Saturday, November 06, 2010
On Income "Inequality"
I stumbled upon an article lately on my Google Reader feed that ranted somewhat predictably about how income "inequality" has risen significantly in the United States and how the middle class in the US has stagnated over the past 2-3 decades. Here's the link
It is a very provocative article as most poorly reasoned articles are. The worst part of it is that the author attempts to place the blame for "inequality of incomes" on Corporate America without rhyme or reason. In this post, I ponder on the possible reasons for stagnation of middle-class incomes. There are several of them and the most obvious ones have nothing to do with Corporate America or conservative economic policies.
Let's look at certain portions of the article that are worthy of repudiation.
globalization's significant profits were captured by a small corporate elite in the U.S. and a new corporate elite and rising middle class in China and India. The American middle class got very little of it. No wonder people are mad.......Americans accept income and wealth inequality to a much larger degree than Europe........... Looking at the stats on inequality gives us an idea of why so many are angry at the business elite — it's the highest since the 20's and getting worse
Okay. So the moot point is that while incomes have soared in the top bracket, the "median" income of the "representative" Middle American has stagnated over the last few decades notwithstanding the outstanding economic growth during the same period.
I checked up the income stats on wikipedia and it appears that this contention is quite compelling on the surface.
We observe that while the 95th %ile income has risen by nearly 40% between 1979 and 2003, the median incomes have remained quite stagnant. On the surface, this might seem like an indictment of Reagan era deregulation and the increasing preponderance of economic conservatism in the US since the late seventies.
But there are several problems with this story.
Think about Individuals and not some mythical "Middle American" : Anybody with an iota of sense can readily see that the 50th %iler who earned a median income of $38,649 in 1979 is not necessarily from the same household as the 50th %iler who earned $43,318 in 2003. It is quite possible that someone who was at 50th %ile in 1979 now has a gainfully employed son who is closer to the 80th %ile on the income distribution curve.
The American Middle class has changed in constitution since the late seventies. Several households have moved up the economic ladder as one would expect in any society bustling with private economic activity. Then, the natural question is that if most households have been upwardly mobile over the past three decades, why have median incomes remained stagnant?? The answer could well be immigration.
Immigration likely to push down median Incomes: A lot of people emigrate to the US with the hope of working their way out of poverty in their native lands and entering the "middle class". These immigrants are often unskilled and poorly educated and hence unlikely to land up with jobs that fetch them more than the median US income.
Households that have immigrated in the eighties and nineties did not feature in the dataset that generated a median income of $38,649 in 1979. Which is why it is highly irregular and inappropriate to compare two very distinct datasets from 1979 and 2003 and make sweeping statements about stagnant "middle class" incomes in the country.
So, does that mean the US should place restriction on immigration to help solve this "problem" of seeming income inequality? No. Reducing inequality of incomes should never be an end in itself. Most recent immigrants to US earning less than the median income are quite happy with their adopted country and wouldn't want to return to their roots. Take for instance a waiter in an ethnic Indian restaurant in NYC (Saravana Bhavan for eg). The guy probably earns $20,000 in his present role which perhaps places him at the 40th %ile on the income distribution curve. It is quite likely that percentile-wise he was much better off in his native country, prior to immigration (given that median income in India is barely $500 p.a). Yet, immigration makes sense for this guy as he is better off being a 40th %iler in NYC than an 80th %iler in Trichy, TN.
The Tamil waiter's immigration to US has contributed to a drop in the median American income. Nevertheless, it is welcome as the waiter's immigration was a personal preference and leaves him better off than he otherwise would've been in his native town.
"Inequality" could be an outcome of personal choices : Let's consider Bob, a successful corporate executive of yesteryear who used to earn the equivalent of $300,000 back in 1979. He has a daughter - Alice who has led a rather comfortable life thanks to her father's affluence. Unlike her father, Alice has little aptitude for business. She has always evinced keen interest in Native American history and wants to specialize in the same and eventually end up as a professor of Native American history in one of the eastern colleges. Alice is 30 years old now in 2003 and is well settled in a Boston college enjoying her role thoroughly. Her annual income is in the vicinity of $50,000, not even one-fifth of what her father used to earn in 1979!!
Is this an instance of downward intergenerational mobility? Yes. Nevertheless, it is an outcome of personal preferences and shouldn't be bemoaned. Alice is less well off than her parents in terms of monthly cash-flow. But she loves her job and probably enjoys more leisure than her father ever did in all his working life!
This little story emphasises an important point that's often overlooked by liberals who bemoan income inequality :
"It is quite likely that the 50th %iler enjoys more leisure and leads a less stressful life than the 95th %iler!"
Distribution of Leisure fairer in recent decades : Back in 1900, the distribution of Leisure was terribly unfair in the Western world. The rich were not just wealthy in terms of cash but also leisure, with little accountability. The workers who slogged 18 hours a day in unwholesome sweatshops, had neither the income nor the leisure to compensate for the lack of income.
Today, the distribution of leisure is distinctly fairer. The clerk in a Federal office may languish at the 50th %ile of the income curve, but he is quite probably placed much better (perhaps 90th %ile+) on the leisure distribution curve! The corporate executives of today enjoy far less leisure and peace of mind than the landed gentry who constituted the affluent class in the 19th century.
Disclaimer : This is only a hypothesis. But I do wish someone undertakes a study that examines how the distribution of leisure has shifted over the past 100 years in favour of the lower income groups.
Writers in the press who talk about rising income inequality in America seldom think about the points discussed in this post because of their obsession with aggregate nation-wide statistics and an indifference to what the statistics actually mean in the context of average individuals and households. Which is why we keep reading pieces where "pundits" use statistics such as the ones used in this post to launch a tirade on outsourcing and corporate executive compensation.
Inequality of outcomes need not necessarily always be a plot hatched by Wall Street wolves or neo-conservative policy makers. People who think so misunderstand not just economics but also human nature. Economics is a social science that concerns real people gifted with a free will. To reduce these people to a statistical abstraction is not just downright unfair, but bad science.
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I stumbled upon an article lately on my Google Reader feed that ranted somewhat predictably about how income "inequality" has risen significantly in the United States and how the middle class in the US has stagnated over the past 2-3 decades. Here's the link
It is a very provocative article as most poorly reasoned articles are. The worst part of it is that the author attempts to place the blame for "inequality of incomes" on Corporate America without rhyme or reason. In this post, I ponder on the possible reasons for stagnation of middle-class incomes. There are several of them and the most obvious ones have nothing to do with Corporate America or conservative economic policies.
Let's look at certain portions of the article that are worthy of repudiation.
globalization's significant profits were captured by a small corporate elite in the U.S. and a new corporate elite and rising middle class in China and India. The American middle class got very little of it. No wonder people are mad.......Americans accept income and wealth inequality to a much larger degree than Europe........... Looking at the stats on inequality gives us an idea of why so many are angry at the business elite — it's the highest since the 20's and getting worse
Okay. So the moot point is that while incomes have soared in the top bracket, the "median" income of the "representative" Middle American has stagnated over the last few decades notwithstanding the outstanding economic growth during the same period.
I checked up the income stats on wikipedia and it appears that this contention is quite compelling on the surface.
| Sluggish Growth in Median American Incomes | ||
|---|---|---|
| Data | 2003 | 1979 |
| Median (50th) | $43,318 | $38,649 |
| 95th percentile | $154,120 | $111,445 |
We observe that while the 95th %ile income has risen by nearly 40% between 1979 and 2003, the median incomes have remained quite stagnant. On the surface, this might seem like an indictment of Reagan era deregulation and the increasing preponderance of economic conservatism in the US since the late seventies.
But there are several problems with this story.
Think about Individuals and not some mythical "Middle American" : Anybody with an iota of sense can readily see that the 50th %iler who earned a median income of $38,649 in 1979 is not necessarily from the same household as the 50th %iler who earned $43,318 in 2003. It is quite possible that someone who was at 50th %ile in 1979 now has a gainfully employed son who is closer to the 80th %ile on the income distribution curve.
The American Middle class has changed in constitution since the late seventies. Several households have moved up the economic ladder as one would expect in any society bustling with private economic activity. Then, the natural question is that if most households have been upwardly mobile over the past three decades, why have median incomes remained stagnant?? The answer could well be immigration.
Immigration likely to push down median Incomes: A lot of people emigrate to the US with the hope of working their way out of poverty in their native lands and entering the "middle class". These immigrants are often unskilled and poorly educated and hence unlikely to land up with jobs that fetch them more than the median US income.
Households that have immigrated in the eighties and nineties did not feature in the dataset that generated a median income of $38,649 in 1979. Which is why it is highly irregular and inappropriate to compare two very distinct datasets from 1979 and 2003 and make sweeping statements about stagnant "middle class" incomes in the country.
So, does that mean the US should place restriction on immigration to help solve this "problem" of seeming income inequality? No. Reducing inequality of incomes should never be an end in itself. Most recent immigrants to US earning less than the median income are quite happy with their adopted country and wouldn't want to return to their roots. Take for instance a waiter in an ethnic Indian restaurant in NYC (Saravana Bhavan for eg). The guy probably earns $20,000 in his present role which perhaps places him at the 40th %ile on the income distribution curve. It is quite likely that percentile-wise he was much better off in his native country, prior to immigration (given that median income in India is barely $500 p.a). Yet, immigration makes sense for this guy as he is better off being a 40th %iler in NYC than an 80th %iler in Trichy, TN.
The Tamil waiter's immigration to US has contributed to a drop in the median American income. Nevertheless, it is welcome as the waiter's immigration was a personal preference and leaves him better off than he otherwise would've been in his native town.
"Inequality" could be an outcome of personal choices : Let's consider Bob, a successful corporate executive of yesteryear who used to earn the equivalent of $300,000 back in 1979. He has a daughter - Alice who has led a rather comfortable life thanks to her father's affluence. Unlike her father, Alice has little aptitude for business. She has always evinced keen interest in Native American history and wants to specialize in the same and eventually end up as a professor of Native American history in one of the eastern colleges. Alice is 30 years old now in 2003 and is well settled in a Boston college enjoying her role thoroughly. Her annual income is in the vicinity of $50,000, not even one-fifth of what her father used to earn in 1979!!
Is this an instance of downward intergenerational mobility? Yes. Nevertheless, it is an outcome of personal preferences and shouldn't be bemoaned. Alice is less well off than her parents in terms of monthly cash-flow. But she loves her job and probably enjoys more leisure than her father ever did in all his working life!
This little story emphasises an important point that's often overlooked by liberals who bemoan income inequality :
"It is quite likely that the 50th %iler enjoys more leisure and leads a less stressful life than the 95th %iler!"
Distribution of Leisure fairer in recent decades : Back in 1900, the distribution of Leisure was terribly unfair in the Western world. The rich were not just wealthy in terms of cash but also leisure, with little accountability. The workers who slogged 18 hours a day in unwholesome sweatshops, had neither the income nor the leisure to compensate for the lack of income.
Today, the distribution of leisure is distinctly fairer. The clerk in a Federal office may languish at the 50th %ile of the income curve, but he is quite probably placed much better (perhaps 90th %ile+) on the leisure distribution curve! The corporate executives of today enjoy far less leisure and peace of mind than the landed gentry who constituted the affluent class in the 19th century.
Disclaimer : This is only a hypothesis. But I do wish someone undertakes a study that examines how the distribution of leisure has shifted over the past 100 years in favour of the lower income groups.
Writers in the press who talk about rising income inequality in America seldom think about the points discussed in this post because of their obsession with aggregate nation-wide statistics and an indifference to what the statistics actually mean in the context of average individuals and households. Which is why we keep reading pieces where "pundits" use statistics such as the ones used in this post to launch a tirade on outsourcing and corporate executive compensation.
Inequality of outcomes need not necessarily always be a plot hatched by Wall Street wolves or neo-conservative policy makers. People who think so misunderstand not just economics but also human nature. Economics is a social science that concerns real people gifted with a free will. To reduce these people to a statistical abstraction is not just downright unfair, but bad science.
Labels: economics, statistics
Saturday, May 29, 2010
On why our bank deposits earn even less income than a Risk-free Government bond
This was a question that had been vexing me for quite a while. My savings deposit earns an interest of 3.5% a year. Whereas, the 90 day Government bill issued by the Indian Government earns about 5% p.a currently.
Shouldn't my salary account at a risk-ridden private bank yield me an income that atleast exceeds what can be earned by holding a "risk-free" 3 month government security?
Irving Fisher, the American Economist of the early 20th century, provides the answer in his opening chapter of The Theory of Interest published in 1930.
Reading this unpretentious prose is a bit like being present at the invention of something new - like the discovery of fire or the invention of the wheel. I love the way he uses the term "pure" instead of the cliched modern phrase "risk-free". Also, I love the very broad-minded definition of the term "chance". Back in B-school, we invariably used to think of sigma (the standard deviation of cash flows) when the word "chance" was mentioned. Fisher is delightfully free from all the jargon conventions that bind us.
Most importantly, he manages to answer the question posed in the beginning of the post. There is some merit in reading 80 year old classics once in a while
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This was a question that had been vexing me for quite a while. My savings deposit earns an interest of 3.5% a year. Whereas, the 90 day Government bill issued by the Indian Government earns about 5% p.a currently.
Shouldn't my salary account at a risk-ridden private bank yield me an income that atleast exceeds what can be earned by holding a "risk-free" 3 month government security?
Irving Fisher, the American Economist of the early 20th century, provides the answer in his opening chapter of The Theory of Interest published in 1930.
While any exact and practical definition of a pure rate of interest is impossible, we may say roughly that the pure rate is the rate on loans which are practically devoid of chance. In particular, there are two chances which should thus be eliminated. One tends to raise the rate, namely the chance of default. The other tends to lower it, namely, the chance to use the security as a substitute for ready cash. In short, we thus rule out, on the one hand, all risky loans, and on the other, all bank deposits, subject to withdrawal on demand, even if accorded some interest...
Reading this unpretentious prose is a bit like being present at the invention of something new - like the discovery of fire or the invention of the wheel. I love the way he uses the term "pure" instead of the cliched modern phrase "risk-free". Also, I love the very broad-minded definition of the term "chance". Back in B-school, we invariably used to think of sigma (the standard deviation of cash flows) when the word "chance" was mentioned. Fisher is delightfully free from all the jargon conventions that bind us.
Most importantly, he manages to answer the question posed in the beginning of the post. There is some merit in reading 80 year old classics once in a while
Labels: economics
Sunday, April 11, 2010
On how malleable "economic" Theories can be
Back in business school, I was told that the spread of any interest rate over the "risk-free" short term government bill rate is a function of maturity risk, liquidity risk and default risk among other things. So, the higher the spread of the longer term Government bond rate, the greater the perceived uncertainty of the government's finances in the long run. Let's call this Theory A.
Theory B: At the same school, I was also told that longer term interest rates can be interpreted as the function of the market's expectations of short term interest rates in the future. For instance, one can think of the two year bond yield as the product of the current short term Fed rate and the market's expectation of the short term Fed rate one year hence.
I didn't note the contradiction between these two points of view back then. It all seemed very sober and scientific in the classroom. But now, I often wonder if these were political theories after all, masquerading as science.
The recent blog debate starring Megan McArdle of The Atlantic and Paul Krugman is particularly interesting. Here is the chart that spurred the debate (courtesy Steve Waldman). It shows that the spread of the 30 year/10 year bond yield over the 3 month "risk-free" rate has widened since the recession. Also, the spread is not showing signs of decline even after the recession subsided mid last year.
Megan is worried about this and interprets the trend as a sign of the market pricing in the perceived default risk posed by the US government. Like a good conservative Republican, she thinks this ought to be a warning to the government to stem the deficit and stop adding to the burgeoning public debt. I guess it is very clear that she subscribes strongly to Theory A.
Paul Krugman of the NY Times responded in typical fashion. Quite predictably, he said that Megan was all confused about yield curve basics. The long term bond yield remains high because the market expects short term interest rates to go up in future. Now, we all know that short term rates generally go up only if the Fed perceives improved economic times ahead. So Krugman is in effect saying - Don't worry about the yield spread. It is mostly good news!
Now, this is the classic Market expectations theory which we labeled Theory B earlier in the post.
The question is - which theory holds water? Krugman makes his theory sound more plausible, which is no surprise given his considerable verbal skills. But is he right? Can we be altogether sure that the long term rate is purely a function of future market expectations? If that's true, what about the default risk premia, liquidity risk premia and maturity risk premia that I read so much about in FM-1?
I'd like to believe that all these "theories" are political beliefs in the main. A liberal like Krugman who is so sceptical of Fama's efficient market theory and Lucas' rational expectations hypothesis is so willing to buy the prowess of the same inefficient market in predicting future Fed actions! It is convenient because the "market expectations" interpretation of the yield curve helps him shrug off critics who cavil at government spending and the huge debt burden by saying "Look...the bond market isn't particularly worried about the debt. Why bother!"
Similarly, the conservative Megan does not buy Theory B in the context of government bond market, but is quite likely to buy the not too dissimilar rational expectations theory which helps her make a case against expansionary government policy.
It's all so very politically convenient.
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Back in business school, I was told that the spread of any interest rate over the "risk-free" short term government bill rate is a function of maturity risk, liquidity risk and default risk among other things. So, the higher the spread of the longer term Government bond rate, the greater the perceived uncertainty of the government's finances in the long run. Let's call this Theory A.
Theory B: At the same school, I was also told that longer term interest rates can be interpreted as the function of the market's expectations of short term interest rates in the future. For instance, one can think of the two year bond yield as the product of the current short term Fed rate and the market's expectation of the short term Fed rate one year hence.
I didn't note the contradiction between these two points of view back then. It all seemed very sober and scientific in the classroom. But now, I often wonder if these were political theories after all, masquerading as science.
The recent blog debate starring Megan McArdle of The Atlantic and Paul Krugman is particularly interesting. Here is the chart that spurred the debate (courtesy Steve Waldman). It shows that the spread of the 30 year/10 year bond yield over the 3 month "risk-free" rate has widened since the recession. Also, the spread is not showing signs of decline even after the recession subsided mid last year.
Megan is worried about this and interprets the trend as a sign of the market pricing in the perceived default risk posed by the US government. Like a good conservative Republican, she thinks this ought to be a warning to the government to stem the deficit and stop adding to the burgeoning public debt. I guess it is very clear that she subscribes strongly to Theory A.
Paul Krugman of the NY Times responded in typical fashion. Quite predictably, he said that Megan was all confused about yield curve basics. The long term bond yield remains high because the market expects short term interest rates to go up in future. Now, we all know that short term rates generally go up only if the Fed perceives improved economic times ahead. So Krugman is in effect saying - Don't worry about the yield spread. It is mostly good news!
Now, this is the classic Market expectations theory which we labeled Theory B earlier in the post.
The question is - which theory holds water? Krugman makes his theory sound more plausible, which is no surprise given his considerable verbal skills. But is he right? Can we be altogether sure that the long term rate is purely a function of future market expectations? If that's true, what about the default risk premia, liquidity risk premia and maturity risk premia that I read so much about in FM-1?
I'd like to believe that all these "theories" are political beliefs in the main. A liberal like Krugman who is so sceptical of Fama's efficient market theory and Lucas' rational expectations hypothesis is so willing to buy the prowess of the same inefficient market in predicting future Fed actions! It is convenient because the "market expectations" interpretation of the yield curve helps him shrug off critics who cavil at government spending and the huge debt burden by saying "Look...the bond market isn't particularly worried about the debt. Why bother!"
Similarly, the conservative Megan does not buy Theory B in the context of government bond market, but is quite likely to buy the not too dissimilar rational expectations theory which helps her make a case against expansionary government policy.
It's all so very politically convenient.
Sunday, October 12, 2008
Thoughts on banking
Prof. Jayanth Varma seems to hold a view similar to what I wrote in the previous post. Securitization has little to do with the current crisis. Here's the link. Ofcourse, a fiasco like AIG probably wouldn't have happened but for the misuse of Credit Default swaps. However, it isn't wise to pin the blame on CDS product per-se, especially when the infrastructure to support it is inadequate. The CDS market is mostly OTC. In the absence of an exchange that bears counterparty risk and ensures liquidity, credit derivatives were unlikely to be successful.
The professor's remarks on the basic unsoundness of a bank driven financial system were quite provocative. Ideally, a credit intermediary would want to borrow long and lend short (who wouldn't!). However, no saver wants to lend long and no investor wants to borrow short. As a result, the banking system is forced to resort to very high leverage levels to make its business model viable.
Now, the most facile solution is to do away with credit intermediaries (banks) and move towards a world where credit allocation happens entirely through financial markets. Securitization is a step in that direction. In an idealized version of that world, every credit-seeker, be it an individual or a business, will issue a bond. The prospective lenders will make the investment decision based on the borrower's creditworthiness (say his FICO score). Sounds very good.
However, there is a hitch. For such a system to function, it is important that we have borrowers and lenders who are willing to borrow and lend respectively over an identical timeframe. That's seldom the case since most reasonable people want to borrow long and lend short. Which is why we have highly risky institutions called banks with humongous leverage levels :(
To do away with banks would imply a considerable shrinkage in the economy's capacity to supply credit to those who need it. To persist with them would mean many more financial crises similar to what we're witnessing.
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Prof. Jayanth Varma seems to hold a view similar to what I wrote in the previous post. Securitization has little to do with the current crisis. Here's the link. Ofcourse, a fiasco like AIG probably wouldn't have happened but for the misuse of Credit Default swaps. However, it isn't wise to pin the blame on CDS product per-se, especially when the infrastructure to support it is inadequate. The CDS market is mostly OTC. In the absence of an exchange that bears counterparty risk and ensures liquidity, credit derivatives were unlikely to be successful.
The professor's remarks on the basic unsoundness of a bank driven financial system were quite provocative. Ideally, a credit intermediary would want to borrow long and lend short (who wouldn't!). However, no saver wants to lend long and no investor wants to borrow short. As a result, the banking system is forced to resort to very high leverage levels to make its business model viable.
Now, the most facile solution is to do away with credit intermediaries (banks) and move towards a world where credit allocation happens entirely through financial markets. Securitization is a step in that direction. In an idealized version of that world, every credit-seeker, be it an individual or a business, will issue a bond. The prospective lenders will make the investment decision based on the borrower's creditworthiness (say his FICO score). Sounds very good.
However, there is a hitch. For such a system to function, it is important that we have borrowers and lenders who are willing to borrow and lend respectively over an identical timeframe. That's seldom the case since most reasonable people want to borrow long and lend short. Which is why we have highly risky institutions called banks with humongous leverage levels :(
To do away with banks would imply a considerable shrinkage in the economy's capacity to supply credit to those who need it. To persist with them would mean many more financial crises similar to what we're witnessing.
Labels: economics
Monday, September 15, 2008
On Financial Meltdowns
Frederick Bastiat, the nineteenth century French economist, once authored a memorable essay aptly titled 'What is Seen and What is not Seen' in which he said that the unintended, often invisible consequences of an event tend to be overshadowed by the more obvious effects. We are so preoccupied with the visible problems resulting from an event that we completely overlook the much more darker possibilities that might have unfolded had the event not happened.
The current financial meltdown is a classic example. Large, hitherto formidable, investment banks have succumbed, marking what's clearly the worst financial crisis in atleast a generation. Pundits of all hues have been quick to demonise financial innovation (read CDOs and derivatives) as the prime culprit. However such an inference is incorrect since it is based on the faulty assumption that there would have been no crisis in the absence of the much maligned financial products.
The seeds of the current crisis were sown by the discretionary monetary policy of the Federal Reserve which kept interest rates too low for too long by overreacting to the economic slowdown in 2001. The fact that Asian central banks were propping up the dollar and suppressing long-term interest rates by investing in American bonds did not help matters. The abundance of liquidity and the availability of easy money triggered a huge demand for credit among those who had hitherto not entertained notions of taking on debt and successfully servicing it. When the rates eventually started increasing circa 2005, defaults started piling up and the banks had to face the music.
Now, all of this would have happened regardless of the sophistication of the financial products in place. Securitization is essentially a tool for managing risk. No...it doesn't help us get rid of risk. But it ensures that the risk is borne by those who are most capable of bearing it. Imagine a world without securitization and derivatives. A more traditional world where banks borrow short from depositors and lend long to individuals and businesses. In the event of widespread defaults, the risk would be borne by those who are least capable of bearing it - the small time depositor, the average Joe on the street who has placed all his lifetime savings in the neighbourhood bank. Bank runs would have ensued thus contracting the money supply in the economy. What's worse, many depositors would've lost savings of a lifetime. This is precisely what happened in the early thirties during the Great Depression. The amount of money in the economy declined remarkably and the size of the economy shrunk by almost a third in a couple of years!
Thanks to securitization and the widespread use of derivatives, bank runs are now a thing of the past. The real economy continues to grow at a reasonable rate despite the carnage in the financial sector. Yes, there will be job losses resulting from bankruptcies. But the ones affected belong to the highly skilled, educated and affluent section of the workforce who are extremely employable and can afford to make ends meet without a job for a few months atleast.
Commentators who cannot look beyond the obvious claim that the current crisis is an indictment of free markets and financial innovation. They cannot be more wrong. The crisis is infact reason enough for us to celebrate the virtues of financial innovation, which have helped insulate the real economy and also ensured that the risk is NOT borne by the more vulnerable sections of society.
Postscript :
Bank runs are now a part of our economic mythology - a curiosity from a bygone era that can only be recreated in movies. Here's a clip from the classic Frank Capra film, It's a Wonderful Life that illustrates a bank run :)
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Frederick Bastiat, the nineteenth century French economist, once authored a memorable essay aptly titled 'What is Seen and What is not Seen' in which he said that the unintended, often invisible consequences of an event tend to be overshadowed by the more obvious effects. We are so preoccupied with the visible problems resulting from an event that we completely overlook the much more darker possibilities that might have unfolded had the event not happened.
The current financial meltdown is a classic example. Large, hitherto formidable, investment banks have succumbed, marking what's clearly the worst financial crisis in atleast a generation. Pundits of all hues have been quick to demonise financial innovation (read CDOs and derivatives) as the prime culprit. However such an inference is incorrect since it is based on the faulty assumption that there would have been no crisis in the absence of the much maligned financial products.
The seeds of the current crisis were sown by the discretionary monetary policy of the Federal Reserve which kept interest rates too low for too long by overreacting to the economic slowdown in 2001. The fact that Asian central banks were propping up the dollar and suppressing long-term interest rates by investing in American bonds did not help matters. The abundance of liquidity and the availability of easy money triggered a huge demand for credit among those who had hitherto not entertained notions of taking on debt and successfully servicing it. When the rates eventually started increasing circa 2005, defaults started piling up and the banks had to face the music.
Now, all of this would have happened regardless of the sophistication of the financial products in place. Securitization is essentially a tool for managing risk. No...it doesn't help us get rid of risk. But it ensures that the risk is borne by those who are most capable of bearing it. Imagine a world without securitization and derivatives. A more traditional world where banks borrow short from depositors and lend long to individuals and businesses. In the event of widespread defaults, the risk would be borne by those who are least capable of bearing it - the small time depositor, the average Joe on the street who has placed all his lifetime savings in the neighbourhood bank. Bank runs would have ensued thus contracting the money supply in the economy. What's worse, many depositors would've lost savings of a lifetime. This is precisely what happened in the early thirties during the Great Depression. The amount of money in the economy declined remarkably and the size of the economy shrunk by almost a third in a couple of years!
Thanks to securitization and the widespread use of derivatives, bank runs are now a thing of the past. The real economy continues to grow at a reasonable rate despite the carnage in the financial sector. Yes, there will be job losses resulting from bankruptcies. But the ones affected belong to the highly skilled, educated and affluent section of the workforce who are extremely employable and can afford to make ends meet without a job for a few months atleast.
Commentators who cannot look beyond the obvious claim that the current crisis is an indictment of free markets and financial innovation. They cannot be more wrong. The crisis is infact reason enough for us to celebrate the virtues of financial innovation, which have helped insulate the real economy and also ensured that the risk is NOT borne by the more vulnerable sections of society.
Postscript :
Bank runs are now a part of our economic mythology - a curiosity from a bygone era that can only be recreated in movies. Here's a clip from the classic Frank Capra film, It's a Wonderful Life that illustrates a bank run :)
Labels: economics
Saturday, January 19, 2008
More on the Rupee
There still isn't a consensus on the ideal future course for Indian currency policy. Today, Surjit Bhalla in the Business Standard laments the adverse impact of the rupee appreciation on the economy-wide growth figures in general and the Indian exports in particular. Though this might be true to some extent, we can actually do something about it only if the following conditions hold
In the wake of huge capital inflows, the RBI typically undertakes large-scale purchases of US Dollars in the currency market to keep the rupee down. However, currency market intervention inevitably leads to increases in liquidity and acceleration in prices. To suck the excess liquidity out of the system, the RBI sterilizes its intervention by issuing government bonds. But sterilization is no magic wand. Large scale sale of government securities increases interest rates and tightens credit conditions. Moreover, the interest payable on these bonds constitutes an enormous burden on the exchequer.
The RBI's experience in Dec 2006-Mar 2007 clearly illustrated the problems created by the weak-rupee policy. Call rates shot up to astronomic levels. To bring them down, the RBI resorted to partial sterilization which resulted in an inflation scare. Eventually, the RBI had to ease its dollar purchases and let the rupee appreciate in order to retain some semblance of control on inflation and the credit conditions.
As Milton Friedman once quipped, there is no such thing as a free lunch. The cost of pursuing a weak rupee policy, amidst strong global pressures, is enormous. Successful pegging of the exchange rate will either entail the loss of monetary policy independence or the imposition of draconian capital controls. Neither of the outcomes is desirable or viable.
Instead of trying to have a currency policy, the RBI should be focusing on setting up a vibrant currency derivatives market that will mitigate some of the distress caused by a free-float exchange rate regime.
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There still isn't a consensus on the ideal future course for Indian currency policy. Today, Surjit Bhalla in the Business Standard laments the adverse impact of the rupee appreciation on the economy-wide growth figures in general and the Indian exports in particular. Though this might be true to some extent, we can actually do something about it only if the following conditions hold
- The RBI is in fact pursuing a strong-rupee policy
- If it makes up its mind, the RBI can actually keep the rupee at a much lower level
In the wake of huge capital inflows, the RBI typically undertakes large-scale purchases of US Dollars in the currency market to keep the rupee down. However, currency market intervention inevitably leads to increases in liquidity and acceleration in prices. To suck the excess liquidity out of the system, the RBI sterilizes its intervention by issuing government bonds. But sterilization is no magic wand. Large scale sale of government securities increases interest rates and tightens credit conditions. Moreover, the interest payable on these bonds constitutes an enormous burden on the exchequer.
The RBI's experience in Dec 2006-Mar 2007 clearly illustrated the problems created by the weak-rupee policy. Call rates shot up to astronomic levels. To bring them down, the RBI resorted to partial sterilization which resulted in an inflation scare. Eventually, the RBI had to ease its dollar purchases and let the rupee appreciate in order to retain some semblance of control on inflation and the credit conditions.
As Milton Friedman once quipped, there is no such thing as a free lunch. The cost of pursuing a weak rupee policy, amidst strong global pressures, is enormous. Successful pegging of the exchange rate will either entail the loss of monetary policy independence or the imposition of draconian capital controls. Neither of the outcomes is desirable or viable.
Instead of trying to have a currency policy, the RBI should be focusing on setting up a vibrant currency derivatives market that will mitigate some of the distress caused by a free-float exchange rate regime.
Labels: economics
Sunday, December 30, 2007
SS Tarapore leaves me nonplussed
I recently read a piece by SS Tarapore in IIMA's management journal - Vikalpa (Issue - Apr/Jun 2007) titled - "Impact of Monetary Policy on Bank's Growth Path"
The title is a misnomer of sorts since a substantial part of the article is dedicated to an examination of the recent rupee appreciation and RBI's handling of the same.
Below, I will point out whatever seemed downright incorrect to me in the article.
Tarapore:
Also, the comment on REER appreciation is unfounded. The REER is a function of both the nominal rate and the rate of inflation in the economy. If the nominal rupee appreciation can help moderate prices, the REER shouldn't change by much. And it hasn't. Check out this piece by Swami Iyer for more on this.
Tarapore:
Tarapore:
To my mind, the article has far too many open-ended unsubstantiated statements that one would not expect in an academic journal, albeit one published by a Bschool. Please do point out if I've got it wrong anywhere.
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I recently read a piece by SS Tarapore in IIMA's management journal - Vikalpa (Issue - Apr/Jun 2007) titled - "Impact of Monetary Policy on Bank's Growth Path"
The title is a misnomer of sorts since a substantial part of the article is dedicated to an examination of the recent rupee appreciation and RBI's handling of the same.
Below, I will point out whatever seemed downright incorrect to me in the article.
Tarapore:
It is still not clear as to what extent the Indian economy has integrated with the world economyI see no reason why this shouldn't be clear. As of 2007, gross capital flows amount to a staggering 45% of the GDP. Gross two way flows on both the capital and current account exceed 110% of the GDP!
Tarapore :
Persistent capital inflows into the country could result in an unrestrained monetary expansion and a REER appreciation which in turn is likely to end up in a crisisHow on earth can capital inflows increase the stock of money in the economy? Ironically, it is RBI's attempts to defend the dollar in the wake of capital inflows which is contributing to monetary expansion and not the capital flows per-se.
Also, the comment on REER appreciation is unfounded. The REER is a function of both the nominal rate and the rate of inflation in the economy. If the nominal rupee appreciation can help moderate prices, the REER shouldn't change by much. And it hasn't. Check out this piece by Swami Iyer for more on this.
Tarapore:
Now suppose that the RBI does not intervene in the forex market. There would be an unbridled monetary expansion and...an appreciation of the REERNow, this borders on the preposterous. RBI's vain attempts to defend the dollar and its largely ineffective sterilization attempts are to be blamed for the price acceleration India witnessed in March this year. It seems like Tarapore is inhabiting a different planet.
Tarapore:
A real appreciation of the rupee is clearly against fundamentals and is clearly unsustainable as it would imply an over-valuation of the exchange rate.What does he exactly mean by "fundamentals"? How does one arbitrate on whether a certain rate is overvalued or not? The comment reminds me of the fatal conceit that Hayek once wrote about. The very idea that a handful of "wise" central bankers can figure out the appropriate value of an asset which is traded by millions of market participants smacks of an arrogant condescension towards the market and an exaggeration of a central bank's abilities.
To my mind, the article has far too many open-ended unsubstantiated statements that one would not expect in an academic journal, albeit one published by a Bschool. Please do point out if I've got it wrong anywhere.
Labels: economics
Tuesday, December 11, 2007
Equity Research vs Wisdom of the Crowds
This is an arbit post. Not much thought has gone into it. So please feel free to correct me.
What is the true 'value' of a good/asset? Whatever the buyer is willing to pay for it in my opinion.
Equity analysts disagree. They claim that certain people (read analysts) are better equipped to estimate an asset's 'true' value than the riff-raff crowd.
Isn't that very similar to the argument put forth by socialist command-and-control freaks about half a century ago? The Nehruvian conviction that a handful of wise men at New Delhi are better placed to allocate resources and dictate the destiny of the economy is not very different from the condescending attitude of equity researchers, especially the ones who rely on so-called 'fundamental analysis'.
In both cases, there is a blind faith in the discretionary wisdom of a handful of technocrats as opposed to the wisdom of the crowd (read market).
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This is an arbit post. Not much thought has gone into it. So please feel free to correct me.
What is the true 'value' of a good/asset? Whatever the buyer is willing to pay for it in my opinion.
Equity analysts disagree. They claim that certain people (read analysts) are better equipped to estimate an asset's 'true' value than the riff-raff crowd.
Isn't that very similar to the argument put forth by socialist command-and-control freaks about half a century ago? The Nehruvian conviction that a handful of wise men at New Delhi are better placed to allocate resources and dictate the destiny of the economy is not very different from the condescending attitude of equity researchers, especially the ones who rely on so-called 'fundamental analysis'.
In both cases, there is a blind faith in the discretionary wisdom of a handful of technocrats as opposed to the wisdom of the crowd (read market).
Labels: economics
Thursday, September 20, 2007
|Saturday, February 03, 2007
On Conservatives, Liberals and.....Hypothesis Testing
What makes a person conservative or liberal? I don't know.
But the theory of Hypothesis Testing does help us gain insight into a person's political predilections. Gobsmacked, eh? Read on.
Suppose, for the sake of argument, that youth from the Middle East/N.Africa are more likely to resort to terrorism than any other race. To strengthen this supposition, we have to reject the hypothesis that terrorism finds no special favour among any specific group of people.
H0 : Youth from the Middle East/North Africa are no more inclined/indifferent towards Terrorism than youth from any other part of the world.
The alternative hypothesis is that youth in certain parts of the world are indeed more likely to turn into terrorists. Hence, racial profiling can help apprehend potential terrorists and debar entry to dubious immigrants.
For instance, assume that 5% of the youth wanting to immigrate to US are of Middle Eastern/N.African extraction. Going by the Null Hypothesis, in any sample of immigrant terrorists, the proportion hailing from M.E/N.A shouldn't exceed 5%. Right?
Now, consider a random sample of immigrant terrorists wherein 20% are Arabs/N.Africans and the probability of more than 20% of a random sample of immigrant terrorists being N.Africans/Arabs, given that the null hypothesis holds, is 5%.
Does this figure justify racial profiling? This is where your political predilection comes into play. A liberal might be wary of rejecting a true hypothesis (Type I error) and may be unwilling to disregard it even if the figure was as low as 1%. A conservative right-winger on the other hand, would not want to run the risk of accepting a false hypothesis (Type II error). He may be tempted to ditch the hypothesis for any figure less than 15%!
This has to be one of the great debates in public policy. What is the most appropriate significance level? Should policy makers opt for a high significance level and aggressively pursue racial profiling to weed out the slightest possibility of terrorist infiltration at the expense of civil liberties? Or should they refrain from 'profiling' altogether, and thereby run the risk of terrorist attacks?
The answer would vary depending on whether you're a fan of George Bush or Michael Moore ;)
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What makes a person conservative or liberal? I don't know.
But the theory of Hypothesis Testing does help us gain insight into a person's political predilections. Gobsmacked, eh? Read on.
Suppose, for the sake of argument, that youth from the Middle East/N.Africa are more likely to resort to terrorism than any other race. To strengthen this supposition, we have to reject the hypothesis that terrorism finds no special favour among any specific group of people.
H0 : Youth from the Middle East/North Africa are no more inclined/indifferent towards Terrorism than youth from any other part of the world.
The alternative hypothesis is that youth in certain parts of the world are indeed more likely to turn into terrorists. Hence, racial profiling can help apprehend potential terrorists and debar entry to dubious immigrants.
For instance, assume that 5% of the youth wanting to immigrate to US are of Middle Eastern/N.African extraction. Going by the Null Hypothesis, in any sample of immigrant terrorists, the proportion hailing from M.E/N.A shouldn't exceed 5%. Right?
Now, consider a random sample of immigrant terrorists wherein 20% are Arabs/N.Africans and the probability of more than 20% of a random sample of immigrant terrorists being N.Africans/Arabs, given that the null hypothesis holds, is 5%.
Does this figure justify racial profiling? This is where your political predilection comes into play. A liberal might be wary of rejecting a true hypothesis (Type I error) and may be unwilling to disregard it even if the figure was as low as 1%. A conservative right-winger on the other hand, would not want to run the risk of accepting a false hypothesis (Type II error). He may be tempted to ditch the hypothesis for any figure less than 15%!
This has to be one of the great debates in public policy. What is the most appropriate significance level? Should policy makers opt for a high significance level and aggressively pursue racial profiling to weed out the slightest possibility of terrorist infiltration at the expense of civil liberties? Or should they refrain from 'profiling' altogether, and thereby run the risk of terrorist attacks?
The answer would vary depending on whether you're a fan of George Bush or Michael Moore ;)
Labels: economics, politics, statistics
Wednesday, January 03, 2007
Does Big Government help reduce Income Inequality?
Here's an interesting piece that examines the Government spending/GDP ratios in countries across the world.
In US, as per the 2005 estimate, federal government expenditure constitutes 19.7% of the national GDP. The corresponding figure for India is 18.75%!!
As one would expect, for most Western European countries, the figure is around 50%. For instance, in Norway and the United Kingdom the Government taxes away more than 40% of the national output.
As always, the data lends itself to different interpretations. The purported intention of having a big government is to ensure a more equitable distribution of income. If Government does indeed help alleviate gross inequality of income, there ought to be a negative correlation between the Govt Spending/GDP ratios and the Gini Index, which is a measure of income inequality.
But, this is clearly not the case -
Country Gini Index
Norway 25.8
India 32.5
UK 36.0
US 40.8
The United Kingdom, whose Govt Spending/GDP ratio is more than twice that of US or India, has a higher level of Income Inequality than India!! Hence, the cliched argument of the socialists that governments need to spend more to reduce income inequality doesn't hold water.
Instead, a more plausible theory is that countries that are culturally and ethnically homogeneous are more likely to be egalitarian in terms of income distribution. Denmark, Japan, Sweden and Norway are all excellent examples of nations that are predominantly homogeneous and hence more egalitarian. In contrast, melting pots like US, UK and India tend to be less egalitarian because of the sheer ethnic diversity of their populations. Spending more money on wasteful government programmes is not going to make a positive difference, as shown in the case of UK.
PS: I must admit I haven't considered the redistributive part of Government Spending separately. These figures would include expenditure on Defence which is not redistributive. Even after making allowance for that, the case against big government appears pretty strong.
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Here's an interesting piece that examines the Government spending/GDP ratios in countries across the world.
In US, as per the 2005 estimate, federal government expenditure constitutes 19.7% of the national GDP. The corresponding figure for India is 18.75%!!
As one would expect, for most Western European countries, the figure is around 50%. For instance, in Norway and the United Kingdom the Government taxes away more than 40% of the national output.
As always, the data lends itself to different interpretations. The purported intention of having a big government is to ensure a more equitable distribution of income. If Government does indeed help alleviate gross inequality of income, there ought to be a negative correlation between the Govt Spending/GDP ratios and the Gini Index, which is a measure of income inequality.
But, this is clearly not the case -
Country Gini Index
Norway 25.8
India 32.5
UK 36.0
US 40.8
The United Kingdom, whose Govt Spending/GDP ratio is more than twice that of US or India, has a higher level of Income Inequality than India!! Hence, the cliched argument of the socialists that governments need to spend more to reduce income inequality doesn't hold water.
Instead, a more plausible theory is that countries that are culturally and ethnically homogeneous are more likely to be egalitarian in terms of income distribution. Denmark, Japan, Sweden and Norway are all excellent examples of nations that are predominantly homogeneous and hence more egalitarian. In contrast, melting pots like US, UK and India tend to be less egalitarian because of the sheer ethnic diversity of their populations. Spending more money on wasteful government programmes is not going to make a positive difference, as shown in the case of UK.
PS: I must admit I haven't considered the redistributive part of Government Spending separately. These figures would include expenditure on Defence which is not redistributive. Even after making allowance for that, the case against big government appears pretty strong.
Labels: economics
Thursday, November 09, 2006
Why MBA
No...I'm not going to talk about the cliched arguments about how investment in business education from a good bschool yields a positive NPV in the long run. Nor is it about what you and I as individuals expect from an MBA education.
Was wondering why the economy needs MBAs? Will the macro-economy be worse off without business graduates? According to Solow, the growth prospects of an economy in the long run are determined by the capital stock, labour stock and productivity. The reason why the government is subsidising our education is in the hope that graduates from elite bschools will go on to run businesses more efficiently and thereby improve the productivity of the aggregate economy. In 'growth theory' jargon, they hope that MBAs will increase the rate of 'technical progress' in the economy.
After subsidising management education for over forty years, it is about time for the powers that be to ask some pertinent questions.
-Are MBAs from IIMs more efficient and productive than managers who don't have a business degree/have one from a lesser bschool?
-If yes, should we attribute the efficiency to the inherent competence of these executives or to the 'education' they received at IIM?
-Most importantly, do MBAs actually think along these lines? If I were to continue taking decisions based on gut feeling post MBA despite having learnt Linear programming at IIM, would I not be letting the tax payer down?
Food for thought. The debt that IIMites owe to society is humongous considering the largely superfluous learning we acquire at college. The Private gains of Business education ( better career prospects, brand value) outweigh whatever little benefit that accrues to the economy because of our human capital.
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No...I'm not going to talk about the cliched arguments about how investment in business education from a good bschool yields a positive NPV in the long run. Nor is it about what you and I as individuals expect from an MBA education.
Was wondering why the economy needs MBAs? Will the macro-economy be worse off without business graduates? According to Solow, the growth prospects of an economy in the long run are determined by the capital stock, labour stock and productivity. The reason why the government is subsidising our education is in the hope that graduates from elite bschools will go on to run businesses more efficiently and thereby improve the productivity of the aggregate economy. In 'growth theory' jargon, they hope that MBAs will increase the rate of 'technical progress' in the economy.
After subsidising management education for over forty years, it is about time for the powers that be to ask some pertinent questions.
-Are MBAs from IIMs more efficient and productive than managers who don't have a business degree/have one from a lesser bschool?
-If yes, should we attribute the efficiency to the inherent competence of these executives or to the 'education' they received at IIM?
-Most importantly, do MBAs actually think along these lines? If I were to continue taking decisions based on gut feeling post MBA despite having learnt Linear programming at IIM, would I not be letting the tax payer down?
Food for thought. The debt that IIMites owe to society is humongous considering the largely superfluous learning we acquire at college. The Private gains of Business education ( better career prospects, brand value) outweigh whatever little benefit that accrues to the economy because of our human capital.
Saturday, December 10, 2005
The Unintended Consequence of Bankruptcy Laws
....is the perpetuation of poverty.
The conclusion may not sound intuitive. So let me explain.
Let us at the outset understand the rationale behind Bankruptcy Laws and the problem supposedly being addressed by this legislative fiat.
Finance, in most countries, is beyond the reach of aspiring first-generation entrepreneurs without the backing of collateral. If the debtor does not have sufficient means, he often resorts to mortgaging the house in which he resides, which could well be his sole tangible asset. In the event of failure to repay the loan, he faces the grim prospect of being deprived of the only thing that he could lay claim upon.
To alleviate the distress of people facing such a predicament, Bankruptcy Laws are framed, wherein a substantial portion of household assets are exempted from seizure by creditors. The intent of this fiat is to prevent the borrower from being rendered destitute in case of a financial disaster.
At first sight, the law is seemingly beneficial. But the result is disastrous. The law deprives the talented entrepreneur without means of his only chance of gaining access to credit. The Bankruptcy exemption ensures that he is left with no assets that can be used as collateral. The probability of banks turning him down goes up considerably. This is how an entrepreneurial career is nipped in the bud, and enterprising businessmen are doomed to a mediocre existence.
The main beneficiaries in this system are the well-to-do established businessmen who will have enough assets left even after the exemptions that can be used as collateral. Such laws also insulate them from competition as new players will find it well-nigh impossible to finance their ventures.
Hence, a law that was framed with the intent of levelling the playing field has the opposite effect of widening the gap between the haves and the have-nots. Sad.
Do read this wonderful book for more on this.
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....is the perpetuation of poverty.
The conclusion may not sound intuitive. So let me explain.
Let us at the outset understand the rationale behind Bankruptcy Laws and the problem supposedly being addressed by this legislative fiat.
Finance, in most countries, is beyond the reach of aspiring first-generation entrepreneurs without the backing of collateral. If the debtor does not have sufficient means, he often resorts to mortgaging the house in which he resides, which could well be his sole tangible asset. In the event of failure to repay the loan, he faces the grim prospect of being deprived of the only thing that he could lay claim upon.
To alleviate the distress of people facing such a predicament, Bankruptcy Laws are framed, wherein a substantial portion of household assets are exempted from seizure by creditors. The intent of this fiat is to prevent the borrower from being rendered destitute in case of a financial disaster.
At first sight, the law is seemingly beneficial. But the result is disastrous. The law deprives the talented entrepreneur without means of his only chance of gaining access to credit. The Bankruptcy exemption ensures that he is left with no assets that can be used as collateral. The probability of banks turning him down goes up considerably. This is how an entrepreneurial career is nipped in the bud, and enterprising businessmen are doomed to a mediocre existence.
The main beneficiaries in this system are the well-to-do established businessmen who will have enough assets left even after the exemptions that can be used as collateral. Such laws also insulate them from competition as new players will find it well-nigh impossible to finance their ventures.
Hence, a law that was framed with the intent of levelling the playing field has the opposite effect of widening the gap between the haves and the have-nots. Sad.
Do read this wonderful book for more on this.
Labels: economics
Saturday, September 03, 2005
THE PITFALLS OF SUBSIDISED INSURANCE
This piece
pinpoints one of the principal causes for the colossal loss of life and property in New Orleans in the wake of Hurricane Katrina.
It is the classic case of a 'well-intentioned' Governement initiative proving to be counter-productive. Government provides heavily subsidised insurance against flood. As a result,people heedlessly built seaside dwellings without a care in the world,and are now paying a price for it.
Without Govt intervention, the proverbial Invisible Hand of the Market would have mitigated the damage.
Private insurance firms might have insisted on high premiums for providing cover to property in flood-prone areas, thereby making people think twice before constructing houses close to the seafront.
Ofcourse, such a market-based solution makes little sense to India, as vulnerable fisherfolk in our country can't afford private insurance.
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This piece
pinpoints one of the principal causes for the colossal loss of life and property in New Orleans in the wake of Hurricane Katrina.
It is the classic case of a 'well-intentioned' Governement initiative proving to be counter-productive. Government provides heavily subsidised insurance against flood. As a result,people heedlessly built seaside dwellings without a care in the world,and are now paying a price for it.
Without Govt intervention, the proverbial Invisible Hand of the Market would have mitigated the damage.
Private insurance firms might have insisted on high premiums for providing cover to property in flood-prone areas, thereby making people think twice before constructing houses close to the seafront.
Ofcourse, such a market-based solution makes little sense to India, as vulnerable fisherfolk in our country can't afford private insurance.
Labels: economics
