What Donald Trump Can Learn From Adam Smith

The American President Donald Trump wants to make America great again. At the heart of his plan to make America great again lies the idea of encouraging American manufacturers, Trump wants to implement tariffs on imports into America from other countries. He has already implemented tariffs on steel and aluminium.

This method of trying to make America great again by forcing Americans to buy stuff made in America, goes against basic principles of economics.

One of the most quoted paragraphs in economics was written by Adam Smith in a book called The Wealth of Nations. Steve Pinker writes about this in Enlightenment Now—The Case for Reason, Science, Humanism and Progress: “Smith explained that economic activity was a form of mutually beneficial cooperation: each gets back something that is more valuable to him than what he gives up.”

As Smith put it: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

Hence, exchange is at the heart of any market. Trump is basically trying to clamp down on this exchange, which ultimately makes things cheaper for Americans.

The reason why the United States lost its manufacturing prowess over the years, is simply because other countries produced similar or better goods at a cheaper price. Take the case of China. In 2017, the United States ran a trade deficit of $375 billion (or more than a billion dollars a day) with the country.

Why did the situation come to this? The answer lies in the fact that China produced stuff  that American consumers wanted to buy, at a much more competitive price than the American manufacturers did.

Of course, the American consumer benefited from this because he had to pay a lower price than if he had bought the same thing from an American manufacturer. As Smith had said, “through voluntary exchange, people benefit others by benefitting themselves”.
Americans benefited because of competitive pricing of Chinese goods and the Chinese benefited because they got dollars in return for what they sold. Of course, it needs to be said here that Americans paid paper dollars for tangible goods from China.

These dollars earned by China helped pull many millions  of Chinese out of poverty in a period of around four decades starting in 1978. At the same time, it helped America maintain a lower rate of inflation, though many American jobs were lost due to lack of competitiveness of American firms.

The Chinese companies earned dollars while selling stuff in the United States. But they couldn’t spend these dollars in China because the Chinese currency happens to be the renminbi (also known as the Yuan). They exchanged these dollars with the Chinese central bank, the People’s Bank of China, which gave them renminbi to spend. The Chinese central bank then invested a good portion of these dollars in financial securities issued by the American government and other American institutions.

This flood of dollars from China and other big exporters earning dollars, helped keep interest rates low in America.

Donald Trump is now looking to break this arrangement that has been in place for the past few decades. As economist Ludwig von Mises put it a few centuries after Adam Smith: “If the tailor goes to war against the baker, he must henceforth bake his own bread.”

By imposing tariffs, Trump will force American consumers to buy expensive American goods. And this will not create any jobs. Take the example of steel. Buying American steel will make things more expensive for American car manufacturers.

They will either pass on this increase in cost to the American consumer, who will then have to cut down on expenditure somewhere else. If they don’t do that and decide to maintain the cost, they will have to fire a few employees that they currently employ.
All in all, there are no short-cuts to make America great again. The only way is to be competitive. The sooner Trump understands this, things will be much better.

The column originally appeared in the Bangalore Mirror on March 22, 2018.

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If Home Loans Are Growing, what is the Problem with Real Estate?

India-Real-Estate-Market

The government shared some data earlier this month in the Lok Sabha, which has led to this column. Take a look at Table 1. It gives us the total home loans given by public sector banks and housing finance companies over the last few years.

It was further pointed out as a part of an answer: “As per the data compiled by National Housing Bank, the growth in housing loans of public sector banks and housing finance companies during the six month period from 1st July, 2017 to 31stDecember, 2017, has been about 34% as against 12% during the corresponding previous half year.”

Table 1: Total amount of home loans given by public sector banks and housing finance companies.It would have been great if the government had shared the total amount of home loans given out between July 1, 2017 and December 31, 2017, instead of just sharing percentages.

Also, on a slightly different note, the National Housing Bank needs to share home loan lending data (both banks and housing finance companies) on a regular basis, which it currently doesn’t. While, the Reserve Bank of India shares the total amount of home loans given out by banks, no such data is regularly available for housing finance companies.

Anyway, getting back to the point. Between July 2015 and June 2016, the home loan disbursement grew by around 25%. Between July 2016 and June 2017, it grew by around 13%.

Since then, growth rate has improved considerably, which tells us that the ill-effects of demonetisation which plagued the sector, are on their way out to some extent.

Now contrast this to data recently released by property consultant JLL. As of December 2017, a total of 4.4 lakh housing units remained unsold in seven major cities. Delhi along with the National Capital Region came on the top with 1.5 lakh unsold homes. Mumbai, Delhi-NCR, Chennai, Hyderabad, Pune, Bengaluru, Kolkata were the seven cities covered in this survey.

How does one contrast the JLL data with the increase in home loans being disbursed, is a question worth asking. There are several explanations. One is that homebuyers are no longer buying under-construction properties. Take the case of the JLL data, only 34,700 units are ready-to-move-in flats. Hence, people are not interested in buying properties which aren’t totally ready. Why?

The answer for this is very simple. Many builders in the last decade have taken money from prospective buyers and not delivered homes. And the prospective buyers have seen what has happened to the earlier set of buyers, and does not want to make the same mistake again. Nobody wants to get into a situation where the biggest investment of their life gets stuck and doesn’t go anywhere.

Given that many people bought real estate as an investment over the years, and kept those homes locked, my guess is, it is that inventory which is now being cleared, to some extent.

This loss of trust between the real estate companies and the prospective buyers, is the basic problem at the heart of India’s real estate crisis. And the data suggests, the lack of trust continues to prevail.

Further, the growth in home loans is basically coming in the affordable housing segment. As the Affordable Housing Report released by the Reserve Bank of India (RBI) in January 2018, points out: “Affordable housing is currently driving home loan growth in India… Housing loans up to Rs 10 lakh recorded robust growth in 2016-17, primarily driven by the public sector banks.. While the number of beneficiaries for loan amounts up to Rs 10 lakhs has increased sharply in 2016-17, the number of beneficiaries for higher value loans of above Rs 25 lakhs has, in fact, declined marginally during the year.”While the bulk of the lending still happens in the greater than Rs 25 lakh category, the growth actually is coming from the sub Rs 10 lakh segment, which is where the real market for homes in India is. Of course, much of this growth is being pushed by the government (which is why the government loves public sector banks) and is not happening in the top seven cities that JLL covers.

What this again tells us is that if home ownership in large cities has to pick up, the prices need to still fall from where they are. Also, buyers are not interested in buying under-construction property and that is something that the real estate companies need to realise and do something about. But that would mean a substantial change from their current way of operating. It hits at the heart of their current business model. And all change is a slow process.

This appeared on Equitymaster on March 22, 2018

Let’s Move Beyond Nirav Modi, Bad Loans Are Bleeding India

Nirav_Modi
Nirav Modi, Nirav Modi, where have you been?” is a question that the bankers at the Punjab National Bank (PNB), must be asking themselves these days.

Media reports suggest that Nirav Modi is in New York, and has no plans of coming back to India. His operational fraud is expected to cost PNB Rs 12,646 crore. PNB is the second largest public sector bank in the country and as of December 31, 2017, had accumulated bad loans of Rs 57,519 crore. A bad loan is a loan which hasn’t been repaid for a period of 90 days or more.

The one good thing that has happened since Nirav Modi’s fraud came to light is the relentless focus of the mainstream media on the operations of India’s government owned public sector banks.

The total bad loans of the public sector banks as of December 31, 2017, stood at Rs 7,77,280 crore. This forms 86.4% of the total bad loans of scheduled commercial banks (i.e. public sector banks + private sector banks + foreign banks).  This basically means that the total bad loans of scheduled commercial banks as of December 31, 2017, would be around Rs 9,00,000 crore.

Hence, Nirav Modi’s fraud of Rs 12,646 crore is just a drop in this ocean of bad loans. But his fraud has put a face to the sad state of affairs that prevails at public sector banks and has thus elicited interest from the mainstream media and the common public.

Before Nirav Modi came long, the bad loans of public sector banks was just an issue which with the business press was concerned about. Now even the TV channels in different languages are having discussions around the issue.

Nevertheless, the fundamental issue at the heart of the bad loans of India’s public sector banks continues to remain unaddressed. Who is responsible for this mess and what should be done about it?

The government released some interesting data earlier this month in an answer to a question raised in the Lok Sabha. As per data from the Reserve Bank of India (RBI), the total bad loans from the “industry-large” category of loans, as of December 31, 2017, stood at Rs 5,27,876 crore. This was for scheduled commercial banks as a whole. The RBI defines a large borrower as a borrower with whom the bank has an exposure of Rs 5 crore or more.

Such borrowers are essentially responsible for a bulk of the bad loans of the banks in India. They are responsible for around 59% of the bad loans (Rs 5,27,876 crore expressed as a percentage of Rs 9,00,000 crore) of scheduled commercial banks. Bank loans to large industrial borrowers formed 59% of the bad loans, even though the total lending by banks to such borrowers formed only around 30 per cent of the total loans given by banks.

Public sector banks accounted for Rs 4,64,253 crore or 88% of bad loans in this.
In fact, the much criticised public sector banks do a pretty decent job of lending to the retail sector. Take a look at Table 1, which basically compares proportion of retail loans which turn bad with proportion of loans to corporates which turn bad, for a few public sector banks.
Table 1:

Name of the bank Retail bad loans
( in %)
Corporate bad loans
(in %)
State Bank of India 1.3 21.9
Bank of India 2.6 27.6
Syndicate Bank 4 16
Bank of Baroda 3.4 16
IDBI Bank 1.4 39.4
Central Bank of India 4.6 23.5
Bank of Maharashtra 4.4 15.3
Andhra Bank 1.8 29.1
Source: Investor/Analyst presentations of banks.    

Table 1 clearly shows that corporate bad loans are much higher than retail bad loans. The question is why? The answer perhaps lies in what economists call regulatory capture. As Noble Prize winning French economist Jean Tirole writes in his book Economics for the Common Good: “The state often fails. There are many reasons for these failures. Regulatory capture is one of them. We are well aware of the friendships and mutual support that create complicity between a public body and those who are supposed to be regulating it.”

How does one interpret this in the Indian case? While it would be totally unfair to suggest that the RBI, which regulates banks in India, is pally with corporates, but it would be totally fair to say that Indian politicians are very pally with Indian corporates. This is where the problem for public sector banks in India lies.

While giving out retail loans, the managers running public sector banks, can make right lending decisions, the same cannot be said when they carry out corporate lending, given the political pressure that prevails on many occasions.

In this scenario, it is worth asking whether all the 21 public sector banks in India should actually carry out corporate lending and put public deposits at risk, over and over again? This is a discussion that we should now be having as a nation and the mainstream media is where this discussion should be happening.

The column originally appeared on The Quint on March 22, 2018