Monday, December 19, 2016
Wednesday, November 16, 2016
It is intuitive to grasp some of the implications of the recent demonetization of 500 and 1,000 rupee notes by the central government in India. If there is one thing the corrupt government officials are good at, it's collaboration. Those running a one-man show don’t survive the swamp. When the Indian Revenue Service and the Central Bureau of Investigation are currently not able to effectively prosecute the corrupt government officials they have already identified, owing to an overburdened judiciary, it is unreasonable to expect them to pin down the collaboration that takes place between the good, the bad and the ugly between November 08th and December 30th, the two dates between which one can deposit old notes in a bank. This intuition is likely to kick in when the commotion settles. Right now, it is the thought of a cash hoarder running around and losing sleep over piles of cash under his bed that is keeping people standing in bank queues happy.
Other implications, and the underlying reasons behind demonetization, are not so intuitive to understand. I intentionally did not use the term tax-evaders in the paragraph above when I referred to those with illegitimate hoardings of cash. It would be an egregious error for an economist to conflate businessmen who evade taxes and corrupt government officials who take bribes. What you call tax evasion, a free market economist, in the context of the Indian economy, will, and should, call a tax cut. An effective tax cut that incentivizes businessmen to produce goods and services that people need. A businessman’s wealth is not, unlike the wealth of a corrupt government official, an ill-gotten wealth. He takes risks, employs people, and his wealth is a function of what people were willing to pay for the goods and services he produces.
The idea is not to encourage tax default, but to acknowledge the inefficiency of the tax machinery of the government for a low effective tax rate. Lower taxes, to an extent, imply smaller governments. The period between 1776 and 1913 during which the United States became an industrial superpower, the country had a very small government and income tax was unconstitutional. To understand in layman’s terms how the Indian economy will crumble if all businessmen were to be forced to pay a high tax rate, I would encourage you to read the article Republic of Ghaziabad – Part I. The belief that “taxes are high because businessmen don’t pay them” is a fallacy; many businessmen will simply close their operations if they are forced to pay such high taxes.
But this is not the gravest implication of demonetization; I am confident that businessmen in India are smart enough to find a way around it. The most concerning part is that this is not just demonetization as claimed by the government. I predicted the collapse of the banking system in India in my two articles published in 2015: Will India Be The First Domino To Fall? and You Can't Just Invest On Hope. The hard-earned money that people deposited in nationalized banks was squandered away during the ten years of the UPA government. These banks financed boondoggles, welfare schemes and luxuries of friends of governments, and have now run out of money. The collapse I predicted is here. I believe that the Finance Ministry is grasping for straws and the demonetization step is a last-ditch effort to postpone the financial crisis. This is not demonetization. This is a bank holiday, and it will backfire.
No set of words capture what happens when money is not in the hands of people but their government better than this quote by Milton Friedman.
“There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, you really watch out what you're doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I am not so careful about the content of the present, but I am very careful about the cost. Then, I can spend somebody else's money on myself. And if I spend somebody else's money on myself, then I am sure going to have a good lunch. Finally, I can spend somebody else's money on somebody else. And if I spend somebody else's money on somebody else, I am not concerned about how much it is, and I am not concerned about what I get. And that's government.”
- Milton Friedman
Let us read the quote above considering the current situation. Under demonetization, a poor woman who has been saving cash to spend on the education of her child will be forced to deposit it in banks operated by the government. The banks (somebody else) will use her money to finance ever-increasing salaries of government officials (somebody else) and to fund “new and innovative” schemes centrally planned for the poor (“somebody else”) by an army of bureaucrats (somebody else). Somebody will use her money to build a toilet for her. Somebody will buy her an LED bulb.
When she asks for her money back, and if the cash withdrawal restriction has been lifted by that time, the RBI will print new notes for her. Direct taxation is not the only way the government takes people’s money. Inflation is a tax, and printing notes out of thin air causes inflation. The woman will not be able to educate her child when she receives the devalued cash as the cost of education would have risen. In effect, she won’t be able to educate her child because somebody else has been granted the power to spend her money on somebody else.
The money she would have spent on the education of her child would have employed a pencil and copy manufacturer, a carpenter and a teacher. Now that money will be spent on salaries of bureaucrats who make decisions for her, on salaries of welfare officials who produce nothing for her, and on LED bulb which she doesn’t think is as important as education for her child. Think about millions of people whose choice to spend their own money in a way they want has been taken away by this step, and you will start getting an idea of the magnitude of the impact of this decision. This, I believe, is more damaging than other consequences associated with demonetization, and will continue to worsen the fundamentals of the economy until the cash withdrawal restriction is lifted
Tuesday, June 28, 2016
In Mahabharata, Krishna started his campaign against Kansa with a protest against the income tax. He encouraged the dwellers of Gokul not to pay the income tax (Kar) imposed on them by Kansa. Escalation of the conflict between the people of Gokul and the state of Mathura culminated in Kansa’s death at the hands of Krishna. This episode has a striking resemblance to how the United States was founded. In 1765, the American Colonial Society rejected the authority of the British to levy taxes on the people of America. Escalation of this conflict resulted in the defeat of the British and the independence of America in 1776. Between 1776 and 1913, when the United States grew at its fastest pace to become a superpower, the country did not have an income tax (only corporate profits were taxed). The money people earned remained in their hands to be spent on what they deemed fit.
When Krishna tried to convince the people of Gokul not to pay their taxes, he pointed out to them how Kansa, as a king, had abdicated his primary responsibility of protecting the life and property of the people of Gokul. Mahabharata starts with king Bharat defining the role of a government (king). When he announced his decision not to hand over his throne to any of his nine sons, he described the three responsibilities of a king and emphasized that these are his only responsibilities. The first is to protect the life and property of the people from external attacks, the second is to provide justice to the people, and the third is to nominate a worthy successor.
Bharat did not mention redistribution of wealth as a responsibility of a king. It was Duryodhan who later violated this principle and started giving away money (gold) in the treasury (Raj Kosh) to the people of Hastinapur to get public opinion in his favor when he faced a threat from the Pandavas. Charity is embedded in the Hindu culture. A government, by enforcing redistribution, can only demonstrate its distrust of the people.
Since FDR’s new deal in the 1930’s, the U.S. has continued to abandon the principle of minimal taxation and limited government and has started walking on Duryodhan’s path. In 2008, after allowing gambling in the Wall Street casinos, the U.S. government stripped the constitution, laid down by the seven founding fathers, by bailing out the banks, in plain sight, the same way Duhshasana tried to strip Draupadi, wife of the five great warriors, in front of the people who were entrusted with the responsibility of protecting the fundamental principles of governance laid down by king Bharat.
The Indian government needs to learn from Mahabharata, and listen to Dr. Subramanian Swamy when he says that the government should abolish the income tax. The government can perform the three core functions prescribed in Mahabharata without the burden of income tax on the people of India.
I recommend you to read the following two articles to understand how important it is to get rid of the income tax, and to focus on empowering our judiciary. The article Republic of Ghaziabad – Part I explains in layman’s terms how income tax is impeding our economic progress. The article Breaking One Shackle Of The Fatal Conceit explains with the help of an analogy, how the government of India is making the same mistakes that have kept India trapped in poverty for seventy years.
Friday, May 27, 2016
“I am against the system” has been the overarching sentiment and “I will change it” the clarion call of many well-intentioned political leaders that have been voted to form governments at the center and many states in India since her independence. Others have tried to work within the system to serve the population. Regardless of their approach, these leaders have continued to disappoint us in the long run. A prevalent misconception is that these leaders fail us because the system changes them and makes them corrupt. This fallacy has its costs. With no valid rationale to rely upon, the voters in India have turned to faith; it always begins with “I believe that this man is incorruptible. I feel that he is the one who will do it.” And when it ends badly, and it always does, we have someone else raising the hopes of those who were disappointed, and of those who were too young to witness the prior debacle(s).
The repeated failures of our political leaders have nothing to do with their corruptibility, insincerity or their inability to meet the standards of virtue that the voters have come to expect from them. The cause of our failures has a name. It is called the fatal conceit, and we, as a nation, are trapped in it. This article is not going to discuss the broad, and sometimes well understood, errors of socialism. It will discuss, using an analogy, a specific problem area that is not so well understood, especially in India, but has strengthened our entrapment in the conceit.
If aliens were to land in New Delhi, and see how our political leaders and bureaucrats try to get things done, they might compare them to the passengers of a broken car who, with no knowledge of what makes the vehicle run or why it broke down, roll up their sleeves and start pushing it, pulling it, lifting it and rolling it, just to get it moving. The car does not start, and it never will, with efforts of such kind. But the co-passengers, who themselves don’t realize how the car ought to be run, see, and are appreciative of, the emotions, the honesty, the hard work and the relentlessness with which their leaders try to move the car.
While one doesn’t need an alien brain to deduce that pushing, pulling or rolling a car are not the most efficient ways to move it, and will never appreciate someone trying to run a car without engine oil or gasoline in it, it is not so intuitive to understand what is needed for ‘the system’, which our leaders have been promising to change or which they’ve been trying to serve us with, to function efficiently. The mechanics are subtle and sometimes even counterintuitive.
We will investigate how the mechanics, or lack thereof, have or have not worked on the ground, with the help of experiences of three individuals I recently met - Anil Chowdhary, Lalit Mohan Jindal, and Dr. Subramanian Swamy.
Anil Chowdhary is a BJP Parshad in the Govindpuram locality of Ghaziabad. He is an ambitious politician; I first got a glimpse of the municipal work he has been able to facilitate in the public park of Govindpuram (pictures below). It has two gazebos, swing sets, and paved path around the park for walking and running. Anil has certainly got the car moving, but not with engine oil and fuel. He has tied ropes to the axle of the car and is pulling it relentlessly. The car is still broken. Let’s get on the ground to better understand the analogy.
During the mid-19th century, Ellis Sylvester Chesbrough was assigned the task to build the sewer system of Chicago. The city of Chicago sits on a flat plain, and engineers of the time didn’t think it was possible to design an underground sewer system in the city. So Mr. Chesbrough did something nobody had imagined. He lifted the entire city of Chicago using jackscrews; an unbelievable engineering feat. 150 years later, the engineers of Ghaziabad did something even more unbelievable; they tried to reverse the laws of physics. They built a sewer system in Govindpuram against the natural incline of northern plains. A kindergarten kid in India would tell you that the rivers in the subcontinent flow from north to south. The engineers built the sewer lines to flow from south to north. It has been a nightmare for the people of Govindpuram, especially when it rains and the rain water flows in the opposite direction.
On top of this engineering marvel, a man, in the process of constructing the basement of his house, poured cement into one of the primary sewer lines and blocked it.
I asked Anil “Why don’t you penalize this person and repair the sewer line? I am sure there must be a provision in the contract signed between the state and the plot owner when the land was sold. Or there must be a law under which Parshads can impose penalties to punish damages caused to public property. Is it not possible for you, as the representative of the people of Govindpuram, to file a lawsuit against the state government for using public money for building a dysfunctional, and a potentially life-threatening sewer system?” Anil was quick to reply to the first part of my question “There is a provision in law to levy fines or to get the sewer line repaired, but if I impose a penalty, or try to get my laborers inside his basement to unclog the line, I will probably need to take the offender to court only to get stuck in a long trial. He is not going to comply otherwise.”
There are two reasons why the car does not start for Anil. Firstly, the engine oil is in short supply; the courts, that resolve friction between moving parts of the system, are overburdened and therefore slow to respond. The second reason is a result of the first. Having lived with this state of the judiciary, people’s understanding of its role, and their expectations from it, especially in the matters of disputes that do not involve private property, have waned over the years. The passengers don’t know that the car needs engine oil. The people of Govindpuram, who could have themselves taken the “sewer-clogger” and the authorities that approved the sewer design to court under several sections of the current law, don’t do it because a legal resolution is, or rather has become, as counterintuitive to them, as it is to our political leaders.
So Anil does what he can do in his capacity as a Parshad. He has been trying to reason with the offender to get the sewer line working again. He is trying to move the car by tying it to a horse. A lawsuit against the municipal corporation, I guessed, was out of the question for him. To be fair to Anil, producing engine oil is not his job.
Note here, that we are not talking about the fatal conceit, the inevitable failure of central planning, or about how keeping the involvement of the government, in making the choice of engineers and contractors in building the sewer system of Govindpuram, at a minimal level, would have prevented the waste in the first place. That discussion, as mentioned above, is not in the scope of this article. Neither are we talking about how the engine oil ought to be produced. Judicial and police reforms are also out of the scope of this article. The goal of this article is to illustrate how important good quality engine oil is to get the car started.
Our conversation drifted to the central government’s Clean India campaign. Garbage disposal, as opposed to sewerage, is strictly a municipal subject, so it comes directly under Anil. There is garbage on the roads and around local markets. Stray dogs fight over the jurisdiction of the areas with maximum garbage and sometimes forget that humans are not their competitors. It’s quite a spectacle. Anil has got dumpsters installed on the side of the roads as a temporary solution, but there is litter around them too.
My questions to Anil were becoming repetitive. “Can’t you impose penalties on people who litter garbage around the dumpsters, on the road, or near the market? Have you examined the private garbage collectors who might be violating their contract with the municipal corporation” My questions might have been repetitive, but they are valid; there is no need for an earth-shattering revolutionary solution to make India clean. The problem is simple and so is the solution.
Anil’s answer should not surprise you if you’ve lived in Ghaziabad (the city’s crime rate rivals that of Chicago). “Forget about taking the contract between private garbage collectors and the municipal corporation to court, there are a few people in this area that take pride in littering garbage. They feel that doing something that the law does not permit demonstrates their power. They have connections with the ruling party in the state. If I knock on their door with a summon in my hand, I will probably need bodyguards. Then there are others who will simply take the summon courteously only to later throw it in a dustbin.” Anil, in his answer, indicated that the small amount of engine oil he has access to has become useless, as the mechanism to deliver the oil to the engine is not working. He does not have access to a functional police.
I’m glad that he didn’t say “Where will I get the evidence to furnish in court?” A summon by a police officer who has witnessed littering is a sufficient enough deterrent (I will explain in a bit). I was also relieved that he did not suggest the hundreds of expensive bureaucratic “intuitive-fixes” on the lines of “installing CCTV cameras to collect evidence”, for if he did, he would have shown, that like the passengers of the broken car, he too missed an aspect that is crucial to understand how the car runs. Dr. Subramanian Swamy often explains it with the help of an equation. If α is the probability of being caught in the act, B is the benefit one gets out the act, and P is the penalty of getting caught, then your expected return R is equal to α X P + (1- α) X B. For the expected return of the act to be negative, we need that P > B [(1/ α) -1]. You don’t necessarily need a high α, all you need is that the penalty P is high enough to make the return negative. Besides, the benefit B one gets in littering garbage is not monetary; it only takes a little bit of effort not to litter. So even if α is low, a summon from an officer who can testify, under penalty of perjury, should be a sufficient deterrent.
[Side Note: I don’t want to digress into the topic of how the engine oil ought to be produced or how we can enhance its quality, and I am not sure whether a video recorded on a mobile phone is an admissible evidence in a court for misdemeanors, but it seems to me that it might be difficult for someone to deny when he/she is confronted with a video of him/her littering garbage.]
And don’t worry, there won’t be havoc with police officers accusing their enemies, or enemies of their relatives, of littering garbage. Conflicts will still be settled in courts. Most people won’t litter only because they don’t want to go through the trouble of appearing in a court.
I can relate to this equation with one of my personal experiences. I used to speed on the highways of Georgia like there was no tomorrow. I never got caught. In the summer of 2012, when I was driving from Atlanta to Washington D.C., I was chased by a police officer and served a summon to appear in court. The police officer was supremely disgusted having chased my car in the middle of the night at more than 90 miles per hour. (Speeding 20 miles per hour above the 70 miles per hour speed limit is a Class-I misdemeanor in the state of Virginia.) I had to hire a lawyer and pay a huge penalty. I stopped speeding even before the court penalized me, and haven’t exceeded the speed limit since. The people in the U.S. who want to start the car have access to high-quality engine oil; the rule of law.
Anil is also trying to enforce a regulation to limit the number of floors that can be built on a plot of land. What intrigued me was that he is doing so to solve a relatively simple problem. “Parking space in the area is limited and when people rent out their multi-storied houses, there might be chaos.” he says. Unlike in the U.S., where neighborhoods decide on such subjects with a majority vote, Anil needs a court order, and he has been able to secure one. When I asked, “Don’t you think that giving parking permits to each homeowner, with temporary permits for guests, is a better solution?” Anil said that he fears for his life “If I try to tow a car that does not have a parking permit, they will come after me with a bamboo stick.” I thought in my mind “Won’t the same people come after you when you try to limit the number of floors?” but I guessed that there are a few regulations that even the most reprobate won’t dare to break. Just because he does not have access to engine oil, Anil is trying to roll the entire car to move it.
“You don’t understand the situation in India.” he continued. “Just to get an injunction on a few illegal shops, that clearly violated the town planning rules, I have been running up and down the Allahabad High Court. A housing unit was recently rented by three rowdy brothers who eve teased women in the area. An old man in the neighborhood confronted them, and after a few days when he went to the police station to lodge a complaint, he found that the goons had already filed a complaint against him accusing him of stalking their mother. Now tell me what should one do?”. Anil held a meeting in the neighborhood and was successful in encouraging the home owners to take a stand against the goons. The issue got resolved without, repeat: without, a court intervention. Without the engine oil.
Our current government at the center is devising new ways to move the car with the Clean India campaign and Smart Cities with state-of-the-art sewer systems. These are same-old ways of pushing, pulling and rolling the car. There is no doubt that our leaders have been emotional, honest, hardworking and relentless. And it is hard to criticize their sincere efforts. But as Milton Friedman often said, “Sincerity is an overrated virtue.” These leaders with their sincere initiatives might move the car, but what they certainly will not be able to do is to start it. All they need to do to start the car is to empower Anil and the people of Govindpuram with an effective judiciary and police.
Lalit Mohan Jindal
Lalit Mohan Jindal is my batch mate from IIT Delhi. He passed the civil service exam after his graduation and is now an IRS officer in Delhi. In the room of Aravali hostel, we frequently discussed national and local political issues. “I want to bring about a change” was a common theme of his answers when he was asked about his motivation to prepare for the civil service exam. In our last two meetings, I have seen his frustration growing. In our latest meeting, we had a chance to discuss his work in the IRS in detail. Lalit is working on an online system that will enable tracking of pending cases of Income Tax violations easier. “Officers keep rotating, and the new officer who takes charge loses track of the cases, pending in courts, that were filed by the preceding officer(s). Courts are overburdened and there is a lot of backlog”, he says. “This gives tax defaulters an upper hand when a case goes to court. Besides, there are certain loopholes in the current law that benefit the defaulters who show income as interest-free loans; tax officers like me keep looking for those generous creditors, who the defaulters sometime claim they met at a local tea-shop.”
The first limitation faced by Lalit is almost identical to the one faced by Anil. Both have an insufficient supply of engine oil. The second limitation is a bit different. While Anil needed a functional police, Lalit needs laws with fewer loopholes. The engine oil that Lalit has access to is of low quality and does not have the required additives.
We cannot hold Lalit responsible for the same reasons we could not hold Anil responsible. Lalit cannot produce engine oil. So he does what he can do in his capacity as an IRS officer. Lalit is pursuing a bachelor degree in law (LLB) from Delhi University to be able to file cases that make it easier for the courts to adjudicate; so as to make the best use of the limited supply of low-quality engine oil he has. But is that an efficient solution? That seems to go against the premise of a modern economy, i.e. specialization of labor. Wouldn’t it be more effective, if both Lalit had Anil had access to a resourceful judiciary that resolves conflicts efficiently?
Our political leaders and bureaucrats have, over the years, come up with different ways to push, pull and roll the car Lalit is struggling with. The voluntary disclosure schemes launched by several governments have created a moral hazard and made Lalit’s job even more difficult. In trying to roll the car, they have scratched it all over. Some governments have even come on television to verbally threaten to punish the tax violators. All these are anything but ways to start the car.
[Side Note: I should point out, that this article is not in support of income tax. Income tax is a menace and should be abolished. I am only using Lalit’s experience as an example to show the vital role of engine oil.]
Dr. Subramanian Swamy
Dr. Swamy needs no introduction. He has been appreciative of my articles on economics, and that inspired me to meet him in person. In the meeting, Dr. Swamy talked about his current struggle to bring economic reforms in India. We also discussed his paper Political Structure and Economic Reforms, a comparative appraisal of India and China. A section of the paper discusses an issue that is relevant to this article. It talks about two fundamental premises of causation that can potentially keep the leaders, who do understand how the car runs, from starting it.
It essentially says that a politician who is trying to push, pull or roll the car is perceived by the passengers as a sincere leader. The passengers, in the course of time, have come to expect that a leader ought to push the car with his muscular strength. This is because the passengers have never witnessed a car start before. On the other hand, a politician trying to add engine oil and fuel in the car, or trying to repair the gear box, might be perceived as a conspirator trying to blow it up. Moreover, there is a wealthy restaurant owner, near the place where the car has broken down, who benefits from the slow-moving car; the passengers have no other choice but to eat at his place. And this restaurant owner, unlike the passengers, can anticipate the losses he will have to bear if the car starts running; so he tries to make sure that the mechanic never reaches the car. In such circumstances, it is difficult for any politician to try to start the car and infuriate both the passengers and the influential restaurant owner.
Dr. Swamy’s paper does not talk about engine oil. It talks about the broken gear box. The passengers are you and I who will oppose if any politician talks about privatization of banks, the restaurant owners are the wealthy businessmen who fraudulently default on multi-billion dollar loans from these banks, and Subramanian Swamy is the mechanic that the restaurant owners are trying to stop from reaching the car.
Coming back to the specific problem area of engine oil, Dr. Swamy has been successful in getting results out of several courts in India. He is not an exception by chance or due to any favors granted to him by the judiciary. He is an exception because he is brilliant, relentless, well connected, knows the law, knows economics and knows politics. Even a drop of engine oil is sufficient for this mechanic. Besides, many of his cases are high profile and followed by the media, bringing attention and pressure from the voters.
His well-publicized cases have a crucial implication. Remember the second reason why the people of Govindpuram avoid going to courts to resolve their conflicts? Dr. Swamy’s cases have the potential to restore that lost confidence in the judiciary. Moreover, if the penalty P awarded in any of his cases is high enough, and even if the courts send just one, who is proven guilty, for a life in prison, the publicized negative return R can create a deterrence significant for a billion.
Why is it not obvious to economists in India?
Just imagine what Anil, Lalit, Dr. Swamy and millions of others can achieve if they are empowered with a judiciary and police that resolves conflicts quickly and reasonably. Yet, we don’t see our economic advisors talking about it. It seems to me that the role judiciary plays in a free market is not obvious to them. The prime minister, the chief ministers, and their ministers have an incentive to be “the one” to do it all, and all they end up doing is pushing, pulling or rolling the car. Instead of pointing out how the car needs to be started, our “economists” have simply continued to endorse new and innovative boondoggles. In 2016, we saw billions of dollars being allocated for schemes that can only come from a government trapped in the fatal conceit. The amount of funds earmarked for the development of judicial infrastructure in states, on the other hand, was a mere $135 million.
There is a reason for this ignorance among economists in India. All the developed countries in the world today were built on the rule of law and limited government. The former is taken so much for granted by prominent economists of these countries that they don’t even mention it in their discourse; the same way prominent physicists don’t talk about the transitive axiom of mathematics when they discuss complex formulae. It is human nature to take something that has existed for long for granted, and the rule of law has existed in some of these countries for more than 200 years. What you do hear from them are their views on fiscal and monetary policies, i.e. limiting the role of the government in commerce. The U.S. is the hub of thought leaders in economics who shape the intellectual environment of the world. Since FDR’s new deal in the 1930s, the U.S. has continued to abandon the principle of limited government that made it a superpower, and many free-market economists in the country are not happy with the current state of the union.