Why Most Cars Look the Same

car

A few days back I was at a friend’s party. I was introduced to other men at the party and soon they were all talking about the latest cars to hit the market. This basically played into the stereotype of putting four men in a room and once they are done talking about their jobs, they will be talking about cars.

I find it difficult to be a part of any such conversation because my ability to differentiate between two different car models is fairly limited. Well, I can differentiate between small cars and sedans, and less expensive cars and more expensive cars, but that is where it all ends. Of course, I do recognise the Mercedes Benz logo.

And to be very honest, the only two cars that I can confidently recognise at any point of time are the Ambassador and the Premier Padmini (better known as the Fiat). Both these cars aren’t produced anymore.

This inability to recognise car models gets me into a problem while coordinating with app based cab services. So, unlike others who keep a lookout for the model and colour of the car, I keep lookout for the number of the car.

For a long time, I felt that I was one of the few people who thought that modern cars look very similar. It turns out I was wrong. Cars that are produced these days do look the same. In his book Scale—The Universal Laws of Growth, Innovation and Sustainability in Organisms, Economies, Cities and Companies, Geoffrey West, talks about how different the 1927 Rolls-Royce and the 1957 Studebaker Hawk were from the “relatively boring-looking 2006 Honda Civic or a 2014 Tesla”. The modern cars might be far superior machines than the cars made earlier, but it is difficult to differentiate one from the other, unless you are really into them.

What has happened here? As West writes: “It represents the transition from a primitive trial-and-error, rule-of-thumb approach that served us well for thousands of years towards a more analytic and principled scientific strategy for solving problems and designing modern artifacts ranging from computers and ships to airplanes, buildings, and even companies… Sophisticated computer analysis are now central in the design process… The phrase “computer model” is now an integral part of our vocabulary.” It is also used to design cars.

This has led to an unintended consequence, something which wasn’t really planned for but has happened and become a part of our lives, without us really realising about it.

As West writes: “One of the curious unintended consequences of these advances is that almost all automobiles, for example, now look alike because all manufacturers are solving the same equations to optimize similar performance parameters. Fifty years ago, before we had access to such high-powered computation and therefore less accuracy in predicting outcomes, and before we became so concerned about fuel performance and exhaust pollution, the diversity of car design was much more varied and consequently much more interesting.”

The point being that most companies that produce cars are using more or less the same science to produce it, and given that most cars now look more similar than they did in the past, when trial and error was a part of the solution. Now, it isn’t.

As a result, what we have now are much superior machines, but their sameness makes them all so boring to look at. And cars, after all, aren’t all about acceleration, though some people may not agree on this.

The column originally appeared in the Bangalore Mirror on October 4, 2017.

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Bengaluru’s Sriperumbudur Problem

One thing that is common across my friends in Bengaluru, is how much they complain about the city’s traffic. It’s not like the other big cities in India do not have traffic. But it’s just that between 2001 and 2011 (when the last two censuses were carried out).

Bengaluru’s population more or less doubled from around 43 lakh to 84 lakh. The roads and the other physical infrastructure haven’t really been able to keep pace.

But this is not a column about the physical infrastructure in Bengaluru not being able to keep pace with the city’s population. What I want to explore is that if people are so irritated with the city’s traffic eating into their time and lowering their quality of life, why don’t they simply move to a city which has lesser traffic, like Hyderabad or Pune, for that matter.

The answer lies in the fact that Bengaluru does not face what Karthik Shashidhar calls the “Sriperumbudur problem” in his book Between the Buyer and the Seller. For those who don’t know where Sriperumbudur is, it is a small town near Chennai. For many years it was famous as the place where the former prime minister and the Congress leader Rajiv Gandhi was assassinated in May 1991.

In the last few years it has been famous as the place where the telecom giant Nokia first set up a factory and then it shut it down. The Nokia factory used to employ 8,000 employees at its peak. Once the factory shutdown, the skilled workers who used to work there had a tough time finding comparable jobs in Sriperumbudur. Most workers were forced to settle for jobs that paid less and the working conditions were not as good as they were at Nokia.

Almost at the same time that Nokia shutdown it’s factory, Yahoo decided to shutdown its engineering operations in India, which were largely located in Bengaluru. Other companies scrambled to recruit the Yahoo employees. Some even set up dedicated portals to recruit them.

While, the Nokia employees in Sriperumbudur had a tough time finding comparable jobs, the Yahoo employees were lapped up one after the other. As Shashidhar writes: “The market for people building mobiles phones was rather thin in Sriperumbudur, with only one employer (Nokia) and the set of people working there.”

This basically shows the importance of clusters or a group of companies manufacturing a similar product or providing a similar service, being located close to one another. Bengaluru is a cluster of IT companies and the kind of IT jobs that are available in Bengaluru are simply not available anywhere else in the country.

As Shashidhar writes: “[The] cluster tends to attract companies which hope to supply to more than one of these companies. The presence of several companies in the cluster means that the risk of setting up a supplier infrastructure is reduced – the supplier is partly hedged even if one of the manufacturers he supplies to goes bust. The reverse is also true.” This basically makes the labour market liquid.

And this explains why my friends and many other people who keep complaining about the Bengaluru traffic, continue to stay in the city. The quality of work and the job options that they have in the city, they don’t have in other cities.

In fact, industrial clusters have been around for a while. The first industrial clusters happened after the Industrial Revolution started in Great Britain. The textile mills were set up in towns like Manchester and Birmingham and not all over the country. Along similar lines, Detroit emerged as the automobile hub in the United States, where the big three car companies operated out of. Globally, the financial services business is clustered around New York and London.

In India, a bulk of Hindi films are shot in Mumbai. The financial services business is also largely based out of the city. Bengaluru has the IT companies. The hosiery business is based out of cities like Ludhiana and Tirupur.

And this happens because there is a certain logic to the entire thing. Clusters make sense, the huge traffic in Bengaluru notwithstanding.

The column originally appeared in the Bangalore Mirror on Sep 27, 2017.

25 Things PM Modi Did Not Tell You About the Indian Economy

narendra modi

The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

In a speech last week, Prime Minister Narendra Modi, offered several data points to tell his fellow countrymen, that all is well with the Indian economy. And those who didn’t think so were essentially being needlessly pessimistic, he suggested.

Now only if he had bothered to look at data points beyond those he chose to offer, a totally different situation would have emerged. In this piece, I offer many data points to show that all is not well with the Indian economy.

1) Let’s start with the loans disbursed by banks during the course of this year. Let’s look at non-food credit to start with. These are the loans given out by banks after we have adjusted for food credit or loans given to the Food Corporation of India and other state procurement agencies, for buying rice and wheat directly from farmers at the minimum support price (MSP) for the public distribution system. Take a look at Figure 1.

Figure 1: 

The Figure 1 clearly shows that the total amount of non-food credit given by banks during the course of this year has been in negative territory. This basically means that on the whole banks haven’t given a single rupee of a loan. The situation is the worse it has been in five years. Non-food credit consists of loans given to agriculture, industry, services and retail sectors, respectively.

Let’s take a look at each of these sectors.

2) Let’s take a look at Figure 2, which plots the loans given by banks to agriculture and allied activities.

Figure 2: 

Loans given to agriculture and allied activities are in negative territory during the course of this year. Again, this basically means that on the whole banks haven’t given a single rupee of a loan to agriculture. In technical terms, their loan book to agriculture has shrunk. Is this possibly because of farm loans being waived off by state governments, that only time will tell.

3) Let’s take a look at Figure 3, which plots the loans given banks to industry.

Figure 3: 

Figure 3 makes it clear that loans given to industry by banks continue to shrink. This isn’t surprising given the huge amount of bad loans accumulated by banks on lending to industry. Banks still don’t trust the industry.

4) Let’s take a look at Figure 4, which plots the loans given by banks to the services sector.

Figure 4: 

This comes in as a major surprise, loans given to services have shrunk majorly during this financial year. Services constitute half of the Indian economy. If the firms operating in this sector are not interested in borrowing, then how can the Indian economy possibly be doing well?

5) Let’s take a look at Figure 5, which plots the retail loans given by banks during this financial year.

Figure 5: 

Retail loans are the only loans which have been in positive territory during the course of this year. Nevertheless, they have been more or less at the same level over the last few years.

This, despite the fact that interest rates have come down dramatically. If people are not willing to borrow more even at lower interest rates, how can things be alright with the Indian economy, is a question well worth asking.

Sadly, Prime Minister Modi, did not include any of these data points in his speech and presentation.

6) The latest Consumer Confidence Survey of the Reserve Bank of India (RBI) for September 2017, states: “Households’ current perceptions on the general economic situation remained in the pessimistic zone for four successive quarters, with the outlook worsening… The employment situation has been the biggest cause of worry for respondents, with sentiment plunging further into the pessimistic zone; the outlook on employment has also weakened.”

7) Take a look at Figure 6, which plots the cement production over the years.

Figure 6: 

Cement production is down this year, in comparison to the previous year. This tells us clearly that the construction and the real estate industry continue to be in trouble. These industries are huge employers of people, especially those who have low-skills.

8) The commissioning of new projects has slowed down. As Centre for Monitoring Indian Economy, which tracks this data, points out: “Projects worth Rs 512 billion were commissioned during the quarter ended September 2017. In the coming weeks this estimate is expected to rise. It could reach about Rs 700 billion. Even if this happens, this would be the lowest commissioning of projects during the Modi government’s tenure so far.” 

9) There has been a fall in new investment proposals. As Centre for Monitoring Indian Economy, which tracks this data, points out: “Projects worth Rs.845 billion were proposed during the quarter ended September 2017. This is the lowest level of intentions to invest seen in a quarter during the tenure of the Modi government.”

10) There has been a huge fall in the profit of companies. As Centre for Monitoring Indian Economy points out: “We infer this and other related nuggets of information from the financial statements of 1,127 listed companies… Profit before taxes of these companies fell by 27.9 per cent over their level a year ago.”

11) Take a look at Figure 7, which plots the trade deficit or the difference between exports and imports.

Figure 7: 

The trade deficit has jumped up majorly during the course of this financial year. This as I have explained beforehas primarily been on account of a jump in non-oil non gold non silver imports, in the aftermath of demonetisation. The unseen negative effects of demonetisation continue to impact the economy.

12) The growth in private consumption expenditure is at a six-quarter low. As the RBI Monetary Policy Statement pointed out: “Of the constituents of aggregate demand, growth in private consumption expenditure was at a six-quarter low in Q1 of 2017-18 [April to June 2017].”

13) As the RBI Monetary Policy Statement further pointed out: “India’s export growth continued to be lower than that of other emerging economies such as Brazil, Indonesia, South Korea, Turkey and Vietnam, some of which have benefited from the global commodity price rebound.”

14) Take a look at Figure 8 which plots the investment to GDP ratio.

Figure 8: 

The investment to GDP ratio has improved a little in the period of three months ending June 2017, but it continues to remain very low. As the RBI Monetary Policy Statement pointed out: “The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates.”

15) Now let’s take a look at Figure 9, which plots the growth of the non-government part of the GDP.

Figure 9: 

Figure 9 basically plots the growth of the non-government part of the economy, which typically constitutes 87 to 92 per cent of the economy. The growth of the non-government part of the economy has fallen to around a little over 4 per cent. This extremely important detail did not find a place anywhere in Prime Minister Modi’s speech.

If the non-government part of the economy is growing at such a slow rate, how will jobs for the one million youth entering the workforce every month, ever be created.

16) The situation becomes even more worrisome if we look at Figure 10.

Figure 10: 

As is clear from Figure 10, the growth rate of industry in general and manufacturing and construction in particular is at a five-year low. The manufacturing part of industry grew at 1.17 per cent during April to June 2017, whereas construction grew by 2 per cent during the same period.

This is a big reason to worry simply because manufacturing and construction have the potential to create new jobs. An estimate made by Crisil Research suggests that in construction 12 workers are typically required to create Rs 10 lakh worth of output. In case of manufacturing it is seven workers.

17) Take a look at Figure 11, which basically shows that labour intensive sectors have slowed down between January to June 2017.

Figure 11: 

As Crisil Research points out in a recent research note: “In the past two quarters, three sectors have grown much faster than GDP: 1) Trade, hotels, transport, communication and services related to broadcasting; 2) Electricity, gas, water supply and other utilities, and 3) Public administration, defence and other services. Of these, only the trade, hotels and restaurants sub-sector is labour intensive, requiring about 6 workers to produce Rs 10 lakh worth of output. But the share of this sub-sector in total output is low at ~12%. In contrast, a fast growing sector like public administration, defence and other personal services, despite having a larger share in output, has low labour intensity of only 3. And sectors with higher labour intensity – such as construction (12) and manufacturing (7) – have been undershooting overall GDP growth.”

It needs to be said here that public administration, defence and other personal services sector is basically a proxy for the government. And the government has stopped creating jobs.

18) Take a look at Figure 12.

Figure 12: 

Figure 12 plots the index of industrial production (IIP), a measure of the industrial activity in the country. It also plots manufacturing, which forms more than three-fourths of IIP. The growth of both these measures has been in low single digits for a while now and is clearly a reason to worry.

19) Take a look at Figure 13, which basically plots the consumption of petroleum products, over the years.

Figure 13: 

The consumption of petroleum products has more or less been flat in comparison to the last financial year. This is another good indicator of slowing economic growth.

20) Take a look at Figure 14, which plots the sale of commercial vehicles during the course of this financial year.

Figure 14: 

Commercial vehicle sales, which are a very good indicator of a pick-up in the industrial part of the economy. Commercial vehicle sales this year were lower than they were last year.

21) Take a look at Figure 15. It plots the fiscal deficit ratio of the government over the years.

Figure 15: 

As can be seen from Figure 15, in the first five months of the current financial year, 96 per cent of the annual fiscal deficit has already been crossed. Fiscal deficit is the difference between what a government earns and what it spends. Why is the fiscal deficit during the first five months of the year at such a high level? The answer lies in the fact that the economic growth is slowing down and the government is trying to drive up growth, by spending more.

22) Take a look at Figure 16.

Figure 16: 

It tells us that the increase in government expenditure has been a greater part of the increase in GDP over the last two years. For the period April to June 2015, the increase in government expenditure made up for around 1.3 per cent of the increase in GDP during that period. Since then it has jumped to 39.2 per cent between January to March 2017 and 34.1 per cent between April to June 2017.

So, the government is spending more and more in order to drive economic growth. This again shows that the government in its actions does believe that the economic growth is slowing down, but PM Modi won’t say so in his public posturing.

23) Take a look at Figure 17, it plots the bad loans ratio of public sector banks.

Figure 17: 

Figure 17, basically plots the gross non-performing advances ratio or simply put. the bad loans ratio of public sector banks, over the years. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. There has been a huge jump in bad loans of public sector banks over the last two years.

On October 7, the Reserve Bank of India imposed restrictions on the banking activities of Oriental Bank of Commerce (OBC). OBC was the seventh public sector bank on which restrictions have been placed. Now, one-third of public sector banks have restrictions in place. And all is well with the Indian economy?

24) Take a look at Table 1.

Table 1:

Gross NPAs (in Rs Crore) Gross Advances Gross non-performing advances ratio
Indian Overseas Bank 35,098 1,40,459 24.99%
IDBI Ltd. 44,753 1,90,826 23.45%
Central Bank of India 27,251 1,39,399 19.55%
UCO Bank 22,541 1,19,724 18.83%
Bank of Maharashtra 17,189 95,515 18.00%
Dena Bank 12,619 72,575 17.39%
United Bank of India 10,952 66,139 16.56%
Oriental Bank of Commerce 22,859 1,57,706 14.49%
Bank of India 52,045 3,66,482 14.20%
Allahabad Bank 20,688 1,50,753 13.72%
Punjab National Bank 55,370 4,19,493 13.20%
Andhra Bank 17,670 1,36,846 12.91%
Corporation Bank 17,045 1,40,357 12.14%
Union Bank of India 33,712 2,86,467 11.77%
Bank of Baroda 42,719 3,83,259 11.15%
Punjab & Sind Bank 6,298 58335 10.80%
Canara Bank 34,202 3,42,009 10.00%

Source: Author calculations on Indian Banks’ Association data.(The table does not include the associate banks of the State Bank of India which were merged into it).

What does Table 1 tell us? It tells us that many public sector banks are in a big mess on the bad loans front. Banks like Indian Overseas Bank and IDBI with bad loans ratio of 24.99 per cent and 23.45 per cent, will pull down the performance of any big bank they are merged with.

Even the big banks like Union Bank of India, Bank of Baroda, Punjab National Bank and Canara Bank, have a bad loans ratio of 10 per cent or more. If and when weaker banks are merged with these banks, their performance will only deteriorate. The question to ask is, why are many of these banks still being allowed to operate?

25) The capacity utilisation of 805 manufacturing companies tracked by the RBI OBICUS survey fell to 71.2 per cent during the period April to June 2017. This is the lowest in seven quarters.

I guess I will stop at this. There are many other economic indicators which can be used to point out that all is not well with the Indian economy. (For more details on how PM Modi cherry picked data to build a positive economic narrative, you can click here and here). Of course, this is not to say that there are no positive economic indicators right now. But the negative indicators far outnumber the positive ones.

As I keep saying, the first step towards solving a problem is recognising that it exists. But that doesn’t seem to be the case with PM Modi. In his world, all is well.

The column originally appeared on Equitymaster on October 9, 2017.

Robots Don’t Take Toilet Breaks

robot
One of the points I often make is about one million Indians entering the workforce every month. That makes it 12 million or 1.2 crore youth entering the workforce every year.

That is our ‘so called’ demographic dividend.

And that is half the population of Australia.

And that is more than 2.5 times the population of New Zealand.

The question is where are the jobs for these youth?

The former RBI governor Raghuram Rajan made a similar point recently, when he said: “Remember that we have what we call the population dividend. A million new people entering the labour force every month… If we don’t provide these jobs that are required, you have a million dissatisfied entrants. And that could create a lot of social mischief.”

The government’s response to this issue seems to be, that we have done what we could, now it is the industry’s turn to do its bit. As Arvind Panagariya recently said“The major impediment in job creation is that our entrepreneurs simply do not invest in labour intensive activities.” Pangariya said this on August 25, 2017. He was the vice-chairman of the Niti Aayog at that point of time. His term came to an end on August 31, 2017.

Recently, the Labour Secretary M Sathiyavathy also made a similar point, which was that eight states had amended the Industrial Disputes Act. This gave firms more flexibility to hire and fire workers. But despite this the corporates were not investing in labour intensive industries in these states.

The question is why are firms not investing in labour intensive industries. First and foremost, the Industrial Disputes Act is not the only labour law going around which needs to be amended, if corporates are to invest in more labour-intensive industries.

As Jagdish Bhagwati and Arvind Panagariya (the same Arvind Panagariya quoted earlier, and this makes me wonder why did he say what he did) write in India’s Tryst with Destiny: “The costs due to labour legislations rise progressively in discrete steps at seven, ten, twenty, fifty and 100 workers. As the firm size rises from six regular workers towards 100, at no point between the two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra costs of satisfying these laws.” Hence, India needs better labour laws. The work that has already been done on this front is clearly not enough.

We will get back to labour laws later in the Letter. Recently, I came across a very interesting research report by Nikhil Gupta and Madhurima Chowdhury of Motillal Oswal, who have a very interesting data driven take on why Indian corporates prefer to use capital rather than labour.

The analysts use data up to 2014-2015 from the Annual Survey of Industries and based on it conclude that over a period of 35 years up to 2014-2015, the rate of employment in the Indian industry has increased at 1.9 per cent per year on an average. At the same time, the gross value added has increased at the rate of 8 per cent per year on an average.

One method of measuring the gross domestic product (GDP) is by calculating the value added by the different industries during the period the GDP is being measured. This value added is referred to as gross value added (GVA). The GDP is defined as GVA plus indirect taxes minus subsidies.

What the Motilal Oswal analysts are essentially saying is that while the gross value added has grown at a rate of 8 per cent per year, labour employment in the industrial sector has grown at just 1.9 per cent. Factories covered by the Annual Survey of Industry covered around 1.4 crore individuals in 2014-2015. This basically reflects labour employment in the formal sector and forms around 20 per cent of the total employment in the Indian manufacturing sector.

So, what is happening here? Why has GVA grown at 8 per cent per year and the employment at just 1.9 per cent per year? The companies have expanded using capital (i.e. money to buy machinery and equipment). Gupta and Chowdhury point out that employment has grown at an average of 1.9 per cent per year, over a period of 35 years. In comparison, the capital employed by industry has grown at the rate of 14 per cent per year.

Clearly, capital has won the race hands down. Or if I were to put it in simple words, when it comes to Indian industry, machine has won over man for a while now.

The total number of employees per factory has come down from 80 in the early 1980s to around 60 in 2014-2015. Hence, the average Indian factory now employs one fourth fewer people than it did earlier. At the same time, the total capital employed in a factory has jumped from less than Rs 50 lakh to more than Rs 10 crore, during the same period.

There are multiple things that we can conclude from these numbers:

  • The Indian corporates prefer machine to men and they have done that for a while now.
  • The Indian corporates like the idea of expanding their production and in the process their business, by installing new machines and equipment, rather than employing more people. (Okay, I know I am saying the same thing in different ways. But it is important to make this point multiple times).
  • It also tells us that Indian corporates like corporates in any other part of the world, do what is beneficial for them. They are in the business of doing business and not in the business of creating jobs.
  • The question is why do Indian corporates prefer machines over men? The reason is straightforward. Machines are cheaper and more productive than men. Over the years, the labour costs have been growing at a much faster rate than the capital cost. The ratio of cost per unit of labour divided by cost per unit of capital was greater than 2.5 in 2014-2015. This basically means that hiring additional employees to expand is much more expensive than simply installing extra machines and other equipment.

The cost of per unit of labour has gone up over the years, whereas the cost per unit of capital has remained more or less stable. What this tells us very clearly is that when companies expand, it is cheaper for them to employ more machinery and get the machines to do the job, than human beings. If I were to put it simplistically, robots (i.e. machines) have won the employment race in India.

Other than this, labour laws remain a major issue which discourage companies from employing people. Take a look at Figure 1.

Figure 1: Distribution of manufacturing workforce among small, medium and large firms in India and China. 

What does Figure 1 tell us? It tells us very clearly that close to 85 per cent of Indian manufacturing firms are small. They employ less than 50 workers. In case of China, only around 25 per cent of the manufacturing firms are small. Also, in case of China, more than 50 per cent of manufacturing firms are large i.e. they employ more than 200 workers. In the Indian case, around 10 per cent of the manufacturing firms are large. And India has very few middle-sized firms which employ anywhere between 50 to 200 workers.

Since, a bulk of manufacturing firms are small, they create fewer jobs. This is a phenomenon which plays out across labour intensive sectors which can employ a huge mass of India’s unskilled and semi- skilled labour, as well. Some of the most labour intensive sectors in India are textiles, apparels and food and beverages.

The Motilal Oswal analysts point out that while the gross value added by these sectors has grown at rapid rates, the employment in them hasn’t. Take the case of textiles, the GVA has grown at the rate of 12 per cent per year, whereas employment has grown at just 3.1 per cent per year. In case, of apparels, the GVA has grown at 11.4 per year and employment at 1.8 per cent per year. For food products, the rates are at 12.3 per cent and 2.4 per cent, respectively.

These data points are again telling us that the businesses in these different sectors are growing at fast rates but they aren’t creating jobs at the same pace. At the aggregate level, what it tells us is that while companies are expanding and so is the economy, jobs aren’t being created at the same pace. In fact, jobs are being created at a very slow pace. A major reason for this, as explained above, lies in the fact that it simply makes more sense for corporates to use machines rather than human beings when they are looking to expand.

Take a look at Figure 2. It worth remembering here that the apparel sector has the potential to create huge jobs. As the chief economic adviser Arvind Subramanian along with Rashmi Verma in a June 2016 column in The Indian Express, wrote: “Every unit of investment in clothing generates 12 times as many jobs as that in autos and nearly 30 times that in steel.”

Figure 2: Distribution of Enterprise Size in Apparel Sector. 

What does Figure 2 tell us? It tells us that a bulk of Indian apparel firms employ less than eight employees. This basically tells us that they start small and continue to remain small. The question is why? Labour laws the way they are, are a major reason, as I explained at the beginning of the Letter. It’s time to get into a little more detail on the issue.

As the Niti Aayog – IDFC Enterprise Ease of Doing Business – An Enterprise Survey of Indian States report points out: “Stringent labour laws have continued to hold back the emergence of large enterprises… It is however noted that a majority of enterprises tend to have less than 49 employees regardless of whether they are located in a high- or low-growth state. This may be of interest with regards to the impact of In¬dia’s labour laws on the enterprise sizes in India. Only few laws are applicable to enterprises of all sizes such as the Minimum Wages Act of 1948. As far as legal registration of manufacturing firms is concerned, the employment threshold of ten is a major mark¬ing point in the sense that all those employing ten or more workers and using electric power (20 or more if power is not used) are required to register under the Factories Act of 1948.”

If jobs are to be created the size of these firms need to go up. They need to employ more people. But these firms need to draw a comparison between labour cost and capital cost, and for a while the capital cost has been winning hands down. In this scenario, it seems highly unlikely they will create jobs.

To conclude, robots (i.e. machines bought with capital(money)) are more productive than human beings.

They are cheaper than human beings.

And also, they don’t take toilet breaks. Yes, Robots don’t take toilet breaks.

The column originally appeared on Equitymaster on October 3, 2017.

How Demonetisation Destroyed Indian Jobs and ‘Possibly’ Helped Create Jobs Abroad

The ill-effects of demonetisation are still coming to the fore. In this issue of the Diary, I will talk about how demonetisation destroyed Indian jobs and “possibly” helped create jobs abroad.

Before I get into explaining why I am saying what I am saying, a recap of some basic economics is necessary here.

At its most basic level, the gross domestic product(GDP), a measure of the economic size of a country, is expressed as Y = C + I + G + NX, where:

Y = GDP

C = Private Consumption Expenditure

I = Investment

G = Government Expenditure

NX = Exports minus imports

The point to remember here is that imports are a negative entry in the GDP formula. The more a country imports, its GDP falls to that extent. Having said that imports also represent consumer demand at the end of the day, even though that demand does not add to the country’s GDP. For example, every time an Indian buys an electronic good manufactured in China, he is adding to the consumer demand but not to the GDP. Of course, he is adding to the Chinese GDP because exports are a positive entry into the GDP formula.

Hence, if we remove the imports of oil, gold and silver, from the total imports number (in dollars), what remains (i.e. non-oil non-gold non-silver imports) is a good indicator of consumer demand.

Now let’s take a look at Figure 1, which basically plots the year on year growth in the monthly non-oil non-gold non-silver imports. Hence, the non-oil non-gold non-silver imports in April 2017 went up by 42.5 per cent in comparison to the imports in April 2016. And that’s how it is for all other data points in Figure 1.

Figure 1: 

What does Figure 1 tell us? It tells that non-oil non-gold non-silver imports have grown at an extremely fast rate after October 2016. They are growing at rates at which they haven’t grown for a couple of years. What is happening here?

As Jahangir Aziz, head of emerging market economic research, told Bloomberg Quint recently: “What we had also feared was the demonetisation would disrupt the supply chains that run through both the formal and the informal economies. And if those supply chains get disrupted, then the revival in demand would not get fulfilled by domestic production.”

This basically means that demonetisation destroyed domestic supply chains. Without supply chains products can’t move. This has resulted in consumer demand being fulfilled through imports.

This is clearly visible in the huge growth of non-oil non-gold non-silver imports. What this also means is that as demonetisation destroyed supply chains in India, it also led to a huge job destruction. If goods weren’t moving, there was no point in producing them either. This meant shutdown of firms and massive job losses.

Further, by importing stuff that we used to produce in India earlier, we have helped the manufacturing business in foreign countries and in the process “possibly” helped create jobs there.

The irony is that one million youth are entering the workforce in India, every month. The economist Kaushik Basu had said in November 2016 that “[The] economics [of demonetisation] is complex & the collateral damage is likely to far outstrip the benefits.”The impact of this complex economics is still playing out and along with the botched up implementation of GST, has pulled down non-government GDP growth to around 4.3 per cent.

The column was originally published on Equitymaster on September 26, 2017.

What ails the Indian economy?

indian flag

A blueprint on economic revival is to be submitted to the Indian prime minister Narendra Modi, or so reports the Business Standard newspaper. This comes on the back of the slowest economic growth since Modi took over as the prime minister in May 2014.

For the period between April and June 2017, the Indian gross domestic product (GDP, a reflection of the size of the economy) grew by just 5.7 per cent. Between January and March 2016, the GDP had grown by 9.1 per cent. The last time the economy grew by less than 6 per cent (at 5.3 per cent) was between January and March 2014, when Manmohan Singh was the prime minister.

Also, the GDP growth of 5.7 per cent was achieved with the government spending more than what it usually does. The non-government part of the GDP, which forms roughly around 90 per cent of the economy, grew by a meagre 4.3 per cent.

The industry as a whole grew by 1.6 per cent, with manufacturing and construction growing by 1.2 per cent and 2 per cent, respectively.

We live in a world where any rate of economic growth greater than 2 per cent is considered to be good. But what is true for the West, isn’t really necessarily true for India. India needs to be growing rates of GDP growth faster than 7 per cent, if it has to continue to pull its millions out of poverty.

As Vijay Joshi, an economist at the University of Oxford, writes in India’s Long Road—The Search for Prosperity: “The ‘power of compound interest’ over long periods is such that even a small change in the growth rate of per capita income makes a big difference to eventual income per head.”

And how do things look for India? Where would it end by 2040 at different rates of economic growth? As Joshi writes: “At a growth rate of 3 per cent a year, income per head would double, and reach about the same level as China’s per capita income today. At a growth rate of 6 per cent a year, income per head would quadruple to a level around that enjoyed by Chile, Malaysia and Poland today. If income per head grew at 9 per cent a year, it would increase nearly eight-fold, and India would have a per capita income comparable to an average high-income country of today.”

This explains why high economic growth is so important for India. Another factor that needs to be kept in mind is that 12 million Indian youth are entering the workforce every year. This is India’s so called demographic dividend. But with construction and manufacturing growing at the rates they are, where will the jobs for the demographic dividend come from? The services sector growth continues to remain robust, but the support from industry is necessary, especially construction, given that most of these youth are low on jobs skills.

A major reason for the same comes from the lack of a good basic education. As per the Annual Status of Education Report 2016: “The proportion of children in Std III who are able to read at least Std I level text has gone up slightly, from 40.2% in 2014 to 42.5% in 2016.” Further, “in 2014, for the country 25.4% of Std III children could do a 2-digit subtraction. This number has risen slightly to 27.7% in 2016.” This has how the situation has been since 2010, after the introduction of the Right to Education.

Given this, a large portion of the youth entering the workforce are low on skills. Hence, they need low-skilled jobs which the construction and the real estate industry can provide. Both these sectors are going through a tough phase.

What hasn’t helped are India’s convoluted labour laws and the lack of ease of doing business. This has ensured that even industries like apparel manufacturing, which have the potential to create many jobs, continue to operate on a small scale. A recent report titled Ease of Doing Business—An Enterprise Survey of Indian States, published by the Niti Aayog, a government body, found that 85 per cent of the firms operating in the apparel sector employed less than eight workers. At a broader level, 85 per cent of Indian manufacturing firms are small and employ less than 50 employees.

The government feels that it has done enough to reform the labour laws, and it is the industry’s responsibility now to respond and set up labour-intensive enterprises. But that as the data suggests isn’t really happening.

Over and above this, agriculture which contributes around 15 per cent of the GDP, continues to employ half of the workforce. Exports during the first five months of this financial year (April to August 2017) are lower than where they were in 2013 and 2014.
All these factors have ensured that India has huge underemployment. Numbers from 2015-2016, suggest that only three out of five individuals who are looking for a job all through the year, are able to find one. The situation is worse in rural India, where only one in two individuals looking for a job all through the year are able to find one.

The negative effects of demonetisation have made things worse on the jobs front with many firms operating in the informal sector, which were the real job creators, having to shutdown. The botched-up launch of the Goods and Services Tax (GST), which was supposed to be a good and simple tax and it isn’t, hasn’t helped things either.

The other big worry for India is the mess its largely government owned public sector banks continue to operate in. 17 out of the 21 public sector banks have a bad loans rate of 10 per cent or more ( as of March 31, 2017). This basically means that out of every Rs 100 of loans given by these banks, loans of Rs 10 or more have already been defaulted on. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. One bank (the Indian Overseas Bank) has a bad loans rate of 25 per cent.

These bad loans have primarily accumulated on lending to industry (read crony capitalists) where the overall bad loans rate, stands at 22.3 per cent.

The government has pumped in close to Rs 1500 billion as capital since 2009 to keep these banks going. With the banks continuing to accumulate bad loans and the Basel III norms coming into force from 2019 onward, these banks are going to need billions of rupees as capital in the years to come, to continue to be in operation.

The government clearly does not have this money and they remain reluctant to privatise or even shutdown some of these banks. Also, a major impact of the bad loans has been that the public sector banks are now reluctant to lend to industry.

To conclude, there are way too many structural issues with the Indian economy as of now. If a long-term growth rate of 7-8 per cent per year has to be sustained, these issues need to be tackled on a war footing.

The column originally appeared on the BBC on Sep 26, 2017.

There’s No Free Lunch in Economics

free lunch

So here is a small story, which you, dear reader, should probably try and remember all through your life.

There are four mithaiwallahs (sweetshops) in a colony (You can call them cookie shops or cake shops or bakeries, if you want to. It doesn’t change the argument that I am trying to make in anyway).

A fifth mithaiwallah, who is loaded with money, decides to set up shop. Given that his mithais(sweets) are more or less same to what everyone else is offering, he needs to offer something more to attract customers. So, he offers free mithais, up to one kg, every day, for the first 2 months.

Given that we all love a good deal, soon, there is a queue in front of his shop everyday. And not surprisingly, the business of the remaining four mithaiwallahs collapses. There is only so much mithai that people can consume. (I mean they can go briefly overboard on this front, but then there are health consequences that they would have to bear).

The four mithaiwallahs decide to compete with the new kid on the block. They are not as loaded with money as the fifth one to be offering stuff for free, so they cut prices of their mithais. The hope is that at lower prices the consumers who have ditched them, will come back to them. After all, they have shared a healthy relationship over the years.

And come to think of it, it is their fault as well. For a very long time, they have operated like a cartel, and have kept prices high. Given that the four mithaiwallahs are all related, the gains have been shared all within the family.

So, not surprisingly, when the fifth mithaiwallah sets up shop, the consumers who are seeing the benefits of competition for the first time, go running to him. I mean, if someone sells you products of the same and better quality for a lower price, why wouldn’t you buy stuff from him. The money thus saved can be spent somewhere else. At the end, there is only so much money going around and that has to be judiciously spent.

Soon, the four mithaiwallahs come to the realisation that cutting prices isn’t taking them anywhere because the fifth mithaiwallah continues to offer mithais for free. He is bleeding but in the process, he is ensuring that they are bleeding as well.

The fifth mithai wallah has owned government ration shops for many years and has made pot loads of money selling cheap rice, wheat and sugar, in the open market at higher rates. Hence, he is loaded with money and can outlast the four mithailwallahs he is competing with.

In order to compete the four mithaiwallahs also start offering some mithais in a limited amount for free. They are left with no other option. If they have to compete they have to offer stuff for free.

But as a result, they have to dilute the quality of their mithais. In their line of business, quality and quantity rarely go together. The consumer realises this shift in quality. This is not to say that the fifth mithaiwallah was offering good quality mithai. It’s just that he was offering it free. The fall in quality of the four mithaiwallahs leads to a situation where the consumers who were sticking on to them because of their better quality, also decide to desert them.

Soon, because of offering free stuff, they are losing money hand over fist. The wait for the customers to turn up has become endless. Of course, with no money coming in, they find it difficult to repay the loans they had taken from the local bank to build their shops.
Very soon, one of the mithaiwallah defaults on a loan. Soon, the others join them. And the local bank has a problem.

Meanwhile, the fifth mithaiwallah, seeing that his competitors are in trouble, starts cutting down on the free stuff on offer and raises prices. He figures out that soon he will be the only one left with any cash and the market will be all his. So, best to start cashing in on it.

He is the last man standing in the market and can price mithais, any way he wants to. The people are already addicted to his free mithai, cannot do without it and hence, have to pay whatever he asks for.

With the bank tottering, the depositors start making noise, and the local government has to come to their rescue, and ends up in financial trouble as well. This basically means that the taxpayer has to bailout the bank.

Dear Reader, you will see a version of this story, play out over and over again. The point being there are no free lunches in economics. Never!

There is always a cost that the system has to pay. Hence, if something looks too good to be true, maybe it is.

The column originally appeared on EquitymasterThe column originally appeared on Equitymaster on September 25, 2017.