Friday, December 15, 2017

A Dangerous Bill on Banks:Where Depositors Are Made to Pay For Corporate Defaulters

PRABHAT PATNAIK | 14 DECEMBER, 2017

NEW DELHI: The BJP government, it appears, cannot remain content without inflicting irreparable damage on the institutions of the Indian economy. Its latest move in this direction is the Financial Resolution and Deposit Insurance (FRDI) Bill which was introduced in Parliament on the last day of the winter session and is now with a Select Committee.

What this Bill proposes is the setting up of a Resolution Corporation, consisting largely of central government officials, which, in the case of stressed banks whose condition is considered “critical”, will use creditors’ money, including that of depositors, to overcome the default by borrowers.

Until now it was the budget of the central government, the owner of the nationalized banks, which was supposed to be used for their “bail out”; now, however, the idea is not to have a “bail out” but a “bail in”, i.e. not to have central government help for supporting distressed financial institutions but creditors’ funds, including those of depositors.

Currently all deposits up to Rs.1 lakh are insured by banks themselves, so that there is no risk of loss to these depositors in the event of a bank failure.

The Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the Reserve Bank of India, which covers such depositors is proposed henceforth to be wound up; and no other institution has been suggested in its place in the Bill.

More importantly, however, it is not just the existence of this Corporation that instilled confidence among depositors about the safety of their deposits with the nationalized banks; it was the fact that the banks were government-owned, the conviction that the government would never let these banks fail.

It is this confidence which made millions of depositors, especially pensioners and senior citizens, hold their wealth in the form of bank deposits, even though such deposits offered comparatively lower rates of return than shares, mutual funds and many other assets. This confidence will now disappear.

In the old days people used to hold cash in boxes, since they had little confidence in the banking system which was controlled in their perception by a set of unknown private operators with no scruples.

Bank nationalization changed all that, and an enormous amount of deposits got mobilized across the country because of the confidence it generated among people that these banks, being owned by the government, would never let depositors down, that depositors’ money was totally safe in these banks.

While this confidence is now set to be undermined, demonetization, with Modi’s explicit promise that the experiment will be repeated from time to time, has served ironically to undermine people’s confidence in currency as well at the same time. (Though demonetization does not necessarily involve an actual monetary loss, it means standing in long queues and going through a lot of hassles, even if we ignore the inconvenience it causes by the temporary relinquishing of purchasing power).

Hence money in both its forms, currency and bank deposits, is now no longer going to be considered a safe asset to hold. Since the FRDI Bill also covers State-owned insurance and other financial companies, their liabilities too, like bank deposits, would lose their attractiveness for numerous small wealth-holders.

In an economy in which people’s confidence in money and these other financial assets is sapped, assets like gold or land or physical commodities become the favoured forms of wealth-holding, because they are considered comparatively “safe”. A shift from money to these latter assets constitutes a retrogression in economic terms; this is what the BJP government is bringing about.

To be sure, the FRDI Bill is not a brainchild of the BJP government. It is based on the recommendations of a Financial Stability Board which was set up in the wake of the 2008 global financial crisis to ensure that financial systems caught in such crises in future did not need rescuing through budgetary resources, as the U.S. financial system had done at that time. India was one of the G-20 countries that accepted the Financial Stability Board’s recommendations, and the FRDI Bill is the outcome of this acceptance.

But there is a fundamental difference between tax-payers’ money being used for rescuing a privately-owned financial system and its being used for rescuing a government-owned financial system; the former lacks legitimacy but not the latter.

In fact the government can come into the picture much earlier to prevent the banks it owns from getting saddled with “toxic” assets, so that the very question of banks needing to be rescued through tax-payers’ money should not arise at all, and certainly not on the scale of the banks in the advanced countries at that time. It is not surprising that even at that time the exposure of nationalized banks in India to the “toxic” assets was so minuscule that hardcore private-sector-enthusiasts too had to concede that bank nationalization had stood India in good stead.

Hence the very idea of adopting in India measures devised in the advanced capitalist countries, despite our having a very different financial system, whether these measures are the Basel “capital adequacy norms” (for meeting which the nationalized banks are supposed to dilute the share of government equity), or the institution of a “bail-in” programme in the place of a “bail-out”, is quite absurd.

But the BJP government, lacking any imagination of its own in economic matters and blindly pursuing whatever course the neo-liberal “pundits” hand down to it, fails to see this.

Finance Minister Arun Jaitley has assured the public that depositors’ interest will be protected; but it is not clear how. The FRDI Bill lists those to be protected, in the event of a bank being in a critical condition, in order of priority; and uninsured depositors come fifth in this list. Even in their case, no doubt, the government claims that they would not lose their deposit value; rather their deposits would be converted into equity.

In other words, bank are supposed to recapitalize themselves, when they are in a critical condition, by using depositors’ funds under this Bill, rather than by using budgetary resources as now. But this, apart from being of little consolation to depositors, provides a surreptitious route to privatization of public sector banks.

It is of little consolation to depositors, because the value of such equity will fall precisely when the bank is in such a critical state that deposits have to be converted into equity; the depositors therefore will lose much of their wealth anyway. Additionally, they are likely to sell off this equity to private corporate entities to get back at least a part of their money, and this will mean a privatization of public sector banks.

A bunch of government nominees on the Resolution Corporation in other words can so orchestrate a public sector bank’s financial credibility that it can pass into private hands, and even into private corporate hands at throwaway prices, without Parliament coming into the picture at all, and entirely at the whim of the executive.

But then, it may be asked, is it “fair” to use “tax-payers’ money” for rescuing banks?

The principled answer to this is “yes”, provided banks are playing their assigned social role.

It is not “fair” if banks are financing speculative bubbles and come to grief for that reason; but this is not what public sector banks are supposed to be doing anyway.

In other words, “tax-payers’ money” should in principle be available for rescuing public sector banks, but there must be democratic control over the activities of such banks. Being State-owned alone is not enough; they must be subject to democratic control in order to be deserving of “tax-payers’ assistance”.

Besides, this entire wedge that is sought to be driven between “tax payers” and “depositors” is a red herring being used for pushing through the FRDI Bill.

Notwithstanding all the hullaballoo over non-performing assets of the banks, these assets are no more than about 12 percent of total bank assets. Almost 90 percent of such NPAs belong to the nationalized banks; but given the large share of such banks in total banking business, the weight of the NPAs even in their case is not so large as to be alarming.

In addition, the government has just announced a Rs. 2.11 lakh crore recapitalization programme. So there is no question of such banks being in any critical condition now, or even in the foreseeable future.

To present a Bill in Parliament that is sought to be justified by a presumed conflict of interest between the “tax payer” and the “depositor” which can only arise in an eventuality that is nowhere on the horizon, and that can be prevented from arising anyway if we are careful, is not just absurd; it is actually quite mischievous.

It is ironical that the government, instead of measures whereby the corporate defaulters on bank loans, who reportedly account for 75 percent of total NPAs, are made to pay for their misappropriation of depositors’ resources, is announcing measures whereby the depositors would be made to pay for such corporate misappropriation!

Thursday, December 14, 2017

Who is Benefitting from Lower Interest Rates?

Over the last one year, bank interest rates have fallen majorly, at least in theory (it will become clear later in the column, why I say this). The question is, who is benefitting from the lower interest rates? The savers, whose fixed deposits have matured, have had to reinvest them at significantly lower interest rates. This includes retirees who have seen interest rates on their deposits, fall from nine per cent to six per cent in a short period of time. In the process, their incomes have crashed by a third. Not surprisingly, they are having a tough time.
People have suggested that senior citizens should invest with the post office where higher interest rates are on offer. Anyone who has actually invested money with the post office for generating a regular income, would never suggest anything like this. Their service levels are abysmally low. They can give a thorough run around to anyone looking to get paid regularly on the investment he has made with the post office.
In fact, I know of several retirees who have reluctantly moved their investments into mutual funds (both equity and debt), given the low after-tax returns on fixed deposits. Even if the returns on mutual funds are the same as bank fixed deposits, the different tax treatment for both these forms of investing, helps generate higher after-tax returns in case of mutual funds.
This investing strategy has worked well for retirees in the last one year, given that the stock market has rallied massively. Nevertheless, is this a sustainable strategy in the long-term for anyone who is looking to generate a regular income out of his accumulated corpus, given the volatility that comes with investing in a mutual fund?
In a country with almost no social security and a health care system which keeps getting expensive by the day, this is a fair question to ask.
Another set of savers who has lost out due to low interest rates are people saving for their future, the wedding and education of their kids, and their own retirement. These people now need to save more in order to meet their long-term investment goals. Of course, these people still have the option of discovering the power of compounding by investing in mutual funds through the systematic investment plan (SIP) route.
But given the abysmal levels of financial literacy that prevail in the country, the chances that they will be mis-sold a unit linked insurance plan(ULIP) by a private insurance company or an endowment or a money-back policy by Life Insurance Corporation of India, remain very high. These forms of investing remain the worst way you can invest your money.
Also, consumption growth and interest rates are closely linked. Conventional economic logic tells us that at lower interest rates people borrow and spend more, and this increases private consumption growth and in turn helps economic growth. QED.
While that may be true for developed countries, it doesn't quite work like that in India. In India, if interest rates fall, the retirees need to cut down on their regular expenditure because their regular income also falls. People who are saving for the long-term also need to save more in order to meet their investment goals.
Given that most household financial savings get invested in fixed deposits, a fall in interest rates makes people feel less wealthy and this has an impact on their consumption. Due to these reasons people end up cutting down on their expenditure. This is reflected to some extent in Figure 1, which plots the growth in private consumption expenditure over the last few years.
Figure 1:

As interest rates have fallen through 2017, the growth in private consumption expenditure has collapsed from 11.1 per cent to 6.5 per cent. As of December 2016, private consumption expenditure formed 59 per cent of the Indian gross domestic product. Since then, it has fallen to 54 per cent. So, much for lower interest rates.
There are two sides to interest rates, the saving side which I was talking about up until now, and the borrowing side, which I will talk about in the remaining part of this column.
The total non-food lending carried out by Indian banks has actually contracted during this financial year. But weren't lower interest rates supposed to help increase lending? Now only if economic theory and reality played out same to same, the world would be such a different place.
Banks are extremely quick to cut interest rates on their fixed deposits, as well as raising interest rates on their loans. Nevertheless, the same cannot be said about a situation where they need to pass on the benefit of lower interest rates to their borrowers.
Let's take the example of people who have taken on home loans from banks as well as housing finance companies. Over the last one year, the interest rate on a home loan has fallen from 80 to 100 basis points. One basis point is one-hundredth of a percentage.
The trouble is in many cases the banks and the housing finance companies haven't bothered to inform the borrower, about the lower interest rate. And the borrower has unknowingly continued to pay the higher EMI. This never happens when the banks and the housing finance companies need to raise interest rates on their home loans. In that case, the letter/sms/email arrives right on time.
In fact, I have heard cases where people have pointed this dichotomy out to a leading housing finance company, and they have been told that they are expected to come to the office of the housing finance company and keep checking. So much for market competition which is supposed to lower interest rates. Of course, the stock market rewards such companies with a higher price to earnings ratio, given that they can do these things, get away with it, and make more money in the process.
The media which is quick to announce lower EMIs whenever RBI cuts the repo rate, never goes back to check whether EMIs have actually fallen. This is simply because it is easier to take the theoretical way out and announce lower EMIs when RBI cuts the repo rate, whereas actual checking would involve doing some legwork and speaking to banks, housing finance companies and borrowers. And who wants to work hard? It's worth pointing out here that banks are huge advertisers in the media.
The question is when higher interest rates are passed on immediately, why is the same not true with lower home loan interest rates? What are the Reserve Bank of India (RBI) and the National Housing Bank (the RBI subsidiary which regulates housing finance companies) doing about this? Aren't the regulators also supposed to take care of the consumers? Or are they just there to bat for those who they regulate? Or is it a case of "regulatory capture" where those who are regulated (i.e. the banks and the housing finance companies) given that they are organised, manage to get their point of view to the regulator, but the borrowers, given that they are not organised, cannot do that.
Whatever it is, it is not fair. And the RBI and the National Housing Bank need to do something about it. Consumer protection is something that should be high on their agenda, even though it may be the most unglamorous of things that they are supposed to do.

Monday, December 11, 2017

Using Deposits to Rescue Banks is a Bad Idea; It Needs to Be Nipped in the Bud

The following is from Vivek Paul's Diary
I have been travelling for the past two weeks and a question that has been put to me, everywhere I have gone is: "will fixed deposits be used to rescue banks that are in trouble?"
People have been getting WhatsApp forwards essentially saying that the Modi government is planning to use their bank deposits to rescue all the banks that are in trouble. As is usually the case with WhatsApp, this is not true. The truth is a lot more nuanced.
Let's try and understand this in some detail.
Where did the idea of fixed deposits being used to rescue troubled banks come from?
The government had introduced The Financial Resolution and Deposit Insurance(FRDI) Bill, 2017, in August 2017. This Bill is currently being studied in detail by a Joint Committee of members belonging to the Lok Sabha as well as the Rajya Sabha.
The basic idea behind the FRDI Bill is essentially to set up a resolution corporation which will monitor the health of the financial firms like banks, insurance companies, mutual funds, etc., and in case of failure try and resolve them.
The Clause 52 of the FRDI Bill uses a term called "bail-in". This clause essentially empowers the Resolution Corporation "in consultation with the appropriate regulator, if it is satisfied that it necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider."
What does this mean in simple English? It basically means that financial firms or a bank on the verge of a failure can be rescued through a bail-in. Typically, the word bailout is used more often and refers to a situation where money is brought in from the outside to rescue a bank. In case of a bail-in, the rescue is carried out internally by restructuring the liabilities of the bank.
Given that banks pay an interest on their deposits, a deposit is a liability for any bank. The Clause 52 of FRDI essentially allows the resolution corporation to cancel a liability owed by a specified service provider or to modify or change the form of a liability owed by a specified service provider.
What does this mean in simple English? Clause 52 allows the resolution corporation to cancel the repayment of various kinds of deposits. It also allows it to convert deposits into long term bonds or equity for that matter. Haircuts can also be imposed on firms to which the bank owes money. A haircut basically refers to a situation where the borrower negotiates a fresh deal and does not payback the entire amount that it owes to the creditor.
But there are conditions to this...
The bail-in will not impact any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance. This basically means that the bail-in will impact only the amount of deposits above the insured amount. As of now, in case of bank deposits, an amount of up to Rs 1 lakh is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). This amount hasn't been revised since 1993.
Typically, anyone who has deposits in a bank tends to assume that they are 100 per cent guaranteed. But that is clearly not the case. Over the years, the government has prevented the depositors from taking a hit by merging any bank which is in trouble with another bigger bank.
So, to that extent the situation post FRDI Bill is passed, is not very different from the one that prevails currently. It's just that the government has come to the rescue every time a bank is in trouble and I don't see any reason for that to change, given the pressure on the government when such a situation arises and the risk of the amount of bad press it would generate, if any government allowed a bank to fail.
Over and above this, Clause 55 of the FRDI Bill essentially states that "no creditor of the specified service provider is left in a worse position as a result of application of any method of resolution, than such creditor would have been in the event of its liquidation."
This basically means that no depositors after the bail-in clause is implemented should get an amount of money which is lesser than what he would have got if the firm were to be liquidated and sold lock, stock and barrel.
While, this sounds very simple in theory, it will not be so straightforward to implement this clause.
So why is the government doing this?
In late 2008 and early 2009, governments and taxpayers all over the world bailed out a whole host of financial institutions which were deemed too big to fail. In the process, they ended up creating a huge moral hazard.
As Mohamed A El-Erian writes in The Only Game in Town: "[IT] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism."
If governments and taxpayers keep rescuing banks what is the signal they are sending out to bank managers and borrowers? That it is okay to lend money irresponsibly given that governments and taxpayers will inevitably come to their rescue.
In order to correct for this moral hazard, in November 2008, the G20, of which India is a member, expanded the Financial Stability Forum and created the Financial Stability Board. The Board came up with a proposal titled "Key Attributes of Effective Resolution Regimes for Financial Institutions". This proposal suggests to "carry out bail-in within resolution as a means to achieve or help achieve continuity of essential functions". India has endorsed this proposal. Hence, unlike what WhatsApp forwards have been claiming this proposal has been in the works for a while now.
But does this really prevent moral hazard?
A bulk of the banking sector in India is controlled by the government owned public sector banks. As of September 30, 2017, these banks had a bad loans rate of 12.6 per cent (for private banks it is at 4.3 per cent).
Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. The bad loans rate when it comes to lending to industry is even higher. In case of some banks it is close to 40 per cent.
This is primarily because banks over the years, under pressure from politicians and bureaucrats, lent a lot of money to crony capitalists, who either siphoned off this money or overborrowed and are now not in a position to repay. This is a risk that remains unless until the banking sector continues to primarily remain government owned in India.
Also, the rate of recovery of bad loans of banks in 2015-2016, stood at 10.3 per cent.
This does not inspire much confidence. In this scenario, having a clause which allows the resolution corporation to get depositors to pay for the losses that banks incur, is really not fair. The moral hazard does not really go away. The bankers, politicians and crony capitalists, can now look at bank deposits to rescue banks. As of now, the government and the taxpayers have kept rescuing public sector banks, by infusing more and more capital into them. Now the depositors can take over, if FRDI Bill becomes an Act.
It is worth pointing out here that the other G20 countries which have supported this proposal have some sort of a social security system in place, which India lacks. Given this, deposits are the major form of savings and earnings for India's senior citizens and clearly, they don't deserve to be a part of any such risk.
While, any government will think twice before using depositor money to rescue a bank, this is not an option that should be made available to governments or bureaucrats in India. It is a bad idea. It needs to be nipped in the bud.
These are my initial thoughts on the issue. Depending on how the situation evolves, I will continue to write on it.
Vivek Kaul is the Editor of the Diary and The Vivek Kaul' Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Wednesday, November 29, 2017

Bitcoin: Headed to the Stars?

BALTIMORE - Bitcoin blew by another milestone.

This morning, the world's first cryptocurrency hit a new record of $9,680.

It started off the year trading at just $997.

"I can't believe what happened," said a friend.

"I bought $1,000 worth in 2012. Bitcoin was trading at about $8 at the time. Then one of the big cryptocurrency exchanges, Mt. Gox, was hacked and almost $500 million worth of bitcoin was stolen. I got out.

"If I had just held onto my stake, it would have been worth more than $1.2 million today."

Lighter Than Air
You hear stories like that all the time now. They are bull market stories. The hero regrets having sold too early.

Later on come the bear market stories when he regrets having sold too late.

But let's enjoy the bull stories now... while we can.

The typical story has its hero... and its villain. The hero bought bitcoin when everyone told him not to. Now he's regarded as a genius. Even his father-in-law is asking his opinion on everything from politics to cocktail recipes.

Last week, the geniuses multiplied...

From what we can tell, bitcoin is headed to the moon. Or to Hell.

Weightless... frictionless... why not?

If it hit $9,000... why not $90,000... or even $900,000?

Bitcoin is a perfect "investment" for the fake-money era. Lighter than air. Not here; not there. Neither animal, vegetable, nor mineral.

Immaterial. Implausible. Imponderable. And immeasurable. There is nothing to hold it back.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Shutting Out Chinese Products is Not Going to Create Jobs

Public rallies against imported Chinese goods are held quite regularly these days, across different parts of the country. India's dependence on Chinese goods has only grown over the years. This can be made out from Figure 1, which plots India's imports from China every quarter, for the last few years.

Figure 1 tells us very clearly that India's imports from China have grown over the years. Having said that, it doesn't make sense to look at imports in isolation given that India exports stuff to China as well. Hence, Figure 2 (on the next page) plots India's trade deficit with China (i.e. the difference between our total imports from China and our total exports to it).

Figure 1:



Figure 2 clearly shows that India's trade deficit with China has grown over the years. This means that we import much more from China than we export to it. A major reason for this lies in the fact that most of the Indian firms are small in size. Take a look at Figure 3.

Figure 2:



What does Figure 3 tell us? It tells us very clearly that close to 85 per cent of Indian manufacturing firms are small. They employ less than 50 workers. In case of China, only around 25 per cent of the manufacturing firms are small. Also, in case of China, more than 50 per cent of manufacturing firms are large i.e. they employ more than 200 workers. In the Indian case, around 10 per cent of the manufacturing firms are large. And India has very few middle-sized firms which employ anywhere between 50 to 200 workers.

Figure 3: Distribution of manufacturing workforce among small,
medium and large firms in India and China



Given this small size, Indian firms lack economy of scale, which is basically a proportionate fall in costs gained with increased production. Hence, Indian products are costlier than Chinese products. In a recent newsreport, Blooomberg quotes a small shopkeeper as saying: "India-made lights cost twice as much... Customers aren't willing to pay that."

The other factor that helps make Chinese imports cheaper is the huge fall in international shipping costs over the years. This is a point that Tim Harford makes in his new book 50 Things That Made the Modern Economy: "Goods can now be shipped reliably, swiftly and cheaply: rather than the $420 that a customer would have paid... to ship a tonne of goods across the Atlantic in 1954, you might now pay less than $50 a tonne."

This has had a major impact on the way goods are manufactured and business in general is carried out. As Harford writes: "Manufacturers are less and less interested in positioning their factories close to their customers - or even their suppliers. What matters instead is finding a location where the workforce, the regulations, the tax regime and the going wage all help make production as efficient as possible. Workers in China enjoy new opportunities; in developed countries [AND DEVELOPING COUNTRIES] they experience new threats to their jobs; and governments anywhere feel that they're competing with governments everywhere to attract business investment. On top of it all, in a sense, is the consumer, who enjoys the greatest possible range of the cheapest possible products - toys, phones, clothes, anything [EMPHASIS ADDED]."

The point is that the Chinese factories operate on a very large scale and that makes their products cheaper than the ones being made in India. The fact that transportation costs are low, helps as well.

Those against Chinese products want this dominance of Chinese products on India to end. As Arun Ojha, national convener of Swadeshi Jagran Manch recently told Bloomberg: "Our youth are losing jobs and we are becoming traders of Chinese products."

It is important to dissect Ojha's statement. What he is essentially saying is that because Indians are buying Chinese products, Indian industry is shutting down and the Indian youth are losing jobs. So, what is the way out? The way out is that we stop buying Chinese products and start buying Indian ones. Will this help?

This is where things are no longer as straightforward as they seem. The straightforward interpretation here is that, as Indians stop buying Chinese goods and start buying Indian goods, Indian industry will flourish, and Indian youth will find jobs. Now only if it was as simple as that.

Henry Hazlitt discusses a similar situation in his brilliant book Economics in One Lesson, in the context of United Kingdom of Great Britain and United States of America. As he writes: "An American manufacturer of woollen sweaters... sells his sweaters for $30 each, but English manufacturers could sell their sweaters of the same quality for $25. A duty of $5, therefore, is needed to keep him in business. He is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whom their spending in turn gives employment. Throw them out of work, and you create unemployment and a fall in purchasing power, which would spread in ever-widening circle."

An American manufacturer of sweaters can sell his sweaters for $ 30 per piece. At the same time, an English manufacturer can sell the same sweater for $25 per piece. Hence, the American manufacturer charges $5 or20 per cent more for the same product than the British one. Of course, if both the products are allowed into the American market, the consumer will buy the cheaper one. This would mean that the British manufacturer would flourish. In the process, the American manufacturer might have to shutdown and this would mean a loss of a huge number of jobs.

The American government would obviously be bothered about the American manufacturer and the American jobs. Given this, to ensure that the American manufacturer can compete, the American government needs to impose a duty of $5 on the British manufacturer. This will mean the British manufacturer will also sell sweaters for $30. In the process, the American manufacturer would be able to compete, and jobs would be saved.

This trouble with this argument, as convincing as it sounds, is that it does not take the point of view of the consumer buying the sweater into account. As Hazlitt puts it: "The fallacy comes from looking merely at this manufacturer and his employees, or merely at the American sweater industry. It comes from noticing only the results that are immediately seen, and neglecting the results that are not seen because they are prevented from coming into existence."

If the consumer ends up paying $30 per sweater, he would be paying $5 more. This basically means that he would have $5 less to spend on other things. As Hazlitt writes: "Because the American consumer had to pay $5 more for the same quality of sweater he would have just that much less left over to buy anything else. He would have to reduce his expenditures by $5 somewhere else. In order that one industry might grow or come into existence, a hundred other industries would have to shrink. In order that 50,000 persons might be employed in a woollen sweater industry, 50,000 fewer persons would be employed elsewhere."

If the British manufacturer was allowed a level playing field and sweaters continued to sell at $25 per piece, the American manufacturer would soon have to shutdown. The loss of these 50,000 jobs would be noticed. This would be the seen effect of letting the British sell in the American market.

If these jobs are to be protected, then even the British sweaters would have to sell at $30 per piece. This would leave the consumer with $5 less, which he could have spent on something else, otherwise. This lack of spending would impact other industries and jobs would be lost there. It's just that the loss of these jobs would not be so visible as was the case with the American sweater industry. This is the unseen effect.

Now replace the United States with India and the United Kingdom with China in the above example, the entire logic remains the same. If Indians move towards buying more Indian goods than Chinese, they will end up paying more for those goods. This will leave them with less money to spend elsewhere. This would impact other industries, where jobs would be lost. It's just that these job losses won't be so obvious.

This is a rather obvious point that most people miss out on while analysing this issue. There is a certain opportunity cost of money. As Dan Ariely and Jeff Kreisler write in Dollars and Sense-Money Mishaps and How to Avoid Them: "The opportunity cost of money is that when we spend money on one thing, it's money that we cannot spend on something else, neither right now nor anytime later."

Given this, shutting out Chinese products is not going to create jobs in India. The only way jobs can be created is if Indian industry can compete with China. Right now, it doesn't.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul' Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.


Friday, November 24, 2017

We told you so: AAP on ‘EVM tampering’ in UP

The Aam Aadmi Party (AAP) on Thursday reignited the electronic voting machine (EVM) tampering debate, after some incidents were reported during the first phase of civic elections in Uttar Pradesh on Wednesday.

Senior AAP leader Atishi Marlena said the party had been shouting from rooftops since March this year about EVM tampering to favour the BJP.

Viral video

Wednesday’s incident came to the fore after a video of a voter from Meerut, Tasleem Ahmad, went viral on social media. In the video, Mr. Ahmad is seen pressing the button for the BSP but the light next to BJP glows.

He reportedly waited for 15 minutes at the booth, called the senior district officials and the media, and recorded the entire episode on his phone. Similar incidents of tampering were also reported from Kanpur and Agra.

“In all these incidents of tampering, the common thread is that the votes go to the BJP no matter for whom they are cast,” Ms. Marlena said.

She said the first such incident happened in Dhaulpur, Rajasthan, in April this year, where no matter what button was pressed the light aside BJP would come on.

Incidents have also been reported from Bhind in Madhya Pradesh, Uttarakhand and Sultanpur in UP.

Ms. Marlena said that the AAP local leaders from UP had on several occasions in the last few months requested the election commission to conduct the local elections using ballot paper instead of EVM.

“We had doubts on the authenticity of the elections using EVMs as it could easily be tampered as it has been in the past. The latest cases have only established what we have been saying,” she said.

Wednesday, November 22, 2017

One Example of How a Good and Simple Tax Should Work

Late last week I was paying the Goods and Services Tax (GST) I had collected on behalf of the government, to the government.
In the process of payment, I made a mistake, which, with the benefit of hindsight I can say was a rather silly one. Basically, the entries for the state GST and integrated GST got interchanged. In the process, I ended up paying more integrated GST than I had to and less state GST than I had to.
Integrated GST is a tax which the seller must collect from the buyer on the inter-state supply of goods and services. State GST and central GST are taxes which the seller must collect from the buyer on the intra-state supply of goods and services.
Let's understand this through an example. I am based out of Mumbai in the state of Maharashtra. I write a column for a magazine, which is based out of New Delhi. In this case, when I bill the magazine (the buyer), I will raise an invoice with an integrated GST of 18 per cent.
If I write a column for a website (it could even be a magazine/newspaper) based out of Mumbai, then I will raise an invoice with a central GST of 9 per cent and a state GST of 9 per cent. The point to be noted here is that the overall rate of tax in both the cases (interstate and intrastate) is the same. Only the division is different.
Anyway, getting back to my story. Given that I hadn't paid the right amount of state GST, this meant that I had logon to the GST portal once again and pay the state GST I hadn't. The integrated GST I had already paid will now get adjusted against the payments that I will make in the months to come. The money is safe. There is nothing to worry on that front.
Of course, I didn't realise I had made a mistake while paying the GST. It was only when my chartered accountant started filing the GST return, this mistake was noticed. After this, I frantically logged on to the GST portal in order to pay the state GST, I hadn't. In fact, I almost ended up paying the integrated GST all over again. Thankfully, I noticed the mistake this time around.
In the process of making this mistake I had a rather obvious realisation. As someone who is collecting GST on behalf of the government, it doesn't matter to me whether I am collecting state GST or central GST or integrated GST. This is something that should work at the backend of the system that has been created to implement GST.
How the GST collected by the government is split between the different governments (central and states) is not something I am really bothered about. Once I have upload my returns and have paid the right amount of GST, the system should be able to figure out, using GST numbers which have state codes and the PAN number of buyer as well as the seller built into it, what proportion of the GST should go to the central government and what proportion should go to the state governments.
Given this, I as a user should simply be making an entry for the total GST that I need to pay. The GST system can then easily figure out, the various kinds of GST, given that each buying-selling transaction along with the value, is reported as well.
But that is not how the current GST system works. The backend has become the front end as well. That is how the system has been designed.
It is well worth asking why? Dear Reader, if you have ever filed an income tax return form on your own even once, you would already know the answer. When the government designs these forms, it does not keep the ease of use of the end user in mind. That's the idea with which the government has always operated. This has seeped into the GST system as well.
The success of any government system (or for that matter any system) also depends on how easy it is to use. This ease of use will make GST a good and simple tax, which it currently isn't. In case of the GST, the government has just made the laws. The actual taxes need to be collected by the seller from the buyer. The seller then needs to hand the tax over to the government. The seller also needs to file returns. Currently, this entire process that has been made extremely cumbersome.
I am no GST expert, but I am sure that if some thought was given to the entire process of filing GST returns and paying GST to the government, it could be simplified. But for that to happen, first and foremost what is needed is bureaucratic will, even more than political will.
Indian bureaucrats have never liked to make things simple for the citizens of this country, because a simple system would discourage rent-seeking, which many of them excel in. And therefore, I feel that the GST will continue to be as complicated as ever.