Why Bangalore Came Last in IPL

Virat_Kohli_26_Feb_2012

The Indian Premier League(IPL) is just about to come to an end. The Bangalore team did not do particularly well in this year’s edition and won only three out of their 14 games. They lost 10 games and one game was drawn because of rains.

The team was a finalist last year and lost to Hyderabad in the final. Given this, at the beginning of the 2017 season, nobody expected that the Bangalore team would come last among the 8 teams. Nevertheless, reasons are now being offered on why the Bangalore team did not do well this time around.

While analysing and offering reasons is fine, some of the cricket experts are now saying that they always knew that Bangalore wouldn’t do well this year. Multiple reasons have been offered. Here are a few that I have heard.

The captain Virat Kohli was injured and missed the first few games. KL Rahul missed the entire tournament because of an injury. Chris Gayle was not in his usual form. AB de Villiers was also injured and came in only after the first few games. One expert even said that the injury to batsman Sarfaraz Khan hit the team hard.  And hence, the team was never able to build the momentum that is required to keep winning T20 games.

While all this sounds fine, none of these reasons were offered at the beginning of the tournament. At the beginning of the tournament none of the experts said that they don’t expect the Bangalore team to do well this year. But now once the Bangalore team has not done well, they are busy coming up with various reasons to explain the non-performance.

And along with that they are convinced about the fact that they had always believed that the Bangalore team would not do well this year. As David Hand writes in The Improbability Principle: “After the fact, it’s easy to put the pieces together, and show how they form a continuous chain leading to the outcome.” Or to put it simply, everything is obvious once you know the answer. Hence, Bangalore did not do well because Kohli was injured and could not play in the first few games. Bangalore did not do well in these games and in the process, they were never able to build the required momentum which is an essential part of a tournament of this kind.

This kind of storyline could not have been offered at the beginning of the tournament. As Hand writes: “Before the fact, however, there are many pieces and potential chains and it’s just not possible to know which events fit together. This isn’t because there are too many pieces, but simply because they can be put together in a vast number of possible ways, and there’s no reason to select any one of them.”

Hence, before this year’s IPL started one did not know that Chris Gayle, the master of the T20 game, would have the kind of disastrous year he did. It was always difficult to predict that the likes of de Villiers, Travis Head and Shane Watson, brilliant T20 players in their own right, wouldn’t have much of an impact on Bangalore’s overall performance. Even Kedhar Jadhav burdened with the  responsibility to keep wickets, looked out of touch.

But all this and more can be now said with confidence, almost at the end of the tournament. As Hand writes: “Our innate tendency to retrospectively adjust a new recollection as new information becomes available, to identify the chain which led to the disaster and to say, after the fact, ‘Look, it was staring us in the face!’ is called hindisight bias.”

The point being that Bangalore lost because they did not score enough runs and they did not take enough wickets. Any analysis beyond this, is essentially hindsight bias.

The column originally appeared in the Bangalore Mirror on May 17, 2017

Why We Complete Reading Books We Don’t Like

business-books

I love reading crime fiction. It’s my favourite weekend activity. It really relaxes me and gets me ready for the next week.

This weekend I happened to read this book called The Baltimore Boys by the Swiss author Joël Dicker. I read this book because I had particularly liked reading Dicker’s previous book The Truth About the Harry Quebert Affair, a couple of years back.

Other than being a thriller with a great plot and several twists at the right places, the book also examined what goes on in a writer’s mind while he is writing a book. And that is something I enjoyed tremendously.

With this background in mind, I started reading Dicker’s new book The Baltimore Boys. This book at the same time is a prequel as well as a sequel to The Truth About the Harry Quebert Affair.

Fifty pages into it, I knew that this book was nowhere as good as Dicker’s first one. It didn’t have the one liners that the first one did. Neither did it have the kind of intricate plot that Harry Querbert Affair did.

This disappointment notwithstanding I continued reading the 444 page book and finished it over one and a half days. Why did I do that? One was because I had been extremely impressed by Dicker’s first book and kept thinking all along that the second book is also building towards something. That something never came.

But more importantly I had become a victim of what economists call the sunk cost fallacy. This, despite knowing about it. In his book Thinking, Fast and Slow, Daniel Kahneman defines this fallacy as “the decision to invest additional resources in a losing account, when better investments are available”.

I could have easily given up reading The Baltimore Boys, 100 pages into it, and spent my time reading something else, or I could have slept more over the weekend, or I could have seen IPL matches a little more carefully than I currently do. But I chose to finish reading The Baltimore Boys. This for the simple reason that I did not want to feel that I had wasted the time I had already spent reading the book. In the process, I ended up wasting more time on it.

This phenomenon is clearly visible in other things we do in life as well. Like books, we continue watching a move till the end even though half way through it we know that the movie is not going anywhere. The last time this happened to me was when I saw Vishal Bhardwaj’s Rangoon. Bhardwajs reputation from his previous films made sure that I watched the movie till the end, hoping that something substantial might come up and I would miss it, if I chose to walk out.

The sunk cost fallacy is also visible in bad marriages and relationships. People remain stuck in them. If they get out of it, they will feel that all the time they spent on it was basically a waste. And to avoid that feeling, they end up wasting more time on it than they should have in the first place.

As Kahneman writes: “The sunk-cost fallacy keeps people for too long in poor jobs, unhappy marriages, and unpromising research projects. I have often observed scientists struggling to salvage a doomed project when they would be better advised to drop it and start a new one.”

In fact, sunk cost fallacy even leads to wars continuing longer than they should. As Richard Thaler writes in Misbehaving—The Making of Behavioural Economics: “Many people believe that the United States continued its futile war of in Vietnam because we had invested too much to quit.” This escalation of commitment led to the war lasting longer than it should have and in the process killed many more people. But that is not how things turned out.

To conclude, the funny thing is that you can become a victim of the sunk cost fallacy despite knowing about it, which is precisely what happened to me.

The column originally appeared in the Bangalore Mirror on May 10, 2017.

Price Fixing and the Law of Unintended Consequences

 

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One of the beliefs that governments and regulators have is that they can control prices. All that is needed is a government decree fixing the price of a particular product and everything will fall into place.

But is that how things eventually work out? The answer is no. The first point here is that letting the market work and evolve a certain price of a product is very important, otherwise it leads to unintended consequences.

The law of unintended consequences essentially states that purposeful actions of the government have unintended or unanticipated consequences, the noble intentions of the government notwithstanding. Take the case of glass production in the erstwhile Soviet Union. Everything was government owned and like other things, the government produced glass as well.

The idea of course was to produce different types of glass and enough glass. The trouble was that there was no pricing mechanism in place, which could inherently coordinate the demand and supply of different kinds of glass. All that was in place were government diktats.

As Swaminathan S Anklesaria Aiyar writes in From Narsimha Rao to Narendra Modi—25 Years of Swaminomics: “In the absence of pricing mechanisms, Soviet planners set physical targets of glass production in terms of weight, factory managers started producing the heaviest sorts of glasses to meet plan targets. This meant shortages in terms of square feet.”

The planners then decided to shift the targets from tonnes to square feet in order to correct for this unintended consequence. “Alas, this induced factories to produce the thinnest glasses to meet targets, and much of it shattered,” writes Aiyar.

The point being that when the government tries to interference with a pricing mechanism of a product, it has unintended consequences which are not good for the overall economy. Aiyar provides another excellent example of this phenomenon, in his book.

He talks about the days when India had only two car companies Hindustan Motors and Premier Automobiles. Those were also the days when the government fixed the price of a new car. And this had unintended consequences.

As Aiyar writes: “There was a long queue of several years to buy a car, and only people with contacts could get early delivery. The price of new cars was controlled by the government in the 1970s, but not of old cars. So, second hand cars cost more than new cars! As an accredited journalist, I was entitled to a car from the government, and I bought a Fiat car for Rs 22,000 in 1972.  I sold it for Rs 35,000 after five years of use.” These days the moment a car leaves a showroom it’s price comes down by as much as 30 per cent.

Nevertheless, the government continues to believe in price control mechanisms. Recently, the National Pharmaceutical Pricing Authority, put a price cap on stents which are used to open blocked arteries in the heart. Of course, those who pass such diktats have really no idea of how any market economy works.

Companies in the high-end stent business now want to withdraw stents from the market because these high-end stents are no longer viable at the price set by the government. Also, as happens in most cases where prices are capped, eventually the market for stents will move into the black economy. Those who can afford it, will settle in cash, or simply go abroad and get the procedure done and get the best stent available.

The hospitals which obviously made a cut from the stents that they sold can simply charge more for other procedures, in order to ensure that their revenues don’t fall. From the little anecdotal evidence that is available that has already started to happen. There have also been newsreports of high-end stents disappearing from the market.

In a column in the Mumbai Mirror on February 18, earlier this year, Dr Sanjay Oak had made a very sensible suggestion when he said that the government should “adopt an a la carte approach, making available stents at Rs 7000, Rs 28000, Rs 85000 and uncapped”. The way things currently are, the government diktat treats all stents to be the same.

And this as we have seen is having and will continue to have unanticipated consequences.

The column originally appeared in the Bangalore Mirror on May 3, 2017

The Unseen Effects of Banning Alcohol Along Highways

Bastiat

Sometime back the Supreme Court prohibited the sale of liquor within 500 metres of state highways and national highways. As it said in its second judgement on the issue: “India has a high rate of road accidents and fatal road accidents – one of the advisories states that it is the highest in the world with an accident occurring every four minutes.”

It further pointed out: “There is a high incidence of road accidents due to driving under the influence of alcohol… The existence of liquor vends on national highways is in the considered view of…expert authorities with domain knowledge—a cause for road accidents on national highways.”

The point being that people get drunk at shops and restaurants around highways, drive under the influence of alcohol and then cause accidents.

It is important to try and understand why people in India drink in shops and restaurants around highways. It’s not considered a good thing in India to be seen drinking with friends, colleagues and acquaintances. Hence, people like to drink outside the city near highways, so that they don’t get seen by the people whom they happen to know.

The question is will this banning of the sale of alcohol lead to a fewer accidents. Before I try and answer this question I will have to take a brief detour in order to introduce a 19th century French economist called Frédéric Bastiat.

In an essay titled That Which is Seen, and That Which is Not Seen, he wrote: “In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously—it is seen. The other unfold in succession—they are not seen: it is well for us if they are foreseen.”

In the case of the Supreme Court’s decision to ban alcohol along highways what is seen is that once shops and restaurants selling alcohol shutdown, it would lead to a major loss of taxes for the state governments. State governments earn taxes on the manufacture and sales of alcohol. If shops shutdown, then these earnings will fall.

This is something that the Supreme Court judgement has foreseen: “The states are free to realise revenues from liquor licences in the overwhelmingly large swathe of territories that lie outside the national and state highways and the buffer distance of 500 metres.”

Hence, the Supreme Court does not think that its decision would lead to lower taxes because the government could offer more licenses away from the highway. This is something that the government will eventually do. Meanwhile, what state governments have started to do in order to get around the decision is to denotify highways and have turned them into local, municipal or district roads, so that the sale of alcohol can continue. In many cases this is justified because highways are a part of the city and not outside it.

This has been done in order to ensure that the taxes from alcohol keep coming in. This is the unseen effect which Bastiat talked about and the Supreme Court decision did not foresee. In fact, the government of Maharashtra recently hiked the drought cess on petrol from Rs 6 to Rs 9, even when there is no drought in sight. This has been done to make up for the loss of revenue from shutting down of alcohol shops around highways.

Another unseen effect lies in the fact that those who used to go out of the city to drink in shops and restaurants along the highway, will now have to drink in the city. And if they drive after drinking, accidents will continue to happen. Given that they may not have to drive as long as they had to do in the past, the rate might fall.

Hence, the basic issue in this case is not drinking, but driving after drinking. And that cannot be solved by banning alcohol along highways. It can only be solved by better policing, in the city as well as on the highways.

 

The column originally appeared in the Bangalore Mirror on April 26, 2017

Why Rich Indians Don’t Donate Their Wealth

220px-Azim_H._Premji_World_Economic_Forum_2013

In economics there is this concept called the diminishing marginal rate of utility. While the term sounds pretty complicated, the concept isn’t.

As James Kwak writes in Economism—Bad Economics and the Rise of Inequality: “People generally gain utility by having more stuff—more food, more clothes, more toys—or at least people behave that way. But the more you have of a particular thing, the less you benefit from getting even more of it.”

A good example of diminishing marginal utility is a comparison between two individuals making an extra Rs 10 lakh, during the course of a year. In the first individual’s case his salary doubles from Rs 5 lakh to Rs 10 lakh. In the second individual’s case, the salary increases by 5 per cent from Rs 1 crore to Rs 1.05 crore.

While the Rs 5 lakh increase in the second case might seem like small change, in the first case it is clearly a lot of money. And this is the basic point behind diminishing marginal utility—as you have more and more of something, the less it matters.

As Kwak writes: “This concept applies to most things—think about eating five pieces of pizza in a row—but in particular it applies to overall wealth: an increase in your net worth from $1 million to $1.1 million will never be as significant as going from $0 to $100,000.”

The point being that as overall wealth goes up, it matters less and less, or at least it should matter less and less to the person earning it. And if that is the case we should see more and more rich donate their wealth to noble causes. But that is clearly not the case in India, Azim Premji notwithstanding.

A simple reason for this could lie in the fact that income and wealth are ways through which the wealthy “keep score in a long-running competition with each other”. The other major reason may lie in the fact that in India people like to leave their wealth to their families. And that to an extent explains why any mention of inheritance tax in the country gets hugely negative reactions. Further, that may also be a reason as to why the rich don’t donate even a fraction of their wealth.

The second reason needs to be elaborated on. Typically, it’s the businessmen who tend to be rich and have more money than others. While, the first generation builds the business, in most cases, the second and the third generation are not able to do much with it, though there are always examples in which case the second generation does better.

Gurcharan Das in his book India Unbound talks about a book titled Buddenbrooks written by Thomas Mann. He calls it the best book ever written on family businesses. As he writes about the book: “It describes the saga of three generations: in the first generation the scruffy and astute patriarch works hard and makes money. Born into money, the second generation does not want more money. It wants power… Born into money and power, the third generation dedicates itself to art. So the aesthetic but physically weak grandson plays music. There is no one to look after the business and it is the end of the Buddenbrook family.”

How is this linked with the rich not donating their money? At some level, the individual starting and running a business knows that his company may not survive the test of time, when he is no longer there to run it. His progeny may not have the same instinct or for that matter inclination towards business.

Hence, it is important for him to ensure that the wealth that he has built up through his business over a period of time, continues to remain with the family, so that the coming generations can continue to have a good and a comfortable lifestyle. And that is only possible if the wealth is not donated away and continues to remain in the family.

The column originally appeared in Bangalore Mirror on April 19, 2017

Why is Narayana Murthy so angry

In the recent past, Infosys co-founder and former chairman NR Narayana Murthy, has been critical of the salary hikes the company has been giving its top management. Other former executives of the firm have also criticised it.

The most recent example is that of the company giving a hike to its chief operating officer UB Pravin Rao. The company has said that the hike will apply over a number of years. It said that the hike could “go up to 33.4% in year 4, assuming similar grants are made in subsequent years based on company and individual performance.”

Murthy on the other hand feels that the top management should not be taking such high salary increases when most employees have got just a 6-8 per cent hike.

The high salaries of top management vis a vis the salaries of normal employees, has been an issue across large parts of the world. The belief, at least at the board levels of companies is that the top management is getting paid adequately for bringing enough value to the company. Of course, nobody bothers to define the word value.

The question that arises here is: Does the top management impact the performance of companies? And with that logic, does it make sense to pay them more?

Of course the top management does impact performance. It would be silly to say no. The direction the company takes in the future is decided by the top management of the company. At the same time, the impact that the top management has on the performance of companies, is not as much as it is made out to be.

As Daniel Kahneman writes in Thinking, Fast and Slow: “CEOs do influence performance, but the effects are much smaller than a reading of the business press suggests.” The business press tends to make heroes out of the top managements of companies. If a company is doing exceptionally well, the typical conclusion that is drawn is that it is doing well because of the CEO and the other top management.

As James Kwak writes in Economism—Bad Economics and the Rise of Inequality: “The idea that good CEOs are entitled to enormous rewards is based on the belief that success or failure of a company depends on one person—what historian Nancy Koehn calls the Great Man theory of history”

Given this belief it is not surprising that the CEOs and the top management get paid as much as they do. But the link between top management pay and the continued success of a company isn’t so high. As Kahneman writes: “Researchers measure the strength of relationships by a correlation coefficient, which varies between 0 and 1… A very generous estimate of the correlation between the success of the firm and the quality of its CEO might be as high as .30, indicating a 30% overlap.”

Hence, the link between CEO quality and the success of the firm is not very strong. What is forgotten is that business at the end of the day is a team game. The top management sitting at the headquarters can only do so much to keep ensuring that the company continues to be as successful as it was in the past.

As Kwak writes: “Business is a team sport… Because no one knows what a CEO is worth, her pay is whatever she can convince her corporation’s board of directors to give her.”

Also, luck plays a big role in the success or failure of a CEO. As Kwak writes: “A 2001 study by Marianne Bertrand and Sendhil Mullainathan found that high CEO pay is often the result of dumb luck. For example, they found that heads of oil companies were paid more when profits increased, even when those profits were simply due to rising oil prices.”

Hence, as Kahneman concludes: “Because luck plays a large role, the quality of leadership and management practices cannot be inferred reliably from observations of success.” Once you take these factors into account, it is not surprising that Narayana Murthy is angry.

The column was originally published in the Bangalore Mirror on April 12, 2017

Dear Mr Urjit Patel, Have You Ever Heard of Wasim Barelvi?

For a man who rarely and barely speaks, the Reserve Bank of India governor Urjit Patel spoke quite a lot in the press conference that happened after the first monetary policy of this financial year was presented on April 6, 2017.

In response to the question, “What do you think are the implications of the farm loan waiver schemes and is it a cause of concern for the RBI?”, Patel had this to say: “There are several conceptual issues, if one were to put one’s hat as an economist on. I think it undermines an honest credit culture, it impacts credit discipline, it blunts incentives for future borrowers to repay, in other words, waivers engender moral hazard. It also entails at the end of the day transfer from tax payers to borrowers. If on account of this, overall Government borrowing goes up, yields on Government bonds also are impacted. Thereafter it can also lead to the crowding out of private borrowers as higher government borrowing can lead to an increase in cost of borrowing for others. I think we need to create a consensus such that loan waiver promises are eschewed, otherwise sub-sovereign fiscal challenges in this context could eventually affect the national balance sheet.

Basically in one paragraph, Patel summarised all that is wrong about waiving off farmer loans or in fact, any loan. I had discussed most of these issues in my Diary dated April 5, 2017, last week.

The first issue that a waive-off of bank loans creates is that of a moral hazard. The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.”

This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future. Or as Patel put it: “it impacts credit discipline, it blunts incentives for future borrowers to repay”.

The second issue that a waive-off of bank loans creates is that it can lead to the crowding out of private borrowers. The state government waiving off the bank loans needs to compensate banks which had given these loans. In case of the Uttar Pradesh government which recently wrote off the loans, this amounts to Rs 36,359 crore. The government will have to borrow this amount in order to pay the banks simply because its earnings are lesser than its expenditure.

When a government borrows more, it leaves a lesser amount of money for others to borrow. This can push up interest rates and as Patel aptly puts it, “higher government borrowing can lead to an increase in cost of borrowing for others”. What also needs to be taken into account here is the fact that the Uttar Pradesh government waive-off might inspire other state governments to waive-off farmer loans as well. This will mean greater government borrowing and a higher crowding out effect.

It will also lead to the overall fiscal deficit of the nation (i.e. fiscal deficits of state governments plus that of the central government) going up. Fiscal deficit is the difference between what a government earns and what it spends during the course of a year. The difference between the earning and the spending is met through borrowing.

If several state governments waive-off bank loans and borrow more, it will lead to the national fiscal deficit going up. As Patel puts it: “sub-sovereign fiscal challenges in this context could eventually affect the national balance sheet.”

So far so good. It is nice to see the RBI governor speak out against what is essentially bad economics and can screw up the economic and financial situation of the nation. Nevertheless, the question is where has all this forthrightness been when it comes to the issue of corporate defaults and loan write-offs?

As is well known, corporates have defaulted on several lakhs of crore of bank loans over the years. These defaulters have been treated with kid gloves. Over the years, a huge amount of corporate loans have been written off. It needs to be mentioned here that loans written off are different from loans being waived off, at least theoretically.

This is something I discuss in detail in my new book India’s Big Government—The Intrusive State and How It is Hurting Us. The loans written off are no longer be a part of the balance sheet of the bank, even though they can be recovered in the future. There is no chance of recovery in case of a loan that is waived off. Hence, theoretically there is a difference between a write-off and a waive-off.

Let’s try and understand this issue in a little more detail. Let’s first take the case of the State Bank of India. As of April 1, 2015, the bank had Rs 56,725 crore of bad loans, or gross NPAs. During the course of the year, Rs 4,389 crore of bad loans was recovered. At the same time, the bank wrote off Rs 15,763 crore of bad loans. The loans written off would no longer be a part of the balance sheet of the bank, even though they could be recovered in the future.

As we can see in case of the State Bank of India, the total amount of the loans written off during the year was more than three times the total amount of the loans recovered. That tells us the sad state of the loan recovery process. There were also fresh bad loans that were added to the balance sheet of the bank during the course of the year, and by March 31, 2016, the total bad loans of the bank had slipped to Rs. 98,173 crore.

Or take a look at Table 1 which shows the overall scenario comparing write-offs and recoveries.

Table 1: Write-offs versus recoveries of public sector banks

Write-offs versus recoveries of public sector banks

Year Writes-Offs
(in Rs. Crore)
Recoveries
(in Rs. Crore)
2015-2016 59,547 39,534
2014-2015 52,542 41,236
2013-2014 34,409 33,698
2012-2013 27,231 19,832

Source: Reserve Bank of India

As is clear from Table 1, write-offs of public sector banks have been greater than their recoveries. And the absolute difference between the two has only gone up over the years. A bulk of these loans are corporate loans. Hence, it is safe to say on the basis of this data that a large portion of corporate loans which are written-off are over the years, are practically waived-off because banks are really not able to recover these loans.

Hence, if the issue of moral hazard comes up with farmer loan waive-offs, it also comes up with corporate loan write-offs. And given that a large portion of what is technically a write-off is actually a waive-off, the case for moral hazard in this case is really very strong. The RBI governor Patel could have talked about this as well, given that he has been in office for more than seven months now.

Over and above this, corporate loan write-offs have led to the situation of diminishing bank capital. This has led to the central government having to recapitalise the public sector banks over the years. Between 2009 and now, the amount of money put in has been greater than Rs 1,30,000 crore. This money is ultimately borrowed by the government and leads to crowding out, higher interest rates and a weaker national balance sheet. All these issues pointed out by Patel in case of farm loan waive-offs apply to corporate write-offs as well.

But a word hasn’t been spoken against them.

In the Diary dated March 22, 2017, I had quoted the British author George Orwell. In his book Animal Farm, Orwell writes: “All animals are equal, but some animals are more equal than others.” The point being, if there is a moral hazard for the farmer, there is also one for corporates. And if the RBI governor has pointed out one, he should have pointed out the other as well.

Over the weekend, I came across a very interesting couplet which makes the same point has George Orwell did in the Animal Farm, but rather more forcefully.

As Wasim Barelvi, probably the greatest Urdu poet alive today, writes:

Garib lehron par pehren bithaye jaate hain
samundaron ki talashi koi nahi leta”.

(I couldn’t come across a good translation of this couplet. Hence, I am leaving it untranslated. But its basic meaning is the same as the line from Orwell’s Animal Farm, quoted earlier).

The column originally appeared on April 10, 2017 on Equitymaster