Sunday, February 27, 2011

The human obsession for easy generalities

I have often wondered how much the talking heads on CNBC and the experts waxing eloquent on various issues really understand about the full context of what they are talking on. (disclaimer: i don't understand much myself and i am not offering myself to be someone with better understanding of a given topic than some X or some Y. This post is about a more fundamental epistemological issue.)

Lately I have come to realize a few things - which has led me to a general conclusion. The observations first.
1. The devil is always in the details. Generalities sound enticing and are often intellectually quite seductive. E.g. consider the following: "The debt to GDP ratio of India is already 60% (or some similar number) and that of the worst hit economies in the developed world is 105% (or something similar) and hence continued fiscal deficit in India is a sign of slowdown in future growth and crowding out of private investments, worst still it may bring about fiscal crisis of the sort Greece is facing."
The details put a huge question mark on the relevance of this gross oversimplification. For one, debt to GDP is a ratio and in India's case the denominator is increasing (and no, not at 8-9% but at 15-17% since these are nominal number not real). While the numerator also is increasing, the rate of growth is lower and is likely to go down further.
Secondly, the debt to GDP ratio of X or Y is not behind the fiscal ills of the western economies. Translating a ratio that general into an assessment of fiscal health of a country is a tall order.

2. Most often a given generality gets repeated often enough to make majority of the lay people as well as the 'experts' believe in its accuracy. That the crude oil products in India are subsidized is an example of the same. What Indians pay for a litre of petrol is higher than what Americans or most other developed countries' citizens pay. The subsidy then is simply payback from the higher taxes and duties.
If one follows a given generality to its logical end, one would realize that most of these are drawn from a vast array or general statements and ideas stated everyday by hundreds and thousands of sources. Collectively by choice or through active propaganda, some of these get picked up. Truth or accuracy is not the deciding criteria for what gets picked. Its mostly a matter of what the source is, how palatable that statement is and how intellectually or emotionally titilating it is. Through the life of the generality, it grows stronger, weaker or dies depending on the public sentiment and/or active money and energy spent in the propaganda. This life of the generality is also fairly divorced from its degree of truth.
(disclaimer 2: this is not meant to be a cynical view of the world. I am only trying to assess how we as humanity behave. That then may have some learnings of academic interest as well as of interest to those looking to actually do some good for the humanity)

3. The story of the the blind men and the elephant for me is the most profound epistemological allegory. It shows the fundamental limitations of what we claim to be our knowledge of the world. This ties in partly with observation 2 above. Since subconsciously all of us are aware of this limitation of the 'truth', we are (again subconsciously) ok not looking too hard for it if what is presented as truth is entertaining enough, satisfactory enough and not outright ridiculous.
However, at a conscious level we do not seem to be particularly perturbed by this limitation. Most of the conduct of our affairs (especially when dealing with decisions involving large number of self-conscious entities like humans e.g. large company affairs, macroeconomics, investment decisions etc) is carried out as if the blind men are either not blind or they are dealing only with a tree trunk - thus making all their observations and inferences identical and non-contradictory.

Now the general conclusion: this is more of an answer to the following question - if 3 above is true, why do we engage in 2 and routinely ignore 1? Or stated in English - if our knowledge of the world is fundamentally limited, why do we create and sustain quasi-true generalities and almost actively avoid getting into details that might contradict the generalities?
For one, it is simply the mis-match between the amount of information on one hand and the ability in a single human mind to grasp and appreciate it to draw useful general conclusion on the other. There is simply too much stuff known to us at the first level to handle for a single person. Compartmentalization helps, use of computers helps - but only so much. The higher levels of general conclusions cannot be automated and cannot be segregated into smaller tasks or disciplines.
Secondly, the remoteness of the decision and the sheer intractability of the cause-and-effect relationship between one decision and its effects in isolation from everything else make us almost jaded when dealing with our pursuit of truth. There is almost a resignation to the fact the it is all so very complex that even if we knew the exact truth and we acted on the basis of it, the outcome may not be as expected. So why bother?

An interesting aside is one specific tendacy amongst the investors and their asset managers - this bunch is is almost hypersensetive to decision oriented information. Take a look at the variation in the GDP growth of the Indian economy and the variation in its assets markets - be it equity, debt or real estate. The sharp ups and downs in the asset market are significantly exaggerated vis-a-vis the same in the underlying economy which is what these assets are supposed to be based on!
One tends to think that this bunch (which includes me!) is always looking for something to react to. This can be a small downward revision of GDP forecast, some issue of governance in a given company amongst 500 of them and so on. This lot is all the more prone to the above mentioned generalities!

Sunday, February 20, 2011

G20 summit - a very small baby step (of sorts!)

The latest G20 Summit has managed to reach consensus on - hold thy breath - the indicators which will be tracked to measure global economic imbalances! It seems public debt, fiscal deficit, private debt and current account deficit will be used to track the state of imbalance. No points for innovation there! Sarcasm aside, this is a start, however small it might be. Hopefully it would least get the world leaders to start to have some faith in dealing with economic imbalances in a multilateral manner.
As Dominique Strauss Kahn is rightly worried, the belief that the worst has passed in terms of global financial and economic crisis has made many governments too complacent to invest energy into the tedious and circuitous processes and rounds of multilateral efforts to deal with the imbalances. The worry is not alarmist. The shock has passed, the crisis has not. Recovery in emerging economies and reaction of developed economies to a unprecedented stimulus is not a sure sign of long lasting global economic recovery. It is not that things will come to the same scary pass again in a short while. However, one should not see the crisis as a one-off shock which came and went after everyone scrambled together to deal with it. It happened due to some fundamental reasons - including the global economic imbalances - which are not yet fully gone away. The next crisis may not be as severe. It may just sap the vitality of global economy over a decade. That is the scary part. It is not shocking scary, it is just scary when one puts everything down in detail. Unfortunately humanity is not known to respond very well to such subtle - even if highly potent - threats!

Sunday, February 06, 2011

Inflation - some preliminary dissection

Inflation has been spooking everyone - from housewives to prime minister and from retail investors to FIIs. Two numbers have been doing the rounds - the headline (WPI) inflation and the food inflation with the latter taking most of the limelight.

RBI duly increased interest rates in its latest monetary policy - thankfully by only 25 bps. I wonder if it is doing so out of ideological belief or out of the need to be seen doing something. Here's why I wonder so.

Data on the finance ministry website shows the nominal and real growth in three sectors of the economy.
                         Nominal         Real           Inflation
Agriculture             25.4%           4.4%      ~21%
Industry                 15.5%           8.9%        ~6%
Services                 18.7%           9.8%        ~9%

This means that industrial output and services have become costlier by a much more modest 6-9%. Food has been the only source of sustained high inflation. In this scenario, how is interest rate likely to reduce it is difficult to see. It will of course bring about a reduction through further decrease in industry and services inflation. However, I think the agricultural inflation is largely immune to interest rates and will continue to remain stubbornly high unless some other policies work or we get lucky. The sad part of this story is that monetary tightening will end up hurting growth anyway.

What can the policy makers do to contain food inflation in a targeted manner? Tax-sops? Imports? Increasing supply through Food Corporation Stock?

There is a much neglected another angle to this story - full of political implications. High food inflation in turn is income re-distributive - it takes money from rest of the agents in the economy and puts it in the hands of the farmers. I have no value judgment in the matter. It is noteworthy though. And this can be helpful to create a positive sentiment amongst farmers before the near term elections after all.