The THRIFT paradox

Continuing from the last blog about public debt, some economists have been arguing that the government should get out of the way and let the market heal itself. They warn that massive government "stimulus" packages only divert resources away from the private sector, thus delaying recovery.

Although its a wise thought (more so because I believe in it), some schools believe that the government must borrow and spend many hundreds of billions of dollars in order to close the "output gap." Such thoughts are very common amongst the Keynesian economists.

While listening to a podcast in which Russ Roberts interviewed the eloquent Keynesian professor Steve Fazzari, I came up with a very interesting idea - "The paradox of thrift" as they call it. This is what this blog is going to be about and not really the economic debate on government spending.

To understand the idea, lets imagine a family that decides to save more, in the hopes of providing for a future vacation or the kids' college expenses. To that end, the family cuts back on how often it eats out at a local restaurant. At first, it might seem that the total saving of the community would rise, but the paradox of thrift argues -

The decision by such families in the neighborhood to not eat out as often forces a reduction in income—indeed destroys the income of the restaurant. Now how does the restaurant adjust to this? One way they might adjust to it is to keep doing things the same way they used to. So the workers continue to get paid, they continue to consume, the income of the restaurant is lower but the spending of the restaurant and its employees stays the same. hat means that the saving of the restaurant group has to go down. So yes, the family that decides to eat at home rather than eating out is saving more, but—by exactly the same amount—the restaurant owner and its employees are saving less. So the initial reaction to lower consumption and higher saving by one group in the economy is less income and therefore less saving by another group in the economy. So they just cancel out.

Another alternative the restaurant owner has is to cut on his spending by firing people and producing less food. What does that eventually lead to? Bankruptcy....

This example should give a good idea about the underlying philosophy. I tried coming up with a counter argument. Don't really know if its that convincing. To understand it, we need to point out the fallacy in the underlying assumption. The system we considered starts at a point of time and stops before the cycle completes. Moreover the sample considered is biased. Lets try and explain that using the earlier example.

First of all, the example assumes that once the family spends less, the restaurant owner straight away goes into bankruptcy. There is a possibility (a very high one at that) that the restaurant owner saves money by cutting on his expenditure a little bit, produces only as much is required and eventually survives the recession to have the whole economy saved enough money for the time when it revives. When we extend the sample, maybe a few restaurants go out of business, but eventually everyone will have saved enough money and the recession would have passed.
Moreover, th sample assumes that everyone in the economy behaves the same way instead of some families spending and some being thrifty. The sample bias is clearly visible.

All said and done, each argument has its merits. If i were to decide, I truely believe in the paradox that a thrift in recession presents. So guys, spend and live your life. Thats the only way we are ever going to get out of recession.

Public Debt - Ruling Elite (Pun intended) undoing its sin with another one

The worst global economic storm since the 1930s may be beginning to clear, but another cloud already looms on the financial horizon: massive public debt. The "RICH" and "Elite" governments around the world are borrowing vast amounts as the recession reduces tax revenue and spending amounts.

The IMF report I read the other day suggests that the public debt of the ten leading rich countries will rise from 78% of GDP in 2007 to 114% by 2014. These governments will then owe around $50,000 for every one of their citizens. The bigger question now is will they default inflate or somehow manage?

Its a classic case of a dog trying to catch its own tail. In the short term government borrowing is an essential antidote to the slump. Without bank bail-outs the financial crash would have been even more of a catastrophe. Financial Institutions form such an integral part of the world economy that a free fall is not permissible. That said, even if we do come out of recession (formal now), governments’ thirst for funds will eventually crowd out private investment and reduce economic growth. More alarming, the scale of the coming indebtedness might ultimately induce governments to default or to cut the real cost of their debt through high inflation.

The "Rich" government, as I shall refer to it as, has come up with the worst possible solution - "Printing money to buy government bonds". That's what the real worry is. How can you avoid inflation and eventual default or vice-versa? BTW, isn't that what Japan did?

If Murphy went to B School

I guess when Murphy left a legacy of cynical laws which he believed the world follows, what he didn't realize was that he was creating a cult. Some people as a rule of nature are born with a very cynical view of life. I have been trying to put myself into their shoes and look at Management education.

This sprung up from a discussion with Eric, when he asked, "So, who are the people who want to go for management education?"

He probably just asked me the question on the wrong day. I thought and thought some more until I came up with a perfectly legitimate (Murphian legitimacy theorem - As long as its a grim , pesimistic, cynical view of life, its legitimate) profile of such people. This is how the list goes :-

People who are really money minded and have no other concerns/likes/dislikes in life. These are people who don't understand that money is just the means to an end, but apparently they dont understand that, because they have no end in mind. Money seems to be end of their quest.. Such shallow b******s who dont even deserve to get primary education are the first to be selected in B schools.

The argument that Eric gave me was backed up with substantial data. We looked into the class profiles of major schools in US. His highlighted points were -

The selected people have diverse backgrounds
Most of them have had some social work experience or the other
Most have socal enterprise as a goal in life
They are achievers
They have had a significant contribution in whichever field they are from

So these people are not really money minded, but also have other purposes in life. On another day, these would have been my arguments. Anyways, I felt like I was forced on to the back foot and was running out of pessimism eventually. Thats when I murmered to myself. Hail Murphy..,and asked him what would you say if you were in such a situation.

I am not sure if it was Murphy or was it just some innate pesimism, but suddenly I had a perfectly logical explaination for all of these.

Diverse backgrounds - How does that help? Such money minded and socially blind people exist in every nook and corner.

Social Work experience - I do know most of the people who are applying to B-Schools this year and have no idea what those words mean. Most of the poeple do that to fit the profile.No one cares about the dying children in Africa becaue the rebels cleared out a whole village, neither do they care that Mongolia is becoming the next big power struggle after Afhanistan. People in Somalia are dying because of hunger and povety - which reminds of a joke one of my freinds (now in Columbia) told me about Somalians where he compared a Somalian tiger to a small house cat elesewhere in the world. Not that Idont have a sense of humor but I wouldn't consider people like that as the ones who give a damn about the social situation.

A group of people in my office have started a campaign to save trees, whereby we are supposed to not use unnecessary paper, reduce our carbon footprint and infact they got rid of paper cups in the office. What do we get in return, plastc mugs and plastic bottles, which will probably be in environment polluting it for atleast 5000 years as cmpared to paper, which can e remade by planting more trees. Not that I intended to get carried away, but I often see such people taking unnecessary printouts when no ones loking, go for bike rides, do everything possible in their hands to increase the carbon footprint just for leasure.

Anyways, back to Eric's qestions : Most people have social enterprise as goals . But ofcourse that just until they get to the B school. But there have been so many social entrprices that sprung up from these schools. Really, didnt they get a corporate job? Eventually you do have to make a living dont you, be it with donations to your NGO or from the big fat salary from an office at Wall Street.

This is when Eric decided to just give up and walk away. I have been thinking a lot about why I want to do an MBA. Maybe, next time I eneumerate those reasons.

Leadership like Love ...

Who do you listen to? How do you decide to follow? And, more importantly, for enthusiasts like us who will be the business leaders of the world, how do we chose to lead?

I was listening to Susan Hockfield's chat with Charlie Rose online. Among other things she was talking about research, higher education, stereotypical thinking around women not being engineers, and about being a woman in a leadership position.

The conversation around leadership started this morning. I was sitting at home staring into my computer screen and cradling my coffee mug. Lazy Saturday had just begun and I was thinking about valuation. Value. Value creation The other day I came across an interesting idea. The idea goes something like this:

Value is created from "beauty and good", and that is what allows people to expand their capacity as members of society. Because they are more capable, they can likewise expand the activities which society itself engages in.

Value-creation has a slightly different definition in the world of strategy, and valuation is a lot more different in the world of finance. That just led me to this.....

While we are on the subject of leadership, I attended a conference on corporate social responsibility by a senior executive at Coca Cola. The speaker said he'd seen both good leadership and bad leadership throughout his career. He also said something that made me think about the legacy of the work we choose to do in society. Who will take up the work that we've put so much time and effort into? These were some of the things I was thinking about when I asked a friend what she thought leadership was.

"Leadership, like love, is hard to define. It is something you always have to work at."

"Well said", is what I should have said, instead, I said, "what crap?" That reminded me every time I had to make up crap when someone asked me this question. Some people went on to say, "This is the first time someone has so simply defined leadership that it sounds right." We kept on arguing for a while when someone turned the whole thing around. It was like Chinese Whisper.

"Leading is different than managing. Managing requires a certain level of competence, but leadership is another thing. Setting the course is another thing," he said. Even before I could say, "Where did that come from?", he had people all over him trying to prove this wrong.

I walked out so I don't know whether they reached any consensus. Come to think of it, these two words are so interchangeably used that one tends to forget the difference. I thought of an experiment. I tried to list don a few leaders and a few managers I could think of , just to reinstate the difference. I could not get past the first name itself for an hour, pondering if he was in either class. Mahatma Gandhi, was he a leader, was he a manager or just a good orator? Who's to decide? After this unsuccessful attempt, I eventually jumped to another name, Adolf Hitler. Now that should be easy, I thought. He has to be a leader.

After accomplishing this, I thought to myself, can someone who led a whole civilization to ground zero ever be termed as a hero? Surprisingly, Hitler was not a good choice after a mind boggling Gandhi. While I was planning to work out another name, the same words sounded in my head again.

"Leadership, like love, is hard to define. It is something you always have to work at."

It suddenly sounded true. Maybe true leadership is just a pursuit. Like the image of god, or love that has been puled over peoples eyes to make them perform better. Maybe every leader has weaknesses. Maybe as long as you can lead people the good way, or the bad way to whatever fate and people blindly follow your ideas, you are a leader.

I wish I could give the right answer to that question someday.