Tuesday, January 20, 2009

Narendra Modi, Nano, YSR, and Satyam

(Updated below)
Here is a special in rediff.com about the sops offered to Tata's Nano factory by Gujarat CM Modi.
I participated in the forum discussions in that article and found several weird arguments about Modi and capitalism. Many commenters praised Modi for being competitive in business. Modi seems to be the darling of "India Inc" and his aggressive policies are said to be a model for the nation.
Now it has turned out that Andhra Pradesh government has been following similar policies for transferring public lands to Satyam. You can read Praful Bidwai's excellent article in rediff.com here.
There is a talking point here - many defenders of Modi claim that pro-business policies followed by Modi are appropriate and will pay themselves off in the future. For example, while the Gujarat government loses lots of tax revenue from the benefits offered to Tata, this loss will be compensated by the thousands of new jobs created by Tata in Gujarat. This same argument is also used by many state governments in India.
It is obvious that most politicians and policy makers have accepted the idea that you can shower lots of favors to a businessman from public money. While in the past this would have been considered scandalous to offer freebies to businessmen, now everyone seems to think it is a very wise, intelligent policy. Surely Modi has received lots of credit for his wooing of Tata.
Whatever this policy is, it is definitely not capitalism. If anything, such policies can be called "Crony capitalism" and have always been detrimental to growth - not favorable. In the rediff forums, most commenters thought such policies were followed by developed countries. That is just untrue. There is a very strong theoretical, logical reason why the policies promoted by Modi and the AP CM, YSR will not work.

I will describe that reason below.

The Market and The Invisible Hand
The fundamental idea that almost every economist in the world accepts is the efficiency of the Market. Adam Smith, in his "Wealth of Nations" described how the market works. Purely selfish motives of individuals (economic agents) in an economic system gives raise to the market. Adam Smith said that such a market would meet demand much better than a centrally planned economy.
Consider an imaginary city, Gotham.
Let us say the Gotham city mayor sits in a room and says which individual should produce how much and which individual should consume a certain quantity. This is a centrally planned economy - it does not depend on the market to match supply with demand. Such a economic system would be very inefficient and would soon fail.
This is what happened to communist countries. Communist economic theory depends on a centrally planned economy.
On the contray, let us say the Gotham mayor and city council created a minimal set of laws. One such law will be to make sure businesses do not use violence against each other. Another may be to make sure that the businesses do not employ slave labor. Yet another may be that businesses do not spoil the environment.
After passing these laws, the Gotham city mayor does nothing. he lets the selfish motives of businessmen play out in the market.
Adam Smith proved that such a market will be much more efficient in meeting needs and only such an economy would grow well. In effect, the centrally planned economy would fail while a free market would succeed.
Every reasonable economist in the world accepts Adam Smith's premise. Developed economies are guided by these principles and they have obviously worked very well.

Markets and Regulation
Then what do economists differ on? What are the policy differences between Paul Krugman (Nobel economic prize winner) and Alan Greenspan (former US federal reserve board chairman)?
The difference is usually on the set of laws passed by the government - one set of economists believe that markets should have zero regulation by the government. This is called laissez-faire capitalism. In the above Gotham city example, the law that prohibits environmental damage will be opposed by free market economists. They believe that environmental issues will be ironed out within the market. Similarly, let us say Gotham city mayor passed a law that imposes a minimum wage for laborers (that is, employers should pay at least that amount for any work). This law would be opposed by free market economists.
The other set of economists believe that government should protect society as much as possible - therefore they would welcome a minimum wage.
Thus, the fight is over government's role. There are many who blame the current financial crisis on the lack of government regulation in the United States. These economists believe that businessmen may be motivated by greed and may violate the market in different ways.
In India, one prime example for such greed acting against society was the rise and fall of several finance companies in the 90s. The market was not well-regulated at that point and allowed businessmen to make money by cheating innocents.

Crony Capitalism
Now, even though both these sets of economists disagree on several issues they also agree on something crucial - the market is the judge of businesses. In a just society, the market should never be weighed down in favor of a specific businessman or group. If you do that, you are weighing down the economic system. The growth produced by such favors to a certain family or group will be short-term. The market will automatically create jobs and manage supply with demand - government should NOT influence the success or failure of indvidual businesses. If they do that, they are not being fair to other competitive businesses.
That is, instead of the market rewarding good ideas and rejecting bad ideas, the government tries to take on that task itself. This is always a bad idea - every economist around the world would oppose such policies.
Such acts of favor or bribes cause a skewed form of capitalism called "Crony Capitalism". It is harmful to an economic system.

Modi and Crony capitalism
In the article linked first in this blog, rediff.com lists a number of favors arranged for Tata's benefit by the Gujarat government. Tata is a businessman and he has managed to play the role of a noble soul after the Singur protests. He seems to have the negotiation advantage, if there were any negotiations at all. Thanks to the media, there has been a fevered pitch of excitement on Nano and the media has succcessfully managed to make Tata's travalils our own.
There are people who argue that job creation is primary goal. Some guy even calculated that in 10 years the government of Gujarat would get money back from the Nano plant because of tax payments by employees. But there is a vital flaw in such arguments:
What if the Nano is a failure?
Let us say that some design flaws make Nano a failure. Can the Gujarat government assure that the Nano will be a success? They can't - the factory is not even in their control. They have not studied the market or discussed the quality procedures or the thousand other things that can go wrong with a product. By tying themselves to a single businessman's product, the government has committed taxpayer money for something it has no capability to ensure or manage.
Instead sound economic theory requires that the Gujarat government create conditions for manufacturers in general and then wait for business to flourish.
Let me point out another flaw - when Tata gets such a huge set of benefits, his competitors cannot thrive. They are contributing their money while Tata is getting taxpayer money from Gujarat. Thus the market is skewed by the government in favor of Tata.
This is the very definition of Crony capitalism.
What Modi has done is worse than funding public sector companies - he has funded something he has no control over. Atleast with public sector companies the government has the management in its control. Modi, instead, has handed over money for no control.
I have to point out - the slogan of "India Inc" and a purposeful, noble business class has been created and sustained by the media. If Tata was so noble, he would have rejected these crony capitalist sops. Instead, the media has made it somehow the Indian people's task to fund the Nano.

YSR and Satyam
Now, it has turned out that the AP CM has been doing the same thing for Satyam. The same media which was cheering on Modi are now pretending that YSR is corrupt. If YSR is corrupt, so is Modi. Just an year back, everyone was celebrating Satyam and people were applying the same wrong arguments of job creation when YSR was handing over public land to Ramalinga Raju.
In the case of Satyam, the communists have been the smartest in bringing public attention to the government sponsored bailout (read Sitaram Yechury's opinions here) . It seems Manomohan Singh, the renowned free-market economist is now trying to pour public money to Satyam. People are still talking about "job creation" by Raju - if the economy adds ten thousand jobs and then loses double that every few years, it is not growth. If we could grow by cooking numbers all the time, every country would be prosperous.

Update I:
1. At any other period in modern history, if a politician poured public money into private hands, people would suspect bribes. Instead, the politician is hailed as a hero now. This sea change in attitudes (without any matching change in the quality of politicians) is purely a result of brainwashing and propaganda.
For example, the media has successfully created the myth of "India Inc" as a set of patriotic businessmen, focussed on India's growth. People have tended to identify themselves with Tata or Ambani than with other middle class labor. The truth is in a country like India, the rule of law pretty much does not exist, and a feudal system is persistent. In such a scenario, businessmen act as predators - not benign patriots. This is not to blame them - they have incentives to circumvent the law.

For the last twenty years the residents of the Chennai suburbs of Chromepet and Pallavaram have been fighting a battle against the tanning factories in that area. These factories have polluted the air and water bodies of that region and made it almost uninhabitable. Well, the citizens who organized and fought had to face threats of violence and intimidation by the "patriotic" businessmen.
The truth is, the Indian system encourages systematic lawbreakers - just as our politicians have grown to be lawless, so have our businessmen.

2. Let me explain the economic theory a little bit better:
As I said, the main differences between economists is on government's role in passing laws. Why is that? Because every sensible economist believes in the market. More importantly, they believe in a fair market. But how the market maintains neutrality, fairness and encourages growth is not determinable all the time. The market responds to incentives in different directions; sometimes these responses may be complex to measure.

For example, the software industry in India is treated as a sunrise industry and there are many subsidies offered to that industry. By classical economics, such subsidies are wrong and should not be applied - because they lead to "protectionism". Adam Smith and most famous economists after him (such as Ricardo and Marshall) have been against protectionism. Ultimately, they believe that a protected market offers fewer choices and innovations to the consumer.
Yet, the subsidies do seem to be working very well.

As yet another example, the American laws that abolished the differences between commercial and investment banks in 1999 and enabled unregulated derivatives trading may have caused the current financial crisis, 10 years later.

Therefore, the effects of the laws are open to speculation. Mathematical models of great complexity are required for analyzing the direction of the markets from incentives.
But, what is NOT open to speculation is this - every economist desires a fair market.
The key motivator in economics is the fairness of the market. Every economist agrees with THAT, even though they may not agree on how to reach there.

Handing off public land to Tata or Satyam skews the fairness of the market. That is why it is called crony capitalism.

This is why Modi's actions and YSR's actions are wrong - because they go against every economic basics. They may claim they are brave souls experimenting with the economy, but they should experiment with their own money, not our money. I suspect that the truth is not that they are clairvoyant or brave - I think Modi's actions and YSR's actions come from base ignorance and greed. That is a potent combination.


AlvaThundu said...

Excellent analysis, and fruitful points/arguements, I totally buy this, it is true that Modi cannot guarantee the success of Nano, however investments are chances what Modi investments here are just a fraction when compared to Tata's investment, and if everyone start looking for such guarantee's then BSE and NIFTY has to shut down there shutters, I think :)

Ramiah Ariya said...

But, Mr.Alva, Modi is not investing his money. When did we get the idea that the state governments can just take public money and "invest" in certain corporations? BSE and NIFTY will down their shutters if Individuals look for guarantees, correct. But no one is complaining that Modi is investing his own money.
The complaint is when a government starts supporting individual corporations instead of enabling market competition.
I think you consider Modi as somehow the "owner" of government money. He is not. Therefore it is not "Modi's investments" vs "Tata's investments".

AlvaThundu said...

Absolutely, I buy it, I never said either, probably I should'nt have used the word investment there I dont want to use the word encourgement which will make me sound Pro-Modi :). All that I want to share was Modi's helping hand to Tata, is something like SEZ across India, which I meant as investment from government, which Ford, SaintGobian, Mahindra IT Park, CocaCola, Catepillar Inc India and etc enjoyed in India. Then why not an Indian company for Indians, all these above mentioned foreign compaines have also got few thousand crores as investment from the respective state and central government (Public Money) which Tata is also getting from Gujarat Government. I'm only seeing Nano Plant asn SEZ. Why did TN government invest in MRF and with whose money? why did AP Government invested on Ongole Mills and with whose money? I'm definetely not conisdering CM's/PM's as owner of Government money. I'm not sure exactly what you mean by enabling market competition?

Ramiah Ariya said...

Let us summarize this argument - Your first question was about Modi investing in Tata which I explained is possible if he does it with his own money.
Your new question is this - if government can invest in SEZs, then why not Gujarat with Tata.

First of all, SEZs are bad by economic theory. Most economists are clear about that. I have written about SEZs in this blog itself, here: http://ramsrants.blogspot.com/2008/03/are-sezs-good-thing.html

Now, let us assume that SEZs are ok; atleast they allow any company which fulfills a certain set of criteria (such as export-orientedness). Thus SEZs are STILL better than handing over money to a single company. It does not matter if the company is Indian or not. That is irrelevant for economics.
The reason is, government favoring a single business group instead of a general set of businesses is "Crony capitalism". This is the subject of my whole post. Let us say that Gujarat allowed car manufacturers in general to setup shop in the state for certain subsidies. If those subsidies are not a big sell-out, then this policy is ok (kind of). The reason is that then the government role becomes "encouraging" different manufacturers to compete for the consumer's choice. The consumer benefits in that case and competition keeps the cars on technology edge.
Instead if you take all your money and start pouring it down a SINGLE businessman then you are basically bribing a single businessman to somehow solve problems that HE HAS NO INCENTIVE TO SOLVE. He gets so much largess from the state that he has no reason to fear competition. Presto - Modi has created a kind of public sector company with no control over its functioning.
This is all sound economic theory by the way - I am not saying anything new here. NO developed country encourages individual businessmen by subsidizing them - at best, whole industries are subsidized. NEVER a single businessman.

Now, your comment seems to show a set of fundamental misunderstandings. Let me clarify those:
1. Government is not a business group. That is, it is not the role of government to take public money and "invest" or "encourage" businesses. There are good economic reasons for why this is the case. Government's role is to REGULATE businesses.
I think our national media has somehow blurred this important role and made it sound like government is another type of business. It is not.

2. Government CANNOT provide a "helping hand" to businesses randomly. That would just make sure those businesses have no reason to fear competitors.

Again, it has become a trend in India to justify such investments by the state governments. These sort of payments to individual businesses is a disaster and is against economic theory and is not practiced in any capitalist society. The reason it happens in India - the explanation is really simple; the governments are not interested in "encouraging" anyone. They are simply doing this because government leaders get "subsidies" in return.

AlvaThundu said...

Thanks for your time on this Ram, I'm clear now :)

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Anonymous said...


I agree to the view that individual busineses should not be favoured. But i disagree with your view on sez or software or favoring an industry in general the reason is that there are other countries in the world and to stay competitive you have to match the policies and subsidies that others may procide. As an example look at china by manipulating currency and having state acting a so called croony capitalists they have made china the strongest growing economy..today the largest the fastest the tallest the longest the deepest all you will find in china. all over the world manufacturing suffered..toy factories closed down because other countries could not give the subsidies and state support that china gave. Your arguments on free economy will only be practical in a utopian world where all countries follow same policies. specific to auto thailand is the biggest hub of autos in asia and now china picking up because of state support. The inefficiencies that our country has in terms of lack of infrastructure, trained manpower, ports, facilities, high interest rate are all local and to compete with the world states like gujarat have to give subsidies to businesses to negate the effect and bring businesses and jobs to india.