06 September 2014

12 August 2014

"What to do with money?"

OK, you managed to save some money. Feel like an investor?

What do you do?
  1. Stay away from wealth managers. In the end, all they achieve is to make your savings work for them. If any wealth manager persists in chasing you, ask him two questions:  (a) Does his fee depend on the increase in your wealth? Or on the number of transactions he executes for you? (b) Can he explain what are "alpha", "beta" and "r squared" in portfolio theory? What has been his "alpha" last three years?  Most would run away by this time
  2. Stay away from hedge funds. Yes, you read about several billionaire hedge fund managers. You have seen their yachts. Have you seen their clients' yachts? Understand two facts: One in a thousand hedge fund managers makes profit by predicting a "tail end event" well. Two, no hedge fund manager has predicted two "tail end events" well. Your dilemma: If you join a star hedge fund manager, odds are against you making money. If you join a yet to be star fund manager, odds are against you making money. You still want to go with hedge funds? Read "When Genius Failed" before you do.
  3. Stay away from technical chart makers. Run away from anyone who talks about candlesticks. Technical advisors presume that the past is a good indication of future. Remember Eastman Kodak in photography industry? Remember Lotus 1 2 3 as a spreadsheet?
  4. Resist the temptation to pick individual stocks. Resist the temptation to study the alpha (superior performance of an individual stock over risk adjusted return of a benchmark) and beta (correlation between volatility of stock and volatilty of market). Sharpe got his Nobel prize for this theory. Shiller, another Nobel laureate, discredited Sharpe's theory. As far as you are concerned, invest in businesses, not in stocks. If you think a company's business has a great future, go ahead. If you think a company's business model sounds suspect, stay away.
  5. Do not believe you can predict stock prices next week. With some luck, you can predict the long term trend of a stock price. There is no way you can predict what the stock price is going to be next week. That is more likely to be swayed by sentiments in the economy and sentiments in the market (that you cannot predict) or inside information (which can make you rich until regulators catch you and put you in Lavenworth maximum security; food, am told is not very good).
  6. Do not believe debt is safe. The price of debt varies inversely with interest rate. If the Fed increases interest rate, your asset value would come down proportionately (unless you have short maturity paper). Are you comfortable you can predict how Raghuram Rajan is going to behave next week? Understand that debt has its own risk.
  7. Do not believe anyone offering above market returns. They cannot. Not unless what they do is illegal or they plan to do the old trick of using the next guy's investment to provide you superior return so that they can attract the third guy to make an investment into their fund. Google "Ponzi" for more details. This was Boston's contribution to financial world more perfected by several benefit funds in Chennai.
  8. Do not believe Gold is a safe asset class. Gold gets you a warm hug from the wife. That is pretty much about it. Gold is just one more asset class with its own risk and volatility.
  9. Do not believe fixed deposit is therefore the better thing to do. Fixed deposits are constantly eroded by inflation. When you deposited, you could have bought ten bananas with the money. When you get it back with interest, unless the interest compensated for inflation, you can buy less than ten bananas. Interest rates have not been compensating for inflation.
  10. If you are in the US, do not believe you can make money by earning more interest in India than in the US. There is a reason why interest rates are high in India (remember, inflation?). Inflation has an unavoidable impact on currency rates. By the time your deposit matures, you may have more rupees translating to less dollars and you are, if market works to mathematics, back to square one.
  11. Do not invest any money that you may need in the next year or two. Keep that in cash. Market has its short term ups and downs. The day you want to encash your investment could be one of those "down" days!
What, therefore, can you do?

Invest in exchange traded index funds. (Translation: You are investing in all the stocks that go into the index. In other words, in the entire market). An equity index and a debt index. More equity if you are young. Less equity if you are old.

After you do this, do not bother tracking your wealth on a daily basis. Leave if for a few years. Investment in securities is a long term business. Plus, there are better things to do in life than wearing anxiety over the movement in your wealth on a daily basis.

Baaki advice sub bakwas.

(Oh, btw, my lawyers want you to know you are on your own, and am not responsible for any losses you suffer. In spite of this if you believe I am the cause for any profits and therefore you want to share them with me, do call me. I will send you the wiring instructions!).

09 July 2013

"The Dispensable Nation: American foreign policy in retreat" by Vali Nasr

There are two ways you can pursue the foreign policy of a country.  One is to do what is good for the country (strategic interests, shared values etc) and the other is to do what is good for the ruling administration (popularity, acceptance to legislature etc).

Vali Nasr, an insider in Hillary Clinton’s State department (and a scholar in US foreign policy from John Hopkins University) thinks Obama is prone to do what wins votes than what serves US interests.

An insider can provide an insight that a dispassionate outsider cannot.  To that extent, the book is a value-add.  However, an insider can suffer from bias.  To that extent, the book can disappoint.

At start, the bias comes through more often than analyses.  According to Nasr:
  1. Obama gets high mark on foreign policy because his decisions are popular; not strategic.
  2. The State department did not have a reasonable independence in shaping US foreign policy.  There was disproportionate influence from (a) Military and (b) a small cabal of inexperienced political advisers in White House,  
  3. Richard Holbrook had strong insight and experience; but Obama did not make best use of Holbrook.  Obama let Pentagon run Afghanistan and CIA run Pakistan.
There are some snippets that only a frustrated insider can provide:
  1. An Arab Minister told US that it would be far less costly to buy off Afghan warlords than wage a war to keep Al Qaeeda away.
  2. General Kayani of Pakistan predicted that US will fail and leave a half trained Afghan army that will break into militias and add to the lawlessness in the region.
  3. Obama passed an opportunity to deal with Iran because a deal would be difficult to sell within US and to Israel; sanctions on the other hand were very popular.
However, the tour d'horizon Nasr provides reflects the intellect and experience of this John Hopkins scholar:
  1. US engagement in Afghanistan suffered a mission creep.  What started as a fight against terrorism (with Al Qaeeda as the enemy) became an attempt at nation building (with Taliban as the enemy).    Fighting insurgency is a challenge.  The challenge is even tougher when the insurgency has a safe haven in a friendly population and finance/intelligence support from a government.   Pakistan was “Laos, Cambodia and China all rolled into one” in this modern day Vietnam that Afghanistan became.  The counterinsurgency strategy (of winning the local population) as a tool in an asymmetric engagement with terrorists required governance; and governance required government.  This was missing in Afghanistan.  US did not end the Afghan war in battlefield; or in negotiating table.  All it aspires is for a decent interval between its departure and the chaos that would follow so that US is not blamed for it.
  2. Pakistan had two objectives:  Keep India out of Afghanistan and prevent Pashtuns carving out a Pashtunistan from Pakistan.  An Islamic jihad helps in keeping Pashtuns in and India out.  US tacitly tolerated Pakistan’s duplicity and used aid alone as a leverage to shape Pakistani thinking. However, the aid was small and misdirected to have any meaningful impact.  US’s Pakistan policy did not achieve either the immediate security goals or the long run strategic interests.
  3. Iran is trying to gain leadership in Arab world by pursuing an anti Israel agenda.  However, the Sunni/Shia divide prevents Iran from emerging as such a leader.  Iran’s investment in defense is very tiny when compared with the defense spend of its Arab neighbors.  Iran sees nuclear capability as a poor man’s way of acquiring strategic parity.  US is pursuing “sanctions” as a tool to contain Iran.  This tool is blunt and suffers a questionable track record.  US paid a huge price to win Russian/Chinese support for sanctions against Iran.  US tolerated Russian invasion of friendly neighbors.  US facilitated the economic rise of China as a price for Chinese support of sanctions.  Was Iran that important? 
  4. The Arab Spring is not likely to result in liberal Arab order.  It is more likely to give rise to Islamist states that are adversarial to US and Israel.  However, shifting the focus from Middle East to South/East Asia (in the name of containing China) ostensibly because US is not likely to depend on Middle East for energy is a bad idea.  This would provide elbow room for China to spread its influence in the Middle East. 
Vali Nasr has one prescription for US to retain its leadership in global order: Fashion foreign policy based on shared values and shared interests; not just on military power.

09 January 2013

"Durbar" by Tavleen Singh

Quora had an interesting question: If Mahatma Gandhi were to come back to India today, what is the one thing that would be toughest to explain to him?  Abhishek Anand had the best answer: “Rahul Gandhi”.

MKG would be very surprised indeed at what could cause a dynasty in a democracy.  He would have quickly figured out it is the ability to win elections that requires 50% charisma and 50% spending power.  And, that his party has understood how to create charisma for someone who (to borrow a phrase from Beatles) “doesn't have a point of view, knows not where he's going to, isn't he a bit like you and me?”. And that his party has perfected the cycle of “collect, spend, win, govern, collect” to acquire money.

However, MKG would be even more surprised by Sonia Gandhi; a foreigner whose only credential to shadow leadership of his country is marriage to the reluctant elder son who was forced into politics to preserve power, and property.

Durbar is an apt title for the story of Nehru clan’s pseudo royalty play in Indian polity:  suspension of Constitutional rights by Indira Gandhi, insensitive and violent shadow government by Sanjay Gandhi, and a “pass-up on opportunities” administration by Rajiv Gandhi.

Tavleen Singh is a socialite with pretensions to journalism.  She moved in the elite circles of Delhi; attending the right parties; meeting the right people; and having the right connections.  She knew at a personal level several members of Nehru clan and several young men (Naveen Patnaik and Farooq Abdallah included) who went on to become political leaders in India.

She used her connections to arrange an interview for India Today with Sonia Gandhi.  India Today did not return the favor and wrote an article that was not exactly complimentary.  Sonia Gandhi dumped Tavleen Singh from the “inner circle”.  Tavleen conveniently wears the “journalist” hat and sneaks about the Nehru clan (and Sonia Gandhi in particular) in a way that can be done only by a scorned insider.

We got lucky.  We are able to get an insider view of the shenanigans of the dynasty.

Some highlights of Tavleen’s writing:
  1. Sanjay Gandhi’s master political plan included “finding a way to defeat Akali Dal in Punjab”.  Sanjay’s friend Anant Bir Singh Attari persuaded Sant Jarnail Singh Bhindranwale to play a political role by appealing to his religious sense; a sense that saw the Nirankari arm of Sikhs as not pure and considered the Hindu Punjabi Leaders such as Lala Jagat Narain as traitors eventually creating the Khalistan secession movement.
  2. Indira and Rajiv Gandhi played a political game to deny Farooq Abdallah his fairly entitled rule of Kashmir and ended up creating a new “Kashmir problem” that had nothing to do with the historical one.  Kashmiris always tended to prefer Indian democracy except when their fundamental and religious rights are challenged.  Hemavati Nandan Bahuguna observed that “Kashmir is going to be the last nail in her coffin… Sadly it will also create problems for the nation”.
  3. Rajiv Gandhi remained silent when H K L Bhagat exhorted the nation to extract revenge upon Sikhs after the assassination of Indira Gandhi.  An immediate and statesmanlike protest could have avoided the violence unleashed on Sikhs.  He said that “When a big tree falls, the earth shakes”.  Atal Behari Vajpayee had a better take:  “When the earth shakes, big trees fall”.  
  4. Rajiv Gandhi’s economic views were similar to that of his mother (who ran a government that punished producers if they produced more than what they were permitted by the Government).  It is incorrect to give credit to Rajiv for ending the license-permit raj that enriched the ruling party, kept the optics of being pro poor and ensured people were kept needlessly in poverty.  It was during his rule that the founders of Infosys had a tough time explaining to bureaucrats why importing a server would be beneficial to India!
  5. Rajiv was myopic in pandering to Muslim vote by retroactive legislation denying Muslim women rights to alimony under Indian law and subjecting them to the Muslim code.  He was equally myopic in a counter-act to appease Hindu zealots by listening to his advisors who told him that “the best way to make the Hindus happy was to open for worship a disused, disputed mosque in Ayodhya”!
  6. Rajiv’s honeymoon with India ended when the Bofors scandal broke.  Rajiv sacked V P Singh ostensibly because V P Singh vowed to find out who took the bribe.  Rajiv ordered several income tax raids on Indian Express and Arun Shourie when Arun Shourie vowed to find out who took the bribe.  Ten years later, Swiss banks revealed that the money went to Ottavio Quattrocchi and his wife Maria, friends of Sonia Gandhi.
  7. At the end of his term, Rajiv began to look more and more like a “comical, half witted prince with no idea of the country he was ruling or its problems; in the Durbar around him, there were now only sycophants”.
  8. To top it all, in her younger days, Sonia Gandhi said that she would rather have her children “beg in the streets of Delhi than enter politics”!

Though Tavleen Singh's motivations to write the book could be suspect, the story she narrates is important.  Rajiv Gandhi’s legacy cannot be crystallized without some reference to this book.  Congress party’s worries about the impact of this book would be just and reasonable.

However, our visitor, Mahatma Gandhi would consider that inconsequential.  He would, on the other hand, be more worried about whether there is going to be a Rahul Gandhi (or Robert Vadera) legacy in future!

01 January 2013

"The Universe in a nutshell" by Dr Michio Kaku




As a young boy, he accompanied his mother to the Japanese garden in San Francisco.  It was raining.  The pond was murky; its surface full of rain induced ripples.  The lily flowers were swaying in the wind.  The young boy imagined what an intelligent fish swimming in the pond would observe and what conclusions would such a fish come to about its universe.  The fish would conclude that there is a strong correlation between ripples in its sky and the sway of the lily stems and the dirt in its ambience.  The fish would miss the rain and the wind.  Dr Michio Kaku suggested that we should not be prisoners of our own observations; and learn to see beyond.

That started my journey with Dr Michio Kaku's books.  I have been a fan ever since.

Here is a 42 minutes introduction to Physics that is worth a fresh man year.  Enjoy the best 42 minutes of your life.

"Grand Brand Rajini" by Ram N Ramakrishnan & P C Balasubramanian

It takes a personality, a value system, consistency in meeting a need and a defining icon/trait for a person to become a brand.

Mahatma Gandhi understood that and met the need for freedom with a simple symbol of a homespun cotton cap. MGR understood that and met the need for social equality with a simple trait of fighting for justice.

In the last forty years, one person who has cultivated a brand with a mass appeal spanning two generations is actor Rajinikanth.

Rajanikanth started as an average actor and morphed into a big ticket brand strong enough to be coveted by every one requiring votes in Tamil Nadu. The brand represents innocence, devotion, humility, and fairness and was defined by its punchlines.   The brand survived (in an era of exceptionally competing talents), grew, and prospered to convert a Rajini film into a "Rajini experience".

Authors Ram N Ramakrishnan and P C Bala Subramanian (disclosure: both are good friends of mine and fellow CAs) provide an exceptional analysis of how the Rajani brand grew from "இது எப்படி இருக்கு?" days to "என் வழி தனி வழி " days.

Our personal brands (yes, in the era of social media, each of us has one) may not be comparable in appeal but there are some lessons in the book "Grand Brand Rajini" for us to shape our own personal brands so that we leave "nice footprints on the sands of time".

27 December 2012

“On Saudi Arabia: its people, past, religion, fault lines and future” by Karen Elliott House


Karen Elliott House established her career as a journalist by winning the Pulitzer in 1984 for her piece on Middle East Peace initiatives of Ronald Reagan.  She later went on to become the publisher of Wall Street Journal.

Karen’s book on Saudi Arabia strives to provide a portrait of Saudi Arabia.  The latitude of coverage is impressive.  The depth is not impressive.  At times she succumbs to the temptation of simple but misguiding metaphors. 

Karen’s description of Saudi Arabia is comprehensive.  She says:

One, Religion has been the founding principle of Saudi Arabia for a while.  In 1745, founder Mohammed al Saud used the call for Islamic Jihad by Abd al Wahab to conquer all tribes and establish Saudi Arabia.   Since then, Al Sauds have claimed legitimacy as defenders and propagandists of Islam.  

The rulers have struck a fine balance between (a) projecting themselves as supporters of a puritanical version of Islam to win support from the masses and (b) protecting the country and its oil economy against threats from Jihadists from within and without.  

When fundamentalists occupied the Grand Mosque at Mecca in 1979, the rulers evicted the occupiers but adopted their agenda and went ultraconservative to win support from the religious right.  Saudi Arabia became a country where grand mothers could tell grand daughters what it was to drive a car or walk around without covering themselves head to toe.

Two, Succession in Saudi monarchy is not based on primogeniture.  So far it has passed from brother to brother (with 7,000 princes traced to 36 children of the founder King).  When it moves to the next generation, succession requires skillful management of the aspirations of multiple lines of progeny.

Three, Oil income has created astounding wealth; yet in a contrarian way has inhibited economic growth.  40% of citizens live in poverty; 60% do not have a home.  The number of unemployed keeps growing.  Though the country creates 550,000 jobs a year (against 200,000 required for full employment), 90% of the new jobs go to imported workers (whose substantial remittances home drain the economy).  

Of late there is some disappointment about too much religion, too much dependence on US, too much corruption and too great a gap between the rich and the poor.   

Unemployment and under-education have resulted in a pool of alienated youth ready to be recruited as terrorists – on occasions admired as Jihadists (when they murder infidels) and on other occasions branded as outlaws (when they threaten Saudi regime).

Four, King Abdullah has taken several steps to improve education, and improve the role of women in society and business.  He has also taken several initiatives to diversify Saudi economy away from oil.  He has taken several initiatives to dissuade impressionable young Saudis away from terrorism.

However, Karen’s interpretation of what the future might hold for Saudi Arabia is quite pessimistic.  She predicts three outcomes:
  1. Social explosion if status quo is maintained by risk averse elderly rulers
  2. Revitalization if society and economy are opened up and
  3. Chaos and collapse if there is reversion to religiosity and repression.
Saudi society, like every other society, has its own principles of social cohesion, religious ideals and social contract with the rulers.  Saudi monarchs are smart enough and responsible enough to maintain their part of the social contract:  stability to citizenry for loyalty to rulers.

There could be a fourth outcome of diversifying the economy, replacing foreign workers with citizens, ushering in good education and greater role for women without bringing in instability.   You don’t need to look yonder than Aramco campus in Dhahran to see what Saudi society is capable of.   Karen ignores that fourth outcome of economic and social equilibrium without political upheaval.

The book is an excellent primer about Saudi Arabia.

16 December 2012

"Engaging India: diplomacy, democracy and the bomb" by Strobe Talbott


Strobe Talbott, Rhodes scholar at Oxford, classmate and friend of Bill Clinton was Deputy Secretary of State for US for 7 years until 2001.  In this book he writes about his staying engaged with Jaswant Singh for three years to ensure the arrangements for non-proliferation of nuclear weapons stay in the aftermath of India exploding its nuclear devices in May 1998.

If ever you wonder whether an argument can be right and wrong at the same time, you do not need to go farther than the system world has to prevent proliferation of nuclear weapons.

In 1964 five countries had nuclear weapons.  (JFK predicted that this number could reach 20 in a few years).  The five championed a non-proliferation treaty that 
  1. prohibited others from developing nuclear weapons, 
  2. offered use of nuclear technology for peaceful purposes, and 
  3. undertook to dismantle their own weapons over a period of time. 
Everyone agreed; everyone except India, Pakistan, Israel and North Korea.  The treaty worked.  The number did not expand to 20.

India was under pressure to accede to the treaty.  However, India did not.

Why is NPT a good policy?  We cannot ignore the reality of five having bombs.  Their continuing to possess the bombs is not an argument to encourage others to acquire bombs.  In the end this will make the world less safe.  Most countries have acceded to the treaty.  The big five agreed to not provide nuclear technology to anyone who did not accede to the treaty.   The five had capability to destroy each other; and that capability served as a credible deterrent.  All it takes is one country to not respect the arrangement and explode a device.  It would open the floodgates for every country to acquire nuclear weapons technology.  There is a need for responsible behavior.

Why is NPT a bad policy?  The Big Five did not keep up their word.  They kept their stockpile and dragged on dismantling their weapons.  When the deadline came and went, they arm twisted everyone to extend the treaty infinitely.  In effect, they created a nuclear apartheid.  Countries that had adversarial interests against a nuclear power faced nuclear threat.

In May 1974 India exploded a nuclear device “for peaceful purposes”!  The world was shocked; and imposed sanctions restraining India from accessing sensitive technologies.  This prompted Pakistan to acquire nuclear weapons technology (with some help from China).  In May 1998 India exploded nuclear weapons.  In the same month, Pakistan followed.  Both became “de facto” nuclear powers.

President Clinton’s administration was furious.  US imposed sanctions on both; voted against any aid/loan to either in global forums.  Clinton’s desired that India and Pakistan should:
  1. Agree to not develop nuclear technology any further
  2. Agree to not conduct nuclear tests
  3. Agree to not develop further fissile material
  4. Agree to not develop ballistic missiles that usually deliver the bombs
In this book, Strobe Talbott, Deputy Secretary of State for US during that period narrates the story of diplomacy conducted with Indian envoy (and later Minister for External Affairs) Jaswant Singh to achieve the objectives.

The US game plan was to isolate and suffocate India through sanctions; and offer carrots if India accedes to the objective.

The Indian game plan was that the sanctions would wither away over time and US would align with India as a counter weight against China in Asia.  In the meanwhile sanctions would hurt Pakistan more than India providing a minor tactical advantage.

Talbott and Singh met several times in several places.  Talbott sensed “soft stonewalling” with eloquent arguments and cool reasoning by seasoned advisers. Singh was a master of “double negatives” that do not end up becoming positive.  He had the ear of the Prime Minister; but was under compulsions of a democracy to carry public opinion, and the opinions of extreme right in his own party.  Talbott recollects Singh as a sincere and reasonable gentleman.  There may not have been a negotiation; but there was engagement.

This was in complete contrast with his negotiations with Pakistan.  They missed a Jaswant.  PM Nawaz Sharif was either powerless or pretended to be one.  His advisors were happy to correct him in public and back track positions.  Everyone had to keep wondering whether the army would back any deal.  Emotions were high.  (Talbott recollects one incident when a Pakistani interlocutor rises up to ostensibly hit his American counterpart and had to be physically restrained).

There were distractions: 
  1. A poll in India (that BJP won) that suspended discussions. 
  2. An opposition in India that did not oppose the ruling party; hinting solidarity in political views. 
  3. A war that was about to escalate to deployment of nuclear devices
  4. A military coup-de-tai that replaced Sharif with General Pervez Musharraf
  5. A Senate that rejected the very restraints (on US) that US was imposing on others
  6. A terrorist attack on the Indian Parliament
  7. A terrorist attack on the World Trade Center
What happened eventually?

In the end, US views changed after Bush administration came to power.  Bush did not place high value on restraining treaties; recognized India’s self restraint; and did a different deal that brought the civilian nuclear facilities alone under global inspection regime and provided full access to nuclear technology to India. 

When India tested Agni V in Apr 2012 (a missile that can reach several cities in China), and a US State Department spokesman, Mark Toner, was asked for reactions, he did not complain about an impending arms race.  He praised India for its self-restraint and for being a responsible member of the comity of nations.  India had arrived as a nuclear power.

The book provides an excellent insight into how two people with opposing views staying engaged, in the intervening moments, to achieve a common objective of making the world a better place.  One was worried about the signal India’s explosion sent to the world.  Another was protective about sovereignty and sought fairness in treatment.

14 December 2012

"Anza deception" by P R Ganapathy


I know Guns.  In two ways:  As a fellow traveller to investor conferences in the early years of last decade striving to attract/retain investor interest in the stocks we were representing; and as the son-in-law of a cherished and inspiring colleague. 

I did not know Guns.  Seems he studies military history, knows how to fly; owned an aircraft in addition to his mastery on price/earnings multiples.

The combination of interests in military history, skills in flying aircrafts, and creative communication as an IR manager is telling in the way he narrates a story. 

A story that could almost be true.  A story that involves a few missiles going missing in Pakistan; ending up in the hands of jihadists; power play by super sleuths in Pakistan, China and India; cabals who are cunning; and politicians with aspirations.  The story line is awesome, realistic and believable.  The last line is predictable; but it is fun getting to the last line all the way.

The narration is awesome too.  I read the first 25% over three/four sessions.  I had to read the next 75% in one session. 

India now has her own Robert Ludlum to write stories with an Indian background for Indian audience.

I look forward to his next book.

26 September 2012

"Hedge funds"

In the beginning, all collective investment schemes (that raised public money to invest) were regulated by Securities law to ensure full disclosure, minimum asymmetry in information between insiders and outsiders, and good corporate governance to protect investors who are not in control.  In 1949, Alfred Winslow Jones started a fund that "would raise money only from wealthy individuals" but would not be governed by Securities law.  He called it a "hedged fund".  Thousands followed and became $ 2,400 billion hedge fund industry.  Here is a great infographic from PerTrac about hedge funds:

26 April 2012

"Managing chaos: the fragility of the Chinese miracle" by Prem Shankar Jha

China’s story so far is impressive but mysterious. China’s economic growth, competitiveness in global trade and effective management of trade cycles are impressive. The seeming lack of sensitivity to social discontent, intolerance of dissent, and opacity in public policy/governance make it all mysterious.

Prem Shankar Jha, Oxford trained economist, journalist and diplomat does an excellent job in providing a peek into the good and the bad of China’s economy and politics.

China is a favorite with liberal economists. China vindicates their faith in free market. China’s is a story of relentless purposeful growth; smart management of trade cycles; and equally smart exploitation of opportunities in globalization. However, China’s is also a story of an economy trapped halfway in a failed transition suffering from inequality, corruption, and discontented population.

China grew eleven times in thirty years (1976-06). China’s trade with the world grew forty one times. Pretty impressive, by any standards.  However, while China as a whole was flourishing, large segments of its people were not. The “iron rice bowl” assuring life-long security gave way to growing inequality, unemployment, loss of land for farmers, marginalization of migrant workers, corruption, extraction, and growing social discontent. National leaders such as Deng Xiaoping in 1980s and President Jiang Zemin in 1990s preferred to chase growth rather than equity hoping that growth would eliminate the sources of discontent. Those dreams failed thanks to recessions that intervened. President Hu Jintao understood the need for equity and advocated “social harmony”. However, he is reforming the party instead of reforming the polity.  An untimely recession, likely according to Jha, would test China’s social harmony much more severely now than at any time in the past.

Jha has several interesting reasons why:

One, China’s growth is impressive; but exaggerated. Overstatement of growth could be in the range of 2%. That is not worrying. What is worrying is that China is in a state of denial about recessions. The published data show no recessions. However, China suffered three recessions in 1989-90, 1991-96 and 1998-01. China claims these as “soft landing” from hyper growth. However, the impact on society was quite huge.

Two, China’s growth is more due to investment in infrastructure than due to growth in consumption. These investments are not subjected to normal disciplines of market (evaluation of viability, securing funds from willing savers and bankruptcy risk to owners if things go wrong). These investments are made by those in power with privileged access to bank credit and without the burden of entrepreneurial risk; a recipe for enthusiasm prevailing over judgment.  As a result, China suffers from over-investment, excess capacity, bad debts and liquidity threat to banking system, and therefore, recession.

Three, China’s manufacturing is not efficient. The manufacturing for domestic market typically consumes for a given dollar of GDP, six times the resource required by an American or Japanese enterprise; three times that required by an Indian enterprise. (Manufacturing for export market is quite efficient; but mostly owned/operated by foreign investors).

Four, China’s growth is not due to “privatization”.  China's enterprises are anything but private. SOEs (State owned enterprises), the initial powerhouses, were weak and several of them could not survive recessionary pressure. The white elephant SOEs were rolled into profitable ones or sold to TVEs (Town and village enterprises). The TVEs were started by provincial and municipal governments using public land and coerced bank debts, and as ever, unmindful of economic risks. When recession posed challenges to the TVEs, the TVEs were “force sold” to technocratic managers and workers. Later the “nomenklatura” capitalists started thousands of enterprises. These cadre capitalists too had the same advantage: land from subservient municipalities, credit from subservient banks and freedom from the burden of entrepreneurial risk.  These enterprises are anything but private enterprise. They are born out of a coterie’s control over natural/financial resources and control over law. All these have resulted in:
  1. Overinvestment and oversupply that can lead to a deep recession,
  2. Liquidity threat to the banking system thanks to loans going bad and
  3. Shorter and sharper trade cycles that affect the poor more than the rich.
Five, China’s economic growth has not been a remedy to the society

  1. The growth started by “commandeering” arable land from farmers to set up development zones. The arable land in China has now come down to the barest minimum required to feed its population. 
  2. The growth did not create jobs. In the ten years period to 2006 the number of jobs shrank by 2 million. Migrant workers (with no security and severe challenges to peaceful existence) constitute half the urban labor.
  3. The growth punished the poor.  During good times, the controllers of SOEs/TVEs and the cadre capitalists of the so called private enterprises behaved like owners. During bad times, they behaved like political rulers and managed their resource crunch by doing away with social security benefits and imposing taxes on the peasants and the workers.
Six, China’s state and the party officials have become predators on Chinese society. Corruption has taken myriad forms when the state has access to finance; ability to commandeer resources; and ability to convert state enterprises into private enterprises.

Seven, Social discontent has been growing in China.

In summary, China’s economy is more made up of mega size investments in often unviable infrastructure projects creating surplus capacity and overinvestment. China has been prime pumping the economy to boost consumption. China may suffer inflation and recession in the near future. Social discontent, already high, can increase significantly. China lacks the political framework to buttress discontent.

Sustainable economic growth requires political stability. Political stability requires social stability. In the short run suppression can achieve social stability. In the long run, the sources of discontent need to be addressed to sustain social stability.

When China faces another recession (which according to Jha is inevitable given its circumstances) China may not be able to invest/spend its way out of a domestic recession as it did out of a global recession. Such an act may result more in inflation than in growth, triggering social discontent. Such a social discontent may be more difficult to handle in an age where 98% of population has mobile phones and 250 million people have access to internet. China cannot do a Tienanmen Square style suppression again.

On the other hand, a transparent and accountable government and rule of law may buttress the social discontent and help China achieve and sustain its destiny as a giant among nations.

Prem Shankar Jha presents his case in an engaging style. One must read this book to gain a fuller perspective about China.