The Root Cause of Indian Stagflation

Hi Guys,

Two days back, the Economic Indicators of Indian performance in October was out and we reached a new low with CPI Inflation going to 11.24% and IIP dropping to -1.8%. Food Inflation was at 14.72% and Manufacturing growth was -2%. GDP growth was 4.8% for Q2, 2013. RBI is all set to increase interest rates (probably by another 25 basis points) and industries are all set to oppose it.

So, why does RBI want to increase Interest Rates? To understand that, we need to understand Inflation first. Inflation is caused by changes in demand and supply. Generally, Inflation can be said to be a situation where, ‘Too much money chasing too few goods’. It can either be a state where too much of money is there in the economy or when the availability of a product goes down.

So, when inflation exists in an economy, a central bank (RBI) tries to play with interest rate. When interest rates are low, people take loans and the money comes into economy. When interest rates go up, people do not take loans. Rather people deposit their money and money supply would be reduced in the economy. This is done in order to bring Supply and demand to Equilibrium.

Generally it is said that Inflation should be lower than Interest rate by approximately 2% in a country. Only then does a business performs well and would be able to sustain its growth. People would not be affected too much by inflation. In India, Inflation is way above the current interest rate. RBI feels that increasing interest rates would reduce money supply in the economy. On the other hand, Industries feel that it would affect the already faltering Industry growth.

So, is RBI right in saying that increasing interest rates would stop the inflation? In my perception, increasing interest rates would have no effect on the money supply. The main reason is that Inflation is not happening due to the increasing money supply from borrowings. The root cause of the problem lies somewhere else.

The central government in the name of Rural Empowerment, provided lot of subsidies and money transfers. The key among them is the NREGA or the Guaranteed employment scheme. As one of my professor says, it unskilled the people. People who were working stopped working for wages were guaranteed. So, he didn’t have any incentive to work and productivity went down.

For any country to grow from Agrarian to developed economy, Manufacturing is important. Manufacturing doesn’t require much of skills and the employment it generates is tremendous. For once, India thought it leapfrogged that stage and can conquer growth based on Services. The main problem with services is that you need to be educated and it does not generate too much of Employment (26.6% of Labor force accounting for 56.9% of GDP).

The NREGA scheme spoiled an entire community of workforce. They got paid for doing literally nothing. As many people would say, the job of this workforce was to dig and fill holes. Government’s intention of ensuring wages was good, but they should have allocated a suitable work. All this money came back to the economy. The rural consumption pattern changed. From normal diet, they moved into protein diet. Food consumption increased and food prices skyrocketed. When growth came down, Government had no idea of what was happening.

Though our Finance Minister says that Food prices are reason behind inflation, I don’t think he has a solution. Now, Government wants to increase the minimum wages in order to improve the rural conditions. RBI increasing interest rates would affect industries and it would be too difficult for them to recover.

Even if a new government comes to power, they won’t have the audacity to pull back all the subsidies and money transfer schemes. One thing that can be done is to improve their skills and make the rural people productive. Pay them, but get some work out of them.

India is into the trap of low growth and high inflation or what is known as Stagflation and it is not going to be easy to come out of it. Let’s hope something good happens.

Happy Reading!

Thinking, Fast and Slow - Daniel Kahneman - Book Review

Thinking, Fast and Slow by Daniel Kahneman

My rating: 5 of 5 stars

Are Human Beings rational? Most of us know that we are not. Daniel Kahneman has collated his detailed research work into a single book and describes how our mind works. Daniel Kahneman won Nobel Prize for Economics in 2002 for his works in Behavioural Economics.

The book starts with an introduction to our thinking and how we work. Daniel Kahneman speaks about two systems inside our mind, namely System 1 and 2. System 1 is the fast thinking system that works based on intuition. System 2 is the slow thinking system that takes decisions rationally. More often, we take decisions based on System 1. System 1 is so powerful that it overrides System 2 in most of the cases.

The author has divided the book into five parts. The first part is about the two systems and how our mind works. He gives us many famous perceptions and concludes that no matter, how much our mind knows that the perception is false, System 1 will make us believe that it is true. More often than not, we are shown two lines which are of similar size, but appears unequal in appearance. By now, our mind should have understood that they are equal. But, we continue to perceive that they are unequal. This famous Muller Lyer Experiment is a result of our System Conflict.

The second part is on Heuristics and Biases. In this part, the author says how we are susceptible to biases and how our mind plays with it. For example, car accidents result in more deaths than flight accidents. Still, the nature of flight accidents make us fear flight travel. Similarly, rare disasters make us fear about those events rather than normal events. He also says how statistics can turn if wrong base is used and how often we use statistics wrongly to make it comply with our intuition.

The third part is on Overconfidence. Here, the author writes about various illusions. He says that our mind fits in patterns to the success stories and make us think that we need to repeat them in order to be successful. But, more often than not, it doesn't result in a success. He also writes about how intuitions are more often wrong and how we continue to believe them. But, he also writes about when intuitions can be correct sometimes.

The next part is on choices. This is a part where he has written about most of his significant research works in the field of Economics. He says how Utility theory has some errors and how Prospect theory aims to correct them. He writes about the difference between Economists and Human Beings. Reference point is important to find impact and we don't use it very often. Getting rich by $10 is different for a millionaire and a poor guy.

In the final part, he concludes by writing about two type of selves - Experiencing self and Remembering Self. He says that more often, people do works based on Remembering self, though it might be more painful for experiencing self.

He uses the term 'Loss Aversion' in the book often. Human Mind is oriented towards avoiding losses, rather than seeking gains. Gains must outnumber losses in the ratio of 2.5: 1 for us to accept the gamble. He refers this to the evolution of mankind. In order to survive, organisms have been trained to avoid losses and this has been imprinted in our mind.

Overall, the book is a good one for people who want to know about Psychology. The author is very humble and associates all those people who were present with him during that approach. He also writes about the limitations of his theories and says that he might be bound by some the theories and may not be right. The author has understood very well about human mind works and he has presented the book with a lot of examples and practical approaches. The book is a must read, if you are interested in knowing how you make decisions.

So if we read this book, will we think differently? Well, this is what Daniel Kahneman has to say,

It's not a case of: 'Read this book and then you'll think differently. I've written this book, and I don't think differently'

View all my reviews

Happy Reading!!!

Is Success a 'Regression to the Mean?'

Hi Guys,

I have been reading the book ‘Thinking, fast and slow’ written by Daniel Kahneman. It is an interesting book on how our mind works and how we often get things wrong. Yesterday, I was reading an interesting chapter in the book titled ‘Regression to the mean’. In the chapter, he defines the formula for Success.

Success = Talent + Luck

Great Success = A Little More Talent + A Lot of Luck

Success is often attributed with Talent alone. More often than not, we hear people saying that a person was highly successful because he was very talented. People often forget the luck factor associated with it. An equally talented person might not be even half as successful as him.

Malcolm Gladwell in his book ‘Outliers’ would quote people with high IQ and explain how they were not very successful. People generally say that Albert Einstein had high IQ and that was a reason for his success. But, there are lot of other people in this world who have high IQ too, but they end up just being show pieces.

Gladwell would also explain the time factor as to how people who were born in the 1950s had significant advantage than others since when they graduated in 1970s, Computers were in the forefront and they capitalized on that. Not all people would have been benefited out of that, but a few people like Michael Dell and Bill Gates had that luck in them.

Being a cricket fan, I had some thoughts on the game. Most of the great innings would have had some luck factor associated with that. I am a big fan of Sachin and I don’t remember his famous Sandstorm innings at Sharjah against Australia when he hit back to back centuries. When I watched them a few days back, I saw that in the first century, he had an edge that fell between three fielders. In the final, he had an inside edge that missed the stumps by inches. On any other day, he could have got out. Have two chances in back to back matches and getting to be known as the greatest innings has a bit of luck along with his great batting.

If you see players like Mike Hussey or Mathew Hayden or Stuart McGill, they got into the team late. They were not able to get into the team despite the talent. If they were in their 20s today, they would have been selected easily into the team. But, now when the Aussie team wants big talents, they find it hard to get one.

Daniel Kahneman says that the law of averages will catch up with everyone. It is driven by maths and has always happened in the past. We often hear that sportsmen would be nervous after a good performance and would not perform properly. The opposite case would also happen and people would say that they had nothing to lose. But, Kahneman says it is how things happen. This is known as ‘Regression to the mean’. As per Kahneman, good or bad things are not bound to continue for a long period. Everything would tend to move towards the mean.

Just as I was writing this, a point came to my mind. Is Success a ‘Regression to the mean?’ Is luck the main factor that contributes to a person’s success? Sachin might have been a bit lucky here and there, but didn’t he outperform many other batsmen? How come Sebastian Vettel won 8 straight races? Is Usain Bolt lucky to win continuously?

I think that Luck is very much important for the initial success. But then on, you need real talent to go forward. How many batsmen would have got a chance to play for India? A few lucky ones. But how many among them has played more than a few matches? A real talented player would survive, but a player who was just lucky would be thrown away.

Gladwell would have written about the ‘10000 Hours’ concept in Outliers. For anyone to be successful to be in a field, they need to practice for 10000 Hours in order to be perfect. A real talented person who have done this.

There might be few exceptions everywhere. Some would be really lucky and some would be really unlucky. But generally, we can say that a talented person would be successful in life. But for him to reach the heights, he needs certain amount of luck too.

For a person to be one among the top, you need to have the right talent at the right time with a right amount of Luck!

Happy Reading!