Equitable Sharing Of The Pain

India, Tuesday, April 21, 2020. Today is Civil Services Day in India. It is the beginning of Day 07 of the second tranche of our lockdown. India had opened up parts of its economy since last morning.

It is an altered social and economic environment. People need to adjust to the new social and economic environment. They will need a new set of objectives, expectations, attitudes and activities to cope with the changes. They will need to navigate through the new economic realities.

Above all, they will need to motivate themselves to work with the new economic realities. There are higher costs. Some of these costs are variable costs. Many of these costs are fixed costs.

There is uncertainty. Wage incomes are uncertain. Employment and livelihoods are uncertain. Business revenues are uncertain when households face uncertain livelihoods and incomes. It is not a coincidence that both households and businesses are in the private sector.

Public sector, private sector

Rains, avalanches, cold snaps and cold waves, droughts, heat waves, earthquakes, floods and viruses have a social and economic impact. They impact people and businesses that are closest to the ground. These people and businesses are at the heart of the private sector. They face the wrath of the elements and the virulence of the viruses.

They are the bodies and souls of India. They are the muscles and minds of India. They are the sources of savings and taxes that run India. They are the money of India.

The public sector is lucky. It occupies the high ground. It is protected. It takes a while for the wrath of the elements and the virulence of the viruses to touch the public sector.

The public sector is luckier too. It has access to the savings of the households. The public sector issues sovereign and state bonds to tap into the savings of the private sector. It has access to the taxes paid by households and businesses. Households and businesses pay taxes but they do not tax the public sector. The public sector can print money to meet its payment obligations.

The private sector is our locomotive

Households and businesses work for their incomes and revenues. There is real work that adds value and utility. Such value addition goes right into the nation’s gross domestic product (GDP). Taxes and savings emerge from the private sector’s value addition.

Bank deposits emerge from the same source: savings. And, these savings constitute the equity or ownership capital of households and businesses.

The private sector – households and businesses – borrows to build homes, run the farms and businesses, and to educate its children. Households and businesses borrow from their own savings. These savings appear as deposits in the banking sector. When banks lend, they lend from the deposits of households and businesses. Banks do not have their own money on the line. They are merely intermediaries.

The private sector – households and businesses – pays taxes so that the union and the state governments can run the government apparatus and simultaneously build the social, defence and economic infrastructure. When governments spend, they spend taxpayers’ money. When governments invest, they invest from taxpayers’ money.

These are rudimentary and axiomatic. We have no intention to bore you with the principles of public finance, gross savings and capital formation. We have a different objective.

The perils of the private sector

The private sector lives a perilous life. Every household and every household is a risk-taking and risk-facing economic engine. These perils do not appear in the flows, scorecards, incomes and balance sheets of the public sector.

The public sector is a gigantic portfolio. Risk is smothered when more random variables come into this gigantic portfolio of risky variables. This is especially true in normal times.

First, the drop in taxes from some households and businesses will be made up by a rise in taxes from some other households and businesses. Second, the drop in savings from some households and businesses will be made up by a rise in savings from some other households and businesses. Third, the drop in credit quality of some households and businesses will be made up by a rise in credit quality of other households and businesses.

Negative covariance and the process of diversification protect the public sector from the insane and mundane risks that the private sector faces all the time. Consider cricket. Each cricketer is a risky asset. The runs scored by each cricketer will have wild swings. Some may score a zero (duck) or a ten. Some may score a fifty or a hundred (ton). Add the big scores and the small scores. The team’s total score will not swing as wildly. There is stability.

But we live in abnormal times. The risks have increased nonlinearly since the outbreak of SARS-CoV-2. SARS-CoV-2 causes COVID-19, a deadly respiratory disease. Every cricketer is close to scoring a zero (duck) or a ten. The team score will be low.

Let’s peel off the smugness

The public sector is now as perilous as the private sector is. On its own and by itself, the public sector is not the economic engine of India. It should not remain smug. It has to show empathy. It has to show empathy in its own interest and to serve its interests. The smugness of the public sector will have multiple adverse and dysfunctional effects.

The private sector has borne the brunt of SARS-CoV-2. It will continue to bear the brunt of SARS-CoV-2. The private sector has to get off the ground and hit the ground running.

Getting off the ground, getting up and getting ready to go are quiet daunting when costs relative to output are high. Getting off the ground, getting up and getting ready to go are quiet daunting when incomes and revenues are uncertain.

What will the public sector do? What should the public sector do? Does it have its skin in the game? Or, is the public sector seated in the stadium’s stands? Is the public sector lounging in the hospitality boxes in the stadium?

The chemistry of the economy

Consider the chemistry of generating energy from hydrocarbons. The endogenous carbon chain in a hydrocarbon burns with the exogenously supplied oxygen to produce energy. The molecular ratio of carbon and oxygen to produce energy is fixed.

Supplying more carbon for a given amount of oxygen will not result in the production of more energy. Supplying more oxygen for a given amount of carbon will not result in the production of more energy. India needs to get both carbon and oxygen off the ground simultaneously and in the right ratio.

The public sector has to understand the chemistry of the economy. The private sector has understood the chemistry of the economy. Crude oil prices plunged yesterday.

West Texas Intermediate (WTI) crude oil futures for May 2020 delivery slipped below zero! Too much carbon! Prices fell on fear of rapidly filling global storage facilities caused by the novel coronavirus pandemic. The fear in the market is that storage facility will run out of space by mid-May 2020. The June 2020 contract was trading at $21.14 per barrel.

The International Energy Agency in its monthly report said that April 2020 demand may be down by 29 million barrels per day from the same period last year. This is the level last seen in 1995.

We will write this again: this is the level last seen in 1995. The public sector has to understand the meaning of this. Its cost relative to the costs of the aggregate economy has to shrink to the 1995 level.

Returning to the 1995 level may be daunting, but it sets the direction of the agenda-setting for India. The public sector needs to take a haircut. The public sector has to show proof that its cost will fall so as to maintain the ratio of (1) the public sector’s costs to (2) the private sector’s costs.

India’s public sector serves both the trickle-down and the jobs-multiplier effect. It is constructive. We know how the trickle-down and the jobs-multiplier work in India. So, the public sector’s – self-imposed – haircut need not be big. But there is both room and the need for the haircut.  

The four-square squareness

Consider four squares. Each square is identical to the other. Their sides have the same length. The first square represents households. The second square represents businesses. The third square represents banks. The fourth square represents the state and the union governments.

The four squares can be put together so as to make a big square. The collective square will be a perfect square. Squareness is maintained. Squares signal stability and snugness.

The dimension of the squares representing households and businesses has shrunk. The dimension of the squares representing banks and government has remained unchanged. Two small squares and two big squares will not make a perfect square.

The private sector in its current shrunken size will have to be the net-net provider of net interest income to the banks. The private sector in its current shrunken size will have to be the net-net provider of direct and indirect tax income to the state and the union governments. The two small squares are too small to feed the two big squares. India has lost its squareness.

The public sector needs to take a haircut. The public sector has to show proof that it will cut costs so that we can return to squareness, stability and snugness. The public sector has to shed its smugness.

The locomotive’s motivation

The gradient matters in cricket and in the climb of a locomotive. When the target is 180 runs or so in a twenty-twenty game, the chasing team steps up to the game and gives its best. The chasing team may not win, but the probability of a win is high. One-hundred-and-eight (180) is relevant to the measurement of the flatness of the terrain in degrees. 

When the target is 225 runs or so in a twenty-twenty game, the chasing team could be daunted. The chasing team may not lose, but the probability of a win is low.

The target’s magnitude relative to the current position has an impact on the motivation of cricket teams and locomotives. The gradient matters. If the gradient is too high – say, higher than the angle of repose – the climb becomes impossible. Cricket teams give up the chase. Locomotives will refuse to go up the incline.

The fixed costs of staying in business have remained the same. The gradient has gone up for households and businesses. Giving up will be a rational choice for many. There is comfort in poverty, insolvency and bankruptcy.

Unlike the price of crude oil, the bank interest rates and the rates of direct and indirect taxes have not fallen. Microeconomic flexibility has made oil cheap. Buy it if you need it.

By contrast, macroeconomic inflexibility has raised the costs of the public sector relative to the private sector’s uncertainty, output and operating margins. The public sector has become expensive. But you have to buy the high-cost public sector’s output if you wish to stay in business.

India’s private sector has a choice. It can choose to be daunted by the gradient. It can pack up and go. India’s public sector has a choice. Take the haircut. Lower the gradient. Stop the private sector from sliding backwards. Lower the gradient. India’s public sector has to adjust to the new social and economic environment.