Power & Market
Modi's Policy of Higher Taxes, Spending, and Inflation Make India a Growing Risk in Emerging Markets
India’s economy had an annual growth of 5.0 percent in the April-June quarter, the slowest in more than six years dragged down by weak consumer demand and private investments.
A Reuters poll of economists had forecast annual growth of 5.7 percent for April-June, compared with a 5.8 percent rise the previous quarter. For April-June 2018, India reported 8 percent growth.
Last year I commented about the risks for India here.
Governments always consider that economic problems come from lack of demand, and they assign themselves the task of “correcting” that wrong assumption by massively increasing deficits and using monetary policy well beyond any logical measure.
India’s rising populist policies are part of the nation’s current problems.
Recent data is quite concerning.
Industrial production, manufacturing PMIs and growth estimates are coming down (according to Focus Economics).
According to Kotak Economic Research, India’s current account deficit is forecast to be the highest in six years. The overall balance of payments is moving into larger deficits than expected, as capital inflows weaken and are unable to current account deficit.
Another warning comes from the maturities in foreign exchange. Nearly $220 billion of short-term debt, equal to more than half of India’s foreign exchange reserves, will come up for maturity in 2018-2019 fiscal year. Moody’s states that India is one of the countries that are least exposed to a rising US dollar. However, Moody’s did not expect the rupee to fall this much.
The average maturity of debt is close to 10 years and over 96 percent of it is in the local currency, according to Moody’s. However, it also notes the country’s low debt affordability. Given that the vast majority of debt is in the local currency, the incentive to depreciate the rupee is very high.
Foreign exchange reserves remain acceptable but can fall rapidly. Foreign exchange reserves are likely to suffer another dip as the rupee falls against the US dollar.
At the same time, 68% of the fiscal deficit target for 2019 consumed in the first quarter.
India expects a fiscal deficit of 3.3% of GDP in 2018-19 that seems quite challenging, given the weakening of data and the rise in expenses. The deficit was revised up to 3.5% of GDP in 2017-18.
The combination of wider trade and fiscal deficits added to lower reserves makes the currency weaken severely. The rupee keeps plummeting to new lows vs the USD.
India’s government usually solves this equation increasing subsidies and raising taxes. That combination will not work in a world that has a lower tolerance for fiscal and trade imbalances and a risk-off scenario. Additionally, the tax wedge is already a high burden. As Prateek Agrawal notes, “if one looks at GST and taxes on the affluent sections, India would rank as one of the highest taxed countries globally. For consumption, these sections are actually paying close to 60 percent of the income as taxes).
Additionally, printing more rupees is not going to solve the challenges.
The situation in India is not as desperate as in Turkey or Argentina, because FX reserves are not being depleted at a high rate, but the trend is concerning and the outlook for growth, trade and fiscal balances is weakening.
The government has preferred to raise taxes and increase spending, and the demonetization policy was a big mistake (read). All the cash that was taken out of the system came back a few months later. It is time for India to change its historical policies of subsidizing the low productivity sectors to penalize the high productivity ones with more taxes.
India can easily navigate this turmoil if it changes some misguided demand-side policies. The question is, will the government do it? Or will they prefer to blame an external enemy and increase the imbalances?
If the government decides to ignore these issues, India could become a big risk in emerging markets.
The Macro Problem of Microtransactions: The Self-regulatory Challenges of Video Game Loot Boxes by Matthew McCaffrey has been published as a case study for Harvard Business Review.
The video game industry has ignited a global controversy surrounding microtransactions in gaming, especially the use of loot boxes: randomized rewards with potential real-world value. Consumers and legislators are calling for the regulation of these revenue models on the grounds that they are unfair, predatory, or could be considered gambling. This article examines the controversy from a management perspective. First, I introduce current regulatory responses to the controversy and what they mean for business practices. Then, I explain ongoing industry-level and firm-level attempts to self-regulate as a way to placate consumers and governments. These tactics highlight a wide range of broader strategies that game developers and other stakeholders can pursue in order to improve customer relations and, more publicly, signal their commitment to self-regulation and avoiding consumer harm. These practices can be applied more broadly to firms that offer controversial products or services that do not yet fit within current regulatory frameworks.
Available for purchase here.
For more from McCaffrey on the topic on the Mises Wire:
I am quoted in the Washington Post in a story about the controversy over video game loot boxes. Loot boxes have been much debated in the past few years, with consumers frequently venting their outrage and regulators circling the gaming industry eager for a chance to flex their political muscles. As I've argued repeatedly, however, many critics overlook the economic significance of loot boxes and other microtransaction models.
The Post article has to do with upcoming changes to Rocket League that will remove its loot boxes, and what these changes will mean for the thriving black market that's grown up around the game. These changes are likely all to the good, as they show that the market is working to keep consumers happy: gamers complain loudly about loot boxes, and developers and publishers are changing their revenue models in response. My point, as I've been stressing since all this began, is that this process is a small part of a much larger experiment going on in the industry right now in which entrepreneurs try to figure out new ways to keep (mainly AAA) games profitable. Yet despite the much-publicized backlash from consumers, we haven't heard the last from consumers about what they think the best revenue models are, and we don't yet know what the industry will look like once the dust has settled.
As a student of economics, I was forced to learn the mainstream economics, which means neoclassical and Keynesian economics.
But, after attending Mises University, I have decided I learned more real and sound economics at Mises U than I did in four years of taking economic courses as an undergraduate student. Further, I was glad to see that other students had similar experiences. I was told by numerous students that they were taught that recessions, for example, are brought about by a lack of aggregate demand, which, thereafter, drains out spending from the circular-flow model. And, therefore, the only way for the economy to get out of recession is for the government to step in and stimulate demand to get the economy going again.
From day one at Mises U, though, one learns that money, contrary to conventional wisdom, does not come about through some government social contract. Rather, it comes through the marketplace. We learned that, in addition, economics is not a system of mathematical functions and equations, but is the study of praxeology, human action. We also explored how depressions are not caused by a lack of aggregate demand or so-called “animal spirits,” but, rather, through credit creation, artificially encouraged by government institutions like central banks. Ultimately, and perhaps most importantly, one learns at Mises U that the structure of production is complex and that capital goods are not homogeneous.
But Mises U is more than just taking courses about the Austrian School; it allows students to talk to other like-minded individuals, particularly the Mises faculty. I, along with other students, had the opportunity to pick the minds of numerous Mises faculty. In particular, I had the chance to talk to one of the most influential figures in my academic career, Thomas DiLorenzo. I sat at Dr. DiLorenzo’s lunch table nearly every day and had the chance to ask him questions which ranged from history to economics. Personally, I noted that speaking with Dr. DiLorenzo for, at least, thirty minutes was enough for me to realize that the history I learned from my mainstream classes was pure political correctness, not genuine history.
Mises U is more than a typical economics conference; it is a place for students to seek intellectual honesty in a world where professors are paid push propaganda to students. As the Mises Institute notes, “Mises U is what college should be.”
I am forever grateful for the Mises Institute, especially their student programs. Of course, none of their student programs would be possible without their donors. Attending Mises U in 2018 inspired me to become a donor myself. The Mises Institute, and the work they do for students, is essential for Western Civilization, especially in an academic environment which seeks to destroy it.
In the last decade or so there has been a concerted attempt by some economists associated more or less closely with the Austrian school to deny Rothbard’s central role in the modern revival of Austrian economics and to downplay his status as a leading proponent of the Misesian paradigm. In response, I have provided what I believe to be compelling textual evidence that Mises himself, as well as some of his closest followers, regarded Rothbard as Mises's foremost intellectual heir (here, here, and here). Now from the Rothbard archives comes a small treasure that corroborates the evidence I adduced in my earlier posts. This is in the form of Mises’s charming and pithy inscription in Rothbard’s copy of the third edition of Human Action, which reads:
To Murray N. Rothbard, pioneer of praxeological analysis with all good wishes. March 2nd, 1967.
“Pioneer of praxeological analysis”—given Mises’s well-known restraint in meting out compliments to fellow economists, this is high praise indeed and fits nicely with Mises’s remarks about Rothbard’s work in his letter defending praxeology to the French positivist Louis Rougier, which I cited in an earlier post:
The proof of the cake is in the eating. I can only refer to the systematic exposition of the whole doctrine of praxeology in my book Human Action and nowadays in the brilliant book of a younger man, Murray N. Rothbard, Man, Economy and State. . . .But, please, first of all read the book of Rothbard. It is very interesting also from the epistemological point of view.
Marxists hate capitalism and want to replace it with socialism because they believe that profits are stolen from wages. They begin with the idea that originally there were workers but no capitalists and that the value of the products the workers produced and sold was all wages. But then allegedly came the capitalists, who proceeded to deduct a part of wages and claim it as profits. Adam Smith expresses this idea in paragraphs 1,2, & 5-8 of his chapter on wages in bk. I of The Wealth of Nations.
Marx took over Smith's view of profits and went on to claim that the alleged deduction of profits from wages would be so great as to leave the wage earner with nothing more than minimum subsistence, for which he would have to work unbearable hours in unbearable conditions.
I will now show that PROFIT, not wages, is the original and primary form labor income and that this follows both from the actual nature of Smith's "original state of things" and from Marx's version of it that he called "simple circulation."
In simple circulation, "C-M-C," workers produce commodities, "C," sell them for money, "M," and use the money they receive, to buy other commodities, "C." I say that the money the workers receive in exchange for the sale of their commodities is not wages but sales revenues. (To my knowledge, I am the first economist to identify this, and its implications. I was inspired by reading Henry Hazlitt's discussion of John Stuart Mill's proposition "demand for commodities is not demand for labor.") Wages are money paid in exchange for the performance of labor. Here, money is paid not in exchange for the performance of the workers' labor but for the workers' commodities. Thus, the workers have sales revenues, not wages.
However, because this is simple circulation, not "capitalistic circulation," there are NO COSTS to deduct from these sales revenues. Costs appear only in capitalistic circulation, "M-C-M," where they are the reflection of the first "M."
(Costs in business are the prior expenditures of money for the purpose of bringing in the sales revenues. If there are no such expenditures, there are no costs to deduct. Simple circulation is characterized precisely by the fact that there are no such expenditures.) (For the benefit of those unfamiliar with Marx, capitalistic circulation means the outlay of money, "M," for the purpose of producing commodities, "C," which are to be sold for a further sum of money, "M," [or "M'," to indicate a larger sum of money].)
As I say, given the absence of capitalistic circulation and its first "M," there are no costs to deduct from the sales revenues and thus the entire amounts of the sales revenue is profit. In addition, because there is no first "M," there is no monetary capital. The workers of simple circulation have not spent anything for tools or materials, let alone the labor of other workers. Thus, the amount of capital on their books is zero. It follows that in simple circulation profits are both 100% of sales and an infinite percentage of capital invested, which capital is zero.
As I've shown, the workers of simple circulation are not wage earners. Because they sell their commodities rather than their labor, they are more correctly described as small businessmen. They are small businessmen without costs and without capital. Simple circulation morphs into capitalistic circulation as and when some of these worker/businessmen begin to save and productively expend a portion of their sales revenues and profits rather than consume them all. These worker/businessmen are now worker/businessmen/capitalists
Their productive expenditure (i.e., their expenditure for the purpose of making subsequent sales) is the first "M" in capitalistic circulation. It buys capital goods and labor and has the following further major consequences: it brings into existence costs of production in the income statements of business and capital with a monetary value on their balance sheets. Thus, it reduces both the percentage of sales revenues that is profit and, doubly, the percentage that profit bears to capital invested.
I say that the rate of profit on capital is doubly reduced because, per dollar of sales revenue, not only is the amount of profit reduced but also the amount of capital on the books is increased. Marx's sequence for capitalistic circulation can be used to provide a simple formula for measuring the economic degree of capitalism, namely, the higher is the ratio of "M" to "M'," the more economically capitalistic is the economic system.
The biggest threat to our prosperity, to your pension and to the prospects of your children and grandchildren is in all likelihood something that you’ve never heard of. Yet Modern Monetary Theory (MMT), which ironically is neither modern nor a monetary theory, has been setting alight debate on the Left and looks set to form a substantial role in Labour’s interventionist power grab over the economy.
MMT is utopian in the extreme. It provides justification for policies like Jeremy Corbyn’s “People’s Quantitative Easing”, which would require the Bank of England to print money to fund infrastructure and apprenticeships. An important basis of the “Green New Deal” being demanded by socialists in the American Democrat party, MMT has also been used to justify the Bank of England channelling billions into green investment – that is, to use the capacity of the bank to create cash for explicitly ideological investment purposes. American proponents of the idea say that in this way they could slash greenhouse emissions, create cushy taxpayer-funded jobs and offer free healthcare for all without bothering about who would pick up the bill. They claim that since the US government is the issuer of the nation’s currency, it cannot go bankrupt, but instead just keep creating and printing money.
For the adherents of MMT, all public expenditure can thus be financed by public debt – because the bonds of the government are as good as the money that the sovereign state issues. Public debt is no problem because it has its balance in financial wealth in the private sector.
Read more from Dr. Mueller on MMT with his new paper from the Adam Smith Institute, "The Magic Money Tree: The Case Against Modern Monetary Theory"
Unsurprisingly, the idea has found a receptive audience among the Corbynistas that head up the Labour Party. If there is no fiscal restraint for public spending, opposition to huge public expenditure programmes loses its legitimacy and projects like free university for all, renationalisation of services and a comprehensive upgrading of the country’s infrastructure can be launched with gusto. MMT provides the sales pitch for the agenda of socialists who hope scarcity can be abolished with the right policy.
You can see why the Left likes it. Instead of having to think like a household, needing income before it can spend and having to balance its books, they get to say that they can spend with impunity. In their dreams, government spends without hitting your savings, creating income and activity in the private sector instead. A Labour government could spend and have huge deficits without destroying private investment – and could then walk away from the huge piles of public debt they’ve put on the shoulders of future generations. Their argument, though, is that government could always be free of any fiscal restraint because it can always create as much money as is needed.
The problem is, this is all theoretical nonsense. The inflationary consequences of substantially increasing government spending are an economic reality. Promising to spend wisely assumes a knowledge of the economy that we all know politicians don’t have – let alone the current Marxist front bench.
Devotees of MMT assume a one-sector economy with an unlimited supply of capital whose only constraint is labour. Such a view of the modern economy is wholly unrealistic. The real capitalist economy is the one we all live in, where entrepreneurs must incessantly arrange and rearrange to make a profit, and provide goods and services we actually want.
In purely academic terms, the belief that you can spend and spend without any consequence would deserve no further analysis. As a political contrivance, with far-Left populism on the rise in Britain and the USA, MMT is presently one of the most dangerous economic ideas out there, and should consequently attract our utmost attention.
The lessons of history are clear: endless spending brought down the Spanish Empire with the inflow of gold and silver from the American colonies. The massive expansion of the money supply during and after the First World War led to the German hyperinflation that wiped out its middle class.
As John Maynard Keynes rightly observed, inflation brings all the dark forces in a society to work. Modern Monetary Theory qualifies as the financial equivalent to weapons of mass destruction. Politicians who believe in liberty must speak out against something that so threatens our way of life.