RBI, Inflation And Interest Rate

Last week the November inflation number came out at 5.5% - below the upper limit (6%) of the inflation target. So the media is saying that RBI must cut the interest rate. Is this view correct?

The RBI's Bulletin in July said that India's neutral/natural interest rate is around 1.5-2%. What does 'neutral/natural interest rate' mean? The top table illustrates this:

a) When the real interest rate is at the neutral/natural level, it neither decreases nor increases inflation. This is neutral monetary policy.

b) When the real interest rate is above the neutral/natural level, it decreases inflation. This is contractionary monetary policy.

c) When the real interest rate is below the neutral/natural level, it increases inflation. This is expansionary monetary policy.

Currently the inflation and interest rate situation is:

1. Inflation is 5.5% - above the target level (4%). So it must be decreased. That is - real interest rate must be above the neutral/natural level of 1.5-2%. 

2. But the repo rate is 6.5%. So the real repo rate = 6.5% - 5.5% = 1%, which is less than the neutral/natural level (1.5-2%).

3. So monetary policy is actually expansionary - ie, tending to increase inflation!

So to what level must inflation come down to justify a rate cut (in an already expansionary monetary policy)? The bottom table illustrates this. If inflation comes down to 4.5% (Case 1) then the repo rate can be cut to 6.25%. Because then the real repo rate will be 6.25% - 4.5% = 1.75%, which is above the lower limit (1.5%) of the neutral/natural level (1.5-2%) - which it has to be because inflation (4.5%) will still be above the target level (4%). Whereas inflation coming down to even 4.75% will not justify a rate cut (Case 2).

Of course, this is by taking the lower limit (1.5%) of the neutral/natural interest rate (1.5-2%). If we take the upper limit (2%) then inflation has to come down all the way to its target level (4%) to justify a rate cut (Case 3). Even inflation coming down to 4.25% will not justify a rate cut in this scenario (Case 4).

Low Salaries: Law Of Demand And Supply

The internet has many posts criticising the low salaries for:

1. Assistant Professors (like ₹ 35,000/month) in many colleges and universities

2. Fresh engineers (like ₹ 3 lakh/year) in companies like TCS, Wipro and Infosys

Wage is the price of labour. And the most fundamental law of economics is that all prices are decided by demand and supply. High demand or/and low supply leads to a high price/wage. And low demand or/and high supply leads to a low price/wage. Low salaries for Assistant Professors and fresh engineers are simply a reflection of the high supply of these workers.

The average wage of a casual labourer (like farm workers and construction workers) in India is ₹ 400/day. So if a farm/construction worker works 30 days a month, he/she will earn only ₹ 12,000/month - for doing back-breaking work in the hot sun the whole day. Is this fair? Of course, it is not. But the world does not run on fairness - it runs on the laws of economics, especially the law of demand and supply . . .

Why Did The Industrial Revolution Happen In Europe – And Not India Or China?

WHY DID THE INDUSTRIAL REVOLUTION HAPPEN IN EUROPE – AND NOT INDIA OR CHINA?

How did the West become rich? Why did the Industrial Revolution happen in Europe - even though historically, India and China were more advanced in science? This is the biggest question in economic history. Economic historian Eric Jones answered this question in his book 'The European Miracle' (1981). The ultimate determinant of history is geography - and a unique combination of geographical factors put Europe on a unique path of political, economic and technological development:

1. Latitudes: India is in the tropical/sub-tropical zones, China and Europe are in the sub-tropical/temperate zones. The tropical and sub-tropical zones were prone to droughts and famines - which retarded India's and China's development. But North Europe (Britain, France, Germany - the growth engine of Europe) is in the temperate zone - so it did not have this problem.

2. Coastline: India and China have short/smooth coastlines - but Europe has a long/jagged coastline. So India and China did not give much importance to sea transport, but Europe gave it a lot of importance - and hence advanced in shipping. The earth's surface is 70% water - so Europe's advancement in shipping enabled it to reach all parts of the world, and conquer them.

3. Divisions: Both India and China are unified land areas. But Europe is divided by seas, rivers and mountains into separate geographical units - and these separate geographical units became separate countries (Britain, France, Germany, Italy, Spain, etc). And these separate countries continuously competed with one another technologically and economically - and put Europe on a path of technological and economic development. India and China, on the other hand, were ruled by single empires - and did not have this division and competition.

4. Central Asia: Central Asia is a vast grassland whose people were horse-riding tribals. And these tribals (Turks and Mongols/Mughals) invaded the nearby advanced civilisations of India (to the south) and China (to the east) - and retarded their development. But Europe is far away from Central Asia - and so escaped this problem.

5. Americas: North America and South America were thinly populated continents rich in natural resources. America is 10,000 km from Asia - but only 5,000 km from Europe (half the distance). So it was easier for Europeans to go to the Americas, occupy them and get their vast natural resources - which accelerated Europe's development.

Dharmonomics: Dharma And Economics

DHARMONOMICS: DHARMA AND ECONOMICS

Last month Daron Acemoglu, Simon Johnson and James Robinson won the Nobel Economics Prize for showing how institutions produce economic growth. In particular, they have shown the importance of 3 institutions:

1. Law and order 

2. Enforcement of contacts

3. Protection of property rights 

In ancient Indian philosophy, the concept of Dharma (order/morality) had 3 main components:

1. Satya (truth)

2. Asteya (not stealing)

3. Ahimsa (non-violence)

We can see that the 3 components of Dharma are similar to the 3 institutions that produce economic growth . . .

'Phulwanti' Movie Review

'PHULWANTI' MOVIE REVIEW

Based on the famous novel (of the same name) by the great Marathi writer Babasaheb Purandare, 'Phulwanti' is a beautiful meditation on the relationship between knowledge and the scholar (and art and the artist) - and also the real meaning of love. The script, direction, acting, set design, costume design, music and choreography are all top-notch. The movie has English sub-titles.

[An economist's irrelevant aside:

A civilisation that can produce a great work of art like Babasaheb Purandare's 'Phulwanti' is indeed a great civilisation. Where we have fallen short is in building efficient systems - like economic system, administration system, etc . . .]

Why Government Must Be Small

WHY GOVERNMENT MUST BE SMALL

What should be the size of the government? Should it be big or small? Liberals want a big government that provides a lot of generous welfare schemes to as many people as possible. Conservatives want a small government that only performs its core functions of maintaining law & order and providing public goods (because a big government has to be funded by high taxes - and taxes reduce the social surplus). And centrists/realists say that the government must be neither big nor small - but of the optimum size: ie, the size that maximises the long-term growth rate.

These ideological preferences aside, there is one argument in favour of a small government. And we are seeing it in today's Indian politics. The Congress Party is promising the expensive and wasteful Old Pension Scheme (OPS) in every state election - and government workers are voting for it. In theory, democracy is the rule of the majority - and must work for the good of the majority. But as the economist Mancur Olson showed in his 1965 classic 'The Logic Of Collective Action' (for which he shockingly did not get the Nobel Prize) small groups can hijack a democracy. And the voting behaviour of government workers in India is a perfect example of this phenomenon.

Thus if the government becomes big, then government workers will become a big and powerful lobby - and will vote for wasteful government programs like the Old Pension Scheme (OPS). So this is a good reason for keeping the government small . . .

Working Hours, Stress And Salary In India

WORKING HOURS, STRESS AND SALARY IN INDIA

(The Dichotomy Of The Indian Economy)

Anna Sebastian Perayil, a 26-year-old chartered accountant at Ernst & Young, sadly died in July due to overwork and stress. Many people are asking: "Why didn't she quit?". Well, this question applies not just to her but to almost all middle-class Indians in metropolitan cities - who are doing high-stress jobs. According to a survey conducted by the Confederation of Indian Industry (CII) 60% of Indian workers suffer from high stress - the world average is 20%. So the question arises: Why don't all these people quit their jobs and do jobs that are less stressful?

Graph 1 shows an ideal economy:

1. There is a linear relationship between working hours/stress and salary (blue line). As working hours/stress increases, salary also increases - but linearly.

2. Most of the jobs pay a salary that can support a middle-class lifestyle (red line) for a family.

Graph 2 shows today's Indian economy:

1. The relationship between working hours/stress and salary is not just non-linear but exponential. The salary increases only at a high level/value of working hours/stress. 

2. To live a middle-class life in a metropolitan city (ie, house + car + etc) you need that high salary.

In the ideal economy (Graph 1) people can choose the combination of working hours/stress and salary that they are comfortable with - and still live a middle-class life. That is - they can give up some salary in return for lower/lesser working hours/stress. The choice can also be dynamic: People can do high-stress/high-salary jobs when they are young - and switch to medium-stress/medium-salary jobs when they are middle-aged. But in today's Indian economy (Graph 2) there is no choice. If you want to live a middle-class life, you *have to* do a high-stress/high-salary job. You are forced to choose between two extremes: low-stress but low-salary jobs versus high-salary but high-stress jobs - there is nothing in between.

Real development means building the economy shown in Graph 1 - so that there are no more tragedies like Anna's . . .