Multi-Disciplinary Reading – Book Reviews

Day to day Economics, Satish Deodhar, 2012 – If you wanted a well-structured and simple book to understand the basics of Macroeconomics, this could be a very good start. It covers everything you need to know from role of govt., capitalism, stock markets, economic cycles, fiscal and monetary policies, role of central banks, inflation, taxation, globalisation and free trade etc… The stats are bit outdated though since the book is written in 2012 but that could be a positive as you can look up where numbers are today and see how we have fared in the last decade.

My notes –

• Microeconomics – individual economics decisions of households and firms.

• Macroeconomics – decisions of the aggregate business environment

• Role of govt. is to define rights and obligations of citizens and to secure them by enacting and enforcing laws. So enacting laws, enforcing them through a judiciary and police force and defending against external aggression is the primary role of govt. However govt. also gets involved in power generation, water supply, roads and postal services and formulates policies for reducing unemployment and inflation, interfering with free-market forces.

• Govt. in India also manufactured watches, bread and offers air transport services (Modern bread, HMT watches, Air India – some privatised now or shutdown)

• Should govt. be in certain business but not others? How does one decide? The govt. should only produce pure public goods – The ones where non-excludability (Say when you cannot prevent a person from using a good/service) and non-rivalry in consumption (My consumption doesn’t interfere with yours) cannot be enforced. Author explains these beautifully with a street-performer who is watched by everyone but no one pays in the end (They can’t choose who watches, nor can the paying ones exclude the ones that don’t pay)

• Pure public good – National defence – Consumption of this service is non-excludable and non-rival. Why would anyone pay for it when they can have a free ride at the expense of others?. Private firms cannot provide this profitably. Same applies to light houses, street lights, rural roads and the police force (My thoughts – While a road can also be non-excludable and non-rival, a toll road prevents others from using it without paying – so pvt. companies can make them for profit – excludability is so crucial for capitalism!)

• Club goods – restrict membership and charge fees. Say, a swimming pool or a gym at a club creates excludability and though it retains the non-rivalry in consumption. The street-performing trapeze artist does the same by starting a circus instead

• Natural monopoly – A business in which only one player should exist for efficient delivery. Say water delivery. Its inefficient for multiple players to lay water pipelines. If one player is allowed, they can charge whatever they want – so govt. undertakes natural monopolies, alongside pure public goods. (My thoughts – Postal service used to be one such, as laying out a nation-wide service is expensive – but pvt. couriers now compete with India post well – as do bsnl’s competition)

• Most public utilities are natural monopolies, (or at least used to be) – like electricity, landline telephone etc. (Book was written in 2012. Now we have private players doing well in both). Even when pvt. players enter a traditional natural monopoly, the govt. tries to retain regulatory purview over the same on pricing (electricity unit prices?)

• Externalities – Reason for govt. to interfere in a free market. Externality occurs when production, consumption or trade of a good affects a bystander who is not party to the specific activity (late-night loud music at a neighborhood club).

• Externalities can be positive (say renewables) or negative (say alcohol and cigarettes). Govt. uses taxes to regulate these – through green tax and sin tax

• Pure public goods (non-rival, non-excludable), natural monopolies and externalities are clear cases of market failure where govt. may participate

• The word “budget” comes from ‘bougette’, which stands for leather bag. The origin is from 1760 when the exchequer in England would carry govt. statements in a leather bag (even today this image is synonymous with budget)

• Size of budget as a size of the economy shows how big or small govt’s participation is in the economy (14% by expenditure and 9.5% by receipts as of 2012 when book was written. $400b in rev (13%) and $490b in expenses (16%) as of ‘22 budget – so better over 10 yrs). Other countries’ tax revenue is markedly higher than ours and so their govt. participation is also higher (US, France, UK)

• Expenditures for govt. fall under 2 heads – revenue and capital expenditures. Former is what it takes to “run” the govt. (pay judiciary, police, govt. staff etc.) while latter creates assets like bridges, roads etc.

• Lower rev receipts for govt. may not mean govt. participation in economy is low – it might signify inability to collect taxes efficiently

• To fund deficits, govt borrows from public, external financial institutions or under extreme circumstances, from the central bank

• Nominal vs Real GDP – The former doesn’t account for inflation while latter does. Reported numbers are always “real GDP”.

• GDP for goods and services is “final”, i.e. if a book is produced, then the value of book includes the paper, ink, binding material and the author’s efforts – these are not double-counted

• Revenue deficit – diff between revenue expenditure and revenue receipts. If a govt. runs revenue deficit, then it needs to borrow to even fund itself – the equivalent of a household borrowing to pay maids and driver

• Fiscal deficit – Diff between govt’s total expenditure and total non-debt receipts. This is OK as long as deficits are used for funding assets – but within limits

• Primary deficit – Diff between fiscal deficit and interest payments for debt raised by prev govts. This is used by incumbent govt. to measure its prudence (or lack thereof)

• Report deficits are central alone, when state govt. debt is added, the number could be huge

• High fiscal deficit affects the entire ecosystem – interest rates, private investments, foreign trade deficit – govt. borrows heavily, increasing demand for loans, thereby raising interest rates which crowds out private sector and reduces pvt. investments. The interest rate differential also increases trade deficits over time

• Taxation can be done based on Benefit principle (tax proportionate to benefits used – eg. toll road), Ability to pay principle (proportionate to income and wealth, eg. income tax) or Horizontal equity and vertical equity principles (Those who are equal should be taxed equally and unequal, unequally) or efficiency principle (Taxes should have minimal effect on consumption and production decisions)

• Regressive taxes take a higher proportion of income from the poor

• Direct taxes – personal income tax, corp tax and wealth tax. (consistent with Ability to pay principle). Indirect taxes – Charged or good or services consumed indirectly (GST). GST can be regressive if it affects consumption of essential goods by poor (Efficiency principle at odds with equity principle)

• India has traditionally had higher indirect taxes since the direct tax base is low. This has ended up stifling consumption by the poor. (When our tax base increases, there’s a lot of scope for GST cuts and disproportionate inc. in consumption?)

• Laffer curve – When tax rate is zero, tax rev. is zero. But as tax rate inc. revenue goes up until the point where it disincentivises work and production (also increases evasion) – this is the optimal tax rate.

• It is a wise man that lives with money in the bank, it is a fool that dies that way – french proverb

• Money is a unit of measurement, medium of exchange and a temporary store of value

• Wealth is a stock concept – its a point in time value

• The cash with the public (Cash balances on hand) and the demand deposits with banks are considered money (M1). Interest bearing fixed deposits are not as liquid and so are considered as ‘Broad money’ (M3 money supply)

• Double coincidence of wants – You selling something exactly to another who wants it and also has something to offer in return. Money eliminates this problem and is the primary use case

• Since people with deposits do not withdraw in full or not all of them do at the same time, banks use it to lend. They also create secondary deposits when they create credit. The central bank controls how much of this secondary credit can be created through cash reserve ratio (CRR), and also statutory liquidity ratio (SLR) in treasuries, gold and cash so as to avoid a run on the banks and to control risky loans

• Indira Gandhi felt that banks were not serving the priority sectors and felt India could reach commanding heights if banks were nationalised (14 banks were nationalised in 1969 and more in 1980)

• Depression – When GDP, employment and prices fall quite drastically and remain at that level for years

• Its not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner but from their regard of their own self-interest – Adam Smith

• Heckscher-Ohlin theory – or Factory-abundance theory – Every country will use its abundant factor to create goods and services where it has comparative advantage. If India is labour-intensive, it will export labour intensive goods and a capital-abundant country like US or Germany would produce capital-intensive goods

• Despite sounds theoretical basis, countries often impose barriers to trade to protect domestic economy through bans and quotes on exports, restriction on import volumes, high custom duties, non-tariff barriers (NTBs) in the form of stricter quality specs on imports

• Devaluation create a competitive advantage but its a beggar-thy-neighbour policy and everyone does it eventually and it leads to autarkic (no-trade among countries) situation. These prevailed after WW-1 and eventually led to WW-2. Bretton Woods 1944 agreement led to the formation of World Bank and IMF and ITO, which after 50 years of repeat negotiations led to WTO in 1994.

• Trade liberalisation was a hard fought achievement of decades. China was reluctant to join but joined in 2001 and Russia in 2012. (It is striking how recent all this is)

• WTO allows for dumping duties. If an exporter sells a good in a foreign market for a CIF cost (Cost, insurance, freight) that is less than exporter’s domestic market, it is considered dumping (In India DGTR imposes ADD)

• Inflation is the one form of taxation that can be imposed without legislation – Milton Friedman

• Inflation is calculated as the weighted average of increase in prices of different commodity groups in the consumption basket.

• Inflation can be Supply shock/Cost-push or Demand-pull. Crude oil rose from $3/b in ‘73 to $40/b by ‘79 due to Arab oil embargo, Iranian revolution and OPEC regulation, leading to sustained shortage and a cost-push inflation. Optimistic sentiment due to wealth effects can cause demand-pull inflation (Hyperinflation in its most acute form)

• Quantity theory of money – M x V = P x Y – where M is money supply, P is price level, Y is the level of output in the economy and V is the velocity of money (avg. number of times a unit of currency is used in a period of time). PY is the nominal GDP. If productivity and velocity of money remain same, an increase in money supply will only increase the price level, cause inflation

• CPI varies for different segments of the society, between agri labourers and industrial workers or between urban and rural, so there are different CPIs computed with different weights for items

• Headline inflation – calculated on the basis of WPI. Excludes services, but includes raw materials, semi-finished products and imported commodities traded at wholesale level (Cost-push inflation shows up in WPI first and then in CPI). WPI is calculated every 2 weeks

• Core Inflation – In India core inflation is calculated by excluding food and fuel prices from WPI

• Reducing demand-pull inflation – govts will cut down on initiating new projects and hold back on imminent spending. Central banks reduce money supply with the tools they have (CRR, SLR, OMO, Repo)

• Newton controlled money supply in the UK in 1696

• Everything in the world maybe endured, except continued prosperity – Goethe

• Reduced output in an economy follows a glut and accumulation of inventories across sectors just as sentiment shifts

• Animal spirits – spontaneous and contagious optimism with an urge to action in the economy (sometimes this is naive optimism as well). The thought of making losses is put aside, just as a healthy man puts aside concerns of death

• Unemployment can be of several kinds – voluntary (not looking) and involuntary (looking but not finding). Only involuntary is considered. Frictional unemployment – between jobs or finding a job after education. Structural unemployment – no jobs for skills possessed and must retrain. (While overall jobs may remain stable, the skills might change). Around 4-5% unemployment is considered normal (natural rate)

• In a business cycle upswing (pro-cyclical), unemployment dips drastically and lot of attrition occurs and inflation soars (what we experienced last year)

• Counter-cyclical unemployment – economy doesn’t have to produce as demand is low and inventories are at a high, leading to unemployment

• The opportunity cost of going for higher-education is high (hence Ph.D programmes are counter-cyclical)

• Expansionary fiscal policy – To get an economy out of recession govt. spends increase in the economy and also tax cuts are made. This has a disproportionate impact on the GDP (There are however limits to this, as it can lead to higher fiscal deficits)

• OMO – Open market operations by RBI exerts downward pressure on interest rates when it cuts CRR and SLR, increasing liquidity with banks which are forced to lend.

• Repo stands for repurchase order. Banks sell Gsecs to RBI and place repurchase orders with RBI for a future date. The re-purchase price is higher than selling price (annualised % of this is nothing but the repo rate)

• China and South Korea were more or less in the same league as India at the time of our independence in terms of per-capita GDP (Early implementation of land reforms played a crucial factor)

• PPP – Purchasing Power Parity is calculated by World Bank by considering over 1000 commodities from all countries

• The societal benefits from vaccination and primary healthcare to an individual are far greater than benefit accruing to the individual (Numbers don’t lie by Vaclav Smil substantiates this)

• Education, healthcare, agri, labour and land reforms and a focus on infra can create robust long-term growth

Macroeconomics isn’t a subject like physics and is often chided for false-precision. It does help though to understand the basic tenets of it to get high-probability events judged right. I liked the simplicity and India focus of this book and would recommend it to anyone interested on the topic. 9/10