconomics, many more than we thought earlier. We had ignored them, thinking they were the province of the micro-economist. As we integrate finance into macroeconomics, we’re discovering distortions within finance are macro-relevant. Agency theory—about incentives and behavior of entities or “agents”—is needed to explain how financial institutions work or do not work and how decisions are taken. Regulation and agency theory applied to regulators is important. Behavioral economics and its cousin, behavioral finance, are central as well.

4. Macroeconomic policy has many targets and many instruments (that is, the tools we use or variables to implement policy). There are many examples of this that were discussed at the conference, but here are two.

* Monetary policy has to go beyond inflation stability, adding output and financial stability to the list of targets, and adding macro-prudential measures to the list of instruments.
* Fiscal policy is more than just “G minus T” and an associated “multiplier” (the proportion or factor by which changes in government spending or taxes affect other parts of the economy). There are potentially dozens of instruments, each with their own dynamic effects that depend on the state of the economy and other policies. Bob Solow made the point that reducing discussions about fiscal policy to what is the right multiplier does not do service to the issue.

5. We may have many policy instruments, but we are not sure how to use them. In many cases, we are uncertain about what they are, how they should be used, and whether or not they will work. Again, many examples came up during the conference.

* We don’t quite know what liquidity is, so a liquidity ratio is one more step into the unknown.
* It was clear that some people believe capital controls work and some don’t.
* Paul Romer made the point that, if you adopt a set of financial regulations and keep them unchanged, the markets will find a way around, and ten years later, you’ll have a financial crisis.
* Mike Spence talked about the relative roles of self-regulation and regulation. Both are needed, but how we combine them is extremely unclear.

6. While these instruments are potentially useful, their use raises a number of political economy issues.

* Some instruments are politically hard to use. Take cross border flows. Putting in place a multilateral regulatory structure will be very difficult. Even at the domestic level, some macro-prudential tools work by targeting specific sectors, sets of individuals, or firms, and may lead to strong political backlash by those groups.
* Instruments can be misused. The more there are, the more the scope for misuse. It was clear from the discussion that a number of people think that, while there may be an economic case for capital controls, governments could use them instead of choosing the right macroeconomic policies. Dani Rodrik argued for using industrial policy to increase the production of tradables—goods or services that can be traded among countries—without getting a current account surplus. But in practice we know the limits of industrial policy, and they haven’t gone away.

7. Where do we go from here? In terms of research, the future is exciting. There are many topics on which we should work—namely macro issues with, as Joe Stiglitz said, the right micro foundations.

8. Things are harder on the policy front. Given we don’t quite know how to use the new tools and they can be misused, how should policymakers proceed? While we have a good sense of where we want to get to, a step-by-step approach is the way to do it.

* Take inflation targeting. We can’t, from one day to the next, just give it up and have, say, a system with five targets and seven instruments. We don’t know how to do it and it would be unwise. We can, however, introduce gradually some macro-prudential tools, testing the water to see how they work.
* Increasing the role of Special Drawing Rights in the international monetary system is another example. If we go in that direction, we can move slowly from, say, creating a market in private SDR bonds to exploring the possibility for the IMF to issue SDR bonds to the private sector and then, if feasible, issuing them to mobilize funds in times of systemic crisis.

Pragmatism is of the essence. This was a general theme that came up, for example, in Andrew Sheng’s discussion of the adaptive Chinese growth model. We have to try things carefully and see how they work.

9. We have to keep our hopes in check. There are going to be new crises that we have not anticipated. And, despite our best efforts, we could have old-type crises again. That was a theme in Adair Turner’s discussion of credit cycles. Can we, using agency theory and the right regulations, get rid of credit cycles? Or is it basic human nature that, no matter what we do, they will come back in some form?

I was asked whether the conference was “Washington Consensus 2“. It was not intended to be and it was not. The conference was the beginning of a conversation, the beginning of an exploration, and we look forward to your contributions.

[ramana]

Somnath, How will the economic world change if there is a EU-India FTA and also Commonwealth FTA?

Please think it over and give me the reply.

Thanks, ramana

[Abhijeet]

Our very own Tarun Khanna and Krishna Palepu articlated a theory of conglomerates about 15-16 years ago, that argued differently to CK Prahlad's "core competence" axioms...the basic premise was that in developing markets, factor markets are not efficient - labour, capital, regulation...Therefore companies tend to become conglomerates as they build all the requred resources in-house rather than depend on an ineffcient factor market...

That's interesting. A few months ago I had remarked on the fact that most large Indian companies dabbled in just about everything rather than being specialized like most developed country companies. I had asked whether there was an inverse correlation between the development of an economy and the percentage of unspecialized companies in that country. It appears that this is the case.

I'd also add that one more -- very important -- reason for why conglomerates develop in poor countries is severe capital scarcity. Most capital available is growth capital rather than risk capital and is simply not available to entrepreneurs starting new businesses. In such a scenario, access to capital for large companies is itself a source of competitive advantage -- very different from the scenario in countries with more developed systems for acquiring risk capital like the US.

My opinion is that increasing access to seed stage capital for entrepreneurs is one of the most effective ways to help the Indian economy develop -- I don't mean in the sense of micro-loans for subsistence entrepreneurs, but seed stage funding for companies in high-risk, high-reward areas like technology. It's not healthy that it almost always takes one of the usual suspects -- Tata, Reliance, Wipro etc -- to explore new markets, rather than specialized companies coming up to exploit those areas first.

[ramana]

Indian companies dabbling in everything is a out growth of the earlier Managing Agent mode of company organization in Indian Companies Act. After that rule was abolished they had to convert into conglomerates.

[somnath]

I had asked whether there was an inverse correlation between the development of an economy and the percentage of unspecialized companies in that country. It appears that this is the case

Abhijeet-ji, while you are broadly right in most of the things you say in the post, this isnt correct..A conglomerate-driven development process has been quite the hallmark all over Asia...Korea went from subsistence to OECD membership on the back of conglomerates...Post-war Japan is a story of conglomerates...East Asia has tons of conglomerates as most countries graduated to middle income status...So conglomerates arent a "hindrance" per se to development...What one should be careful about is cronyism - and all Asian countries have seen MASSIVe amounts of that...

Your point on risk capital is absolutely valid...For the longest time, developing countires did not have any "risk" capital - hence newer ventures could be started only by groups with legacy businesses generating the cash...For India, the rise of conglomerates had another, more pernicious reason...the license-permit raj meant that businesses couldn grow beyond a point...And businesses were protected by both quantitative and non-quantitiatvie barriers...So what does the entrepreneur do with the cash? He either repatriates them abroad to ventures into new areas...Indian businesmen did both - the latter gave rise to the conglomerates...

If you look at the structure of conglomerates around the country today, most of them are reorganising themselves into quasi VC/PE outfits at the familiy (or "Group") level..The family acts as the risk-taking venture capitalist, while the companies are largely professionalised...Mahindra, the Subbiah group (I remember the old man of the group making a ppt on the then proposed-change to our class in B-school more than a decade back!), Tatas - the companies are increasingly professionalised into individual distinct entities....

the Tarun Khanna-Krishna Palepu HBR (HArvard Business Review) classic has many more examples - I referenced part of the link above...Anyone having access to HBR should read up on the article...It is often also about a "definition" of core competence...For example, when ITC started thinking, they asked themsleves - what is our "core competence" - marketing tobacco? Or is it building a consumer brand? they concluded its the latter...And hence ventured into the lifestyle segment with the Wills brand....

[Arjun]

That's interesting. A few months ago I had remarked on the fact that most large Indian companies dabbled in just about everything rather than being specialized like most developed country companies. I had asked whether there was an inverse correlation between the development of an economy and the percentage of unspecialized companies in that country. It appears that this is the case.

I'd also add that one more -- very important -- reason for why conglomerates develop in poor countries is severe capital scarcity. Most capital available is growth capital rather than risk capital and is simply not available to entrepreneurs starting new businesses. In such a scenario, access to capital for large companies is itself a source of competitive advantage -- very different from the scenario in countries with more developed systems for acquiring risk capital like the US.

My opinion is that increasing access to seed stage capital for entrepreneurs is one of the most effective ways to help the Indian economy develop -- I don't mean in the sense of micro-loans for subsistence entrepreneurs, but seed stage funding for companies in high-risk, high-reward areas like technology. It's not healthy that it almost always takes one of the usual suspects -- Tata, Reliance, Wipro etc -- to explore new markets, rather than specialized companies coming up to exploit those areas first.

1. The idea that most large firms in India dabble in just about anything is not correct. Most firms in India are specialized on a single sector - but the business families that back these firms typically do dabble across industries. So the Tatas as a group would be in every sector under the sun - but each firm within their group would largely be focused on a single sector.

2. The business families need to thought of more as the original Indian equivalents of Private Equity firms - and PE firms globally do invest across industries.

3. New age industries in India like technology and pharmaceuticals / life sciences - are largely not dominated by the traditional business family enterprises. A tremendous amount of new wealth has been created in these industries and there exist a large number of startups to address opportunities in these areas. The VC scene might not be as developed as in the US, but India would still probably figure in the top 4 - 5 countries in terms of VC fund deployment. The quantum of VC funding in the US is actually going down as well - as you probably know.

4. Another reason for business families in India to get into multiple sectors is that unlike in the US, there are high-growth opportunities across a variety of more traditional sectors today - and since there is no entrenched competition in some of these sectors that are opened up, it makes sense to try and get a first-mover advantage. If US firms had been presented with the same kind of opportunities - they would most likely have responded by diversifying similarly as well.

[Arjun]

Will Fed Become Permanently More Proactive? IMF Sparks Debate

[devesh]

^^^ modern day macroeconomics is heavily influenced by Milton Friedman and even more deeply by John Maynard Keynes.

Friedman views monetary stimulus as the lesser devil compared to direct govt programs and considered the lack of monetary stimulus as the reason for the severity of the Depression.

Keynes, if he were not born into an elite family with connections to British Aristocratic elite, would have been considered a nutjob and promptly ignored or ridiculed. according to Keynes, the very concept of "interest rates" was a blasphemy perpetrated by the "exploitative" aspects of capitalism. i disagree with the Austrians on many things, but their assessment is very accurate when the say that: had Keynes been some obscure academician from some obscure part of the world, his theories would have been promptly discarded for their utter lunacy.

i strongly suggest everybody to read the General Theory by Keynes. there are several parts where he expresses his personal opinions on some matter or the other that are utterly lunatic.

the post 2008 era has seen Friedman's theory being tested. only time will tell if Friedman's assertion that continuously pumping money into a debt-deflationary black hole can have any effect at all.

[somnath]

Somnath, How will the economic world change if there is a EU-India FTA and also Commonwealth FTA?

Please think it over and give me the reply.

Thanks, ramana

Difficult to say if the "world" will change - India is a relatively minor player in trade terms just yet..

Generically though, FTAs are always problematic for India, as tariff brriers in India are typically higher than most advanced countries...So there in terms of pure trade tariff terms, most of the "giving" needs to be done by India...We try to offset that by seeking more access to Indian labour and banking capital, and getting concessions on Non-Tariff Barriers....The other typical sticking point is on agricultural trade, European farmers have very very high level of export subsidies while Indian farmers have a very low level of support..There is also another, though increasingly less important for India, issue of differential treatment allowed under WTO for "developing" countries...FTAs, being purely bilteral in nature, makes the arrangement a lot more "reciprocity driven"..

To be honest, the issue of whether FTAs really increase trade is an open question...There is quite a bit of research in public domain on the topic...One here..
http://www.frbatlanta.org/filelegacydocs/wp0503.pdf

For India, Bibek Debroy is the BEST (with a capital analyst on trade issues - and he said something very perceptive 11 years back in a lecture in my school - "India needs an FTA within the country before we do FTAs with other countries"! the situation is better today, but still not fully so...

FTAs are done more for the political optics of bilateral relationships, as well as the fact that it is the "in thing" these days..Apparently more than half of world trade passes through FTA areas, hence it is almost a sine qua non..No one's sure whether it benefits them, but not having a few means that you are not sufficiently "engaged" with the world! To think of how wheels turn - WTO was set-up to remove bilteral distortionism in global trade...FTAs go back to the same bilteral "cozy-ism" all over again

In that respect, Indo-EU FTA is a good signal of India engaging with the world's largest trading bloc...Commonwealth? Its not a cogent geogrpahic, political or economic entity...The only useful part of the Commonwealth is the African bloc - and India is anyway dealing with Africa in various different ways, incl FTAs under negotiation with South Africa, and the IBSA initiative...

[Arjun]

^^^ modern day macroeconomics is heavily influenced by Milton Friedman and even more deeply by John Maynard Keynes.

The credibility of Friedman and monetarism with the emphasis on single policy instrument of determining rates has taken a massive hit with this crisis, as well as earlier ones in the 90s.

The Chicago neoclassical school - identified with the efficient markets hypothesis and rational behavior - has also taken it in the chin.

So it looks to me that the winners today are Keynesian economics and Austrian. At the level of policy makers (governments) and in academic circles - Keynesian thought seems to be seeing a resurgence.

At the level of the ordinary masses - if BR and other blogs I am seeing is any indication, there seems to be a populist resurgence in the Austrian school and 'gold standard' related thought. One reason for this may simply be that the public does not know what to believe any longer and radical ideas are gaining momentum.

One point from Blanchard's summary of the IMF conference that I am in full agreement with-

Monetary policy has to go beyond inflation stability, adding output and financial stability to the list of targets, and adding macro-prudential measures to the list of instruments.

Can you believe it - these guys at the Fed were never seriously targeting measures of financial stability (debt levels at household, firm, bank & government levels) and macro-prudential measures ?? THAT is what led to the crisis....in comparison, my understanding is that the RBI had always incorporated all of these commonsensical measures into its thinking. As long as at least this aspect comes to the fore - that should be good learning for the Fed from the crisis.

[somnath]

So it looks to me that the winners today are Keynesian economics and Austrian. At the level of policy makers (governments) and in academic circles - Keynesian thought seems to be seeing a resurgence.

Arjun-ji, you cant have both Austrian AND Keynesian streams winning the same crisis The reasons why the Austrian school is gaining prominence are precisely the standard invectives reserved for the Keynesians - bloated govt spending, outsized govt, leading to imbalances...To be sure, it is difficult to say whether the problem is a crisis triggered by Keynesian imbalances or by Keynes-meets-Milton-Friedman type attempted solutions to the crisis...

Central banks do inflation-targeting as a core objective function...But to say that they dont look at other variables is stretching it too far - even that work of fiction (Alan Greenspan's Memoirs ) has many references to discussions on public debt for example...

To me, the key to the issue is a moral dilemma - are there banks that are "too big to fail"? If yes, then there should not be any...Banks cannot be allowed to grow too big to fail...Once that is established, crises can be handled much better...

[chaanakya]

For India, Bibek Debroy is the BEST (with a capital analyst on trade issues - and he said something very perceptive 11 years back in a lecture in my school - "India needs an FTA within the country before we do FTAs with other countries"! the situation is better today, but still not fully so....

Yes its really perceptive. We do need FTA within, first of all.

[Arjun]

Arjun-ji, you cant have both Austrian AND Keynesian streams winning the same crisis

Its counter-intuitive certainly, but I guess one explanation is that there is greater polarization of thought. Let me clarify I am not endorsing any one school out here.

Central banks do inflation-targeting as a core objective function...But to say that they dont look at other variables is stretching it too far - even that work of fiction (Alan Greenspan's Memoirs ) has many references to discussions on public debt for example...

The entire financial stability part does not seem to have been a focus for most central banks. Else, debt levels ( & I am talking household, corporate and financial intermediary levels in addition to public debt) would not have been as high in the US. Further, whether prudential lending norms were being followed (in the mortgage case everyone was aware of the fraud in terms of missing documentation and high LTV ratios) was something the Fed should have been on top of.

To me, the key to the issue is a moral dilemma - are there banks that are "too big to fail"? If yes, then there should not be any...Banks cannot be allowed to grow too big to fail...Once that is established, crises can be handled much better..

This may not be enough....Crises are usually caused due to asset bubbles in certain sectors (eg subprime mortgages) - which affect multiple banks at the same time when the bubble collapses. Even if no single bank is TBTF, what if multiple small banks get affected simultaneously, which is a likely scenario?

Also how do you prevent a credit lockup? What we've seen is that credit markets can sometimes get into lockdown mode as lenders are unsure of which banks are solvent and which aren't. One possible solution there is that just as Keynesian economics would recommend that the government step in as a demand generator when the market fails, the government should also step in as a buyer of last resort for the specific asset class (at highly discounted rates), but only for the purpose of stabilizing the credit markets.

[somnath]

Arjun-ji,

the issue of debt is handled by Central Banks, more so as public debt has such a large bearing on inflation, its core objective..In the US, the problem wasnt of leverage on corporate balance sheets - it wasnt high by global or hisorical standards...Individual leverage was a problem, and maybe some more attention should have been given to it than was done..But the really, the big issue was on how banks were taking stuff ostensibly "off" their balance sheets when they really were not going anywhere..

If there was a recession, and a lot of people "normally" defaulted on mortgages, there would be stress on the banks, but not a contagion...Prudential banking norms dictate enough capital, reserves, provisions etc for bad loan contingencies...They are designed to help the banks, and the system absorb shocks...The problem arose because fancy instruments (CDOs, ABS) started ostensibly taking these loans (mortgages incl) "off" the balance sheets..Ergo, with that, out went the entire "normal" banking infrastructure of monitoring and above all capital and provisioning norms...(At a bit more "micro" level, the assets moved from "banking" books to "trading" books..)...These instruments in turn got sold to insurance companies, mutual funds, hedge funds etc, on a leveraged basis, with the leveage coming from the same bank!

When the crisis hit, the banks therefore had no buffer to absorb any shock on trillions of dollars of exposures...And then a loss of confidence contagion took over..

In the event, a clutch of large banks held bulk of the depositors' money and got hit massively...The govts had a choice of either letting them "go", or bail out the depositor...Mostly they chose the latter option..Now if the banks stuck to vanilla banking, even if there were lots of small banks hit at the same time due to a recession, it wouldnt have been so painful..Because the banks themselves would have had enough cushion to weather normal banking shocks without trigerring a psychological contagion..

[Arjun]

But the really, the big issue was on how banks were taking stuff ostensibly "off" their balance sheets when they really were not going anywhere..

True, the shadow banking system should have been accounted for in regards to stress calculations. Even if it does not come under regulation, as is being proposed - the impact of the shadow banking system on stress scenarios is something the Fed should monitor.

[devesh]

how do the Fed and RBI compare when it comes to the "lender of last resort" policy? does RBI have such a policy. this is a key issue. the lender of last resort BS is the excuse that Fed has used to do its money printing. does RBI have such a function too?

[Virupaksha]

how do the Fed and RBI compare when it comes to the "lender of last resort" policy? does RBI have such a policy. this is a key issue. the lender of last resort BS is the excuse that Fed has used to do its money printing. does RBI have such a function too?

yes

[somnath]

how do the Fed and RBI compare when it comes to the "lender of last resort" policy? does RBI have such a policy. this is a key issue. the lender of last resort BS is the excuse that Fed has used to do its money printing. does RBI have such a function too?

Devesh-ji, I dont think thats quite correct...Monetary expansion(whether by printing money or buying up foreign exchange or cutting down bank reserve requirements) is a deliberate policy tool to influence certain desired macro outcomes, nothing to do with "lender of last resort" function...

[devesh]

^^^ i was specifically referring to post 2008 situation where "lender of last resort" was the convenient excuse given to pump trillions into wall street banks. when the panic hit, instead of a restructuring mechanism for banks, the Fed shored up their balances b/c they were the "last resort."

[Arjun]

^^^ i was specifically referring to post 2008 situation where "lender of last resort" was the convenient excuse given to pump trillions into wall street banks. when the panic hit, instead of a restructuring mechanism for banks, the Fed shored up their balances b/c they were the "last resort."

The 'lender of last resort' function is a standard activity of practically all central banks. Typically there is a distinction drawn between banks facing 'liquidity' issues vs 'solvency' issues. Liquidity issues are of a more temporary nature - and may arise due to sudden panic situations, bank runs, credit lockdowns etc - central banks act as a lender of last resort in these occasions.

When the problem is more of a solvency issue (when you refer to restructuring balance sheets, that is a solvency issue) - we are then talking of bailouts and that is certainly a more contentious issue as to how far central banks should be doing this. That's where the TBTF argument comes in - and where the consensus now is that TBTF should be restricted.

My personal opinion is that as long as government rescuing of banks is negotiated well in the form of equity / warrant holdings in the bank - the overwhelming probability is that the bailout would generate profit for taxpayers, so I wouldn't be as bothered about this aspect as the media seems to be.

[somnath]

^^^Issues of solvency anyway cannot be solved by the central bank pumping liquidity - it requires a balance sheet restruturing and infusion of equity - which is the job of the govt..In moments of liquidity crisis, what central banks do is to offer a backstop liquidity facility to banks to increase system confidence - all central banks did that during the crisis, including RBI..

[ramana]

Somnath, Thanks. On the issue of FTA inside India, I was told States raise lot of revenue from octroi etc and need for resource mobilization.

[somnath]

Somnath, Thanks. On the issue of FTA inside India, I was told States raise lot of revenue from octroi etc and need for resource mobilization.

They do, thats the ostensible reason, but study after study have shown how inefficient they are, even from the perspective of revenue generation...GST is an attempt to remove all of that and have a "Common Indian Market" , 60+ years ater independence...

[Abhijeet]

A conglomerate-driven development process has been quite the hallmark all over Asia...Korea went from subsistence to OECD membership on the back of conglomerates...Post-war Japan is a story of conglomerates...East Asia has tons of conglomerates as most countries graduated to middle income status...So conglomerates arent a "hindrance" per se to development...What one should be careful about is cronyism - and all Asian countries have seen MASSIVe amounts of that...

That particular comment was about poor countries having more conglomerates than rich countries, not specifically about whether it was good or bad. Conglomerates may have good or bad points, but there is certainly a correlation between higher economic development and more specialized companies -- the "inefficient factor markets" you mentioned are more likely in poor countries than in rich countries with good physical infrastructure, education systems and capital markets.

I agree that many East Asian countries have ridden the chaebol model to prosperity -- they also had somewhat enlightened governments, which we sadly lack, so I continue to believe that it is extremely unhealthy for the Tatas, Reliance etc to have a stranglehold on entering new markets as they currently do in India.

[Hari Seldon]

Good post by yves smith over at NC on a problem I've been wondering about for quite a bit only.
The Stigmatization of the Unemployed

Many pundits, such as Paul Krugman in his latest New York Times op-ed, have decried the lack of anything remotely resembling adequate responses to the unemployment problem, particularly that of the long-term unemployed. Ronald Reagan, hero of the right, was concerned when unemployment rose over 8% and took a series of corrective measures, including the Plaza Accord, which was a G-5 currency intervention to drive up the value of the yen. So why do we have a nominally Democratic president sitting on his hands in the face of much worse unemployment?

Ain't that a quandry or what? Response to the US unemployment problem does indeed seem muted. The media has been co-opted/recruited in covering it up instead of covering it. The official stats by various gubmint agencies all downplay (some obscenely so, like the BLS) and skit around the issue (sometimes to issue downplayed revisions later when the lights are off)... so what gives?

Of course, official stats actually show stabilizing unemployment by, yup, dropping people off the 'legitimate' labor pool.

We’ve now had a spate of commentary on the fact that official unemployment figures are looking a tad less dreadful by dint of the fact that increasing numbers of the long term unemployed have dropped out of the job market entirely. Even the conservative Washington Post woke up last week, Rip Van Winkle like, to take note of the growing number of long-term unemployed. Bizarrely, or perhaps as a fit illustration of the spirit of the day, the article was titled: “Hidden workforce challenges domestic economic recovery.” In other words, they are Bad People because if the economy ever picks up, they might come out of the woodwork and start looking for jobs!

Yves believes it is the sabotaging of the labor movement in the US that has led to this impasse.

I’d argue that the roots lie in a fundamental change in policy that took place around 1980. The lesson that economists drew from the stagflation of the 1970s was that labor had too much bargaining power. The excessive fiscal stimulus of the later 1960s and the oil price shocks of the 1970s had been amplified by the fact that workers had enough clout to demand and get wage increases when they faces sustained price increases. That of course led to more price increases since higher wages led to higher production costs which led business owners to increase prices of their goods and servicer, thus accelerating the inflation already under way.

The solution, per neoclassical economists, was to use unemployment to keep wage demands in check. Thus having a lower level of employment even in good times and taking other measures, like weakening unions, was key to keeping those pesky workers from ever serving to create a reinforcing inflationary dynamic.

As an aside, there were other convenient (to the capital-owning classes) side effects of this policy. Before, there had been an explicit agreement between unions and employers embodied in the so-called Treaty of Detroit, which was that workers were to share in productivity gains. President Kennedy even warned major corporations that if they did not adhere to this understanding, he’d push through legislation to make sure they did. Since wage growth and productivity growth marched in near lockstep from 1950 to just after 1980, it appears white collar worker benefitted from blue collar bargaining successes.

But surely, the whizzes in NY and DC would have done something! Well,yes, sort of, they did try with an overly loose monetary policy but thanks to persistent and rising trade deficits, phoren supply benefited more than US industry.

The reason that that [loose monetary policy] didn’t lead to firmer employment, as former Fed economist Richard Alford argues, was inattention to persistent trade deficits, and that was due to policy measures outside the Fed’s purview. The Fed failed to factor that in fully due to its reliance on macro models that assumed any trade deficits were transitory and hence could be ignored. But older-school economists would have recognized that sustained trade deficits meant that US stimulus, including monetary policy measures, would leak into foreign demand.

And finally, a good summary:

I think there have been significant second-order effects as a result of a restructuring of the American workplace by employer who like to claim that “employees are our most important asset”: but really treat them as expenses to be minimized, ruthlessly. One is the way unemployment quickly becomes a barrier to getting a job again. There has always been bit of a stigma surrounding unemployment, since the concern is that the individual lost his job for performance reasons, as opposed to bad luck (his company being acquired, say).

But I’ve seen the bias become far more ingrained over time, reinforced and rationalized by the bizarre way that companies now spec jobs. ...

This bias against those out of work is long-standing, although it has gotten worse over time. Talented people over 40 who have lost a corporate perch are pretty much unemployable; I cannot tell you over the last 15 years how many people I’ve seen retire early (and at a modest standard of living) who’d much rather be working. They are the high class version of this problem. And from what I can tell, a significant portion of new business formation is out of necessity: people who cannot find a job setting up their own single instead.

So this “skills” meme is basically an excuse for bad policy and lazy management. It allows for the rationalization of outcomes that would have been seen as unacceptable in the Reagan era. And it’s hard to pin this development on the Fed. This weakening of the position of workers is the result of both deliberate action and misguided economics frameworks. It’s time to take aim at the ideology, not just some of its key followers.

The comments section is half-decent, as well.

[Abhijeet]

1. The idea that most large firms in India dabble in just about anything is not correct. Most firms in India are specialized on a single sector - but the business families that back these firms typically do dabble across industries. So the Tatas as a group would be in every sector under the sun - but each firm within their group would largely be focused on a single sector.

This is splitting hairs. Even if the companies are separate in name, they are effectively run by the same people, generally from the same family that owns the group. They may have professional managers as hired CEOs, but that doesn't make them separate companies.

2. The business families need to thought of more as the original Indian equivalents of Private Equity firms - and PE firms globally do invest across industries.

In the PE world, the equivalent (and a very loose one) might be turnaround specialists who buy firms, install their own management, turn around companies and then sell them. Most PE firms invest in already-running companies and continue to back existing management. No PE firm starts a new company from the ground up. Indian conglomerates are not investors in existing firms, they start their own companies in response to market conditions (often loosening of government control in a sector).

3. New age industries in India like technology and pharmaceuticals / life sciences - are largely not dominated by the traditional business family enterprises. A tremendous amount of new wealth has been created in these industries and there exist a large number of startups to address opportunities in these areas. The VC scene might not be as developed as in the US, but India would still probably figure in the top 4 - 5 countries in terms of VC fund deployment. The quantum of VC funding in the US is actually going down as well - as you probably know.

I don't disagree with this, although VC funding in India is not really risk capital in the same sense as in the US (there was a short discussion about this recently). But yes, the fact that companies like Infosys are specialized and not (yet) into retail or providing DTH connections is a Good Thing.

4. Another reason for business families in India to get into multiple sectors is that unlike in the US, there are high-growth opportunities across a variety of more traditional sectors today - and since there is no entrenched competition in some of these sectors that are opened up, it makes sense to try and get a first-mover advantage. If US firms had been presented with the same kind of opportunities - they would most likely have responded by diversifying similarly as well.

A simple thought experiment will show this is incorrect. The Internet presents probably the greatest economic opportunity of the last several centuries -- high-growth, global scale and (as of 1995) with no incumbents. It would seem like the perfect place for existing US and global companies to establish new, highly profitable lines of business. Yet if you look at the really large, game-changing companies of the Internet age -- Google, Amazon, Facebook -- all of them were started from the ground up to take advantage of the Internet, and none of them came out of an existing US company "diversifying" onto the Internet. Of course, existing companies moved their businesses online, but the biggest winners of the Internet age have all been specialized companies.

This was possible because with a deep pool of risk capital available, even outsiders could get funding for new businesses focused around the Internet, and pursue them with a single-mindedness that existing large companies could not match. If more risk capital were available in India, the same dynamic would play out in the many industries in which there are opportunities available.

The fact that you don't find pure startups in almost any new market in India is more a function of capital scarcity than any particular nimbleness of Indian conglomerates.

[Hari Seldon]

^^^ Good points. Developmentally, we are still decades behind the TFTA world.

As time goes by, we'll get there too. Hopefully.

[Arjun]

This is splitting hairs. Even if the companies are separate in name, they are effectively run by the same people, generally from the same family that owns the group. They may have professional managers as hired CEOs, but that doesn't make them separate companies.

You have to distinguish between firms and shareholders of the firms. In the case of two firms that are owned either fully or partially by the same set of shareholders- as long as their CEOs and organization structures below the CEO do not overlap, and they are separate legal entities - absolutely they are separate firms! The board of directors may be the same - but that is in the realm of the shareholding of the company.

If you are looking at commonality at the level of Board of Directors - there are tons of the same kind of groups in the US. Do you consider Fruit of the Loom to be a different company from GEICO Insurance ? Certainly, but they are both owned by Warren Buffet. Buffet owns more than 50 different firms - but the difference is that if he were in India, these firms would be marketed and known as the Berkshire Hathaway / Warren Buffet group, whereas in the US the company is kept in the forefront rather than the group (which by the way IS a better system, but that is a smaller difference than what you are talking about). Would you consider Harman International (which makes audio equipment) to be the same firm as First Data (the credit card processor)? Well, both are owned by the buyout firm - KKR.

In the PE world, the equivalent (and a very loose one) might be turnaround specialists who buy firms, install their own management, turn around companies and then sell them. Most PE firms invest in already-running companies and continue to back existing management. No PE firm starts a new company from the ground up. Indian conglomerates are not investors in existing firms, they start their own companies in response to market conditions (often loosening of government control in a sector).

Not exactly true..several firms which are integral parts of business groups in India were acquired by them rather than built from scratch. Conversely, smaller PE firms and VC firns in the US have created quite a few firms from scratch to take advantage of opportunities. The one difference between the two cases that I would admit to - is that Indian firms typically (though even this is changing) would bring in industry specific expertise as hired employees, while the US PE / VC firm would be more liberal in parting with some percentage (say 10%) ownership of the firm in return for getting a professional CEO.

The Internet presents probably the greatest economic opportunity of the last several centuries -- high-growth, global scale and (as of 1995) with no incumbents. It would seem like the perfect place for existing US and global companies to establish new, highly profitable lines of business. Yet if you look at the really large, game-changing companies of the Internet age -- Google, Amazon, Facebook -- all of them were started from the ground up to take advantage of the Internet, and none of them came out of an existing US company "diversifying" onto the Internet. Of course, existing companies moved their businesses online, but the biggest winners of the Internet age have all been specialized companies.

Which is why, if you notice, I had restricted my earlier comment to 'traditional sectors'. Technology, Internet, new media, biotech etc are not something traditional businesses can ever be successful in.

But lets take the case of retail - which has only recently opened up to big houses in India. Who's setting up the large retail chains in India ? Its Reliance, Tata, Birla, Goenka... My contention is that if a traditional sector such as retail were to be suddenly opened up in the US without any existing dominant players (ie no Walmart, Sears etc) - you would find existing billionaires from other industries setting up retail firms and putting in the required capital for expansion.

[Arjun]

Good post by yves smith over at NC on a problem I've been wondering about for quite a bit only.
The Stigmatization of the Unemployed

The only solution to the employment issue is higher growth and higher investment. So one has to ask what the US can do to increase the investment rate.

Also - any statistics on % of households where neither partner is earning? There may be a need for some resetting of expectations regarding having a double income for all families.