“I have a student called Suby Roy…”: Reflections on Frank Hahn (1925-2013), my master in economic theory

hahn

1. “What was relatively weak at LSE was general economic theory. We were good at deriving the Best Linear Unbiased Estimator but left unsatisfied with our grasp of the theory of value that constituted the roots of our discipline. I managed a First and was admitted to Cambridge as a Research Student in 1976, where fortune had Frank Hahn choose me as a student. That at the outset was protection from the communist cabal that ran “development economics” with whom almost all the Indians ended up. I was wholly impecunious in my first year as a Research Student, and had to, for example, proof-read Arrow and Hahn’s General Competitive Analysis for its second edition to receive 50 pounds sterling from Hahn which kept me going for a short time. My exposure to Hahn’s subtle, refined and depthless thought as an economist of the first rank led to fascination and wonderment, and I read and re-read his “On the notion of equilibrium in economics”, “On the foundations of monetary theory”, “Keynesian economics and general equilibrium theory” and other clear-headed attempts to integrate the theory of value with the theory of money — a project Wicksell and Marshall had (perhaps wisely) not attempted and Keynes, Hicks and Patinkin had failed at.

 

 

Hahn insisted a central question was to ask how money, which is intrinsically worthless, can have any value, why anyone should want to hold it. The practical relevance of this question is manifest. India today in 2007 has an inconvertible currency, vast and growing public debt financed by money-creation, and more than two dozen fiscally irresponsible State governments without money-creating powers. While pondering, over the last decade, whether India’s governance could be made more responsible if States were given money-creating powers, I have constantly had Hahn’s seemingly abstruse question from decades ago in mind, as to why anyone will want to hold State currencies in India, as to whether the equilibrium price of those monies would be positive. (Lerner in fact gave an answer in 1945 when he suggested that any money would have value if its issuer agreed to collect liabilities in it — as a State collects taxes – and that may be the simplest road that bridges the real/monetary divide.)

 

 

Though we were never personal friends and I did not ingratiate myself with Hahn as did many others, my respect for him only grew when I saw how he had protected my inchoate classical liberal arguments for India from the most vicious attacks that they were open to from the communists. My doctoral thesis, initially titled “A monetary theory for India”, had to be altered due to paucity of monetary data at the time, as well as the fact India’s problems of political economy and allocation of real resources were more pressing, and so the thesis became “On liberty and economic growth: preface to a philosophy for India”. When no internal examiner could be found, the University of Cambridge, at Hahn’s insistence, showed its greatness by appointing two externals: C. J. Bliss at Oxford and T. W. Hutchison at Birmingham, former students of Hahn and Joan Robinson respectively. My thesis received the most rigorous and fairest imaginable evaluation from them…”

 

 

2. “Frank Hahn believed in throwing students in at the deep end — or so it seemed to me when, within weeks of my arrival at Cambridge as a 21 year old Research Student, he insisted I present my initial ideas on the foundations of monetary theory at his weekly seminar.

 

 

untitled4

I was petrified but somehow managed to give a half-decent lecture before a standing-room only audience in what used to be called the “Keynes Room” in the Cambridge Economics Department. (It helped that a few months earlier, as a final year undergraduate at the LSE, I had been required to give a lecture at ACL Day’s Seminar on international monetary economics. It is a practice I came to follow with my students in due course, as there may be no substitute in learning how to think while standing up.) I shall try to publish exactly what I said at my Hahn-seminar when I find the document; broadly, it had to do with the crucial problem Hahn had identified a dozen years earlier in Patinkin’s work by asking what was required for the price of money to be positive in a general equilibrium, i.e. why do people everywhere hold and use money when it is intrinsically worthless. Patinkin’s utility function had real money balances appearing along with other goods; Hahn’s “On Some Problems of Proving the Existence of an Equilibrium in a Monetary Economy” in Theory of Interest Rates (1965), was the decisive criticism of this, where he showed that Patinkin’s formulation could not ensure a non-zero price for money in equilibrium. Hence Patinkin’s was a model in which money might not be held and therefore failed a vital requirement of a monetary economy. The announcement of my seminar was scribbled by a young Cambridge lecturer named Oliver Hart, later a distinguished member of MIT and Harvard University.”

 

 

3.   Then there was Sraffa…I saw him many a time, in the Marshall Library… He would smile very broadly at me and without saying anything  indicate with his hand to invite me to his office.. I fled in some fear… It was very stupid of me of course… Joan Robinson cornered me once and took me into the office she shared with EAG… She came at me for an hour or so wishing to supervise me, I kept declining politely… saying I was with Frank Hahn and wished to work on money… “What does Frankie know about India?” she said… I said I did not know but he did know about monetary theory and that was what I needed for India;  I also said I did not think much about the Indian Marxists she had supervised… and mentioned a prominent name… she said about him, “Yes most of what he does can go straight into the dustbin”…

 

 

4.   “I had been attracted to Cambridge partly by its old reputation for philosophy, especially that of Wittgenstein. But I met no worthwhile philosophers there until a few months before I was to leave for the United States in 1980, when I chanced upon the work of Renford Bambrough. Hahn had challenged me with the question, “how are you so sure your value judgements promoting liberty blah-blah are better than those of Chenery and the development economists?” It was a question that led inevitably to ethics and its epistemology — when I chanced upon Bambrough’s work, and that of his philosophical master, John Wisdom, the immense expanse of metaphysics (or ontology) opened up as well. “Then felt I like some watcher of the skies, When a new planet swims into his ken; Or like stout Cortez when with eagle eyes, He star’d at the Pacific…””

 

 

5. “I went to Virginia because James M. Buchanan was there, and he, along with FA Hayek, were whom Hahn decided to write on my behalf. Hayek said he was too old to accept me but wrote me kind and generous letters praising and hence encouraging my inchoate liberal thoughts and arguments. Buchanan was welcoming and I learnt much from him and his colleagues about the realities of public finance and democratic politics, which I quickly applied in my work on India…” Hahn told me he did not know Buchanan but he did know Hayek well and that his wife Dorothy had been an original member of the Mont Pelerin Society in 1947 or 1948. Hence I am amused reading a prominent NYU “American Austrian” say about Frank’s passing “I do think economics would have been better off if the Arrow-Debreu-Hahn approach had not been taken so seriously by the profession. I think it turned out to be an intellectual straight-jacket that prevented the discussion of valuable outside-the-box ideas”, and am tempted to paraphrase the closing lines of Tractatus — “Whereof one cannot speak, thereof one must be silent/About what one can not speak, one must remain silent” — to read “Of that of which we are ignorant, we should at least try not to gas about…” Hahn and Hayek were friends, from when Hayek taught at the London School of Economics in Robbins’ seminar, and Hahn was Robbins’ doctoral student.

 

 

6. “The Hawaii project manuscript contained inter alia a memorandum by Milton Friedman done at the request of the Government of India in November 1955, which had been suppressed for 34 years until I published it in May 1989. Milton and Rose Friedman refer to this in their memoirs Two Lucky People (Chicago 1998). Peter Bauer had told me of the existence of Friedman’s document during my doctoral work at Cambridge under Frank Hahn in the late 1970s, as did N. Georgescu-Roegen in America. Those were years in which Brezhnev still ruled in the Kremlin, Gorbachev was yet to emerge, Indira Gandhi and her pro-Moscow advisers were ensconced in New Delhi, and not even the CIA had imagined the Berlin Wall would fall and the Cold War would be over within a decade. It was academic suicide at the time to argue in favour of classical liberal economics even in the West. As a 22-year-old Visiting Assistant Professor at the Delhi School of Economics in 1977, I was greeted with uproarious laughter of senior professors when I spoke of a possible free market in foreign exchange. Cambridge was a place where Indian economists went to study the exploitation of peasants in Indian agriculture before returning to their friends in the well-known bastions of such matters in Delhi and Calcutta. It was not a place where Indian (let alone Bengali) doctoral students in economics mentioned the unmentionable names of Hayek or Friedman or Buchanan, and insisted upon giving their works a hearing. My original doctoral topic in 1976 “A monetary theory for India” had to be altered not only due to paucity of monetary data at the time but because the problems of India’s political economy and allocation of resources in the real economy were far more pressing. The thesis that emerged in 1982 “On liberty and economic growth: preface to a philosophy for India” was a full frontal assault from the point of view of microeconomic theory on the “development planning” to which everyone routinely declared their fidelity, from New Delhi’s bureaucrats and Oxford’s “development” school to McNamara’s World Bank with its Indian staffers. Frank Hahn protected my inchoate liberal arguments for India; and when no internal examiner could be found, Cambridge showed its greatness by appointing two externals, Bliss at Oxford and Hutchison at Birmingham, both Cambridge men.”

 

 

7. “I have a student called Suby Roy…”  Frank sends me to America in 1980 to work with Jim Buchanan… One letter from him was all it took…

 

 

269343_10151251945912285_471582801_n

 

 

And then five years later in 1985 he calls me “probably the outstanding young Hayekian”, says I had brought “a good knowledge of economics and of philosophy to bear on the literature on economic planning”, had “a good knowledge of economic theory” and that my “critique of Development Economics was powerful not only on methodological but also on economic theory grounds” — all that to me has been a special source of delight.

 

 

65240_10151251948807285_1328788833_n

We did not meet often after I left Cambridge but he wrote very kindly always, and finally said, hearing of my travails and troubles and adventures, “well you are having an interesting life…”…

 

 

In America, I once met Robert M Solow in a hotel elevator as we were on a  panel at a conference together; I  introduced myself as Hahn’s student… “Aren’t you lucky?” said Solow with a smile…and he was right… I was lucky…

 

 

I said of Milton Friedman that he had been “the greatest economist after John Maynard Keynes”;  Milton’s critic, Frank Hahn, may have been the greatest economic theorist of modern times.

 

 

447px-Frank_Hahn

                                                                      Frank Hahn (1925-2013)

Advertisements

America has yet to play the demographic card: a few million new immigrants would happily buy up all those bad mortgages

From Facebook:

Mr Tim Cavanaugh’s clear-headed criticism of a principal government economist’s waffle seems to me apt and exactly on target. E.g. he says: “The real purpose here is Panglossian: to convince you that whatever Power does is the right thing to do, and to discredit the idea that government should ever again reduce its presence in the private sector.”

In an article dated Sep 18 2008 titled “October 1929? Not!”, I argued “that the American economy and the world economy are both incomparably larger today in the value of their capital stock, and there has also been enormous technological progress over eight decades. Accordingly, it would take a much vaster event than the present turbulence — say, something like an exchange of multiple nuclear warheads with Russia causing Manhattan and the City of London to be destroyed — before there was a return to something comparable to the 1929 Crash and the Great Depression that followed.” A few weeks later in “America’s divided economists” I said

“Beyond the short run, the US may play the demographic card by inviting in a few million new immigrants (if nativist feelings hostile to the outsider or newcomer can be controlled, especially in employment). Bad mortgages and foreclosures would vanish as people from around the world who long to live in America buy up all those empty houses and apartments, even in the most desolate or dismal locations. If the US’s housing supply curve has moved so far to the right that the equilibrium price has gone to near zero, the surest way to raise the equilibrium price would be by causing a new wave of immigration leading to a new demand curve arising at a higher level. Such proposals seek to address the problem at its source. They might have been expected from the Fed’s economists. Instead, ESSA speaks of massive government purchase and control of bad assets “downriver”, without any attempt to face the problem at its source. This makes it merely wishful to think such assets can be sold for a profit at a later date so taxpayers will eventually gain. It is as likely as not the bad assets remain bad assets.”

Restoring a worldwide idea of an American dream fuelled by mass immigration may be the surest way for the American economy to restore itself. America was at its best when it was open to mass immigration, and America is at its worst when it treats immigrants with racism and worse.

My One-Semester Microeconomics (Theory of Value) Course for Graduate Engineers Planning to Become MBAs

For a half dozen or so years from about 1996 onwards, I taught graduate engineers  a course on microeconomic theory  as part of an MBA syllabus.   The level would have been that of Varian’s undergraduate text as well as, where possible, Henderson & Quandt’s intermediate text (Postscript: and, I now recall, a little of Arrow & Hahn Chapter 2 if there was time).   It was quite successful as most students were very serious and had a more than adequate mathematical background.

Subroto Roy

Kolkata

Exchange, utility analysis and theory of demand

Rational decisions as constrained optimization

Theory of the firm, technology, profit-maximization, cost-minimization, cost curves

Market equilibrium under competitive conditions

Pricing under Monopoly, Oligopoly

Theory of games

Inter-temporal decision-making

Asset markets : arbitrage and present value

Decision-making under uncertainty

Mean-variance analysis : equilibrium in a market for risky assets

How tightly will organised Big Business be able to control economic policies this time?

The power of organised Big Business over New Delhi’s economic policies (whether Congress-led or BJP-led) was signalled by the presence in the audience at Rashtrapati Bhavan last week of several prominent lobbyists when Dr Manmohan Singh and his senior-most Cabinet colleagues were being sworn-in by the President of India. Why were such witnesses needed at such an auspicious national occasion?

Organised Big Business (both private sector and public sector) along with organised Big Labour (whose interests are represented most ably by New Delhi’s official communist parties like the CPI-M and CPI), are astutely aware of how best to advance their own economic interests; this usually gets assisted nicely enough through clever use of our comprador English-language TV, newspaper and magazine media. Shortly after the election results, lobbyists were all over commercial TV proposing things like FDI in insurance and airports etc– as if that was the meaning of the Sonia-Rahul mandate or were issues of high national priority. A typical piece of such “pretend-economics” appears in today’s business-press from a formerly Leftist Indian bureaucrat: “With its decisive victory, the new Manmohan Singh government should at last be able to implement the required second generation reforms. Their lineaments (sic) are well known and with the removal of the Left’s veto, many of those stalled in the legislature as well as those which were forestalled can now be implemented. These should be able to put India back on a 9-10 per cent per annum growth rate…”

Today’s business-press also reports that the new Government is planning to create a fresh “Disinvestment Ministry” and Dr Singh’s chief economic policy aide is “a frontrunner among the names short-listed to head the new ministry” with Cabinet rank.

Now if any enterprising doctoral student was to investigate the question, I think the evidence would show that I, and I alone – not even BR Shenoy or AD Shroff or Jagdish Bhagwati — may have been the first among Indian economists to have argued in favour of the privatisation of India’s public sector. I did so precisely 25 years ago in Pricing, Planning and Politics: A Study of Economic Distortions in India, which was so unusual for its time that it attracted the lead editorial of The Times of London on the day it was published May 29 1984, and had its due impact on Indian economic policy then and since, as has been described elsewhere here.  In 1990-1991 while with Rajiv Gandhi, I had floated an idea of literally giving away shares of the public sector to the public that owned it (as several other countries had been doing at that time), specifically perhaps giving them to the poorest panchayats in aid of their development.  In 2004-2005, upon returning to Britain after many years, I helped create the book Margaret Thatcher’s Revolution: How it Happened and What it Meant, and Margaret Thatcher if anyone was a paragon of privatisation.

That being said, I have to say I think a new Indian policy of creating a Ministry to privatise India’s public sector is probably a very BAD idea indeed in present circumstances — mainly because it will be driven by the interests of the organised Big Business lobbies that have so profoundly and subtly been able to control the New Delhi Government’s behaviour in recent decades.

Such lobbyist control is exercised often without the Government even realising or comprehending its parameters. For example, ask yourself: Is there any record anywhere of Dr Manmohan Singh, in his long career as a Government economist and then as a Rajya Sabha MP, having ever proposed before 2004-2005 that nuclear reactors were something vitally important to India’s future? And why do you suppose the most prominent Indian business lobby spent a million dollars and registered itself as an official lobbyist in Washington DC to promote the nuclear deal among American legislators? Because Big Business was feeling generous and altruistic towards the “energy security” of the ordinary people of India? Hardly.  Indian Big Business calculates and acts in its own interests, as is only to be expected under economic assumptions; those interests are frequently camouflaged by their lobbyist and media friends into seeming to be economic policy for the country as a whole.

Now our Government every year produces paper rupees and bank deposits in  practically unlimited amounts to pay for its practically unlimited deficit financing, and it has behaved thus over decades. Why we do not hear about this at all is because the most prominent Government economists themselves remain clueless — sometimes by choice, mostly by sheer ignorance — about the nature of the macroeconomic process that they are or have been part of.  (See my  “India’s Macroeconomics”, “The Dream Team: A Critique” etc elsewhere here). As for the Opposition’s economists, the less said about the CPI-M’s economists the better while the BJP, poor thing, has absolutely no economists at all!

Briefly speaking, Indian Big Business has acquired an acute sense of this long-term nominal/paper expansion of India’s economy, and as a result acts towards converting wherever possible its own hoards of paper rupees and rupee-denominated assets into more valuable portfolios for itself of real or durable assets, most conspicuously including hard-currency denominated assets, farm-land and urban real-estate, and, now, the physical assets of the Indian public sector. Such a path of trying to transform local domestic paper assets – produced unlimitedly by Government monetary and fiscal policy and naturally destined to depreciate — into real durable assets, is a privately rational course of action to follow in an inflationary economy.  It is not rocket-science  to realise the long-term path of the Indian rupee is downwards in comparison to the hard-currencies of the world – just compare our money supply growth and inflation rates with those of the rest of the world.

The Statesman of November 15 2006 had a lead editorial titled Government’s land-fraud: Cheating peasants in a hyperinflation-prone economy. It said:

“There is something fundamentally dishonourable about the way the Centre, the state of West Bengal and other state governments are treating the issue of expropriating peasants, farm-workers, petty shop-keepers etc of their small plots of land in the interests of promoters, industrialists and other businessmen. Singur may be but one example of a phenomenon being seen all over the country: Hyderabad, Karnataka, Kerala, Haryana, everywhere. So-called “Special Economic Zones” will merely exacerbate the problem many times over. India and its governments do not belong only to business and industrial lobbies, and what is good for private industrialists may or may not be good for India’s people as a whole. Economic development does not necessarily come to be defined by a few factories or high-rise housing complexes being built here or there on land that has been taken over by the Government, paying paper-money compensation to existing stakeholders, and then resold to promoters or industrialists backed by powerful political interest-groups on a promise that a few thousand new jobs will be created. One fundamental problem has to do with inadequate systems of land-description and definition, implementation and recording of property rights. An equally fundamental problem has to do with fair valuation of land owned by peasants etc. in terms of an inconvertible paper-money. Every serious economist knows that “land” is defined as that specific factor of production and real asset whose supply is fixed and does not increase in response to its price. Every serious economist also knows that paper-money is that nominal asset whose price can be made to catastrophically decline by a massive increase in its supply, i.e. by Government printing more of the paper it holds a monopoly to print. For Government to compensate people with paper-money it prints itself by valuing their land on the basis of an average of the price of the last few years, is for Government to cheat them of the fair present-value of the land. That present-value of land must be calculated in the way the present-value of any asset comes to be calculated, namely, by summing the likely discounted cash-flows of future values. And those future values should account for the likelihood of a massive future inflation causing decline in the value of paper-money in view of the fact we in India have a domestic public debt of some Rs. 30 trillion (Rs. 30 lakh crore) and counting, and money supply growth rates averaging 16-17% per annum. In fact, a responsible Government would, given the inconvertible nature of the rupee, have used foreign exchange or gold as the unit of account in calculating future-values of the land. India’s peasants are probably being cheated by their Government of real assets whose value is expected to rise, receiving nominal paper assets in compensation whose value is expected to fall.”

Mamata Banerjee started her famous protest fast-unto-death in Kolkata not long afterwards, riveting the nation’s attention in the winter of 2006-2007.

What goes for the government buying land on behalf of its businessman friends also goes, mutatis mutandis, for the public sector’s real assets being bought up by the private sector using domestic paper money in a potentially hyperinflationary economy.  If Dr Singh’s new Government wishes to see real public sector assets being sold, let the Government seek to value these assets not in inconvertible rupees which the Government itself has been producing in unlimited quantities but rather in forex or gold-units instead!

Today’s headline says “Short of cash, govt. plans to revive disinvestment ministry”. Big Business’s powerful lobbies will suggest  that real public assets must be sold  (to whom? to organised Big Business of course!) in order to solve the grave fiscal problems in an inflationary economy caused precisely by those grave  fiscal problems! What I said in 2002 at IndiaSeminar may still be found to apply: I said the BJP’s privatisation ideas “deserve to be condemned…because they have made themselves believe that the proceeds of selling the public sector should merely go into patching up the bleeding haemorrhage which is India’s fiscal and monetary situation… (w)hile…Congress were largely responsible for that haemorrhage to have occurred in the first place.”

If the new Government would like to know how to proceed more wisely, they need to read and grasp, in the book edited by myself and Professor John Clarke in 2004-2005, the chapter by Professor Patrick Minford on Margaret Thatcher’s fiscal and monetary policy (macroeconomics) before they read the chapter by Professor Martin Ricketts on Margaret Thatcher’s privatisation (microeconomics).  India’s fiscal and monetary or macroeconomic problems are far worse today than Britain’s were when Thatcher came in.

During the recent Election Campaign, I contrasted Dr Singh’s flattering praise in 2005 of the CPI-M’s Buddhadeb Bhattacharjee with Sonia Gandhi’s pro-Mamata line in 2009 saying the CPI-M had taken land away from the poor.  This may soon signal a new fault-line in the new Cabinet too on economic policy with respect to not only land but also public sector privatisation – with Dr Singh’s pro-Big Business acolytes on one side and Mamata Banerjee’s stance in favour of small-scale unorganised business and labour on the other.  Party heavyweights like Dr Singh himself and Sharad Pawar and Pranab Mukherjee will weigh in one side or the other with Sonia being asked in due course to referee.

I personally am delighted to see the New Rahul Gandhi deciding not to be in Government and to instead reflect further on the “common man” and “common woman” about whom I had described his father talking to me on September 18 1990 at his home. Certainly the “aam admi” is not someone to be found among India’s organised Big Business or organised Big Labour nor their paid lobbyists in the big cities.

Subroto Roy, Kolkata

Posted in Academic research, AD Shroff, Asia and the West, Big Business and Big Labour, BR Shenoy, Britain, Britain in India, British history, Economic Policy, Economic quackery, Economic Theory, Economics of exchange controls, Economics of Public Finance, Economics of real estate valuation, Financial Management, Financial markets, Foreign exchange controls, Government Budget Constraint, Government of India, India's Big Business, India's Banking, India's bureaucracy, India's Capital Markets, India's corporate finance, India's corporate governance, India's corruption, India's currency history, India's Economic History, India's Economy, India's Government Budget Constraint, India's Government Expenditure, India's Industry, India's inflation, India's Macroeconomics, India's Monetary & Fiscal Policy, India's nomenclatura, India's peasants, India's political lobbyists, India's Politics, India's pork-barrel politics, India's poverty, India's Public Finance, Inflation, Land and political economy, Macroeconomics, Mamata Banerjee, Manmohan Singh, Margaret Thatcher, Margaret Thatcher's Revolution, Martin Ricketts, Mendacity in politics, Microeconomics, Monetary Theory, Money and banking, Mumbai financial world, New Delhi, Patrick Minford, Political cynicism, Political Economy, Political mendacity, Political Science, Politics, Pork-barrel politics, Power-elites and nomenclatura, Practical wisdom, Principal-agent problem, Privatisation, Public Choice/Public Finance, Public property waste fraud, Rajiv Gandhi, Rational decisions, Singur and Nandigram, Sonia Gandhi, Statesmanship, The Statesman, The Times (London), University of Buckingham. Leave a Comment »

Indian Inflation: Upside Down Economics from New Delhi’s Establishment

Author’s Note: Articles of related interest include “Against Quackery”, “India’s Macroeconomics”, “Fiscal Instability”, “Indian Money and Credit”, “Indian Money and Banking”, “The Dream Team: A Critique” etc.

Indian Inflation: Upside Down Economics From The New Delhi Establishment

By Subroto Roy

First published in two parts in The Statesman, Editorial Page Special Article, April 15-16 2008, http://www.thestatesman.net

Suppose there are only three real goods and services in the economy, and their prices per unit expressed in terms of money were Rs 3, Rs 2, Rs 6 respectively. If those money prices per unit doubled to Rs 6, Rs 4, Rs 12 respectively, we would say inflation of 100% occurred during the relevant time-period. If the prices had gone instead to Rs 4.50, Rs 3, Rs 9, we would say inflation was 50%, and so on. Notice the ratios between the three prices have remained the same in these examples; i.e., while the money prices of the items have changed, relative prices between them remained constant. In reality, there are many hundreds of millions of differentiated real goods and services in any economy though the logic stays the same.

Decline of money
It is well within living memory that the monthly salary of a Government of India Joint Secretary was Rs 3,000. Middle class parents would wed their daughters respectably to a groom earning such a figure. A Joint Secretary today makes 20 times as much and Rs 3,000 is made by his driver or children’s nanny whose equivalent back then made perhaps Rs 150 per month. The relative distance between the Joint Secretary and his driver has not decreased but the absolute amount of rupees made by each has been multiplied by a factor of 20. That indicates the fall in the value of rupees or rise in prices of goods and services relative to rupees during that period.

One reason this has happened is that the monopoly issuer of rupees, namely the Government of India, has vastly enlarged the stock of rupees present in the economy, both paper-notes and bank-deposits.  Inflation, strictly speaking, is uniform decline in the value of money or, what is the same thing, uniform increase in all rupee prices, including wages, with relative prices constant. The time-period could be a year or even a month; “hyperinflation” may start to be defined if the value of money falls at more than 10% per month.

The main problem with inflation is that rupee prices never expand uniformly and hence some classes of people gain unexpectedly while others suffer catastrophe. E.g., all those with debts expressed in rupee terms pay back less in real terms while their creditors go bankrupt. Those with fixed or slow-changing incomes (like old people, unorganised non-unionised workers etc) and those with paper assets (like currency rather than land or jewelry) are all made worse off by inflation. Unionized workers, like Government employees, do very well from inflation relative to others in society as their compensation is inflation-indexed. And the Government of India itself, as the largest debtor in the economy, gains massively from inflation; indeed, printing more paper is a standard way for all governments around the world to reduce their real debts by subterfuge.

The farmers at Singur or the SEZs who hand over their land for paper rupees from the Government will find the value of that paper declining and the value of that land rising over future years ~ which may help explain the recent keenness of city-people to take over rural India.

Rupee prices are one key variable that tend to expand via inflation with expansion of money stock. The other main change occurs in real income through growth. The Joint Secretary and his driver both use colour TVs for entertainment and gas-stoves for cooking these days; their earlier counterparts would have used transistor radios and coal-fired ovens.

To that extent, we have superior standards of living than we did in the past. There has been enormous technological progress, mostly through spontaneous learning and productivity increase, and that leads to vastly greater commerce and transactions between people, hence greater income and wealth through specialization. The vastly increased volume and value of commerce requires more money to expedite its turnover.

India’s money stock in recent decades has been growing at no less than 15% per annum, most recently reaching an all-time high of 22% per annum last year. Even if current Government estimates of growth of real income at some 9% are taken at face-value, that may mean growth in all rupee prices, i.e. inflation, near 22-9=13% per annum. TV economists parrot Government WPI inflation at 5% per annum, and now newspaper headlines are screaming WPI inflation is at 7.4% ~ more realistically, the decline in the value of India’s paper money has likely been in double-digits for years.

Paper money is a peculiar thing as it has no intrinsic value ~ even a hair pin or shirt-button has more usefulness as such. Paper money derives whatever value it has only because each of us in the economy believes everyone else will accept it in transactions in payment of wages or to purchase food and other items with.

Gold standard

The currency note in your pocket may carry the signature of the RBI Governor and his “promise to pay the bearer” the face-value ~ as if he is going to pay you its equivalent in gold held by the Government. But this is open humbug, a childish fiction. In 1931 the British pound, and the Indian rupee which linked to it at the time, went off the “gold standard” and there has been no backing of the Indian currency with gold ever since then.

In a pure gold standard, gold is money ~ interchangeable in the sense the central bank guarantees it will exchange gold for the paper it issues at an announced price. If that price changes up or down, there is devaluation or revaluation of the currency with respect to gold (depending on how you count it).

A gold exchange standard is similar except gold is not used as money and central banks of nations guarantee the announced prices of their paper moneys with respect to gold in transactions with one another. In the dollar exchange standard (or Bretton Woods system from 1944 to 1971), the US Government alone and uniquely undertook to guarantee the price of the dollar at $35 a troy oz of gold in transactions with all other central banks. That was the underpinning of the international financial system until Richard Nixon “closed the gold window” on 15 August 1971 because the US had largely financed the Vietnam War through money-creation, and other countries’ central banks (like France) had accumulated large dollar-balances.

The “gold standard”, “gold exchange standard”, and “dollar exchange standard” are all examples of “fixed” exchange rate systems which came to end in 1971-1972. The price of gold at $35 an oz was obviously unrealistically low, and it shot up at once, and has even reached $1000 an oz recently. Since 1972, the Western world has been on “floating exchange rates” where currencies find their own values and gold is merely one asset among many. Fixed exchange rate systems can lead to speculation, runs against currencies and the irresponsible international export of inflation which floating exchange rate systems tend to avoid because there will tend to be market-determined movement in the exchange-rate instead.

Elite capital flight

India today has neither a proper fixed nor a proper floating exchange-rate system but instead continues a system of highly discriminatory exchange controls. Twenty or thirty million people in our major cities know how to use the present system well enough to exchange their Indian rupees for as much as US $200,000 per annum to send their children and relatives settled abroad as foreign nationals. Plus Indian corporations have been allowed to convert rupees to buy sinking foreign companies. Foreign-currency reserves have vastly climbed too as domestic Indian companies have been allowed to incur foreign-currency denominated debt. Hence the thirty million special people are rather cleverly able to borrow foreign currency with one hand and then transmit it abroad with the other.

The net result is a clear policy of government-induced elite capital flight, unprecedented in its irresponsibility anywhere in world economic history ~ signed, sealed and delivered by the Montek-Manmohan-Chidambaram trio now just as Yashwant-Jaswant-KC Pant and friends had done a little earlier. The Communists would only be worse, as their JNU economists renounce all standard textbook microeconomics and macroeconomics in favour of street-shouting instead.

Outside the thirty million Indians with NRI connections, the average Indian today is disallowed from holding foreign exchange accounts at his/ her local bank or holding or trading in gold or other precious metals freely as he/she may please ~ the physical arrest of Mohun Bagan’s hapless Brazilian footballer by our inimitable Customs officers the other day reveals the ugliness of the situation most poignantly.

Every TV economist in Delhi, Bombay and Kolkata now seems to have a solution about India’s inflation and all sorts of fallacious reasoning is in the air. Some recommend the rupee appreciating or depreciating ~ as if anyone in the country has the faintest idea how elastic imports, exports and capital flows may be in fact to changes in the (controlled) exchange-rate. The Finance Minister and PM keep saying inflation is being “imported” because international commodity prices are high ~ someone should explain to them inflation is “imported” when fixed exchange rates allow transmission through the price-specie flow mechanism, and that is far from being India’s main problem. The extra-constitutional “Planning Commission” has, we may be thankful, remained silent about inflation, and seems to have abandoned earlier misconceptions about using forex reserves for “infrastructure”. The UPA Chair, we may be thankful, also has been silent and admits innocence of all economics, implicitly trusting her PM’s wisdom in all such matters instead.

What no one wants to talk about is the hippopotamus that is present in the room, namely, the chronically diseased state of accounts and public finances of the issuer of India’s paper-rupees, the Union Government, as well as the diseased accounts and finances of more than two dozen State Governments that are subservient to it. The macroeconomic and fiscal policy process that the Congress, BJP, Communists and everyone else in the political class in New Delhi and the State capitals have been presiding over for decades is one that turns normal economics upside down.

What happens in the West is that an estimate of technological progress and population growth is made by policy-makers, then an “acceptable” or “unavoidable” or “natural” rate of inflation is added (the figure of monetary change needed for efficiency in the real economy so relative prices adjust to equilibrium in response to demand and supply changes), then a monetary growth target is set, to which the fiscal authority ~ i.e. the legislature handling the Government’s budget ~ must adjust taxation and spending plans accordingly.

What has been happening in India every year for decades is that each of some two dozen state legislatures runs up a large deficit, which are all added up and passed on to the “Centre”; the “Centre” and its “Yojana Bhavan”, at the behest of every conceivable organised interest-group with access in Delhi especially government unions and the military, runs up its own vastly larger fiscal deficit, and then this grand total of fiscal-deficits is offered to the Reserve Bank at the end of a loaded pistol ~ to pay for one way or another via new public debt creation and money printing.  Subtract the WPI rate from the Money Supply Growth rate and government spokesmen and their businessmen friends then exclaim that the economy must try to reach the difference as its “warranted” growth rate! It is all economics upside down from people who have either learnt nothing significant in the subject or forgotten whatever little they once did.

Fragile financial state

The net result has been a banking system (mostly nationalized) in which the asset side of banks’ balance-sheets is made up almost entirely of rather dubious government debt, interest payments on which are received every year from fresh money-printing. The liability side of those balance-sheets consists of course of customer-deposits. In this fragile monetary and financial state, a government-induced capital flight has been allowed to continue under pretence of liberalization ~ with Indian companies being allowed to borrow from foreign markets many times their domestic rupee-denominated net worth by which to acquire ailing foreign companies and brands. Furthermore, there has been a massive fiscal effect as vast new Government spending programs ~ like buying foreign aircraft carriers, fighter-jets or passenger aircraft or writing off farm loans ~ come to be announced and absorbed into expectations of future inflation. A monetary meltdown is what the present author cautioned against in 1990-1995 and again, publicly, in 2000-2005. Economics, candidly treated, tells us not only that there is no such thing as a free lunch but also that chickens come home to roost.


How to Budget: Thrift, Not Theft, Needs to Guide Our Public Finances

How to Budget:

 

Thrift, Not Theft, Needs to Guide Our Public Finances

 

By Subroto Roy

 

First published in The Statesman, Editorial Page Special Article, http://www.thestatesman.net, February 26 2008

 

For most family households in India as elsewhere, the time for weekly or monthly budgeting and accounting is a time of sobriety ~ when reality must be faced about which goals and desires can be achieved and which cannot, about how incomings and outgoings of family resources are going to be matched. The same holds for corporations when their managements must face their boards, shareholders or workers, though individual stakeholders in large corporations may be so ignorant of the facts or so small and insignificant in size that top management can get away with a lot of bluff.

 

When it comes to entities the size of countries, the scope for feeding illusions to the general public becomes enormously large; hence there is need for scientific honesty in government accounting and finance, and when that is lacking as it often is in any country, there is need for intense public awareness and vigorous criticism of what the government of the day may be up to with the public purse.

 

‘Seignorage’

 

Mao Zedong once said “Thrift should be the guiding principle of our government expenditure”. Those who govern fiscal and monetary processes, whether autocratically or democratically, have a general duty to be frugal or economic in using resources that have been forcibly raised from the public and which could have been spent privately in other welfare-enhancing directions.

 

“One must not take from the real needs of the people for the imaginary needs of the state” said Montesquieu. National Governments “take” from the people not only via direct taxation (e.g. of income) and indirect taxation (e.g. of expenditure) but also via inflation ~ invisibly reducing the purchasing power or value of paper money and other paper assets by exploiting the government’s monopoly over currency-printing (a process that economists traditionally termed “seignorage” from the debasing of metal coins that kings historically indulged in to pay for wars).

 

In providing public goods and services, if a government does what it need not do it may end up failing to do what it must and which only it can do. “That part of the public expenditure, which is devoted to the maintenance of civil and military establishments (i.e., all except the interest of the national debt), affords, in many of its details, ample scope for retrenchment. But while much of the revenue is wasted under the mere pretence of public service, so much of the most important business of government is left undone, that whatever can be rescued from useless expenditure is urgently required for useful” (JS Mill).

 

Such an idea that “whatever can be rescued from useless expenditure is urgently required for useful” was used in Gordon Brown’s 2004 rhetoric as Britain’s Finance Minister when, for example, he said 40,000 jobs would be reduced in the UK civil services to release resources to enhance “frontline” public services like schools and hospitals.

 

From such a practical point of view, three questions must be typically addressed by any Parliament or Government trying to optimally align public expenditure and income in a budget placed before it:


(1) Is public expenditure allocated efficiently in given circumstances, in a manner that enhances the public interest to the greatest degree possible? If not, how may it be made to do so?


(2) Can income from government operations be enhanced in given circumstances? What taxation should be imposed, raised, lowered or abolished, why so, and at what least cost to the population?


(3) If government expenditure exceeds income from taxation and operations, how should the borrowing be financed at least cost? Is the government’s existing portfolio of assets and liabilities of different liquidity and term-structure efficient, or can it be improved?

 

Unfortunately, we do none of this in India and have not done so for decades. Indeed New Delhi’s establishment economists and the media have not ever even been thinking on such practical lines. Instead, each bureaucratic department tries to maintain or enlarge its own size and claims on public funds every year. What New Delhi does, in a nutshell, is to allow every Ministry (especially the military) to add a 10-20% inflation-premium to its previous year’s expenditures and assert a new claim during the Budget season. (The most accurate measure of inflation in India may be that involved in growth of nominal expenditure on Government’s bureaucracy). Organised business, organised labour, exporters, importers, farmers, women, and every sundry political lobbyist then assert their claims to subsidies and concessions as well ~ and some gargantuan number comes to be added up.

 

To that number must be added the vast annual expenditure on interest payments by Government on the public debt accumulated from previous years and decades ~ payments which keep afloat the entire banking system in India because our nationalized banks hold such debt-instruments as their main assets where customer-deposits are their main liabilities.

 

A crucial question in relation to the convertibility of the rupee has to do with international valuation of that vast public debt (hence valuation of the asset side of our banking system) in the event the rupee became freely exchangeable into gold and foreign exchange for the general public, not merely city-based super-elites and NRIs.

 

Once interest payments have been added to other government expenditures, some humongous number comes to be reached. That number, and how it breaks down between interest expenditures, military expenditures and other expenditures, is among the key variables to look out for in Mr Chidambaram’s forthcoming Budget-Speech. From it will be subtracted the total taxation and non-tax revenues of the Government ~ each after it has been subjected to its own political lobbying process by different interest groups who have managed to obtain access to the Finance Minister. The residual (government expenditure minus government income) is the “Gross Fiscal Deficit” which is how much the Government of India says it plans to newly borrow from the (mostly captive) domestic financial markets. That residual in turn will add itself to next year’s accumulating public debt on which interest payments will have to be then made. The Finance Minister and his spokesmen typically quote the Gross Fiscal Deficit as some percentage of GDP figures; a better ratio to look for may be the size of Government interest payments per head as a percentage of tax revenues per head.

 

Corruption

 

The Union Finance Ministry no longer appears to exercise effective managerial control over the budgets and accounts of the innumerable publicly funded institutions, entities and projects in the country, nor even remembers how to do so. Everyone knows that the eventual aggregate result of public financial processes will be more deficit-finance paid for by silent and unlimited money-printing. Thus, for example, we see enormous building and construction plans being requested and granted for public institutions and agencies to indulge in ~ if the private builders and developers involved in such public contracts throw in an urban apartment or two for the heads of such institutions, who are powerful enough to be making the spending decisions with their friends, what does it really matter? Deficit-finance, arising from an abysmal state of government and public sector accounting, makes government corruption quite simple and straightforward if one thinks about it.

 

It is sad to say that the principle guiding our public finances may have become theft, not thrift, because political and administrative decision-makers throughout the system, instead of being sober, remain drunk when it comes to spending India’s public resources.

Milton Friedman: A Man of Reason, 1912-2006

A Man of Reason


Milton Friedman (1912-2006)

 

First published in The Statesman, Perspective Page Nov 22 2006

 

Milton Friedman, who died on 16 November 2006 in San Francisco, was without a doubt the greatest economist after John Maynard Keynes. Before Keynes, great 20th century economists included Alfred Marshall and Knut Wicksell, while Keynes’s contemporaries included Irving Fisher, AC Pigou and many others. Keynes was followed by his younger critic FA Hayek, but Hayek is remembered less for his technical economics as for his criticism of “socialist economics” and contributions to politics. Milton Friedman more than anyone else was Keynes’s successor in economics (and in applied macroeconomics in particular), in the same way David Ricardo had been the successor of Adam Smith. Ricardo disagreed with Smith and Friedman disagreed with Keynes, but the impact of each on the direction and course both of economics and of the world in which they lived was similar in size and scope.

 

Friedman’s impact on the contemporary world may have been largest through his design and advocacy as early as 1953 of the system of floating exchange-rates. In the early 1970s, when the Bretton Woods system of adjustable fixed exchange-rates collapsed and Friedman’s friend and colleague George P. Shultz was US Treasury Secretary in the Nixon Administration, the international monetary system started to become of the kind Friedman had described two decades earlier. Equally large was Friedman’s worldwide impact in re-establishing concern about the frequent cause of macroeconomic inflation being money supply growth rates well above real income growth rates. All contemporary talk of “inflation targeting” among macroeconomic policy-makers since the 1980s has its roots in Friedman’s December 1967 presidential address to the American Economic Association. His main empirical disagreement with Keynes and the Keynesians lay in his belief that people held the intrinsically worthless tokens known as “money” largely in order to expedite their transactions and not as a store of value – hence the “demand for money” was a function mostly of income and not of interest rates, contrary to what Keynes had suggested in his 1930s analysis of “Depression Economics”. It is in this sense that Friedman restored the traditional “quantity theory” as being a specific theory of the demand for money.

 

Friedman’s main descriptive work lay in the monumental Monetary History of the United States he co-authored with Anna J. Schwartz, which suggested drastic contractions of the money supply had contributed to the Great Depression in America. Friedman made innumerable smaller contributions too, the most prominent and foresighted of which had to do with advocating larger parental choice in the public finance of their children’s school education via the use of “vouchers”. The modern Friedman Foundation has that as its main focus of philanthropy. The emphasis on greater individual choice in school education exemplified Friedman’s commitments both to individual freedom and the notion of investment in human capital.

 

Friedman had significant influences upon several non-Western countries too, most prominently India and China, besides a grossly misreported episode in Chile. As described in his autobiography with his wife Rose, Two Lucky People (Chicago 1998), Friedman spent six months in India in 1955 at the Government of India’s invitation during the formulation of the Second Five Year Plan. His work done for the Government of India came to be suppressed for the next 34 years. Peter Bauer had told me during my doctoral work at Cambridge in the late 1970s of the existence of a Friedman memorandum, and N. Georgescu-Roegen told me the same in America in 1980, adding that Friedman had been almost insulted publicly by VKRV Rao at the time after giving a lecture to students on his analysis of India’s problems.

 

When Friedman and I met in 1984, I asked him for the memorandum and he sent me two documents. The main one dated November 1955 I published in Hawaii on 21 May 1989 during a project on a proposed Indian “perestroika” (which contributed to the origins of the 1991 reform through Rajiv Gandhi), and was later published in Delhi in Foundations of India’s Political Economy: Towards an Agenda for the 1990s, edited by myself and WE James.

 

The other document on Mahalanobis is published in The Statesman today for the first time, though there has been an Internet copy floating around for a few years. The Friedmans’ autobiography quoted what I said in 1989 about the 1955 memorandum and may be repeated: “The aims of economic policy (in India) were to create conditions for rapid increase in levels of income and consumption for the mass of the people, and these aims were shared by everyone from PC Mahalanobis to Milton Friedman. The means recommended were different. Mahalanobis advocated a leading role for the state and an emphasis on the growth of physical capital. Friedman advocated a necessary but clearly limited role for the state, and placed on the agenda large-scale investment in the stock of human capital, encouragement of domestic competition, steady and predictable monetary growth, and a flexible exchange rate for the rupee as a convertible hard currency, which would have entailed also an open competitive position in the world economy… If such an alternative had been more thoroughly discussed at the time, the optimal role of the state in India today, as well as the optimum complementarity between human capital and physical capital, may have been more easily determined.”

 

A few months before attending my Hawaii conference on India, Friedman had been in China, and his memorandum to Communist Party General Secretary Zhao Ziyang and two-hour dialogue of 19 September 1988 with him are now classics republished in the 1998 autobiography. Also republished there are all documents relating to Friedman’s six-day academic visit to Chile in March 1975 and his correspondence with General Pinochet, which speak for themselves and make clear Friedman had nothing to do with that regime other than offer his opinion when asked about how to reduce Chile’s hyperinflation at the time.

 

My association with Milton has been the zenith of my engagement with academic economics, with e-mails exchanged as recently as September. I was a doctoral student of his bitter enemy yet for over two decades he not only treated me with unfailing courtesy and affection, he supported me in lonely righteous battles: doing for me what he said he had never done before, which was to stand as an expert witness in a United States Federal Court. I will miss him much though I know that he, as a man of reason, would not have wished me to.

Subroto Roy