Death by China?

“We will follow two simple rules – buy American, hire American”, said a defiant Donald Trump to a cheering public & an uncomfortable Washington Establishment, as he was sworn in as the 54^th President of the United States of America earlier this month. In his election victory, Trump smashed most expert forecasts, election pundits, opinion polls and the mainstream media narrative that had consistently projected his opponent as the favorite to win.

For those surprised by Trump’s victory, go no further than videos such as this, which might have played a major role in influencing public opinion during the U.S. Presidential elections. Claiming to be one of the most watched documentaries on Netflix for 3 years, the film narrates the story of an “increasingly destructive trade relationship” with China, which has led to the closure of over 50,000 American factories since China entered the WTO in 2001. The film blames China for causing loss of millions of jobs and accumulation of over $ 3 Trillion of U.S. debt to the “world’s largest totalitarian nation”. You can watch the full video here:

Loaded with terms such as “illegally subsidized exports” or “stealing jobs”, the import of the film is clear: Over the past decade and more, America has lost its ‘trade battle’ with China, and this loss is the result of an ‘unfair’ advantage the Chinese businesses get vis-à-vis their American counterparts. The film makes five basic allegations to corroborate its claims:

1. Polluting for Profits: Stringent environmental norms on U.S. manufacturing levy a heavy financial burden on U.S. businesses, but their Chinese competitors follow no such norms, giving them a cost advantage. 

2. Worker Abuse: China exploits its workers, forcing them to work for long hours often in inhuman conditions. This raises productivity per worker.

3. Currency manipulation: China pegs the value of the Yuan to the Dollar much below what it should be, which benefits its exporters.

4. Counterfeiting & Piracy: The Chinese are cheating on Patents, Trademarks and other such intellectual property.

5. Illegal Export Subsidies: The Chinese Government grants illegal export subsidies to its exporters

Due to all this, says the film, "they are cheating monumentally” by producing - sometimes even at 1/10^th the price of what it costs to produce in the United States. This has led to the death of American manufacturing. Almost 90% of all products sold at Wal-Mart are made in China. From garments to chopsticks, Christmas decorations to computers, and from printers to shoes – often it is almost impossible to find anything in an American store that is NOT made in China.

Really?

The “unfair” Chinese advantage is easy to "see" - and hence to blame, but things become complicated as the film moves on to discuss the role of American Multinational Corporations, who have themselves been at the forefront of outsourcing their manufacturing. From Apple to Caterpillar and IBM to GE and Cisco to Ford, every large American corporate worth its name has shifted it’s manufacturing to China to cut costs and improve profitability. Is it right for a Corporate Entity to cut domestic jobs to maximize profits? The film admits “profits Vs.jobs is at the root of America’s offshoring problem”. Sure corporate CEOs are focused on shareholder value, but isn’t this exactly the way it should be?

From time to time, I have seen the “blame China” narrative make its way into public sentiment. But most such narratives tell only one side of the story. Ask someone who bought his first big screen TV or furniture 50% cheaper, cheap imports have given their buyers a standard of living that was not possible earlier. When a foreign government pays you to buy toys or coffee making machines, is there really a cause to complain? As corporate America offshored jobs, profits got a boost, and despite the Wall Street engineered financial crisis of 2008, stock markets today are at an all time high, boosting the 401(k)s and mutual funds of ordinary Americans.

The documentary also erroneously links the $ 3 T U.S. government debt that the Chinese hold with cheap imports. Contrary to what is shown (and even otherwise believed); the large government debt actually represents a huge advantage the United States enjoys over other nations on account of the U.S. Dollar being the currency of international trade. Most exports worldwide are invoiced in U.S. Dollars, and the exporting country has no alternative but to park them in U.S. Government debt. The money thus represents a virtually free source of financing for the U.S. government. And as Jack Ma, founder of Alibaba pointed out recently, what the U.S. did with this money may tell the true story of why the jobs went where they went.

What about human rights? The film also mentions several human rights violations by China, such as the repression of the Falun Gong or Tibet, or its role in human organ trade or nuclear proliferation and aggressive military build-up. These are non-economic arguments that should not be used to color our judgment over cheap imports. 

It is also a contradiction to state that China’s lack of concern for the environment gives them an “unfair advantage”. Indeed, the documentary itself shows China paying the price for its monumental environmental neglect. It is well known that Chinese cities are now considered to be among the most polluted in the world.

Where are the solutions?

The ‘blame China’ rhetoric is a fallacy, and it best stands exposed when its time to offer solutions. While the documentary ends recommending “trade reform with China” and says that China should be held “accountable for human rights abuses”, it fails to come up with specifics. While pitching for ‘a strong manufacturing base for a prosperous future’, the film fails to tell you exactly how it can be achieved.

And this is no surprise.

For, China is just the symptom, the cause lies elsewhere. And this is pointed out in the film itself by Ralph Gomory, President Emeritus, Alfred P. Sloan foundation, when he says, “we are living beyond our means, we have artificially high standards of living”. Fix that, and everything will fall in place.

And that’s what President Donald Trump will need to do, to “Make America Great Again”.

Beyond the obvious

Is allowing FDI in multi-brand Retail good for the country? What is the true impact of raising diesel prices or restricting LPG subsidy on the people? Should telecom spectrum and coal mines be auctioned to the highest bidder, or should they be allocated cheaply so that the price paid by the ultimate consumer (for telephone services and electricity) is kept low? Should rail fares be raised? Should the Central Bank reduce interest rates to stimulate industry and make loans cheaper? Should the government act against airlines who fleece passengers by charging exorbitant fares during peak season? Should the government explicitly promote export oriented industries that earn precious foreign exchange? Should cheap imports from countries like China be banned to protect domestic industry? Is the government right in spending thousands of crores on welfare schemes like MGNREGA? Questions such as these are debated daily, and are of interest not only to politicians and bureaucrats who decide on these, but also to citizens whose lives are affected.

How does one take a stand on all these? How does one decide what is right and what is wrong? How does one assess the impact of these decisions – beyond the immediate fallout that we can see (such as, for example, that one would pay more for diesel if diesel prices are raised)? Do these decisions have implications that are beyond the obvious? How do we know what will work out best for us in the long run?

“Economics in One Lesson” by Henry Hazlitt is a remarkable book by any means. Written in such a simple language that even a layman can understand, Hazlitt unravels the mysteries of economic decisions and their long run effects on the health of the economy and welfare in general. Hazlitt explains how markets work, how people behave, how governments decide and what they do to the very people they seek to assist. Hazlitt gives a framework that enables the reader to analyze the long run impact of such decisions, including that  which is not so obvious but nevertheless very important.

Hazlitt's remarkable book should
be compulsory reading for all

The book is divided into twenty five chapters, each dealing with a distinct topic such as taxation, effects of mechanization, import tariffs, export promotion, government price fixing, inflation, and so on. Hazlitt explains the basic principles underlying these actions and the impact of these on the economic activity as a result. Hazlitt uncovers not only that which is seen, but also that which is not seen. In Hazlitt’s own words, “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely on one group but for all groups”

It is amazing how much ignorance about economic issues is prevalent even among the policymakers today. Take the following paragraph from the chapter on government price fixing, for example. You might want to read it in the context of the current mess in India’s Oil & Gas sector, but keep in mind that Hazlitt’s small book was written in 1946!

Hazlitt writes, and I quote, “We cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are both tempted to buy, and can afford to buy more of it. The second is to reduce supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants. In addition to this, production of that commodity is discouraged. Profit margins are reduced or wiped out. Marginal producers are driven out of business….if we did nothing else, therefore, the consequence of fixing a maximum price of a particular commodity would be to bring about a shortage of that commodity. But this is precisely opposite of what the government regulators originally wanted to do…. Some of these consequences in time become apparent to the regulators, who then adopt various other devices and controls in an attempt to avert them. Among these devices are rationing, cost-control, subsidies and universal price fixing.” Hazlitt then goes on to systematically demolish each of these.

As we all know, relying on the promise of deregulation, billions of dollars were spent on all stages of the oil & gas value chain in India, from exploration to refining to pipelines to storage & distribution. But the country still doesn’t have enough of what it needs. Most of the capacity in the private sector has been shut or is on the verge of closure, the public sector survives on huge doles of support from tax payer’s money. People don't have enough of what they want and the private producers have all but fled, all because of faulty price fixing.

It is remarkable that such a storehouse of knowledge can be crunched in such a small book and explained so lucidly. This book should be compulsory reading for all the lawmakers who decide our future, and for all of us who choose them.

Property Prices - Part II

(This is the concluding part of a two-part series on property prices. The first part is available here. We continue from where we left off……)

The Central Government has proposed to set up a Real Estate sector Regulator ‘to ensure transparency and ensure fair practices’ (see here). The draft Real Estate (Regulation & Development Bill, 2011) proposes steps such as compulsory registration of projects with the Regulator, deposit of money collected from home buyers into an Escrow account to avoid diversion, setting up of an Appellate Authority to address complaints and grievances and stiff penalties including jail terms for guilty developers. Though the provisions of the Bill are welcome, the Bill will do nothing to increase supply and bring down prices.

Can the demand come down? In a country like ours, it seems impossible unless we are talking about a calamity of such massive proportions that buying property will be the last thing on anyone’s mind at that time.

My belief is that normal economic cycles such as an industrial slowdown and high interest rates are just not enough to cause a sustainable price correction in property prices. What are needed are sweeping legal reforms with far reaching implications. Some suggestions that come to mind: 

1. Eviction of an uncooperative tenant needs to be made easier. Then a big chunk of supply (click here) currently locked up empty will come into the market. The ‘stay order’ culture has to end. 

2. Transaction costs are just too high. Stamp duty, registration, service tax, VAT etc. add to almost 10% of the cost of the flat for the buyer. What the seller sells for Rs.50 lacs costs the buyer Rs.55 lacs. Atleast the first flat for every buyer should be made tax free. Getting a decent place to stay is a basic necessity of life, a Right as much as Right to Education or Food or Freedom of Speech. 

3. Stamp duty based on the value of the agreement provides a strong incentive to under report the transaction value. Today, it is almost impossible to complete a transaction without the ‘cash’ component. This reduces government revenues, which ultimately is compensated by higher taxes from those who pay. Stamp duty should be made payable based on the area of the flat or the ‘ready reckoner’ rate alone, not on the value of the transaction. 

4. Technological solutions that allow mass production of houses in some kind of CKD (Completely Knocked Down) form should be promoted. Such technologies exist, such as pre-fabricated buildings (click here) but need to gain wider acceptability. The governments have to drive this. This is the only way supply can be increased dramatically.

It is too much to expect innovative solutions that genuinely help the people from our present crop of politicians, who are actually beneficiaries of high property prices. A large chunk of their legitimate and illegitimate wealth is invested in property. From time to time, populist announcements such as increase in FSI or redevelopment of old buildings or mill land are made to pacify a gullible population. But such steps can never change the demand – supply imbalance and bring down prices. The batch of college students who is passing out today is not going to ever be able to buy a decent house in Mumbai.

In the long run, this will feed into social unrest. Social unrest can manifest itself in any manner, not necessarily into a demand for cheaper homes. One day, a benevolent dictator may decide that legislative fiat is the only way to alter the situation and dictate ‘all tenants become owners from tomorrow’ (or something similar). Such instances are not unknown to history.  This may seem far fetched today, perhaps it is, but we are heading in that direction only.

Until that happens, do not expect a correction in property prices. Getting a decent accommodation in the city of work will remain a pipe dream for a major part of the Mumbai’s population. “Affordable housing” is just a slogan, unless you believe that staying in Boisar and working in Mumbai is a life.

Why property prices did not fall, and will not. Unless....

(This is the first of a two part series on this subject)

The Reserve Bank of India (RBI) seems to have completed one full series of interest rate hikes with its pronouncements in the latest monetary policy announced this week (full text here). But despite almost two years of continuous interest rate hikes, industrial slowdown, scams and what not, and the prognosis of some experts, property prices have remained stubbornly high. With the talk now turning to when the RBI will reduce rates, you can discount any chance of a price correction. In this two-part article, I pen down some thoughts on Mumbai's property market, based on my observation of the business.

I. Demand:

1. India has 17% of the world’s population (see here), but just 2.3 % of the world’s land mass (see here). From this, if you reduce the land occupied by its water bodies, deserts, forests, hills & mountains and agricultural land, the land available for civil habitation reduces even further. It is only natural that India should have one of the most expensive land rates in the world. Reports such as this should not take you by surprise. 

2.  Considering the population growth rate around 30 years ago, demand today might be growing at 1.1 % p.a. or around 75 lac houses per year for the country as a whole. (Here I have assumed that a person enters the property market at the age of around 30 and two births create a demand for one house 30 years later)  

3.  To this, you can add demand caused due to migration from rural to urban areas, and move from smaller homes to bigger homes due to rising prosperity, and it is clear that the actual demand growth is much higher  than 1.1 % in cities like Mumbai. The economy just cannot build enough houses to keep pace with it. 

4. Property is also bought as an investment. People don’t mind buying a flat and simply locking it up. This absorbs supply without meeting demand of those who want a place to stay.

II. Supply: 

You cannot manufacture buildings on an assembly line

1. You just cannot mass produce houses, as if on an assembly line. Construction is a highly labour-intensive manual process. My observation is, even for a medium sized project involving a few buildings, a few hundred apartments which will accommodate a couple of thousand families, it takes anywhere upto 4 years from the time a project is announced to the time the last of flat is built and families can move in. By that time, demand would have gone up manifold!  Does the economy have so many project managers, architects, civil engineers, labourers, plumbers, electricians, carpenters, etc. who can work cohesively and dramatically increase supply? The truth is - supply can only increase inch by inch, while demand is increasing by leaps and bounds. In my opinion, this is the single biggest factor that drives prices in a country like India.

2. A builder may need as many as fifty different approvals from various government departments to get a project cleared. At each stage, he either faces red tape or bribery. This either reduces supply or increases the cost to the ultimate buyer.

3. Builders ‘release’ only a few flats for sale at a time, usually the least saleable ones first. They have enough supply of money, formal as well as informal, to enable them to hold on to their inventory. If they find themselves in trouble, banks restructure loans to protect their own NPAs. So there is no urgency for the builder to sell. This happened in 2009. 

4. There are thousands of flats lying empty and unused in Mumbai and elsewhere, just because the owners don’t want to risk renting them out. This supply is permanently out of the market. 

5.     At a systemic level, the leveraging among buyers is just not high enough to force distress selling due to a marginal interest rate hikes, such as what we have seen: 3 to 4 per cent increase over a two year period.

In other words, the supply - demand gap is just too much to allow normal economic cycles to induce a price correction. Even the hint of a correction will bring in a hoard of buyers at support the market.

(to be continued)

Is petrol actually very cheap?

There has been a lot of clamour about high petrol prices, and rightly too. Of the Rs.70-odd per litre that petrol is retailed at, only Rs.35-40 would be the true ‘economic price’ of petrol (including a ‘normal’ level of profit and ‘normal’ taxes) and another Rs.35-odd are taxes.  This is nothing but government loot, no other commodity is taxed as much, except liquor and cigarettes where ethical reasons may justify exorbitant taxes.

Drilling for oil in the deep sea

At these levels of Rs.40 (or even Rs.70) per litre, is petrol really that expensive? Consider the economics. Drilling for oil is a difficult business. Oil is formed in the belly of the earth by a gradual process of degradation of fossils over millions of years of earth’s formation. To get it to ground, you hire a team of highly educated geologists, purchase sophisticated satellite imagery, and identify potential areas where oil could be found. Inevitably, most of such areas happen to be inhospitable, such as barren deserts or at the bottom of the ocean. You need expensive drilling equipment that reaches the core of the earth. Of the many wells that one drills, only a few yield oil in quantities large enough for commercial exploitation. The whole process, from prospecting for oil till the first drop is sold may take anywhere upto 10 years. The company employs highly paid consultants, engineers and project managers who work for years together to make the project a success. The exploration company ends up spending tens of billions of dollars, over several years before its first revenue is earned.

World's largest refining complex is at Jamnagar

Crude oil that comes out of the ground needs to be refined before it can be used. Refining is also a highly complex engineering operation, requires another several billions of dollars of investment, and sophisticated engineering and management skills. Building a refinery takes as much as 3 to 5 years.

Refined petrol, one of the many outputs of the refinery, is now ready to fill your fuel tank, but it is yet to reach the consuming markets. Large and small petrol pumps, located in the nook and corner of the country need more money to build than say, a warehouse storing rice or timber or any other commodity. And when it enters your fuel tank, the fuel is burnt within days and is lost forever!

Throughout this process, huge amounts of time and money are also spent in transporting the commodity. World’s major oil exploration centres are in the barren deserts of Arabia, the deep sea in the Gulf of Mexico and Brazil, or in Siberia in Russia. Major refineries are located thousands of miles away, such as in India, China and the Far East. Consuming centres are in Europe and the US. At each stage, oil is transported through massive tankers which themselves run on oil, or by pipelines, which take several years to build and cost several billion dollars. There are pipelines which run across the entire length of Russia, from Siberia in the East to the developed markets of Europe. Giant ships circumnavigate half the globe from Reliance’s giant Jamnagar refinery to the United States and elsewhere.

I have written all this in some detail to give you an idea of what a drop of petrol goes through, before it enters your fuel tank.

Compare this business to that of making any other household product such as a shampoo, detergent, fruit juice or ketchup. These products can be manufactured in any tin-roof shed just across the lane with a handful of uneducated labourers, and sold in a matter of a few days to recover the costs and make a profit.

Prices of some common household products

Product	Rs. per unit (MRP)	Effective Price (Rs./ Litre)
Dabur Vatika Shampoo	165 per 400 ml	413
Dove shampoo	58 per 90 ml	644
Fiama Di Wills conditioner	40 per 50 ml	800
Lifebuoy handwash	40 per 200 ml	200
Rin fabric Whitener liquid	18 per 200 ml	90
Coolmint mouthwash	95 per 250 ml	380
Baygon spray	138 per 500 ml	276
Old spice after shave	150 per 100 ml	1500
Colgate toothpaste	91 per 300 gm	303
Dettol shaving cream	45 per 91 gm	495
Tropicana Fruit juice	90 per 1000 ml	90
Red Bull	85 per 250 ml	340
Maggi Hot & Sweet sauce	107 per 1000 gm	107
Del Monte tomato ketchup	102 per 1000 gm	102
Real Fruit Juice	90 per 1000 ml	90
Navratna Hair Oil	115 per 300 ml	383
Garnier Deodorant	150 per 300 ml	500
Thums Up	10 per 200 ml	50
Petrol (with taxes)	72 per 1000 ml	72
Petrol (without taxes, approx.)*	40 per 1000 ml	40

 When we consider all this, does petrol not appear very cheap?

(Note: Images may be copyrights of respective owners)

Industry captains write a letter - addressed to nobody

A group of 14 prominent and highly respected citizens, which includes the likes of HDFC Chairman Deepak Parekh, ex-ICICI Chairman N.Vaghul, Wipro Promoter Azim Premji, ex-RBI Governor Bimal Jalan, Mahindra & Mahindra Promoter Keshub Mahindra etc have come out with an “open letter to our leaders”  expressing grave concern at the ‘governance deficit’ in government, business and institutions. They have voiced their concern on issues such as rampant corruption, widespread discretionary decision making, ‘extraneous influences’ and the like.

Read the full letter here or the news reports here.

It is true that Manmohan Singh’s Government is proving to be one of the worst governments in recent memory, with failures not just on the political front (terrorism, naxalism, Kashmir, North - East etc), but also on the economic front. One would have at least expected better economic management of the country with an economist Prime Minister at the helm. Instead, food prices are doubling every few months.

But what to make of this letter written by the captains of the industry?

Agreed, these individuals themselves may be clean, but only the most naïve will believe that they are unaware of what is going on in the highest echelons of power. The nexus between politicians – industrialists – bureaucrats – journalists has been well known, and stings like Niira Radia tapes amply prove that everyone is hand in glove in looting the nation. Instead of writing a letter, which is addressed to nobody in particular (an open letter “to our leaders” – why not say to whom?? Who are “our leaders”, what is their name??), these people should come forward and make open disclosures exposing the corrupt. The investigating agencies will be under pressure to investigate and find out the proof. For example, in one of the Niira Radia tapes, ex-CII Chief Tarun Das has talked about Kamal Nath (Minister of Road Transport & Highways) “making his 15%”. Obviously, Das knows what he is talking about. Why can’t he go to the CBI, or the ACB (Anti-Corruption Bureau) and lodge a complaint? Is Deepak Parekh not aware of a single instance of the builder – politician nexus? Why has he not exposed them? What has he done to stop the flow of black money in the real estate industry?

Agreed, these individuals are themselves citizens with high standards of integrity. But this “open letter to our leaders” means nothing to me. In fact, the very fact that the letter is not addressed to anyone in particular, such as the Prime Minister, or “Madam”, or whoever else “our leaders” are, shows an intent to remain in the ‘good books’ of these very leaders who are responsible for this ‘governance deficit’.

To me, this letter is a farce that will achieve little other than a couple of claps from fellow journalist friends. Let them not fool us that these guys have done something great. Let us not clap at this farcical exercise.