This is the second part of Mr. Lobo’s essays on economy. The first one can be read here. Please do share your thoughts and comments in the section below.
by Mr. Francis Lobo
Mr. Francis Leonard Lobo is a Mechanical Engineer from the University of Poona. His education has been in prestigious institutions in Poona like St. Vincents High School, Ferguson College & College of Engineering. He is also a Life Fellow of Indian Institution of Industrial Engineering & a Member of All India Management Association. He has over 50 years of industry & business experience as a planning engineer, company executive, in-company counselor, company director, mentor, consultant, trainer, & CEO. He has written several books like “Getting Things Done — Strategies for Success”; “Strategies & Techniques for Successful Selling — The Sales Mission” etc.
The Free Market vs Regulation and Control
The present market conditions of a struggling credit situation, bank failures, slumping stocks, sliding dollar, rising prices, especially of energy, are the result of those qualified in finance, economics and management advocating the loosening or complete withdrawal of regulations and giving a free hand to the market. Yet the common man, who constitutes the free market, is being kept out of determining the corrective action immediately necessary and the financial market re-structuring that is required — These are the subjects reserved for the specialists, who should have seen the tsunami coming, raised early warning signals and avoided the crash! What are required are Rational Thinking, Public Debate, Dialogue and People Participation. As a common man I find that there are just a few basic principles which are being ignored. These are:
– The Power of Compounding
– Money flows upwards to where the returns are highest.
– The availability of finance grows faster than GDP
– The Power of Education
– The Compounding Effects of Corruption
The Power of Compounding
Steady growth can suddenly reach the point where the balloon bursts. If we start at a low level of say 10 with a 10 % / year growth it will take more that 16 years to reach 50. But, to go from 50 -100 will be done in less than half the time i.e. in a little more than 7 years. It has come as a surprise that global financial assets in the form of bank deposits, government and corporate debt securities, equity should have jumped to $ 167 trillion in 2006 from less than half this figure just 10 years ago. Normal growth has been interpreted as a surge in the emerging markets like the adult failing to appreciate that the young boy of yesterday has been steadily growing and is now suddenly emerging as a grown man.
The demands of compounding are a doctrine to be obeyed in the corporate world where quarter-on-quarter, year-on-year profit growth is expected. It is also seen in inflation where increase in prices, on an on-going basis, is considered a natural phenomenon where nothing can be done.
The power of compounding is seen in the salaries being paid today. As salaries increase the growth is also accelerated. A 10 % increase in a monthly salary of Rs. one lakh is Rs. 10,000, which was the total monthly salary for that position not so very long ago.
Unfortunately, this compounding doesn’t apply to the unorganized, unstructured world, where most of humanity resides. The earning levels are static while costs rise. Even executives, who get year-on-year increases don’t think it necessary to give similar raises to their domestic help. The net result is that the rich are getting richer while the poor are getting poorer and more into debt.
Money flows upwards to where the returns are highest
At the turn of the 20th Century the interest paid on bank savings was considered too high and a bad financial practice. Rates were drastically cut and people were encouraged to invest in the stock market, where returns were said to be much higher. There was pressure even to transfer superannuation funds from deposits, where the returns were guaranteed, into the volatile share market. With funds flowing into the share market, share valuations increased resulting in even greater inflows. The accumulation of wealth in the advanced and oil-rich economies found attractive outlets in the developing markets. The slow pace became a surge with the power of compounding. The rising P: E Ratios [Price: Earnings Ratios] had nothing to do with corporate performance — nothing whatsoever. Stock valuation is a matter of Speculation and the rising P:E Ratios should have been seen as a potential trouble area rather than as a cause for exuberance.
A basic common sense principle is being ignored — There must be a judicious balance maintained between investment for steady returns and investment for growth, in instruments where returns could be high but where there is also volatility and risks. Regulators have made it mandatory that ads for mutual funds should carry the warning that these are also subject to risks, but the announcements are made in such a garbled manner that no one can understand what is being said.
The power of money breaks territorial barriers. It will flow to areas where it will get the best returns. In 2006 the outstanding stock of cross-border investment reached a record of $ 74.5 trillion. To prevent this outflow in India physical growth must keep pace with the growth in finance otherwise money must flow out of India. This can be achieved through new activities and ventures, and investments in agriculture, education, healthcare and housing for the homeless.
The Availability of Finance grows faster than GDP
If people save 20-30 % of their income through provident fund, gratuity provisions, life insurance, savings, investments and other methods the asset growth every 3-4 years will be equal to the annual earnings. That is why we see that financial assets are today worth 3.5 times the global GDP and this financial depth will keep on increasing. This guarantees that inflation will be an on-going phenomenon. Those who understand this behavior of finance are able to draw out this accumulation of wealth through capitation fees for higher education for children, housing, high priced medical services as one ages. Those who are or were employed in the organized sector are able to cope with these rising costs. Those who have no saving capacity are not able to cope with the dynamics of the changing economic situation and are left to get finance from the unstructured money-lending market at exorbitant rates, thereby increasing their poverty and indebtedness. They have no way of getting out of the vicious circle of poverty. The only way is by a massive government intervention. China is better poised than India to meet the needs of its people because finance is centrally controlled unlike India where it is left to market forces. That is probably why in China the per capita income is very much higher and the poverty levels very much lower than in India. Unless India awakens to the reality of the unorganized, unstructured sector there is no hope for the poor though the billionaire club membership may increase. The accumulation of wealth finds its outlet in speculation in the attractive share market, real estate and insurance for old age, sickness, disasters, etc. That is why there is a clamor for liberalization of the insurance sector and even opening it up for foreign participation. Our Minister for Agriculture has been able to draw out billions of dollars from the corporate world through cricket in the form of TV coverage rights, media advertising, sponsoring of events, sale of sports goods, etc. Why can’t he use the same magic to bring out finance for massive investments in the rural and agricultural sectors and create the much needed Second Green Revolution to meet the unsatisfied needs of today’s hungry and starving people and the future needs of an ever growing population?
The Power of Education
The structured, organized world runs on System. This requires technology, knowledge, skills, ability which can be acquired through education. The middle class has realized the power of education and is prepared to go to any length to give their off spring the best education possible. The Power and Growth of the Middle Class springs from education which gives Vision, Hope and Dreams of a bright future, a self fulfilling prophesy for progress. However, the majority in India, despite pious pronouncements and constitutional provisions, are cheated out of education and higher education, which through commercialization is unaffordable for “Aam Admi”. The mindset that keeps the majority of Indians outside the protected “Green Zone” is that all Indians are not equal — We need to maintain the unorganized sector to provide cheap labor and to do our grunt work.
The Compounding Effects of Corruption
We have seen the power of compounding. This power gets multiplied by several orders of magnitude when corruption is institutionalized. We feel that a small kick-back of a few percent is not a crime and will not do much damage. After all we, who are in charge, have the responsibility to get things done and manage the situation! But, a small amount, when compounded can have a disastrous effect as we have seen above. The further compounding effects of corruption are as follows:
– Black Money doesn’t enter the system. It creates a parallel economy of its own. Nobody knows the extent of the Unstructured Finance economy. Various Commissions to study the phenomenon have only come out with estimates.
– It is the source of finance for undesirable activities like money-lending at exorbitant rates to the needy.
– It enables poor quality work to be passed. With shoddy and defective goods being able to enter the system, the entire system is damaged and destroyed and the rule of Law is blatantly ignored.
– The Institutionalization of corruption is like a cancer affecting all parts of society — No part is unaffected. Those who go against it are ostracized, punished, side-tracked, stand to lose their position, status, jobs and even their lives. The whistle blowers are not protected and suffer untold harassment and torture both mental and physical.
– Merit and performance are devalued. The centers of power shift.
– Corruption adds directly to the costs and indirectly through preventive measures such as additional supervision, inspection, vigilance, audits, checks and balances.
The conclusion one should draw from the points given above is that the financial systems, as they are functioning in India, result in the concentration of wealth in the hands of a few, the majority of Indians will not benefit. The structures are well fortified and closed and difficult to penetrate. The wealth growth is not all inclusive. The concept of India as an emerging market is a myth. The above has been written as an invitation for comments, criticism or outright rejection of these concepts. The present situation is anyway “a wake-up call” for a critical look at the financial systems and a drastic re-structuring as is necessary to ensure stability in the times ahead.