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Shubhendu Pathak
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Shubhendu Pathak Education B.Tech - Indian Institute of Technology, Delhi M.Tech - Indian Institute of Technology, Delhi MBA Finance - Goizueta Business School, Emory University CFA Level I
  • Republic Of Ghaziabad 1 comment
    Jan 26, 2014 1:39 PM

    "The nine most terrifying words in the English language are: I'm from the government and I'm here to help."

    - Ronald Reagan

    'Help the poor'. Wherever on the planet, whenever in history these words have come from a government, a social and economic disaster has followed. If we focus on history lessons from East Germany - West Germany, South Korea - North Korea or even the current state of the U.S. to illustrate the point, the economically literate will get a chance to confuse us with terminologies they themselves don't understand. Economy is not a controlled experiment where data can be used to validate a theory. Validity of a theory in economics is better established by how well it explains the relationship between cause and effect. It is not a rocket science. So let us build up from the axioms and corollaries of economics to understand how a help promised by the government not only makes no economic and social sense but is also morally corrupt.

    Axioms are simple. Parallel lines do not intersect. At least one human has to work to produce a good or service that can be consumed by someone. In mathematics, complex theorems are built on axioms. Governments, banks, insurance companies, concept of a contract etc. are built on axioms in economics.

    This story is of a small island called Ghaziabad. It was located in the Indian ocean and had a population of 50, 25 males and 25 females. There were five tasks each individual on the island performed to survive 1. caught fish 2. cultivated land 3. cut wood for fuel 4. made clothes 5. brought water from a waterfall 5 km from the dwelling place. Each island dweller carried out these five tasks during the day to survive, went to sleep at night to recover from fatigue and woke up in the morning to carry out the same five tasks the next day. There was no holiday in Ghaziabad. Everybody worked every day just to survive. Nobody had time to enjoy luxuries of life or even to take care of someone who fell ill.

    One day a dweller who was better than others at catching fish suggested to his friend - "It takes me a lot of time to cut wood. I have a good spear I made and my aim is pretty accurate but I don't have arms as strong as yours. I will catch some fish for you tomorrow. Can you get me some wood". His friend agreed - they entered into a contract. The next day, the fisherman saved the energy he used to waste cutting wood and the lumberjack was glad not chasing fish with his broken spear. Happy with the outcome of this arrangement, the two men started doing it every day. They spent their saved time and energy in luxury activities, climbing trees, swimming in the ocean, looking for lice in each other's hair and what not. When other people saw them spend quality time, they got motivated and followed suit. Specialization of labor, the premise of modern economy, was born.

    The benefits of specialization of labor were so intuitive that after about a year the village had each individual performing just one task the individual was good at. 10 people caught fish, 10 cultivated land, 10 cut wood for fuel, 10 made clothes, and 10 brought water from the waterfall. As a result, production in the island increased significantly and the fruits of labor were enjoyed by all.

    However, there were a few growing concerns in Ghaziabad. The word about the prosperity of the island had spread and there were rumors that people from a neighboring island were planning to plunder some of the houses. The dwellers also suspected that one of the lumberjacks had turned into a thief and was stealing goods from their houses. When the dwellers went out to work, they were worried about the safety of their assets back at home. In addition to this problem, one contract between a lumberjack and a fisherman was violated. The fisherman refused to give the lumberjack the fish due for the day claiming that he did not receive any wood; the lumberjack insisted that he had left the wood in front of the fisherman's house. This had led to tension between the two families. Afraid that their contracts might be violated, some of the lumberjacks started fishing again.

    The productivity of the island started falling. The seniors in the island became concerned about the future of Ghaziabad and held a meeting. It was decided that three people will be appointed to protect the life and personal property of people and to ensure completion of contracts between individuals on the island. One person would guard the beach from potential external attacks, one would guard houses during the day, and one would resolve conflicts whenever a contract was violated.

    To ensure that the appointed individuals can focus on their jobs, they were not required to produce anything for themselves. It was decided that fishermen will give them two fish every day, cloth makers will give them one pair of clothes every two months, farmers will give them adequate quantity of grains and someone will bring them drinking water. Consensus on who to appoint for the job could not be reached so it was decided that people who had the maximum number of island dwellers supporting them will hold the position. Elections were held and a team of three credible individuals was appointed. In the island of Ghaziabad, government was born.

    The role of this government, which people felt was necessary, was to create an environment conducive for efficient production and trade. It was not formed to help the poor, it was not formed to provide education, it was not formed to provide water, it was not formed to control the prices of essential goods. It was formed so that people could do what they did more efficiently.

    With an assurance that their assets were in safe hands, people started going to work. Fishermen and lumberjacks started exchanging goods again as there was someone reliable to resolve conflicts. The economy of Ghaziabad was back on track.

    One more prosperous year passed by. Some interesting developments took place on the island. Four cloth makers thought - "People spend so much time in the evening to start a fire, why not make something that will make it a little easier to create fire." They saved some extra clothes during the year and started working on a process to manufacture matchsticks from locally found chemicals. They exchanged the clothes they had saved during the year for fish and grains to survive while they worked on this new venture. After a few months of hard work the team found success. The product became popular overnight. Matchsticks saved everybody so much time that lumberjacks were willing to give ten days of wood supply and fishermen were willing to give ten kg of fish in exchange for just one pack of matchsticks.

    Note that the fishermen and lumberjacks were willing to pay so much not because they were forced to do so but because they felt that one pack of matches was worth that value. The fishermen could catch more fish and the lumberjacks could cut more wood in the time they saved every day by using the matchsticks they purchased. The value of matchsticks was measured by the amount of goods (money) people were willing to pay for them. The engineers had anticipated the needs of the people of Ghaziabad and had assumed certain amount of risk; they could have lost all their savings had their venture been unsuccessful. Looking at how the risk was rewarded, other people were motivated to take similar risks to build new things and to produce existing goods more efficiently.

    One of the lumberjacks called Shyam had a ground breaking idea. He had a credible image in Ghaziabad and his ability to evaluate the risk of new ventures was well known. He asked his friends to save their extra clothes, wood, fish and matchsticks with him for a year. He promised to give back the savers more than they saved with him after a year. He then identified islanders trying to create new things or working on producing existing things more efficiently and gave them clothes to wear and fish to eat till the time they were working on their initiatives. If the initiative was successful, Shyam was paid back more than what he invested. Some of the dwellers were not successful and were not able to pay back but Shyam got enough from the successful ones and became wealthy. Before people of Ghaziabad gave Shyam their savings, they did a lot of research to make sure that he was trustworthy and competent, and that he was investing their savings responsibly. After making this assessment about him, they made the decision to invest their own hard earned goods. The savers were rewarded for the risk they took when Shyam paid them back more than they saved with him. Bank was born.

    Let us not go into fiat money, central banking, or the fractional reserve banking system. In fact, let us not even go into money, as that will again give the economically literate a chance to confuse us. Money was invented only to reduce the complexities of the barter system. Let us keep our resolve to stick to the basics.

    The island economy started growing at a very rapid pace as people working on ideas had easy access to savings. A farmer borrowed savings from Shyam and worked for four months to develop a process to produce fertilizers from bat droppings he collected from the floor of a nearby cave. Yield of his farmland increased so much that he was able to sell his grains for much less; he could exchange four month's supply of wheat for just a couple of clothes. Cloth makers now had more grains they could save with Shyam. A sixteen year old child prodigy invented a barrel with wheels using which he was able to bring water from the waterfall for ten people at once. Women who earlier spent most of their time bringing water from the waterfall started weaving clothes and exchanged them for water. The women became so efficient at making clothes that they not only made a lot of extra clothes but the clothes they made were of a much higher quality. They used extra clothes to buy matchsticks and saved even more time.

    Did the sixteen year old prodigy's tanker make the women unemployed? (Will FDI in retail increase unemployment of shopkeepers? Did metro, cars, buses and auto-rickshaw drivers make men running horse-carts unemployed?)

    A fisherman had spent sleepless nights making a bigger and stronger fishing net. He caught so much fish every day that it became difficult for him even to unload and pack them. He offered one fish to any dweller willing to help him for an hour to unload and pack the fish in banana leaves. Employment was born.

    Note that the fisherman did not force employment upon the employee. He offered him an opportunity to exchange his labor for fish. The employee accepted the employment because he thought that he would not be able to catch or earn one fish in an hour anywhere else using his current level of skills. It was a win-win for both of them.

    On the other side of the island, lumberjacks were facing a problem. The name of the problem was Black Recluse, a spider common in the woods of Ghaziabad. The spider bite was so poisonous that any lumberjack bitten by it had to take bed rest for at least a month. This had put some of the lumberjacks in a very difficult situation as they could not support their families during the recovery period. To solve this problem, lumberjacks of Ghaziabad formed an association and built a huge storage facility. Every lumberjack who stored one log of wood in this facility every month could use the wood in the facility in case he was bitten by a spider. Insurance was born.

    Government, banks and finally insurance. These institutions provided so much stability to Ghaziabad that it became an ideal economy for neighboring islands. There was so much production in the island that charity was common. Women gave extra fish to people who could not afford them. Cloth makers gave clothes to people who could not temporarily work due to bad health. The system nurtured the inherent human nature to indulge in charity and to treat fellow islanders as brothers. Civilization was at its peak.

    One more year passed by and the next election was upon Ghaziabad. The incumbent government decided to fight the election. Their campaign pitch was - "We carried our responsibilities diligently. We protected life, prevented theft and made sure that transactions were carried out properly. Vote for us and we will continue our sincere service to the people of Ghaziabad" Another team of three individuals Arvind Modi, Narendra Swamy and Subramanian Kejriwal was planning to fight the election and was rapidly gaining popularity in Ghaziabad. (The names are purely coincidental.) They were proposing a plan where every unemployed dweller on the island will get free fish and clothes. "We should at least provide basic livelihood to everybody on the island. It is their right" they said. People were initially confused. They asked - "We have not seen you guys produce a thing in your life. How are you going to give clothes and fish to these dwellers?" To this they answered - "We will collect it from cloth makers and fishermen. We will make this collection mandatory." Cloth makers and fishermen were furious at this idea and started a campaign against the team.

    Legend has it that it was all Rahul's idea. There was a village fool in Ghaziabad, his name was Rahul Chidambaram. He lived in a world of his own - talking to himself, running after kids who teased him and making various types of sounds from his armpits. He used to intentionally burp very loudly whenever anyone asked him his name. One day Modi, Swamy and Kejriwal were walking on the beach when they saw Rahul at a distance playing a game of 'who can pee the farthest' with kids. Kejriwal said to him jokingly - Will you vote for three for us if we fight the election. Rahul thought for a few minutes then said - "only if you give me some clothes and fish". Kejriwal, Modi and Swamy looked at each other and thought - "What a great idea? Forget about all the responsibilities, protecting property and life and yada yada. We will just promise fish and clothes to people. We will make the rules of the game. We will rule." And they decided to fight the elections.

    The team won with an overwhelming majority. Even some of the fishermen and cloth makers who did not feel like working anymore voted for them. Under the new government, hard working cloth makers and fishermen saw their produce being taken away against their will. Many fishermen closed their operations. People of Ghaziabad now had an incentive not to work and live off of production of others. Youngsters were not motivated to gain fishing and cloth making skills; they thought it was government's responsibility to feed them.

    The team announced new job vacancies in the government. They needed someone to collect fish and cloth from fishermen and cloth makers. When people asked how they will pay the employees, they said - "We will collect more fish and clothes from the fishermen and the cloth makers". Even more fishermen closed their operations after this announcement. As a result, fish became so scarce that lumberjacks had to cut wood for an entire day just to pay for one fish.

    Next election came and Swamy, Kejriwal and Modi with the best of their intentions announced "Fish are scarce. We don't want anybody to die of hunger. How can you ask a hungry man to work? We need to put price cap on fish. We need to collect more fish from these fishermen." The team further deviated from their initial responsibility to protect the life and personal property of people and to ensure completion of contracts between individuals on the island.

    Running out of fish and clothes to fulfill their promises, the team overtook Shyam's bank (nationalized it) and started giving saved clothes and fish to people. When the savers asked "Shyam paid us back if the investments were successful. We don't trust your investment skills. What if our savings are invested in ventures that are not successful". The team said "Don't worry about it. We will collect more from people and give it to you. We will sell the resources on the island and cover the losses." They "guaranteed" their savings.

    The guarantee purportedly devised to prevent run on the banks, that are essentially nationalized, is a part of an insidious arrangement. The RBI printing money out of thin air to "lend" to the government or to pay the savers is even more insidious. It devalues the savings. The power given to the RBI to lend to the government and to carry out open market operations is one of the root causes of the evil. Governments and friends of governments can destroy an economy via inflation with this unnecessary power.

    It can get a bit confusing when money is involved in transactions - "The government pays the farmer with money, the government pays the doctor for his services with money, the government pays teachers for education with money." The government does not produce anything. Money is title to goods or services; it does not come out of thin air. Neither do savings. Someone has to work hard to create savings. The one who saves has the right to invest her/his savings where he/she feels the reward is worth the risk. In a true republic the saver has this basic right. When people gave their savings to Shyam, they did their research on his credentials and kept a check on where their savings were being invested. People now with "guaranteed" savings stopped researching before they gave their savings to the team. Kejriwal, Modi and Swamy neither had the competence nor was there any pressure from the savers to invest in the right areas. The trio started giving money to their friends who could convince them easily. When they lost money, they just increased the tax.

    They also started making new rules - who can sell fish, what price can one charge etc. They appointed a planning commission to suggested areas where people should invest. The experts in the commision said - "Fishermen have become very wealthy. Only fishermen who will manufacture salt will be allowed to fish. The people of island need salt. There is a very high demand for it."

    If people need something, they pay for it, be it water, electricity, education or salt. Profit is a measure of value addition. If a business is not making profit producing a good or service, it means that people do not appreciate the value addition the business is offering. When a third party applies its mind and forces a business to invest somewhere, it essentially overrules the will of the people. Without exception, such an application of mind leads to misallocation of resources.

    What about national highways? What about water? Let us take national highways as an example as it seems most intuitive that they are a government responsibility. If people of Delhi say that red light should mean stop and people of Haryana say that red light should mean go, there is going to be a lot of confusion, so rules that fall under this category can be made by the government such as town planning (so that someone does not open a loud factory in the middle of a residential area), road maps (so that people don't build roads every which way) etc. But whether to build a national highway should be a decision made by the people. How? Build-Own-Transfer model has the answer. Highways' value should, like any other good or service, be measured by users' willingness to pay for it. Entrepreneurial individuals will assess this value and decide whether to build the road. An entrepreneur will build a road if he/she feels that its value will be appreciated by people i.e. people will pay for it. The resources the entrepreneur will use will be commensurate to the value of the road as measured by people's willingness to pay for it. If the entrepreneur builds a bad road, people won't pay to use it. The highway will be transferred as a national asset after a certain period of time.

    Governments are known to build roads to nowhere i.e. roads that provide no value. Government's sole responsibility in commerce is to provide an environment conducive for trade, not to apply its mind to interfere in it. No matter how intuitive it may sound, it should never be decided by a third party what goods or services people want to consume or what might benefit them. It takes a strong resolve and character to leave this power with the people. We will discuss one such resolve displayed by one of the 19th century presidents of the U.S. For now, let us return to the island of Ghaziabad.

    To cover for bank losses and to fulfill the promises given to the people of Ghaziabad, the government started collecting even more tax. With 40% of their catch being taken away by the government, even more fishermen stopped fishing. The sixteen year old prodigy who could earlier eat healthily by working for a few hours could only get one fish in exchange of a tank of water and was forced to stop his operation. By the time he came home after pulling the tanker all day, he was so hungry that one fish was not sufficient for him. Women started going to fetch water from the waterfall. As a result, clothes they made became scarce. Rape and theft were common as the team lost focus on its primary responsibility of ensuring safety of life and property. Very few people entered contracts as the authority to enforce them had weakened. Nobody wanted to produce so the team started giving perks to individuals to set up big production facilities. As a result, wealth disparity started increasing.

    The fabric of human nature that inspires every human to take care of others started deteriorating. People stopped charity as they thought it was government's responsibility to take care of "them". "Them" vs. "Us" was born. The "We" started deteriorating. Attitude of people changed to align with the existing set of incentives. Earlier hard work and risk was rewarded and 'Power' was defined as "The ability to help others by producing things that they needed". The new system rewarded connections with the government. The definition of 'Power' changed to "The ability to create problems for others". National character started shaping up in accordance. Everybody thought that everybody else is corrupt by nature. The death spiral had begun. In a few years the economy of Ghaziabad resembled that of India.

    This question from the bleeding hearts always seem to touch a nerve - "But then what will happen to the people dying on streets? Who will take care of them? Only a person who has not seen hunger can ignore their plight."

    When the government decides to help the poor with someone else's money, is essentially weakens the fabric of human nature; it doubts the inherent nature that inspires every human to indulge in charity, to treat a fellow national as his own brother and to take individual responsibility. It does not only make no economic sense but is also morally corrupt to the core. It takes a strong resolve and character to resist the temptation to help the dying with somebody else's money.

    Economists continue to site what the U.S. government is doing today to defend welfare policies. What made the U.S. a wealthy nation is not what it is doing today. Today, it has picked up a road to collapse. The U.S did not have income tax prior to 1913 (only profits were taxed). Income tax was unconstitutional before the 16th amendment. Similarly, the Fed was not allowed to buy the U.S. treasuries. It was only during the crisis of World War I that an exception was made to finance the war. Unfortunately this power given to the Fed was never reverted.

    The nation was built on sound principles. There is a very famous example from the glorious days of the U.S., the days that made the country a superpower. Members of the congress wanted to pass the Texas Seed bill in 1887 to help the farmers suffering from drought in the state of Texas. President Grover Cleveland vetoed the bill. The excerpt below from his reply to the congress summarizes his thinking.

    "I can find no warrant for such an appropriation in the Constitution, and I do not believe that the power and duty of the general government ought to be extended to the relief of individual suffering which is in no manner properly related to the public service or benefit. A prevalent tendency to disregard the limited mission of this power and duty should, I think, be steadfastly resisted, to the end that the lesson should be constantly enforced that, though the people support the government, the government should not support the people.

    The friendliness and charity of our countrymen can always be relied upon to relieve their fellow citizens in misfortune. This has been repeatedly and quite lately demonstrated. Federal aid in such cases encourages the expectation of paternal care on the part of the government and weakens the sturdiness of our national character, while it prevents the indulgence among our people of that kindly sentiment and conduct which strengthens the bonds of a common brotherhood."

    Following this veto, President Cleveland donated his personal money to the farmers of Texas.

    There is a radical difference between a Democracy and a Republic. In a Democracy a government does what the majority wants. In a Republic the power of the government is limited and cannot be increased even if majority wants it. India calls itself a Republic but operates like a Democracy. We adopted this form of government in 1947 and picked up the road to collapse. We will become a true Republic when 1.2 billion people are free to choose how they want to serve each other.

    "I will give you a talisman. Whenever you are in doubt, or when the self becomes too much with you, apply the following test. Recall the face of the poorest and the weakest man whom you may have seen, and ask yourself, if the step you contemplate is going to be of any use to him. Will he gain anything by it? Will it restore him to a control over his own life and destiny? In other words, will it lead to Swaraj (rule of the self) for the hungry and spiritually starving millions? Then you will find your doubts and your self melt away."

    - Mohandas Karamchand Gandhi

    The poor woman who walks for miles every day to get water does not need help from the government; she needs Swaraj.

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    wow....very well explained shubendu
    15 Jun, 07:52 AM Reply Like
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