Homo Economicus?

If you drive in Bangalore (for that matter any city in India), the traffic stops come with a rather uncomfortable experience - interaction with beggars. To begin with the term 'beggar' itself is derogatory - and their very existence is a reflection of a failure of the economic system to provide a safety net for the poorest of the poor. 

Anyway, the other day, I was stuck at one of those interminably long traffic stops when an old man approached me - he was the archetypical 'beggar' with tattered clothes and a ragged look. There was a difference however - instead of pan-handling, he was trying to sell some ear-buds. The underlying approach appeared to be fairly straightforward - trigger a sense of guilt/shame/pity (whatever that is when you are accosted by a beggar), but then follow-it up with an attempt to sell something. A sensible strategy from that individual's point of view I would think - since there could be two possible responses from the 'giver' - 1) you really 'need' the product or you may rationalize that you may need the product at some point in the future or 2) you really don't need the product but you can still rationalize giving money in exchange -you could then rationalize that you are not really giving alms but performing an economic transaction. (The third option is to just ignore - but we shall not be bothered with that class of decision makers for now)

Then the interesting question is - how rational are either of these responses? It does qualify as an economic transaction and hence in a purely economic sense, qualifies as a transaction that contributes to the GDP. But from a utilitarian point of view, it is obviously a sub-optimal situation since the transaction has contributed to two distortionary events:

1. It has created a 'need' where none probably existed - the economic system will now be expected to take this information and feed into its cycle of demand/supply planning. Which in turn, means that the resource allocation has moved away from its pareto-optimal point.

2. It has contributed to creating a sociological dilemma - while everyone seems to agree that begging is demeaning and should not happen, this also sends a signal that getting a begger to sell ear-buds may be all right. Never mind that the actual driver for the transaction was similar to the one motivating the beggar being given alms.

Yet another reason to question the micro-economic edifice based on the purely rational homo economicus.

Third Worlds within a Third World

My job takes me to various cities in India and the breathtaking diversity never ceases to amaze me. India is clearly a multitude of nations within a country. Needless to say, what is germane here is not the cultural diversity but the seemingly vast economic variations that seem to exist in this country. Over the last few months, I have visited Delhi, Hyderabad, Chennai, Kolkata, Kanpur and Patna (from Bangalore where I live). You don't need to be a trained economist to realize that some of these cities - Delhi, Bangalore, Hyderabad, Chennai are on the opposite ends of the economic spectrum from Kanpur and Patna, with Kolkata somewhere in between. While there is the glitz, frenetic construction and the quintessential urban chaos that accompanies rapid and unplanned growth that is unmistakable in a Bangalore or Chennai, the opposite is true of Kanpur and Patna. It is almost as if the much talked about economic growth has bypassed these cities. This is not to say that the richer cities have managed to get rid of poverty - on the contrary, economic disparities may be growing wider in these cities. Despite that, there is an unmistakable feeling of optimism that comes with economic growth - a feeling that is conspicuously absent in a Patna or a Kanpur. There is no better place to see this than the railway station - the one institution that seems to capture the city's economic spectrum in a microcosm. While the Bangalore station even has a wi-fi hotspot, an internet cafe and umpteen Coffee Day kiosks, the Kanpur station is a drab, crumbling edifice dotted by just a couple poorly maintained kiosks. Walk out of the station and the differences are even more stark - the Kanpur station transport system is dominated by cycle-rickshaws, which are fast dwindling (thankfully) in places like Bangalore, Hyderabad and Chennai. In fact the single most striking fact in a Kanpur or a Patna is the vast number of cycle rickshaws that ply on the roads. One obvious reason for this is the fact that as older industries (e.g. tanneries in Kanpur) dwindle and are yet to be replaced by the newer ones, the surplus labour is driven to take up jobs with extremely low entry barriers like ferrying people. One naively optimistic view here is that some enterprising entrepreneur can spot an economic opportunity in these cities for setting up labour intensive industries (obviously, there is a lot more to an attractive investment opportunity than surplus labour). A more likely (and depressing) scenario is that these economic disparities are likely to continue to grow - as the richer states and their cities hope to climb into an economic virtuous cycle while the poorer states are forced to languish in their economic quagmires.

At a more macro-level, such intra-country variations, combined with other political trends (most notably the growth of regional parties) could lead to newer forms of friction. One obvious outcome of this disparity is the growing migration within the country. While little research seems to have been done on the demographic shifts driven by economics, there is growing intolerance on regional lines - the recent events in Mumbai being an example. Further, it is not inconceivable that some of the richer states begin to push back against the current taxation system, where the federal structure translates to the richer states subsidizing the poorer ones, something that is currently an undisputed outcome of the socialist nature of the Indian economy. One scenario could be a push towards a more decentralized form of taxation (moving towards a strongly regional bias similar to the Swiss system of Cantons). This, in a sense, will be an affirmation of the fact that this is a nation of individual states who were brought together by an accident of history and not bound together by a compelling cultural or economic glue. And if and when that happens, the already uneasy nature of this lop-sided growth could take a much uglier turn.

The Economics of Charity

To the economist, the concept of charity ought to be an aberration, at least when viewed through the lens of rational economics. For a profit-maximizing individual, charity will find no place in his calculations. What then, can explain the acts of giving - from the one rupee to the beggar at the traffic signal to more elaborate forms, ranging from supporting causes to even part some or all of your time to acts of giving. Clearly, the drivers are more than merely economic - and yet, little is known as to what motivates people to go out and part with their money, time or both without any clearly quantifiable economic returns. The Platonic view would be to attribute this quality to the 'goodness' or a sense of morality that is intrinsic to humans - but that is in the domain of philosophy, one area where economists fear to tread.

One immediate cause that comes up is Religion. Religions that were born out of socialist ideals have even taken the trouble of linking charity to social justice and in turn, justice as an essential objective of religion. And so there is the concept of 'tithe' in Christianity (which required individuals to contribute a tenth of their output - be it in cash or kind, to the church). Islam is equally formal about this and even empowers the state to collect such contributions and provide guidelines on spending them (http://www.alrisala.org/Articles/mailing_list/charity.html). The underlying message, of course, is that spiritual enlightenment is tied to charity - in other words, there is a potential upside (however vague that maybe) to charity. As the cynic would retort, would it remain charity any longer? Moreover, this fits in with the age-old role that religious establishments have played - that of custodians of an individual's path to spiritual enlightenment. However, this could easily be interpreted as a way for the individual to 'buy' his/her way to his/her spiritual goals. Which is probably why the more philosophical religions like Hinduism and Buddhism are not explicit about charity - they appear to club charity together with a larger basket of material and spiritual activities that drive a way of life leading up to Nirvana. Not that this approach is devoid of issues - for one, it is difficult, for the average person, to clearly identify what constitutes this way of life. It is precisely this ambiguity that created a 'market opportunity' for the Brahmins to step in and offer to be the guardians of an individual's spiritual roadmap. One rather unfortunate outcome of this is the seemingly paradoxical behaviour in India - lavish temples are built all the time in the midst of all the poverty and deprivation. One interesting area of research would be to assess the evolving trends in charity, as incomes grow.

One suspects, however, that in India, a paternalistic form of charity has always been more popular, given its very long history of caste based feudalism. Historically, the ruling, landowner and merchant castes used to indulge in charity - in its benevolent form, this was money doled out to people who worked for them, which only served to perpetuate the social hierarchy. In its more malevolent form, this would take the form of economic slavery, where the giver explicitly 'bought' out individuals (bonded labour is, in fact, still prevalent). In modern times, while economic growth has blurred the caste-driven social hierarchy, the increasing economic disparities have ensured that the opportunities for paternalistic giving have not gone away. Partly as a means to mitigate guilt and partly as a way of buying loyalty, the economic haves are not averse to paying for the maid's children education or the surgery that the driver's wife had to have. While it may give the warm afterglow that accompanies any act of giving, it also has the potential of buying loyalty. At least in this case, there is no doubt in the economics of charity.

And so the question remains - is charity driven purely by a sense of morality or is it the outcome of a sub-conscious (or deliberate) act of calculated cost/benefit analysis? That is a question for the philosopher to ponder.

The Economics of Religion

India is a crowded country - and that is nowhere more evident than in public places, even more in places like Tirupati, where the crush of people can be quite an experience. As India develops, aspirations grow and with that, the need to propitiate the gods on a regular basis. Apparently, there is a huge spike in pilgrimages immediately after examinations - with the growth of the knowledge society, it is increasingly becoming important to get a good education. And since access to good education is determined by exam performance, I suppose it stands to reason that people are willing to invoke any intervention, divine or other, that may be on offer. To top that, transport, accommodation etc are improving and becoming more affordable. The net effect is that there is a steady increase in the number of people making pilgrimages. That in turn, places a heavy burden on the infrastructure, not to speak of the deteriorating quality of experience for the individual pilgrims.
Which brings us to an interesting situation - is there anything that can be done to improve this? In a clear market situation, one would expect the supply to increase to cater to the increase in demand. But spirituality is clearly not an economic good - i.e. it does not seem possible for some other temple (or God) to step in and increase the supply! And since spiritual experience cannot (at least yet) have a monetary value, it is obviously not a candidate for the laws of conventional demand/supply. So what are the alternatives? Here are a couple - we are obviously treading on a very slippery slope - religion tends to bring out a lot of passion in lots of people:
1. Increase the temple user charges. In Tirupati, for example, there are various slabs you can pay to reduce your waiting time. In other words, the temple has tried to assign a monetary value to an individual's time and the individual's willingness/ability to stand in crowded lines in less than hospitable conditions. As purchasing power grows, the demand curve itself moves out - i.e. for the same price point, the demand is higher every year. One way to rein that in is to increase the user charges, a conventional market response. But this in turn, raises other tricky questions in an intensely religious country like India. Religion is treated like a public good - i.e. people tend to assume that everyone has an equal right to a spiritual one-on-one with their chosen God(s), which should normally make it difficult to increase rates. However, given the ability of Hindus to handle contradictions with ease and a deeply ingrained acceptance of elitism, this may come to pass sooner or later. In fact, the charges could even be dynamically determined based on the length of the queue - i.e. as the queue grows, the premium charges go up correspondingly, essentially capturing an increasing share of the consumer surplus.
2. Let the 'wisdom of crowds' make the decision. In other words, it is likely that some people will decide that all the pushing and jostling (not to mention frayed tempers) may not be a very spiritual experience and choose to stay away altogether - these are the people who would have decided that the total physical and mental cost of the pilgrimage may not be compensated by the spiritual upliftment. This is an interesting case of crowd-wisdom: if every pilgrim opts that line of thought, no one would actually go on the pilgrimage. The truth is somewhere in between - and it is not very clear what that equilibrium point would be and how that would be arrived at. Simplistically speaking, the break-even point would be where the cost of the total wait equals the spiritual returns - as the queue length increases, the cost of the total wait keeps on going up linearly and when it crosses the spiritual returns, the line should, logically speaking, terminate. The obvious problem with this is that there is no objective, standard measure of spiritual returns - it changes from one person to another.
3. As in any rational market mechanism, it may be that some other temple(s) may enter the 'market' to offer the same basket of spiritual benefits at a much lesser cost. This is not as inconceivable as it sounds, especially when it comes to religion where people are often willing to suspend rational thought processes - it takes a few myths to start drawing people from the larger places of worship to other alternatives. This may actually be the most plausible solution that may present itself and could even be positioned as cosmic intervention, making it the most politically correct alternative.

Remains to be seen what actually comes to pass - and the fundamental question remains, why is it that religion does not follow the conventional laws of economics?

Why are the Poor poor?

A few days back, we were talking about the notoriously unpredictable maids, which is probably a favourite talking point in our demographic profile. Not surprising, given that the maids/drivers (euphemistically known as the 'Support Staff') play a critical role in determining the quality of our lives. The common refrain is that they lack a work ethic (never mind the times when you log out of work on the excuse that your child is not well, which interestingly seems to coincide with a cricket match) or worse, they lack the foresight to calculate the long-term effects of such erratic behaviour. And so the reasoning goes - this is why the average maid or driver does not seem to stick around in any job for a very long time.

This whole line of argument sounds specious to me - you would expect the exact opposite from a rational being, especially where the costs of such behaviour can be enormous. When you are at the bottom of the economic pile, reason has it that you should be trying without any loss of focus, to climb up the ladder. Continuing along those lines, you should be maximizing the marginal utility of your time and money - the former by working as much as you physically can and the latter by ensuring an optimal consumption mix on current expenditure (e.g. food, shelter etc) as well as capital expenditure (e.g. investing in your child's education). But reality, as we know, is far removed from this rather 'utopian' view of poverty. And so the question arises, why do the poor tend to be more prone to taking drugs, unable to keep a job, do not send their children to school etc. I am not sure there are any clear answers (at least traditional economic theories do not seem to work in such cases).

There is an emerging point of view that the "biggest cause for poverty may be poverty itself". See this article "The Sting of Poverty" that appeared recently in the Boston Globe. The main thrust of this argument is that it is not a question of a lack of opportunity or self-discipline - but given the multitude of their problems, there is no clear incentive in trying to resolve one/some of them. There is not enough data or studies to prove that this is actually the case - but it does seem like a plausible explanation for the seemingly odd behaviour (defined in economic terms). And if it is indeed true, then this could have implications on public policy. For instance, it becomes clear that targeted schemes (like mid-day meal schemes) may not be the most optimal allocation of resources since these schemes just end up targeting one part of a multitude of problems - and moreover, that solution may be too small in comparison to the overall problem of poverty to have any discernible impact. A better alternative could be to give the poor money and let them make their choices (the NREGS is one scheme which could be unwittingly moving in that direction). Easier said than done - since such a policy prescription has its own issues - the important ones being, how do you measure outcomes in such cases and more importantly, hand- outs may end up creating a disincentive to work.

Either way, this promises to be an increasingly interesting area of work, one that could determine welfare policies down the line. At the very least, this alternative is questioning the conventional wisdom of microeconomics that has dominated the landscape so far.

The Economics of Vegetables

Yesterday, happened to visit a "farmers' market" - the amateur economist in me noticed several things, which I am not sure has been covered by the economists. If you visit any such market in India, you would have noticed a few things:
1. There are a very large numbers of sellers, mostly selling an assortment of vegetables. The stocks that the individual sellers carry are fairly small (around 20-25kgs), obviously a sensible strategy since they need to get rid of the entire stocks within a day or two. The optimal mix and quantities is a matter of trial-and-error but how many chances does the vendor have?
2. While some vegetables (e.g. potatoes, onions et al) could last a few days, much of their stocks (e.g. greens, tomatoes etc) would not last more than 1-2 days. Should the mix combine the two types as a hedging strategy? Curiously, you do not see this very often.
3. There is definite lumpiness in demand - while weekends/ holidays tend to be busy, weekdays are almost always slow. Should the vendor then stock more at the beginning of a weekend? How much more?
4. There are extreme cases of a specific vegetable/fruit that is in demand for a specific purpose (e.g. festival) - in such cases, there is a huge spike in demand in the run-up to the festival day, followed by a complete collapse in demand. In such a scenario, how much should a street vendor buy from the wholesaler to sell?
5. The supply chain until that point (i.e. to the suppliers to these vendors) is reasonably well- organized, with bodies like the APMC, setting wholesale prices. One could assume that these prices, in turn, set the floor-price for these vendors. Is cost-plus pricing the right thing to do in such a case?

All of the above must present a highly complex problem to the vendors who are obviously not equipped with any of the fine mathematical tools(!) that have been foisted by the economists. And yet, they seem to be doing reasonably well - not quite sure if they are able to maximize their profit function, but their survival itself demonstrates a keen sense of the market, including discerning its intra-day fluctuations and the ability to react them rapidly. A few trips to such markets throw up some interesting observations:
1. At the beginning of the day, the prices tend to fluctuate quite a bit - with the variation markedly higher for perishables (e.g. tomatoes as against potatoes). The strategy must be to grab as much of the consumer surplus as possible before the market settles down on a price. What the vendor is betting on is quite simple - most buyers would not have the time/inclination to do an extended search for each vegetable to compare prices etc.
2. However, as the day progresses, prices tend to settle down - presumably, at some point above the floor price. The network effects (exchanging notes between themselves, buyers transmitting the information during the process of haggling) probably come into play - and the curious thing here is why these sellers do not turn this information flow into a oligopolistic situation (by price-fixing). Wonder why that happens.
3. The toughest part for the seller, undoubtedly, comes towards the end of the day. She needs to make decisions on how much to carry for the next day, or worse, if the stocks will not last till the next day, when to start dumping at below the marginal cost (i.e. the floor-price). In all this, she needs to ensure that she has recovered her total costs (which could be the sum of her procurement costs and all other overheads, including the travel costs, payoff to the local tout etc)

By now, it is obvious that these vendors are subject to the most brutal, unforgiving form of 'market economics'. And so the question of the welfare-seeker would ask - are there any interventions that are possible to make their lives a little easier? One alternative could be to do a price-setting exercise for the entire market on every day. Obvious implementation issues are - how would this be done (perhaps a committee - but we all know where committees lead) and more importantly the principal agent problem (how can you ask the sellers to set a price without equal representation from the buyers?) All these have upstream effects on the supply chain, all of which makes it an extremely volatile and hence risky industry for all the parties involved (producers, wholesalers, retailers).

In India, such interventions are routinely exercised in cases of food grains (much in the news of late, thanks to inflation), but not much seems to have been done where markets are localized (producers and consumers are typically within a 100km radius). This comes with a simple disadvantage that the supply chain participants are not a vocal enough political force and are hence bypassed by the democratice process.

One obvious intervention could be to invest in better storage facilities (e.g. cold storage) at all levels in the supply chain to help smooth out the supply/demand imbalances. The other intervention could be to create a information network (say using mobile phones) whereby prices are exchanged between the various parties (between sellers as well as between buyers/sellers), removing some of the price distortions.

Interestingly enough, the supermarket chains may be helping in the process - while they do take the market away from the street-vendors, they do bring improved stability of demand further up the supply chain. But the politics (and economics) of the supermarket chains in India is another story altogether.

For now, the street vendor deserves a little more respect - no amount of mathematical modeling can even begin to capture the mind-boggling number of variables and decision matrices that they seem to process effortlessly to eke out a living - may be the 'rational choice theory' is actually an non-oxymoron 'instinctive rational' choice theory !!

Conspicuous Consumption

The last Mint Saturday Supplement (Lounge: 29/March) was devoted to the topic of luxury. That is one area where we can expect to see a lot more discussion in the coming years.
A strict economic definition of a luxury good is one that has a high income elasticity of demand, i.e. demand increases faster than the growth in income. And as we are in the middle of an unprecedented salary boom (at least for the readers of Mint), it would seem logical that luxury is dragged out of the closet and lists of the latest objects of desire or envy (depending on where you are on the elasticity curve) are drawn up.
In India, we tend to be a little apologetic about wealth - call it a hangover from Nehruvian socialism and/or Gandhi's 'pastoralism'; or more realistically, the fact there was too little of it going around for the last 50 years or so. And so the tendency has always been to look down upon it (nothing riles the intellectual snobs more than the naked display of wealth) and for the ones who did have it, the best thing to do was to stuff it in a pillow or at least, not admit to having too much of it. None of the chest-thumping variety of consumption (have it, flaunt it) that is common in the US. I would like to imagine that some of it was also the effect of religion as well - but the fact has been that has been more preaching than practice.

The story, however, is changing - in the last few years, people are increasingly not averse to spending more on discretionary items - including luxury goods. An interesting sub-category of luxury goods is what are called 'Veblen goods' (after the rabble-rousing Thorstein Veblen of the 'Theory of Leisure Class' fame). These are goods where demand actually tends to increase with the price. Apparently, this is because of the envy factor - if you believe that your social standing will go up in proportion with the price-tag, you would be willing to put down that premium. In effect you are buying social prestige - how very noveau riche, some would say.

It would all be very nice, if luxury consumption was just an economic oddity. However, social scientists have been pointing out for sometime that envy as a benign force with salutory effects may work in developed economies but in case of developing economies, where income (and wealth) disparities tend be very large, this could have social implications. Much has been written about this - what remains to be seen is how as societies, we cope up with these kind of trends. This will probably be capitalism's greatest test - can it ensure that economic growth is rapid and inclusive enough to offset the potential for social unrest and such pangs that growth brings along with it?

The economics of happiness

Bhutan recently held general elections (in a planned transition from an autocracy to democracy - quite an interesting process in itself, but that does not concern us). The Royalist Party that won the elections pledged to continue the king's focus on Gross National Happiness (See article).
Needless to say, this is an interesting concept - especially where the mainstream economic and policy thinking revolves around the measurement of material well-being and growth (measured in monetary terms). See the article for how the Bhutanese interpret this concept. While it does sound like an attractive proposition, there are two obvious challenges:
1. How do we measure GNH? Happiness is a devilishly elusive concept - one man's happiness may be the next one's gripe. T
2. The bigger challenge is how do we compare GNH across countries or within a country across states?
3. Third and most importantly, happiness is largely an individual goal - as the hedonist would say, to each his own. In fact, the religions (at least the major non-Semitic ones - Hinduism and Buddhism) have squarely put the responsibility of the definition and subsequently, the pursuit of happiness on the individual. Given that, would it be possible to arrive at a common definition of happiness?
Bhutan, which is largely dominated by a single ethnicity and more importantly, a single religion, may attempt a GNH, but try that in the bewildering diversity (economic, social and religious) that is India. Cannot imagine the argumentative indians agreeing on a common definition.

One of the biggest advantages of the traditional measures of GDP/GNP has been the ability to compare differential growth rates and/or prosperity levels. That serves as an important tool in making policy decisions, especially allocation of resources. Unfortunately, the human race (with its economists, philosophers, godmen et al) has yet to come up with a standard that can improve upon the existing standard measure - money. Since the birth of money, we have come to accept that as a common standard that can be used to assign a value to any TRADEABLE good/service. The assumption here being that anything that is tradeable can be exchanged between two or more individuals and if that be so, it needs to be assigned a value that all the parties could agree upon (that at least is the primary assumption of economics). Conversely, we have also seemed to accept that whatever is not tradeable is not worth measuring in terms of money - which brings us back to the original question - what is the price of happiness, which is clearly not a tradeable commodity?

That said, there is certain merit in taking a more holistic approach to development - something that goes beyond the singular focus on material growth. Such examples abound - selling more cars is good for the economy but that leads to pollution, traffic jams etc which have a definite cost attached to them. So what is the net cost/benefit of putting an additional car on the road?

But then, as the economist would say, it is futile to try and devise a GNH - a worthier goal may be to eliminate all the externalities (positive and negative) so that the 'true' cost can be arrived at, and let the market make the decisions. That of course, is based on the rational choice theory - which, some say, credits the homo economicus with too much intelligence!

Global Warming

Yesterday's papers carried a small news item on the melting of the Wilkins glacier in Antartica (NY Times Article). I am sure most people chose to gloss over it - for a few, there may have been a slight pang of guilt (myself included) but for most, it would amount to some remote news item of little immediate interest. In almost all cases, readers would find it impossible to accept any responsibility for this, just as most people fail to accept any personal responsibility to problems arising out of collective failure like global warming, traffic jams et al. This has often been characterized as the prisoner's dilemma, where participants often maximize their own payoffs, at the cost of the 'collective payoff' (creating a pareto-suboptimal solution).

Here in lies a paradox that has continued to flummox economists for several years now (at least the proponents of behavioural economics) - the fact that we humans consistently end up failing to factor the long-term consequences of our immediate actions. One possible reason could be that we are hard-wired for such behaviour. In the hunter-gatherer mode with the constant threat of predators, natural forces etc, it is hard for the brain to look beyond the next few meals. Even so, it is extremely difficult to quantify the complete set of externalities (negative and positive) in many cases - most notably in the case of environment. What is the incremental impact of switching on the air conditioning in your car? Can the environmental cost of that be built in to the cost of petrol? Assuming yes, who is the beneficiary of that cost? Does it go to some environment fund? The implementation challenges are obvious.

Which then begs the question - is there any point in even trying to influence/change this behaviour? This obviously has profound policy implications - the most obvious (and pressing) issue at hand being global warming and the policy choices to keep the human race from destroying the planet, or at least postponing the inevitable.

The good news is that the academics are beginning to sit up and take notice - hopefully, there will be some solution frameworks soon and then the challenge will be to get the governments to adopt them. One such solution that is being tried out is the idea of carbon credits , which could work at the industrial level - it is possible (and is already happening) to impose carbon charges on polluting industries and also award carbon credits for non-polluting ones and then monetize this by creating a trading market for these credits. The real challenge is to move this to the individual level - i.e. impose/award carbon charges/credits for individual decisions. Measurement (how to measure, how to charge) and agency (who charges and who gets to keep the charges etc) issues need to be overcome.