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Economics

Retail therapy for India

How will Big Box retailers like Walmart affect India? Some have expressed concern that “retail therapy” will put a small army of independent retailers out of business; however, the relocation and reorganisation that happens as a result of a Big Box revolution in India will work to the benefit of Indians.

We generally think of productivity advances coming in the “making stuff” industries like manufacturing. In the United States, productivity growth has, in recent decades, come from the service sector. Retailers – Walmart in particular – have been at the forefront of the recent American productivity growth. Because of the efficiencies they bring to the market, firms like Walmart have given Americans a dizzying selection of quality goods at low prices. Indeed, this has been the most distinct effect of Big Box retailers on the American economy. Prices fall when Walmart enters a market. Using US data, the economists Emek Basker and Michael Noel showed that entry by Walmart super-centres led to lower food prices with the largest price reductions coming from stores that serve low-income shoppers.

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The economists Jerry Hausman and Ephraim Leibtag have published separate studies documenting the enormous increases in well being available to American consumers, particularly low-income American consumers, because of the Big Box revolution. In part because of Big Boxes’ effects on grocery prices, the economist (and Obama advisor) Jason Furman has called Walmart a “progressive success story.”

Inventory control and reduced waste are also significant problems in retail. The economist David Matsa showed that stores responding to Walmart entry reduced the frequency with which they went out of stock on different goods. This in turn improved efficiencies; helped shoppers by saving time and reduced the risk they faced of a store running out of a given item.

Naturally, there are concerns about the meaning of Walmart’s presence in India for incumbent retailers. In the short run, there will be some dislocation. However, the resources saved because of the Big Box revolution will be redeployed elsewhere. Creative destruction in competitive markets tends to leave us better off, on net, and a 2008 study by the economists Russell Sobel and Andrea Dean showed that, at the state level in the US, the number of small businesses remained effectively unchanged as Walmart’s presence grew within a state. Firms that compete directly with Walmart may not survive, but the Big Box revolution (and its associated savings) will create new opportunities for entrepreneurs.

In an article titled “The perils of retail therapy in India” published in Mint, Professor Himanshu of Jawaharlal Nehru University discussed employment in India’s retail sector, but his discussion seemed to proceed as if inefficiency were a virtue. We agree wholeheartedly that the byzantine regulations “and archaic laws that govern [India’s] markets for agricultural products” help explain low Indian productivity; however, this is one of very few cases where there is a “both/and” solution. A market economy is a dynamic system, and allowing FDI in retail will be a boon for India. Policymakers shouldn’t look at retail sector liberalisation and liberalisation of restrictions on retail FDI as substitutes. Rather, they should be seen as complements. By removing barriers to entry by international firms like Walmart and Target and by unshackling Indian entrepreneurs, policymakers can unleash pent-up entrepreneurial energies that will work to the benefit everyone, not just Indians.

Curiously, Himanshu wrote about the share of retail prices that go to farmers. In the United States, this fell from 41 percent in the 1950s to 18.5 percent in 2006. As Thomas Sowell has written, however, people live on real income rather than percentages. A supply chain like what we enjoy in the United States might mean that farmers get a smaller percentage of each dollar spent on food, but there will be more dollars spent on food. The food supply chain has gotten longer as people have increased their demand for processed food. As agricultural economist William G Tomek points out “A wheat grower consistently obtains a relatively small percent of the dollars spent on bread, and apple growers obtain a larger share than wheat producers of the consumers’ dollar.  But this doesn’t mean that Kansas wheat farmers are worse-off than New York State apple growers”.

Consider frozen French fries, for example. Potato farmers might get a smaller share of consumers’ food spending, but the existence of the frozen French fry industry has not made potato farmers worse off. Indeed, the development of processing and storing technology has made frozen French fries possible; in turn, it has increased demand for potatoes and reduced the share of the American potato crop that spoils. Reductions in food spoilage in India will not solve everything, but it will be a definite step in the right direction for a country where chronic hunger is a major problem.

It is true that there will be some dislocation as India’s retail market is opened up to foreign firms like Walmart and Target. This is always true when trade expands or when technology changes. However, this doesn’t mean that the long run effects are negative. To borrow from the US case again, hardly anyone in the United States works in agriculture currently because of expanded trade and technological change. Did they all starve to death because all the jobs in agriculture went away? No: they went to work in expanding sectors like manufacturing across the twentieth century. Way back in 1942 Joseph Schumpeter noted:

The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.

This capitalist engine brought unprecedented wealth to the western world, it promises to do the same for India.

This article was co-authored with Art Carden, Assistant Professor of Economics at Brock School of Business at Samford University.  It was previously published in Pragati.

Economics

Mass exit from poverty

(co-authored with Bill Glod)

Do the poor have too many choices? MIT economists Abhijit Banerjee and Esther Duflo answer in the affirmative in their book Poor Economics. They argue that government intervention circumscribing choices can be beneficial and that “we are kidding ourselves if we think that these [small] businesses can pave the way for a mass exit from poverty”. Banerjee and Duflo’s defence of interventionist policies pins the blame of poverty on poor people’s cognitive and motivational defects rather than what is largely a systemic institutional problem faced by developing countries.

At a recent lecture at Harvard, Duflo explained that the poor have to make too many decisions—like whether or not boil water—which saps them of energy. Moreover, human cognitive limitations mean that sometimes they make wrong decisions, leading to disastrous consequences. There is little doubt that too much choice decreases well-being by making people feel anxious or overwhelmed and, hence, unable to choose effectively. Barry Schwartz, in a 2004 Scientific American article titled ‘The Tyranny of Choice’, finds that, “Although some choice is undoubtedly better than none, more is not always better than less.” However, this is no reason to call for more government intervention. A portion of Poor Economics draws from experiments conducted in India, so let’s take the case of water supply in Delhi. Nearly 40 percent of Delhi’s population lives in areas without full legal status. A 2003 study by the Centre for Civil Society finds that in three such areas government water supply meet 58 percent, 12 percent and 0 percent of demand. The illegal status of these lands means that private water suppliers cannot make the long-term investments necessary to provide clean water. In short, the poor have to make choices on how to purify water precisely because government has failed to assign and enforce property rights and because government has an effective monopoly over provision of piped water.

Contrary to the Banerjee-Duflo position, cognitive limitation is not a cause of market failure. It is the very condition by which markets work. And this happens in two ways. One, markets reduce the need for complete self-reliance in light of our limitations.  Market exchanges allow specialisation that relieves a given actor of the need to make a plethora of decisions taxing her willpower and develop expertise in a particular area of decision making. Laboratory experiments by Nobel Laureate Vernon Smith and others show that financial bubbles caused by irrational trading are less likely when traders are experienced. Two, the mutual self-interest of parties working within organisations creates incentives to develop remedies to an individual’s biases.

Stanford professor Chip Heath and others in a 1998 paper titled ‘Cognitive Repairs’ give several examples of how organisational practices can compensate for individual shortcomings. Microsoft, for instance, had a peculiar problem: when the usability group would tell the developers that “six out of 10 couldn’t use this,” the developers would ask, “Where’d you find six dumb people?” The problem was that individuals tend to discount large samples of statistical information. Microsoft solved this problem by developing a usability test lab, where developers could watch users struggle with new products. Developers took the sight of real people far more seriously than pallid statistics even when the latter involved much larger samples.

Markets are as much about “division of cognitive tasks” as they are about “division of labour”. Saying markets fail because of human cognitive limitations is akin to saying aircraft crash because of gravity. Banerjee and Duflo seem to think that both the rich and poor have cognitive limitations but the rich have a “cushion” which allows them to have cognitive limitations without getting hurt.  We agree with them in this, but we think that this “cushion” comes from the fact that the rich have greater access to markets than the poor because they tend to live in areas with well-defined property rights and work in sectors with more economic freedom. This means that while the rich are able to limit the impact of cognitive limitations and motivational defects through market exchange, the poor are not able to do so.

Duflo claims: “The emphasis on self-reliance can go too far.”  But libertarians typically defend free choice on the basis of an individual’s right to have discretion over what actions she will choose for herself, and where she will defer to those who have a comparative advantage elsewhere. Freedom of discretion is not a mandate that one must go it alone.

Duflo and Banerjee’s micro-level experiments miss the elephant in the room: The fact that a section of humanity (Western Europe and the US) was able to go from the present level of Bangladesh in 1800 to where they are today. The question then is what institutions allowed these countries to escape their own poverty traps centuries ago. Why are they lacking in developing countries today?  Markets are not perfect: nothing manmade is. But if there is any hope of mass exit from poverty, it is through small and large businesses creating wealth in a market economy.

As for regulation, University of California economist David Hirshleifer’s words are worth inscribing in gold: “Much of regulation is driven by psychological bias—on the part of the proponents, not necessarily the regulated.”

Vipin Veetil is doing his PhD in economics from George Mason University. Bill Glod is the Program Officer of Philosophy at the Institute for Humane Studies at George Mason University.

This article appeared in Forbes India Magazine of 20 July, 2012. www.forbesindia.com.

Economics

20 years since India’s economic reforms

India in the last 20 years has started to reverse the Keynesian-inspired planning that clouded its growth since independence.  A large part of this turnaround was driven by one of Hayek’s students at the LSE, B R Shenoy, whose ideas are now coming into fashion. It is interesting that as the West once more embraces the Keynesian policy options, the East is rejecting it.

This article in honour of Prof Shenoy was co-authored with B Chandrasekaran.

“An Indian will, on average, be twice as well off as his grandfather; a Korean 32 times” said Robert Lucas in a 1985 paper titled On the Mechanics of Economic Development. The Nobel laureate’s figures were based on the 1960-1980 period when India’s per capita income grew at 1.4% per year. In the period from 1992-2002, India’s per capita income grew at 3.7%, and from 2003 to 2010 it grew 6.9% – at this rate an Indian too will be 32 times better off than his grandfather.

August 2011 marks two decades since a high level committee—Narasimham Committee—was setup by government of India to initiate financial sector reforms. The deregulation recommendation by the Narasimham Committee went a long way in improving capital market efficiency – a key ingredient of economic growth. Ideas of free market economics, however, were not new to India. Long before 1991, Prof B R Shenoy had fought a lonely battle to promote free-exchange.

Shenoy warned India about the consequences of “central planning” twenty years before Jagdish Bhagwati and T N Srinivasan told us – in their 1975 book Foreign Trade Regimes and Economic Development: India – “that India’s foreign trade regime, in conjunction with domestic licensing policies in the industrial sector… impaired her economic performance”. Shenoy was the only Indian economist to write a Note of Dissent to the 2nd Nehru-Mahalanobis Five Year Plan (similar to the Soviet Gosplan). In the 1955 Note, Shenoy points out that the 2nd Plan “begins by prescribing the increase in national income which the Plan would set to achieve”.  In other words, the plan begins with a certain growth rate and then goes about figuring out how to gather necessary savings. Shenoy says “the availability of real resources must be assessed first and the investment plan must match it”. This was at a time when Joan Robinson’s view that “It is the rate of investment which governs the rate of saving, and not vice versa” was in fashion.

The government of India and its economic advisors choose to reject Shenoy’s wise remarks. What followed was an unfortunate verification of Shenoy’s theoretical vision. The average per capita income growth for the first five 5-year plan periods was a meager 1.5%. Joseph Schumpeter in his 1910 essay on Leon Walras says “It has become long since manifest who was being judged when the Academie des Sciences Morales et Politiques rejected his work”.  Perhaps the same can be said of the government of India’s rejection of Shenoy.

“Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s?” asked Robert Lucas in the mid 80s. In 1991 the government of India took some such actions. And the debate turned ideological, especially with the IMF’s condition-ridden package. Shenoy was the first economist of independent India to lucidly support free-market policies:

Efficient management of business and industrial concerns in a competitive market economy is a highly specialised function…best left to private entrepreneurs.

The reforms were greeted with skepticism at best and outright rejection at worst amongst India’s intellectual class. Arun Ghosh—in an August 1992 Economic and Political Weekly article titled One Year of Narasimha Rao Government: A Balance Sheet—declared “The Narasimha Rao government’s economic policies have not brought any promise of harmony and progress to the Indian economy.” Rather symbolically, the article was on the same page as an advertisement for the Hindi translation of a book titled The Russian Revolution by Rosa Luxemburg. Surprisingly, in the midst of the ideological battle of early 90s, Shenoy’s ideas were not resurrected for intellectual support. S B Mehta wrote in 2001 of  events a decade earlier:

the then Finance Minister was criticized by many that we were mortgaging our sovereignty to IMF. This author wrote to him that he should declare that we were following the policy that Shenoy hinted for twenty long years…. No politician or economist, however, uttered the name of Shenoy… Thus, it seems, we neglected the sound advice of Shenoy during his life-time [and also] when our policies leaned more towards free market.

With his 1931 article in the Quarterly Journal of Economics, Shenoy became the first Indian economist to publish in leading scholarly journal. However, Shenoy is not just a scholar of the past; his ideas are of great relevance today.  Take the debate on corruption, for instance. In February 1975, Shenoy delivered a lecture in Ahmedabad putting forward the thesis that interventionism is the root cause of corruption. And data backs his claim: Transparency International’s perception of corruption index and Heritage Foundation’s economic freedom index are strongly correlated. The 10 least corrupt countries have an average economic freedom index rank of 11, while the average for 10 most corrupt countries is 163!

Shenoy choose to be “right in a minority of one”. As India marks two decades of economic reforms, it is time classical liberals come forward to institutionalize B R Shenoy’s ideas. They say that VKRK Rao, a prominent post-independence Indian economist, “strode like a Colossus over the Social Science disciplines”. He established four institutions: the Delhi School of Economics, the Institute of Economic Growth, the Indian Council of Social Science Research, and the Institute for Social and Economic Change. Shenoy established none. The difference was at least partly because of their respective economic views. Rao was awarded his PhD in 1937 from Cambridge and was a student of Keynes. Shenoy was from the London School of Economics and was highly influenced by the then ‘new’ ideas of F A Hayek. Naturally the government of India loved Rao – a necessary prerequisite for establishing institutions in Gosplan India.

The first round of economic reforms was a matter of necessity, but India still ranks 124 in Heritage Foundation’s 2011 Economic Freedom Index.  Hopefully the much-needed  second round of reforms will be a matter of choice. And a reform by choice will come only if India has institutions promoting ideas of B R Shenoy.  In the long run, ideas must either take the form of institutions or die. And as to the question of where to begin, a chair at the Delhi School of Economics might be a good place.