Republic of Ghaziabad - Part I

"The nine most terrifying words in the English language are: I'm from the government and I'm here to help."

                                                                                                          - Ronald Reagan

"Help the poor". Wherever on the planet and whenever in the history these words have come from a government, a social and economic disaster has followed. If we focus on the lessons from East Germany - West Germany, South Korea - North Korea or even the current state of the U.S. to illustrate the point, the economically literate will get a chance to confuse us with terminologies they themselves don't understand. Economy is not a controlled experiment where data can be used to validate a theory. The validity of a theory in economics is better established by how well it explains the relationship between cause and effect. It is not a rocket science. So let us build up from the axioms and corollaries of economics to understand how a help promised by the government not only makes no economic and social sense but is also morally corrupt.

Axioms are simple. Parallel lines do not intersect. At least one human has to work to produce a good or service that can be consumed by someone. In mathematics, complex theorems are built on axioms. Governments, banks, insurance companies, the concept of a contract etc. are built on axioms in economics.

This story is of a small island called Ghaziabad. It was located in the Indian ocean and had a population of 50, 25 males and 25 females. There were five tasks each individual on the island performed to survive 1. caught fish 2. cultivated land 3. cut wood for fuel 4. made clothes 5. brought water from a waterfall 5 km from the dwelling place. Each island dweller carried out these five tasks during the day to survive, went to sleep at night to recover from fatigue and woke up in the morning to carry out the same five tasks the next day. There was no holiday in Ghaziabad. Everybody worked every day just to survive. Nobody had time to enjoy luxuries of life or even to take care of someone who fell ill.

One day a dweller who was better than others at catching fish suggested to his friend - "It takes me a lot of time to cut wood. I have a good spear I made and my aim is pretty accurate but I don't have arms as strong as yours. I will catch some fish for you tomorrow. Can you get me some wood?". His friend agreed - they entered into a contract. The next day, the fisherman saved the energy he used to waste cutting wood and the lumberjack was glad not chasing fish with his broken spear. Happy with the outcome of this arrangement, the two men started doing it every day. They spent their saved time and energy in luxury activities, climbing trees, swimming in the ocean, looking for lice in each other's hair and what not. When other people saw them spend quality time, they got motivated and followed suit. Specialization of labor, the premise of the modern economy, was born.

The benefits of specialization of labor were so intuitive that after about a year the village had each individual performing just one task the individual was good at. 10 people caught fish, 10 cultivated land, 10 cut wood for fuel, 10 made clothes, and 10 brought water from the waterfall. As a result, production in the island increased significantly and the fruits of labor were enjoyed by all.

However, there were a few growing concerns in Ghaziabad. The word about the prosperity of the island had spread and there were rumors that people from a neighboring island were planning to plunder some of the houses. The dwellers also suspected that one of the lumberjacks had turned into a thief and was stealing goods from their houses. When the dwellers went out to work, they were worried about the safety of their assets back at home. In addition to this problem, one contract between a lumberjack and a fisherman was violated. The fisherman refused to give the lumberjack the fish due for the day claiming that he did not receive any wood; the lumberjack insisted that he had left the wood in front of the fisherman's house. This had led to tension between the two families. Afraid that their contracts might be violated, some of the lumberjacks started fishing again.

The productivity of the island started falling. The seniors in the island became concerned about the future of Ghaziabad and held a meeting. It was decided that three people will be appointed to protect the life and personal property of people and to ensure completion of contracts between individuals on the island. One person would guard the beach from potential external attacks, one would guard houses during the day, and one would resolve conflicts whenever a contract was violated.

To ensure that the appointed individuals can focus on their jobs, they were not required to produce anything for themselves. It was decided that fishermen will give them two fish every day, cloth makers will give them one pair of clothes every two months, farmers will give them an adequate quantity of grains and someone will bring them drinking water. Consensus on who to appoint for the job could not be reached so it was decided that people who had the maximum number of island dwellers supporting them will hold the position. Elections were held and a team of three credible individuals was appointed. In the island of Ghaziabad, government was born.

The role of this government, which people felt was necessary, was to create an environment conducive for efficient production and trade. It was not formed to help the poor, it was not formed to provide education, it was not formed to provide water, it was not formed to control the prices of essential goods. It was formed so that people could do what they did more efficiently.

With an assurance that their assets were in safe hands, people started going to work. Fishermen and lumberjacks started exchanging goods again as there was someone reliable to resolve conflicts. The economy of Ghaziabad was back on track.

One more prosperous year passed by. Some interesting developments took place on the island. Four cloth makers thought - "People spend so much time in the evening to start a fire, why not make something that will make it a little easier to create fire." They saved some extra clothes during the year and started working on a process to manufacture matchsticks from locally found chemicals. They exchanged the clothes they had saved during the year for fish and grains to survive while they worked on this new venture. After a few months of hard work, the team found success. The product became popular overnight. Matchsticks saved everybody so much time that lumberjacks were willing to give ten days of wood supply and fishermen were willing to give ten kg of fish in exchange for just one pack of matchsticks.

Note that the fishermen and lumberjacks were willing to pay so much not because they were forced to do so but because they felt that one pack of matches was worth that value. The fishermen could catch more fish and the lumberjacks could cut more wood in the time they saved every day by using the matchsticks they purchased. The value of matchsticks was measured by the amount of goods (money) people were willing to pay for them. The engineers had anticipated the needs of the people of Ghaziabad and had assumed a certain amount of risk; they could have lost all their savings had their venture been unsuccessful. Looking at how the risk was rewarded, other people were motivated to take similar risks to build new things and to produce existing goods more efficiently.

One of the lumberjacks called Shyam had a groundbreaking idea. He had a credible image in Ghaziabad and his ability to evaluate the risk of new ventures was well known. He asked his friends to save their extra clothes, wood, fish and matchsticks with him for a year. He promised to give back the savers more than they saved with him after a year. He then identified islanders trying to create new things or working on producing existing things more efficiently and gave them clothes to wear and fish to eat till the time they were working on their initiatives. If the initiative was successful, Shyam was paid back more than what he invested. Some of the dwellers were not successful and were not able to pay back but Shyam got enough from the successful ones and became wealthy. Before people of Ghaziabad gave Shyam their savings, they did a lot of research to make sure that he was trustworthy and competent, and that he was investing their savings responsibly. After making this assessment about him, they made the decision to invest their own hard earned goods. The savers were rewarded for the risk they took when Shyam paid them back more than they saved with him. Bank was born.

Let us not go into fiat money, central banking, or the fractional reserve banking system. In fact, let us not even go into money, as that will again give the economically literate a chance to confuse us. Money was invented only to reduce the complexities of the barter system. Let us keep our resolve to stick to the basics.

The island economy started growing at a very rapid pace as people working on ideas had easy access to savings. A farmer borrowed savings from Shyam and worked for four months to develop a process to produce fertilizers from bat droppings he collected from the floor of a nearby cave. The yield of his farmland increased so much that he was able to sell his grains for much less; he could exchange four month's supply of wheat for just a couple of clothes. Cloth makers now had more grains they could save with Shyam. A sixteen-year-old child prodigy invented a barrel with wheels using which he was able to bring water from the waterfall for ten people at once. Women who earlier spent most of their time bringing water from the waterfall started weaving clothes and exchanged them for water. The women became so efficient at making clothes that they not only made a lot of extra clothes but the clothes they made were of a much higher quality. They used extra clothes to buy matchsticks and saved even more time.

Did the sixteen year old prodigy's tanker make the women unemployed? (Will FDI in retail increase unemployment of shopkeepers? Did metro, cars, buses and auto-rickshaw drivers make men running horse-carts unemployed?)

A fisherman had spent sleepless nights making a bigger and stronger fishing net. He caught so much fish every day that it became difficult for him even to unload and pack them. He offered one fish to any dweller willing to help him for an hour to unload and pack the fish in banana leaves. Employment was born.

Note that the fisherman did not force employment upon the employee. He offered him an opportunity to exchange his labor for fish. The employee accepted the employment because he thought that he would not be able to catch or earn one fish in an hour anywhere else using his current level of skills. It was a win-win for both of them.

On the other side of the island, lumberjacks were facing a problem. The name of the problem was Black Recluse, a spider common in the woods of Ghaziabad. The spider bite was so poisonous that any lumberjack bitten by it had to take bed rest for at least a month. This had put some of the lumberjacks in a very difficult situation as they could not support their families during the recovery period. To solve this problem, lumberjacks of Ghaziabad formed an association and built a huge storage facility. Every lumberjack who stored one log of wood in this facility every month could use the wood in the facility in case he was bitten by a spider. Insurance was born.

Government, banks and finally insurance. These institutions provided so much stability to Ghaziabad that it became an ideal economy for neighboring islands. There was so much production in the island that charity was common. Women gave extra fish to people who could not afford them. Cloth makers gave clothes to people who could not temporarily work due to bad health. The system nurtured the inherent human nature to indulge in charity and to treat fellow islanders as brothers. Civilization was at its peak.

One more year passed by and the next election was upon Ghaziabad. The incumbent government decided to fight the election. Their campaign pitch was - "We carried our responsibilities diligently. We protected life, prevented theft and made sure that transactions were carried out properly. Vote for us and we will continue our sincere service to the people of Ghaziabad" Another team of three individuals Arvind Modi, Narendra Swamy and Subramanian Kejriwal was planning to fight the election and was rapidly gaining popularity in Ghaziabad. (The names are purely coincidental.) They were proposing a plan where every unemployed dweller on the island will get free fish and clothes. "We should at least provide basic livelihood to everybody on the island. It is their right" they said. People were initially confused. They asked - "We have not seen you guys produce a thing in your life. How are you going to give clothes and fish to these dwellers?” To this, they answered - "We will collect it from cloth makers and fishermen. We will make this collection mandatory." Cloth makers and fishermen were furious at this idea and started a campaign against the team.

Legend has it that it was all Rahul's idea. There was a village fool in Ghaziabad, his name was Rahul Chidambaram. He lived in a world of his own - talking to himself, running after kids who teased him and making various types of sounds from his armpits. He used to intentionally burp very loudly whenever anyone asked him his name. One day Modi, Swamy and Kejriwal were walking on the beach when they saw Rahul at a distance playing a game of 'who can pee the farthest' with kids. Kejriwal said to him jokingly - Will you vote for three for us if we fight the election. Rahul thought for a few minutes then said - "only if you give me some clothes and fish". Kejriwal, Modi and Swamy looked at each other and thought - "What a great idea? Forget about all the responsibilities, protecting property and life and yada yada. We will just promise fish and clothes to people. We will make the rules of the game. We will rule." And they decided to fight the elections.

The team won with an overwhelming majority. Even some of the fishermen and cloth makers who did not feel like working anymore voted for them. Under the new government, hard working cloth makers and fishermen saw their produce being taken away against their will. Many fishermen closed their operations. People of Ghaziabad now had an incentive not to work and live off of the production of others. Youngsters were not motivated to gain fishing and cloth making skills; they thought it was government's responsibility to feed them.

The team announced new job vacancies in the government. They needed someone to collect fish and cloth from fishermen and cloth makers. When people asked how they will pay the employees, they said - "We will collect more fish and clothes from the fishermen and the cloth makers". More fishermen closed their operations after this announcement. As a result, fish became so scarce that lumberjacks had to cut wood for an entire day just to pay for one fish.

Next election came and Swamy, Kejriwal and Modi with the best of their intentions announced "Fish are scarce. We don't want anybody to die of hunger. How can you ask a hungry man to work? We need to put price cap on fish. We need to collect more fish from these fishermen." The team further deviated from their initial responsibility to protect the life and personal property of people and to ensure completion of contracts between individuals on the island.

Running out of fish and clothes to fulfill their promises, the team overtook Shyam's bank (nationalized it) and started giving saved clothes and fish to people. When the savers asked "Shyam paid us back if the investments were successful. We don't trust your investment skills. What if our savings are invested in ventures that are not successful". The team said "Don't worry about it. We will collect more from people and give it to you. We will sell the resources on the island and cover the losses." They "guaranteed" their savings.

The guarantee purportedly devised to prevent run on the banks, that are essentially nationalized, is a part of an insidious arrangement. The RBI printing money out of thin air to "lend" to the government or to pay the savers is even more insidious. It devalues the savings. The power given to the RBI to lend to the government and to carry out open market operations is one of the root causes of the evil. Governments and friends of governments can destroy an economy via inflation with this unnecessary power.

It can get a bit confusing when money is involved in transactions - "The government pays the farmer with money, the government pays the doctor for his services with money, the government pays teachers for education with money." The government does not produce anything. Money is title to goods or services; it does not come out of thin air. Neither do savings. Someone has to work hard to create savings. The one who saves has the right to invest her/his savings where he/she feels the reward is worth the risk. In a true republic, the saver has this basic right. When people gave their savings to Shyam, they did their research on his credentials and kept a check on where their savings were being invested. People now with "guaranteed" savings stopped researching before they gave their savings to the team. Kejriwal, Modi and Swamy neither had the competence nor was there any pressure from the savers to invest in the right areas. The trio started giving money to their friends who could convince them easily. When they lost money, they just increased the tax.

They also started making new rules - who can sell fish, what price can one charge etc. They appointed a planning commission to suggest areas where people should invest. The experts in the commission said - "Fishermen have become very wealthy. Only fishermen who will manufacture salt will be allowed to fish. The people of island need salt. There is a very high demand for it."

If people need something, they pay for it, be it water, electricity, education or salt. Profit is a measure of value addition. If a business is not making a profit producing a good or service, it means that people do not appreciate the value addition the business is offering. When a third party applies its mind and forces a business to invest somewhere, it essentially overrules the will of the people. Without exception, such an application of mind leads to misallocation of resources.

What about national highways? What about water? Let us take national highways as an example as it seems most intuitive that they are a government responsibility. If people of Delhi say that red light should mean stop and people of Haryana say that red light should mean go, there is going to be a lot of confusion, so rules that fall under this category can be made by the government such as town planning (so that someone does not open a loud factory in the middle of a residential area), road maps (so that people don't build roads every which way) etc. But whether to build a national highway should be a decision made by the people. How? Build-Own-Transfer model has the answer. Highways' value should, like any other good or service, be measured by users' willingness to pay for it. Entrepreneurial individuals will assess this value and decide whether to build the road. An entrepreneur will build a road if he/she feels that its value will be appreciated by people i.e. people will pay for it. The resources the entrepreneur will use will be commensurate to the value of the road as measured by people's willingness to pay for it. If the entrepreneur builds a bad road, people won't pay to use it. The highway will be transferred as a national asset after a certain period of time.

Governments are known to build roads to nowhere i.e. roads that provide no value. Government's sole responsibility in commerce is to provide an environment conducive to trade, not to apply its mind to interfere in it. No matter how intuitive it may sound, it should never be decided by a third party what goods or services people want to consume or what might benefit them. It takes a strong resolve and character to leave this power with the people. We will discuss one such resolve displayed by one of the 19th-century presidents of the U.S. For now, let us return to the island of Ghaziabad.

To cover for bank losses and to fulfill the promises given to the people of Ghaziabad, the government started collecting even more tax. With 40% of their catch being taken away by the government, even more fishermen stopped fishing. The sixteen year old prodigy who could earlier eat healthily by working for a few hours could only get one fish in exchange of a tank of water and was forced to stop his operation. By the time he came home after pulling the tanker all day, he was so hungry that one fish was not sufficient for him. Women started going to fetch water from the waterfall. As a result, clothes they made became scarce. Rape and theft were common as the team lost focus on its primary responsibility of ensuring the safety of life and property. Very few people entered contracts as the authority to enforce them had weakened. Nobody wanted to produce so the team started giving perks to individuals to set up big production facilities. As a result, wealth disparity started increasing.

The fabric of human nature that inspires every human to take care of others started deteriorating. People stopped charity as they thought it was government's responsibility to take care of "them". "Them" vs. "Us" was born. The "We" started deteriorating. Attitude of people changed to align with the existing set of incentives. Earlier hard work and risk was rewarded and ‘Power’ was defined as "The ability to help others by producing things that they needed". The new system rewarded connections with the government. The definition of ‘Power’ changed to "The ability to create problems for others". The national character started shaping up in accordance. Everybody thought that everybody else is corrupt by nature. The death spiral had begun. In a few years, the economy of Ghaziabad resembled that of India.

This question from the bleeding hearts always seem to touch a nerve - "But then what will happen to the people dying on streets? Who will take care of them? Only a person who has not seen hunger can ignore their plight."

When the government decides to help the poor with someone else's money, is essentially weakens the fabric of human nature; it doubts the inherent nature that inspires every human to indulge in charity, to treat a fellow national as his own brother and to take individual responsibility. It does not only make no economic sense but is also morally corrupt to the core. It takes a strong resolve and character to resist the temptation to help the dying with somebody else's money.

Economists continue to cite what the U.S. government is doing today to defend welfare policies. What made the U.S. a wealthy nation is not what it is doing today. Today, it has picked up a road to collapse. The U.S did not have income tax prior to 1913 (only profits were taxed). Income tax was unconstitutional before the 16th amendment. Similarly, the Fed was not allowed to buy the U.S. treasuries. It was only during the crisis of World War I that an exception was made to finance the war. Unfortunately this power given to the Fed was never reverted.

The nation was built on sound principles. There is a very famous example from the glorious days of the U.S., the days that made the country a superpower. Members of the congress wanted to pass the Texas Seed bill in 1887 to help the farmers suffering from drought in the state of Texas. President Grover Cleveland vetoed the bill. The excerpt below from his reply to the congress summarizes his thinking.

"I can find no warrant for such an appropriation in the Constitution, and I do not believe that the power and duty of the general government ought to be extended to the relief of individual suffering which is in no manner properly related to the public service or benefit. A prevalent tendency to disregard the limited mission of this power and duty should, I think, be steadfastly resisted, to the end that the lesson should be constantly enforced that, though the people support the government, the government should not support the people.

The friendliness and charity of our countrymen can always be relied upon to relieve their fellow citizens in misfortune. This has been repeatedly and quite lately demonstrated. Federal aid in such cases encourages the expectation of paternal care on the part of the government and weakens the sturdiness of our national character, while it prevents the indulgence among our people of that kindly sentiment and conduct which strengthens the bonds of a common brotherhood."

Following this veto, President Cleveland donated his personal money to the farmers of Texas.

There is a radical difference between a Democracy and a Republic. In a Democracy a government does what the majority wants. In a Republic the power of the government is limited and cannot be increased even if majority wants it. India calls itself a Republic but operates like a Democracy. We adopted this form of government in 1947 and picked up the road to collapse. We will become a true Republic when 1.2 billion people are free to choose how they want to serve each other.

"I will give you a talisman. Whenever you are in doubt, or when the self becomes too much with you, apply the following test. Recall the face of the poorest and the weakest man whom you may have seen, and ask yourself, if the step you contemplate is going to be of any use to him. Will he gain anything by it? Will it restore him to a control over his own life and destiny? In other words, will it lead to Swaraj (rule of the self) for the hungry and spiritually starving millions? Then you will find your doubts and your self melt away."

- Mohandas Karamchand Gandhi

The poor woman who walks for miles every day to get water does not need help from the government; she needs Swarajya. Links to Part II  Republic Of Ghaziabad - Part II and Part III: Republic Of Ghaziabad - Part III.

An email to Arvind Kejriwal

Dear Mr. Kejriwal,

I hope you remember my last email. My name is Shubhendu Pathak. I graduated from IIT Delhi in 2006 and am currently working in the U.S.

In this email I will discuss the misdirection of your movement in your stance against Ambani brothers and other industrialists in India. I feel that your angst against the industrialists in India is misdirected and will lead to unproductive results.

I will discuss a simple example as I feel that it is, in this case, a more efficient way of describing how your stance against industrialists in India will harm the economy and is principally misdirected. The example centers on a small entrepreneur, say Ramu, who sells Samosas (Momos for non Indian readers) in Rajnagar, Ghaziabad. Don’t yet start criticizing that a Samosa wala cannot be compared with the billionaire Mukesh Ambani/Tata. I will come to that point later. This Samosa wala has a small shop in Ghaziabad. He buys potatoes, spices, LPG cylinder, oil, refined flour, cauldron(s) etc. and rents a space. He incurs some cost to buy all of this. Ramu has the recipe (Intellectual Property) and skills and invests his labor to add value to the ingredients to prepare Samosas. Now remember he is taking a risk when he makes this investment, because he is anticipating that his Samosas will be bought by the residents of Raj Nagar. If he prepares the ingredients in the morning, and nobody buys them during the day, he will have to throw away some of the ingredients at night and incur losses.

How does he make profit? People buy his Samosas at a price which is greater than the sum of the costs he incurred to prepare them. So the price P is greater than the cost incurred C. Why do the customers pay a price P>C? After all, the Samosa wala did not force them to buy his Samosas at gun point. The customers with their own individual discretion decided to pay an extra amount P-C, as that is what they believed was the value the Samosa wala added to the ingredients. Profit P-C is the additional value he added, as measured by the customer’s willingness to pay the extra amount. Profit is not insidious, it is decided by YOU and I. So Ramu adds value to society, and people with their own choice reward him for this value addition. This is true power with the public; public decided who is adding value and who should be rewarded. Now Ramu anticipates more demand from Kamla Nehru Nagar, a nearby locality, and makes additional investment in a machine that can make more Samosas in less time. His anticipation turns out to be correct. Kamla Nehru Nagar residents are pleased with the taste of his Samosas and are willing to travel to Raj Nagar to buy them. Remember here again, he is not forcing anybody to buy his Samosas, neither he is forcing anyone to sell him the ingredients. YOU and I, at every instance, are deciding how much value he is adding. Also recognize the risk he took when he made that investment in the machine. Now YOU and I are rewarding him for that risk.

Now, another Samosa wala in Kamla Nehru Nagar called Suresh is also trying to expand his business. His Samosas are not that tasty and he abuses (verbally) his customers every now and then. Slowly his business starts shrinking due to competition from Ramu. Again, it is every individual’s personal decision that Suresh loses his business. YOU and I decided that we don’t want to be abused and that he deserves not to make any profit. This is free market and it is one of the tenets of a Republic.

Now we come to the second part of the story, after which I will transition to how your protests are misdirected. Suresh is now very angry and tries something that is against free market principles. He reaches out to the MLA of Ghaziabad to strike a deal. He tells him that he wants to see a regulation that allows only one Samosa wala for the region of Kamla Nehru Nagar and Rajnagar, and that the government will provide a license to sell Samosas in the area. Of course Suresh will get the license in the 2-G spectrum type “auction”. In return, the MLA will get 5% of shares in his Samosa shop. The MLA agrees to the deal. Now Suresh knows that the MLA is in his pocket, so he strikes another deal. Now he wants the government to pass a regulation that will bar farmers to sell potatoes in the free market (welcome the insidious APMC act). Then he collaborates with the MLA to acquire land (“auction” of natural resources) to grow his own potatoes. After a few years, he becomes the Samosa king of Ghaziabad. Ramu on the other hand is forced to work as a bonded labor in Suresh’s shop, and after a while he commits suicide.

You are protesting against this Samosa king Suresh. Is he wrong? I think it is an irrelevant question. Most of the humans will happily take any undue favor they can get from the government. It is not an attitude problem. It is human nature, it exists everywhere in the world, and you cannot change it. The Samosa wala is not at fault. He is doing what he is expected to do. He is not responsible to protect the Republic of India. YOU and I did not elect him. We elected the MLA. And he is the one at fault. The regulatory regime is at fault. Big unnecessary government is at fault.

There is more to it. There is one example that might help you understand this concept better. You might know that in India when they have to reduce the population of stray dogs in an area, the municipal authorities have a choice to either castrate the dogs or the bitches in that area. Which method do you think is more effective? Intuitively, everybody would say that one should castrate the bitches, because if you castrate a dog, some other dog will do the job (have sex and impregnate the bitch). Same is true with the government. If you castrate Suresh, Samosa wala no. 1024 will do the job. The impregnable government needs to be castrated. Also, people did not elect Suresh, but they elected the MLA. Suresh is not responsible for their well-being. The MLA is.

The industrialist you are targeting, although have taken undue favors from the government to make their samosas, they have done so under a reasonable presumption that if they don’t do it, somebody else will because unfortunately the bitch is always on heat. Nevertheless, these industrialists have added value to our economy and you cannot discredit that. YOU and I willingly paid for the samosas (cars, cell phones etc.) they have made. They now have the labor and capital that will allow India to excel in the next century. Just castrate the government so that the Ramus don't commit suicide.

The big question is why in the hell would they help you, as they seem to be the beneficiaries of this mess? Well not all of them are beneficiaries. If Suresh gets undue favors, other industrialists suffer. Collectively, all industrialists would want this system cleaned because now it is a mess even for Suresh, because the bitch has gone berserk.

I would request you to reconsider your strategy of targeting the industrialists in India.

Best Regards,

Shubhendu Pathak

Their Grievances Justified – A Case in Defense of Capitalism and Paul Krugman

The dynamics of greed, or a milder version of it called ‘pursuit of wealth’, has favored the rich over the poor in the past few decades. The norm of greed, nevertheless, was and has been equally endorsed by both the classes. Greed is not only supposed to make you wealthy. It can also make you poor, not because of the underlying risks, but due in part to the dynamics of the new economic model. Failure to comprehend this model can grossly misdirect grievances of both the 99% and the 1%.

During the last few decades, and more so in the last fifteen years, the rich became rich by earning what was spent by the poor. What the 99% spent by selling the claims on their future earnings, the 1% earned by selling them goods and services. When it became clear that there were no future earnings to claim, the stakeholders should have taken the losses. At least that is what the virtue of capitalism suggests: risk controls greed.

Missing or obscured in the equation, however, was the risk. An examination of how and where the risk was placed and how the steps taken to "solve" the situation guided the distribution of claims can help us better judge whether the responsibility lies in mere deviation from rectitude of the 100%, or a criminal offence on the part of the 1%, or a little less than 1% to be precise.

Pure and simple trade is – I provide you with goods and services and hold claims on what you produce in the future. I take the risk and it is my loss if you don’t produce anything in the future. In the new economic model the claims on future earnings of the spender, the 99%, are not held by the producer, the 1%. The risk is held by "someone else". The 1% keeps what it earns. This is why the 1% was happy when the welfare program was in effect replaced by a program meant to pander to the greed of the 99%. NINJA loans, LIAR loans and credit card loans financed all the spending and the 1% earned all that was spent with little or no risk.

Do the 99% deserve sympathy? Certainly not for the reasons they sight. The 99% were let off the hook for the risks tied to claims on their future earnings were grossly underestimated, thanks to both the government support for many of these debts and the alleged fraud perpetrated via the collusion of banks and rating agencies. Yes, the banks too helped the 99% spend at their will for it was the demand for MBSs and CDOs that was in effect encouraging the inordinate lending. A portion of the extra dollars that went abroad due to the continuing trade deficit were circulated back into these claims perpetuating a vicious cycle, amplified by various feedback loops, of borrowing and spending; the mighty ability of the United States to earn and pay back was undermined by this modern Opium. When the market forces started functioning and it became clear that the spender is never going to be able to pay back, the holders of the hyper-valued claims started to fail.

The 99% could just move away as they had no risks tied to the collateral, and that is exactly what they did. They walked away from the obligation and started saving, and the businesses that thrived on this spending started to fail. Government shifted a portion of the debt on its balance sheet. The poor became less poor now that the debt was purchased by the government. The rich did not become less rich. People who became rich in the process of this debt financed spending remained rich, thanks to the anthropomorphic nature of corporations. Insider trading further stacked the odds against the 99% invested in stocks.

The banks were not allowed to fail. The government incurred debt to pick up the slack in spending, purchased much of the toxic assets and lowered interest rates to prop up the remaining collateral. So instead of the 99%, now the government will have to pay for the claims. The government will pay back this debt from tax revenues of future earnings. So in effect, the money that the 1% have is actually (a function of) the future earnings of tax payers. How did the 1% earn this money? It depends on who are we talking about. Many corporations (employees and shareholders) provided goods and services to earn this money; that seems legitimate, for it might not be justified to expect them to evaluate the supposed risk the spenders, the 99%, were offering. That risk was not written on the dollar bills they were spending; the risk had been taken by the mythical "someone else". Bank employees allegedly colluded with rating agencies, sold the claims on earnings, and took the cut; prima facie this is tantamount to criminal conspiracy and fraud.

Of course, we cannot ignore China, the elephant in the room, before discussing the fairness of the next steps. The Chinese situation is plain and simple trade – The producer (China) sells goods, and bears the risk that the buyer (the United States) might not pay it back. So Chinese seem worse off than the rich in the U.S. who bore no such risk. On the brighter side, however, the Chinese gained enormously via access to capital goods that the Unites States, Germany and Japan took decades to develop. Chinese now have all these capital goods and more than $ 3 trillion to spare. The moment the Chinese de-peg the Yuan, and start consuming the products they produce, the inflation that the U.S. has been exporting to China will start showing inside the U.S. The resulting spike in interest rates will both reduce the tax base and increase the costs to service the debt and will force either default or hyperinflation upon the U.S. So in effect, the steps Chinese, the primary financier, take in the near future will determine the fate of the 99% and the 1% in the U.S.

No signals from the government suggest that it wants to avoid the inflationary path. Spare a thought here for the Good Samaritan, who worked hard, spent responsibly, and saved for future consumption. Although a very rare species, he does deserve sympathy, as he now stands as the ultimate loser for he did not enjoy the "risk free" exuberance back then and will now look at his savings wiped out as the government tries to inflate its way out of the mess.

Having said that, let us examine the other end of the spectrum advocated most fiercely by Peter Schiff. Taking a situation to an impractical level sometimes helps form rational perspectives, so let us do that here. What will happen if we bring capitalism back to the United States – say, as close as we can get to laissez faire? – Stop all monetary and fiscal stimuli, allow the interest rates to rise, demolish the regulatory burden, reduce government spending and stop all forms of wealth redistribution. Not new to the Americans, this is the old American – Grover Cleveland style, a path strictly guided by the constitution. Of course, under such a scenario, the Chinese can just forget about all their claims on future earnings of Americans. Many businesses will close down as the spenders lose access to debt they cannot pay back and the spending patterns readjust. Banks will fail, and will be allowed to fail. New healthy businesses and financial institutions will come up, and the entrepreneurial spirit of the mighty United States will spring back before anyone in the world can realize. However, the foundation of this resurgence would not be as sound as it seems. Under this reversion to capitalism, a portion of the wealth that the 1% own will effectively be what the debt holders around the world earned and will never be paid back. The 99% can live with that. However, not all the government debt is external. Internal debt represents money that future tax payers will earn. The existing 1% possess some of this wealth as well. The 99% can object to that as they never voted for the government to take on the debt. It should have been the banks and holders of the debt that should have taken the losses. Even if we ignore the origin of wealth of the 1%, wealth disparity under this transfer to capitalism will be enormous. While the wealthy will have the luxury of choosing between starting a business and enjoying their wealth, it will be a matter of survival for the 99%. A reasonable assumption that legitimizes sympathy for the 99% is that they could not have been expected to behave in any other way. Is a citizen of the United States expected to deny if he/she is offered a free lunch? How could he/she be expected to pay the price of the steps taken by the government and the banks? Disparity between competent and incompetent makes sense in capitalism where risk ensures fitness. It does not make any sense if some reckless intervention of the government leaves all the capital that engineers and scientists have developed over decades of hard work into the hands of a certain few. Who will answer the indebted generation some of who have not yet taken birth and whose wealth is already in the hands of the existing 1%?

Before discussing the merit of Paul Krugman’s argument, let us try to identify the root causes that led us into this mess. Intellectual tycoon, politician and economist Subramanian Swamy often discusses in his speeches the structure of society in ancient India as described in the scriptures. The model has an element of relevance here. The Varna Vyavastha (presently known as the caste system) was never meant to be hereditary as it exists in India today. Two great sages Maharshi Bhrigu and Maharshi Bharadwaja led a debate to decide the structure of the Hindu society. (You can imagine it as the greatest philosophers, psychiatrists, mathematicians, economists etc. of the time coming on a platform to discuss the structure of the society.) The outcome of the debate was that there should be four sections of society in alignment with inherent human nature.

Elements of power were recognized as knowledge, weapons, wealth and land. To avoid centralization of power, any single person could hold only one of these elements. The highest and the most revered class was that of intellectuals. However they were not allowed to hold wealth, weapons or land. Second in line were kings who had access to weapons. However, they were not allowed to take decisions without the approval of intellectuals. The third caste was that of businessmen, who did not have the intellectual ability to create, neither had the heart to defend their wife and children, but had the risk appetite (financial) and ability to execute businesses within the framework created by intellectuals. They possessed wealth but did not enjoy any social status. Their social status was determined by how much charitable they were. The last caste was that of labor. Transfer from lower to higher caste was a norm; in fact some of the greatest intellectuals in India were born in low caste families.

There are many parallels that can be drawn from this model but let us focus on human motivations. Let us start with two basic primitive motivations: animals want to secure food to survive and want to pass their genes to the next generation. Recognition from other animals, power to control, and access to territory all help achieve these two objectives. Humans desire these same elements – social recognition, power, and access to wealth driven by these primitive instincts. These elements are not absolute, they are relative. So, a human driven by these elements cannot be satisfied with a finite amount of these elements. (I am not touching the spiritual realm which deals with the absolute and might not be applicable to the current scenario. Pursuit of knowledge is considered closest to the spiritual realm.)

If you create an environment where wealthy are revered and where they can influence decisions to control, you effectively give all the three elements of power to a few. This is the present situation in the United States. Access to capital (that was developed by scientists and engineers and proliferated by industrialists with decades of collaboration), social recognition (driven recently primarily by the media), and control of power via government (lobbying for unconstitutional favors) all belong to a few. This has enormous economic and biological ramifications for mankind. Distributing this power fairly will be impossible unless something unprecedented happens as it is human nature not to let go of what he/she has without resistance.

This brings me to the argument raised by Paul Krugman where he argues that a fake alien invasion can bring the economy out of the current slump in eighteen months. The idea of alien invasion may seem dissociated from reality, but this argument is strongly rooted in the relationship between human motivations and economy. Under war-like situations, human motivations make a radical shift. During wars, a lower standard of living does not invoke frustration, it becomes sacrifice. Massive build-up of capital takes place driven by sacrifice of the poor and the rich alike. Wealthy become less wealthy as capital gets devalued. When the war is over, capital goods can be re-tooled for production. The fit regain control of this capital. Aligned human motivations and hard work can indeed bring back the economy on the right track very quickly. The merit of this argument cannot be discounted on the basis of its "impracticality". If there is any argument that directs us to the virtues that can reinstate the health of the economy, its merit, at least in theory, should not go unappreciated.

Marshmallow Test

Marshmallow test is a very famous psychological experiment on toddlers. In this experiment, an instructor gives a marshmallow to a toddler and tells the child that he/she can either eat the marshmallow right away or can wait for the instructor to return (the instructor returns after about 15 minutes), and if upon return the instructor finds that the child has not eaten the marshmallow, the child is rewarded with another one.

This experiment does not look like a game as there is just one player i.e. the toddler. It is of course reasonable to assume that the possibility of betrayal by the instructor does not occur to the toddler; neither is that the idea behind the experiment. However, a careful consideration of human psychology and the manner in which we conceive and value time reveals an interesting feature of this experiment that can possibly legitimize it as a game.

Now fifteen minutes is a lifetime for a toddler, especially when there is a marshmallow staring at you. The child has to exercise restraint in order to be rewarded. Although the condition is presented to the child as an if-then clause, a careful examination of the decisions the child faces during the experiment reveal some interesting facets. To eat or not to eat is not the only decision the child takes. At every moment, the child is simultaneously assessing her/his ability to bear pain for the remaining of the time, and the possibility of not being able to cope up with the pressure at a later point. Moreover, the instructor never tells the child when he/she will return, adding to the uncertainty about how much time is remaining. Therefore the child is essentially playing a game with herself/himself at every moment where to eat or not to eat, and whether to trust the assessment of her/his own ability to bear the pain for the remaining time, which in this case is uncertain, form the two dimensions of the game. Notice that eating midway and eating a minute before the instructor arrives have two different payoffs. (Notwithstanding the fact that marshmallow might taste a bit sweeter after a longer wait!)

In short, uncertainty about one’s own assessments can replace the uncertainty associated with another player, making single player games possible.

You can watch this cute video with little souls battling with the temptation: 

http://www.youtube.com/watch?v=QX_oy9614HQ

FYI: Follow up studies after sixteen years indicated that the toddlers who chose to eat the marshmallow scored less on SAT than the ones who exercised restraint.

Evolution and Mismatches: Value Revisited

Experiments conducted on mice to study learning patterns of living organisms reveal that genetic inheritance plays a very important role in learning. In one such experiment, two mice, one male and one female are placed in a cage that has a door connecting it to a tunnel. Mice can use this tunnel to go to another compartment of the cage. A naked current carrying wire is placed at the door of the tunnel at a certain height such that mice get a slight electric shock if they touch the wire. Mice slowly learn to avoid the shocks by jumping over the wire without making contact. Time to adopt this behavior gets shorter from one generation to the next and after seven or eight generations the mice learn to jump over the wire almost by birth. Later generations jump over the wire even when it is not carrying any current. It seems like the object of the action is lost in this process. This is what this last generation would say to the world: “I think I have a natural inclination to jump over wires. Sometimes I wonder why but I guess it’s all about being a mouse”

99% of genes in humans and mice are similar. It is only the remaining 1 % that makes us humans. So it would not be a stretch to extrapolate this pattern to humans. It is two and a half billion years since eukaryotes first appeared on earth. Human evolution, according to the current consensus, started a little later about seven million years ago. What we see today as a human is the result of a chain of birth that never broke during this entire period. Your mother, your mother’s mother, your mother’s mother’s mother…..and so on leading up to the Eukaryote – no single organism in this chain died before giving birth. The chain never broke. During this process, human construct acquired and developed various properties and dispositions; to adapt, to survive and to proliferate. Reflex reactions to harmful stimuli such as excessive heat, pain as a signal for something to be avoided or taken care of etc. etc. Several notions or definitions were developed by humans specifically to capture and communicate these notions. These notions are related to how humans interact with their environment. For example, pressure waves of air are one of the primary means via which humans communicate and become aware of objects they don’t see. A notion of “sound” was developed in the human construct referring to these pressure waves.

However in the recent ten thousand years and even more so in the recent-most two hundred years of industrial revolution, the immediate environment of humans has undergone dramatic changes. These changes are radically different from the changes that the environment had undergone prior to this period. Human interactions now involve physical structures and rules that he has created himself. For example, reading this article you are at the same time looking at your computer screen, your table, walls of your room etc. All of these are human made straight line constructions. Straight line constructions are never found in nature. This new environment can affect our subconscious in ways we might never be able to fully comprehend. You can get an idea of the sensitivity of our body to environmental changes by the speed at which the chemical composition of bones of astronauts change within just a few days of exposure to microgravity.

A sudden change of environment can also lead humans to use their dispositions in ways that can have undesirable consequences. Following paragraphs explain this with a few examples.
Animal have very strong instincts that drive their behavior. One such instinct is of judging other animals, their prey, rival or predator, by their size. The primitive mind inside humans also respects size. For example, when you see Tom Cruise on a big movie screen, your thoughts in the subconscious are “I have not seen a man this big …he must be 20 ft tall…. I must follow what he does...to become this big”. Technology provides the size and the preexisting human dispositions recognize it. This recognition process triggers a chain reaction. People start recognizing the big Tom Cruise and then recognition drives recognition. Imagine what image of Tom Cruise you would have had, if you could only watch the actor on screens the size of your wrist watch. You would then see the actor in the size of insects. Insects are mostly prey for vertebrates and commensurate will be your recognition.

Bigger animals are seen with respect and younger animals imitate them to become like them and in the process learn what made them big. Now consider how this disposition performs in the current environment. Big corporations use “recognized” people like Tom Cruise to promote their products. This marketing benefits from the preexisting human disposition of recognition, however in the process leaves a side effect. Imagine a twelve year old boy watching a masculine Hollywood actor enjoying a can of soda in a marketing campaign. The boy’s subconscious thoughts are - “This human is big… I must follow the big…to become big”. However, unlike in the animal world where younger animals get to see what the stronger animals do to become strong, the boy remains oblivious of the efforts of the actor that went into making of his muscles. Younger humans see media coverage of Bill Gate’s success and his riches. Media seldom covers the sleepless nights he spent and the risks he took in life. Welcome to the confusion induced concept of easy money. Economists’ view of utility and the dynamics that influence human behavior need to change in light of these mismatches.

Consider another example. It is observed that some adults suffer from nausea while traveling in cars or other vehicles. Researchers associate this to the mismatch between stationary visual signals humans get while looking at objects within a car which appear stationary and the acceleration/deceleration that their body experiences with the motion of the car. Similar confusion can emerge when humans start to interact with new technologies, especially at an early age where the building foundations are laid. Toddlers observe everything around them and learn to anticipate from the events they observe. When kids learn to catch a ball, their mind in subconscious learns to anticipate the effects of gravity. A child who watches cartoons all day observes, and in her/his subconscious interprets, objects and characters in the cartoon film. Characters in cartoon films defy all the laws of nature. Objects don’t follow laws of gravity. Objectives are achieved without hard work etc. etc. All this is registered in the child’s brain. The child’s brain can get confused when it tries to create a structure by interpreting what the child saw in the cartoon channel and what was observed in the real world. The mind would say – What is the effect of gravity? 9.8 m/sec2 of acceleration or the random motions in the cartoon? The confusion can have undesirable consequences on how the child perceives the world and his/her role in it.

Another example, a little less serious one, and perhaps not with undesirable consequences - When you think of Arnold Schwarzenegger in Terminator 2 – the first scene you recall might be one in slow motion. On the other hand when you think of Charlie Chaplin or a similar funny character – you might remember a fast forward scene. Why do humans use slow motion to emphasize strength and seriousness, and fast forward for something funny and trivial? Again, evolution might have the answer. Big animals move slowly. Elephants, rhinos, hippos, and lions. Even when they move fast you see the motion of their legs, and their motion on ground relative to their size. This relative perception registers their motion as “slow(er)”. This slow perception triggers respect, seriousness, fear and all those emotions these animals have gained over millions of years of evolution.

Now think of insects. Ever seen a cockroach scurry around? You think it is fast, don’t you? It is because you see not only its motion relative to its size but also the motion of its legs relative to one another (fast changing angles and rapidly closing gaps). You perceive these motions as non-serious and funny because you, I mean the primitive you, generally won’t fear for your life when you see an insect. I wonder if cockroaches knew this and moved in slow motion.

All these examples discussed above reveal mismatches. The economic concept of value and the actions that are taken to achieve it are a function of how the human mind, with its pre-existing dispositions, processes information. This process, as explained in the examples, is subject to mismatches that can have undesirable consequences. In light of these mismatches, the concept of value at least needs a revisit if not a major overhaul.

Game Changer

Watch the video above before reading the blog. If you are not able to watch it here, you can watch it using the link: http://www.youtube.com/watch?v=Onwn9EmX1GI 

I saw this video about two years ago and shared it on my personal blog. On the face of it, the story seems quite evident: After barking obscenities at each other from across the gate for so long, the two brave-hearts want to keep it the same way, even when there is nothing to stop them. However, an analysis suggests that this behavior might have roots in game theory.

Let us first look at the payoffs when there is a gate between the two players. Barking at each other gives satisfaction, so let this across-the-gate pleasure have a payoff of 2. If no one barks the payoff is 0. Being able to bark alone will give maximum satisfaction so let that payoff be 3. Being barked at, without a quid pro-quo, is tantamount to humiliation, and therefore has a negative payoff of -1. Clearly there is a nash equilibrium here, and our friends seem to know it.

Now let us look at the game without the gate. Absence of the gate changes the game entirely. Barking now can lead to an actual fight which might have extreme negative consequences for each of the two players. Let this negative payoff be -20. Let the payoff of a bark-off without a fight be 5. (Notice that this payoff is more than across-the-gate pleasure of barking which is 2). The expected payoff of barking when the gate is not between the players, with equal probabilities of either event, is therefore 0.5 X -20 + 0.5 X 5 = -7.5. And of course, there is nothing like barking alone with no gate in between. So that payoff will be very high; let it be 6. Likewise, being barked at, with no response and with no gate to blame on is utter humiliation. So, let the payoff be -4 in this case.

Now comes the tricky part. What is the payoff for circling around each other? The fact that the two players don’t bark at each other when there is no gate in between suggests two possibilities:

1. If the payoff is greater than 6 then there is a Nash equilibrium where each player is better off not barking at each other.
2. If the payoff is less than 6 then there is no Nash equilibrium, and it is difficult to ascertain why our friends kept quiet on all the three occasions.

What is it that is making them behave in this way: Nash equilibrium, disposition, or severity of the negative payoff? Perhaps, that is what the two brave-hearts are trying to figure out when they move in circles around each other. The white one at one point seems confused whether it is the same ‘enemy’ or some parallel universe across the gate, but let us leave that dimension for now.

Slow Motion

I made this observation but could not find any research to vindicate my hypothesis. Perhaps nobody has given it a thought. When you think of Arnold Schwarzenegger in Terminator 2 – the first scene you recall might be a one in slow motion. On the other hand when you think of Charlie Chaplin or a similar funny character – you might remember a fast forward scene. Why do humans use slow motion to emphasize strength and seriousness, and fast forward for something funny and trivial?

Evolution might have the answer. Big animals move slowly. Elephants, rhinos, hippos, and lions. Even when they move fast you see the motion of their legs, and their motion on ground relative to their size. This relative perception registers their motion as “slow(er)”. This slow perception triggers respect, seriousness, fear and all those emotions these animals have gained over millions of years of evolution.

Now think of insects. Ever seen a cockroach scurry around? You think it is fast, don’t you? It is because you see not only its motion relative to its size but also the motion of its legs relative to one another (fast changing angles and rapidly closing gaps). You perceive these motions as non-serious and funny because you, I mean the primitive you, generally won’t fear for your life when you see an insect. I wonder if cockroaches knew this and moved in slow motion.

Another related question – why humans find shades impressive – dilated black pupils as sign of good health perhaps? Now think of a cockroach wearing shades and moving in slow motion. Impressive isn't it?