#
Bro Amit, in the long run we are all alive.
#
I turned towards the door and there was Adam Smith looking all around for someone.
#
Who are you looking for? I asked him.
#
I am looking for the butcher, the brewer and the baker, he said.
#
They were supposed to come watch the film with me. Selfish scoundrels.
#
Just then the hall went dark and the film began on the big screen.
#
What was the film all these dead economists were gathered to watch? I wondered.
#
Just then the title flashed on the screen.
#
Night of the Living Dead Part 17
#
Welcome to The Scene and the Unseen.
#
Our weekly podcast on economics, politics and behavioral science.
#
Please welcome your host, Amit Barwa.
#
Welcome to The Scene and the Unseen.
#
Today's episode is about zombie firms and creative destruction.
#
What are zombie firms, you ask?
#
They are the living dead of the business world.
#
Firms that should have shut down but are kept alive, sometimes by zombie banks.
#
Air India is one example and Jet Airways, which shut down recently, could have been another one.
#
My guest today is the economist Ajay Shah, who is a zombie hunter of sorts.
#
Passionate in his belief that zombie firms are bad for the economy and for common citizens like you and me.
#
And that the state should not allow this horror movie to continue.
#
Before he explains why though, let's take a quick commercial break.
#
This episode of The Scene and the Unseen is brought to you by Storytel.
#
Storytel is an audiobook platform which you can listen to on your Android or iOS app.
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They have thousands of audiobooks that you can listen to on your mobile, including hundreds in local languages like Hindi and Marathi.
#
An unlimited monthly subscription costs only Rs 2.99 per month.
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And you can also get a 30-day free trial if you hop on over to sroyteltenney.com slash IBM.
#
I actually use Storytel myself regularly, so as long as I sponsor this show, I'm going to recommend one book a week that I love.
#
The book I want to recommend today is called Hayek by Eamon Butler.
#
Frederick Hayek is one of the most important thinkers of the 20th century and someone who's had a great influence on me.
#
But this is not a book by him, but a brief introduction to his life and his thinking by an outstanding author called Eamon Butler, so check it out on Storytel.
#
And remember, you get a 30-day free trial only at Storytel.com slash IBM.
#
Ajay, welcome to The Scene and the Unseen.
#
My pleasure to be here.
#
Ajay, I've been reading you and I've admired your work for many, many years, almost since the start of the millennium.
#
Tell my listeners a little bit more about you. Like, you know, how did you become an economist? What was your journey been like?
#
I had the good fortune that I was brought up in a house with 6,000 books and my father was an economist.
#
So in a way, I've been exposed to these things all along.
#
I studied aeronautical engineering at IIT Bombay and then I jumped into a PhD in economics.
#
After moving back to India, I worked at the Centre for Monitoring Indian Economy, the CMIE.
#
I worked at the Indira Gandhi Institute for Development Research.
#
This is a university near Bombay.
#
And I was then in the Ministry of Finance in Delhi.
#
After that, I have been at the National Institute for Public Finance and Policy, NIPFP, in Delhi.
#
So that's my life trajectory.
#
All through my work, I've basically been curious about the world, both in terms of understanding how things are
#
and in terms of what public policy can do to make it different.
#
And when you start thinking about public policy, it inevitably takes one away from simple economics
#
because a lot of public policy is really public management, it's public administration.
#
It is law and of course, it is politics.
#
So I've been exposed into that world.
#
I've had the good fortune of being involved in many of the big and exciting policy projects of the last 25 years.
#
These included the early development of the equity market, the reforms of Building SEBI and NSC, the new pension system.
#
Then I was part of the early thinking on the goods and services tax.
#
I was part of the Financial Sector Legislative Reforms Commission, which did a full clean right of Indian financial law.
#
I was part of the bankruptcy process.
#
I was a member of the committee that drafted the Indian Bankruptcy Code.
#
And I was part of the movement of the Reserve Bank of India towards inflation targeting and so on.
#
So I've had the good fortune of being at the early ideas stages of some of these important projects.
#
And I noticed that you were very fortunate in the same way that I was, that I also grew up in a house full of books
#
and that's where I kind of got hooked on to reading and then you just get curious about the world and that's an incredible habit.
#
So tell me a little bit about what were your early influences in terms of like you said you were in a house with about 6,000 books.
#
So and your dad was an economist, but I'm presuming they weren't all books of economics.
#
They would have been all kinds of books.
#
My father was a 19th century intellectual where it was not a narrow economics view.
#
It was everything. It was history. It was politics. It was philosophy.
#
It was culture. It was religion. It was everything.
#
So I always think of myself as a visitor to this century from the 20th century.
#
For me, the great experience of my mind is the thought process of the 20th century.
#
So if you look at the 20th century, starting from the collapse of the first globalization in 1914,
#
then you play the arc through the First World War, the Great Depression, the Second World War,
#
the collapse of colonial empires, the Cold War, the collapse of communism,
#
the rise of liberal economics and globalization and then its recent minor hiccups.
#
In my mind, this is the story that this is my natural locale.
#
I understand this world. I have spent my whole life studying this world.
#
I think I have some intuition into how things have happened
#
and I think that's a useful thing to have in this century
#
where many people don't quite remember those interconnections and have not lived those experiences.
#
So as a reader of books, I always say that a person lives only one life,
#
but when you read books, you can experience thousands of lives.
#
So I feel I have put together some knowledge and experience from thousands of people of the 20th century.
#
And who were the early thinkers or what were the books that had a big influence on you early on?
#
Like if I had to ask you to name a couple of books which changed the way you think about the world.
#
This is a question I often ask people.
#
This is going to be an embarrassment, but today the book that looms large in my mind
#
is a book that I only read about six or seven years ago.
#
And this is the book Seeing Like a State by James C. Scott.
#
I just think of that book as one of the most important influences in how I think about the world today.
#
And sadly, I got to it only seven years ago.
#
How did it change the way you looked at the world?
#
It made me much more cautious. So I think I have suffered from an engineering disease
#
and a willingness to design the world too much.
#
And I think the book slapped me around and made me much more careful and much more cautious.
#
It also helped that along the way I was gaining more experience
#
and I was learning how things go horribly wrong through more practical experiences.
#
But I think that James Scott has helped me be far more careful and far more grounded
#
in respecting the complexities of the world,
#
in underlining how little we know, we the thinkers about public policy,
#
are actually far less knowledgeable and far less confident in what we do.
#
So this is the sort of caution and change in worldview that James C. Scott has helped me see.
#
Maybe it was brewing all along, but the book just was like a vision for me when I read it.
#
And is that sort of epistemic humility something that is very uncommon in the fields that you worked in?
#
Because I'd imagine that people in government always do imagine that they can see themselves as designers of sorts.
#
So I think of it as two parts. First, right after independence,
#
there was unabashedly a period of modernism.
#
There was this idea of a developmental state. The government was going to build steel mills.
#
You know, there was central planning raged on a large scale,
#
that the governments were quite comfortable and quite arrogant in reshaping the world.
#
By the late 70s and early 80s, when the economic policy philosophy started shifting
#
into a more market-led vision of the world, I think that has subsided.
#
But even then, I think that we in India would do better by crossing the river by feeling the stones,
#
making small moves, learning from experience, always being humble,
#
listening to the world, listening to the data and changing our mind as we go along.
#
Getting to sort of the topic at hand.
#
I mean, the larger topic, of course, is the existence and the danger of zombie firms,
#
the value of creative destruction.
#
And obviously, at the time that we are recording this, we are recording this on April 22nd.
#
And what is looming in front of me as I think of these things is obviously the downfall of JET,
#
where in a sense, obviously, I'm glad it's gone because a lot of the voices for keeping it alive,
#
I mean, for the government to keep it alive would really have been privatizing profits, socializing losses.
#
And that's absolutely the worst for any supporter of free markets can hope for.
#
Tell me a bit about JET. What exactly happened there? Why did it fail? What was the journey?
#
So, I've thought a lot about the Indian airline industry and in my mind,
#
one important root cause of the trouble, which I think has not been adequately appreciated,
#
is the presence of Air India that was making losses.
#
So, here is the key intuition. Just to make up an example, suppose there is an Air India that has 20% market share.
#
So, not a dominant player, but big enough to matter to the price.
#
And suppose Air India systematically loses money, which means that the taxpayer is topping up Air India every year,
#
but Air India is systematically charging an affair that is not enough for Air India to make money
#
and there is an artificial injection of resources from the taxpayer.
#
What that does is, it really puts a crimp on the profits of every other firm.
#
So, if I'm a rival airline, I'm unable to charge slightly higher prices
#
because Air India is here charging relatively lower prices.
#
So, these kinds of firms, firms like Air India have a technical name, they're called zombie firms.
#
So, the phrase zombie is supposed to bring to your mind the living dead.
#
I have a funny story about this. Once I was part of a government committee where the phrase zombie banks was used.
#
So, now the word zombie firms, zombie banks is a technical phrase, it's a term of art in economics literature.
#
But there was a chairman of a public sector bank who was hugely offended
#
because he took this phrase to be a slur and there was an energetic fight
#
where he asked for the deletion of the word zombie banks from all over the report.
#
So, zombie firms, zombie banks, these are technical terms in economics.
#
So, this is a firm that by right would not exist in any reasonable world,
#
but is being artificially kept alive on life support either by taxpayers or by banks or by somebody,
#
but really it's not a viable firm.
#
And it need not always be a public sector firm.
#
And it doesn't have to be a public sector firm.
#
So, for example in Japan, the zombie banks were keeping zombie firms alive
#
and both the banks and the firms were purely private.
#
So, there was an entire ecosystem of zombies of the living dead walking around the landscape.
#
These are firms that are not profitable, they are not viable.
#
But the interesting insight is that if you have one guy with a 20% market share
#
who is being artificially kept alive either by banks or by taxpayers,
#
then that actually contaminates the health of the entire industry.
#
The remaining 80% of the industry will not be healthy
#
because they will not be able to charge suitable prices.
#
So, then the disease tends to spread.
#
So, once you get one zombie firm, you will get others.
#
Then there will be a second firm, there will be a third firm.
#
So, when you look back at the failures of some of the other airlines in India,
#
the counterfactual I would like to play in my head is
#
what if Air India had actually been profitable?
#
What if Air India had been charging a little more for its tickets?
#
What if Air India had been privatized?
#
So, people often think that if Air India was privatized,
#
that would mean more competition for private firms.
#
But I would also say it would probably mean somewhat higher ticket prices.
#
And that would prop up the profitability of all the other Indian airlines.
#
So, this is a part of what led to the failure of JET.
#
It was just too many years of having to compete with Air India.
#
So, let me cite an illustration from one of your pieces,
#
and all the pieces I refer to in this will be linked in the episode page in the show notes,
#
where you illustrated this by saying that imagine that the ticket price
#
which the market is willing to pay is 100 rupees.
#
But Air India is so inefficient that it cannot price it at less than 110 bucks.
#
So, then the taxpayer or the banks or whoever basically gives Air India 11 bucks.
#
So, they can charge 99 rupees.
#
And what that does is because Air India is functioning at 99 rupees,
#
subsidized by us or other zombie banks or whatever,
#
is that the likes of JET and Indigo cannot then charge 100 and 201 or even 100.
#
They have to compete at that level.
#
And the investments that they would have made with their profits and getting more fleet,
#
just expanding overall is something that they can't do.
#
They are barely struggling to get even.
#
And now let me add to that.
#
So, let's imagine a counterfactual where Air India had exited the market.
#
So, just suppose we manage to shut down Air India.
#
Many things would happen.
#
So far we have talked about the pricing side.
#
But also many pilots would then lose their jobs in Air India.
#
The supply of pilots would go up.
#
The prices of pilots would go down.
#
All remaining airlines, all surviving airlines would benefit because pilots would be cheaper.
#
Landing slots would become available.
#
Real estate at airports and near airports would become available.
#
Capital would become available because for many investors and banks,
#
there are limits on the amount of investment you can do in one industry.
#
And by the time you've given loans to Air India, you've choked up your industry concentration limits.
#
And there would probably be space on the balance sheets of banks that is freed up once Air India exits.
#
So, we should see the exit of a firm as playing on these two sides.
#
One is, it improves the pricing power of the survivors.
#
The second, it improves the cost function of the survivors.
#
The survivors are able to buy their inputs at a slightly lower price.
#
And put these two things together, you get a little bit of a bump in the profitability.
#
And that actually could have made quite a difference for some of the airlines that blew up along the way.
#
Right. And you know, from another of your posts, there's a very interesting quote where you kind of illustrate this.
#
So, I'll just quote that.
#
It's useful to focus on the plane.
#
Ultimately, what is required in the economy is that a plane has to fly from Bombay to Nagpur.
#
Earlier, that plane was leased or owned by Jet Airways.
#
An efficient financial system is one where leasing companies shift leased planes from Jet Airways
#
to other airlines and the bankruptcy process sells of the own planes.
#
As long as the plane flies, it does not matter what logo it's painted on its tail stop code.
#
And you have another post like this was in a piece and you have another post on your early blog
#
where you sort of illustrate this by talking about the cost of an idle plane for a single day.
#
And you point out, you know, how, for example, an efficient hypothetical dictator
#
would make sure that every plane ran every day because he has to.
#
But the way and the market would do the same thing if it was allowed to function properly.
#
But because of the way our system is messed up, that doesn't happen.
#
And Kingfisher actually had planes lying idle for an entire year at a phenomenal opportunity cost.
#
So, actually, I started thinking about this field when I saw the Kingfisher planes.
#
It just breaks my heart to see those assets sitting on an airfield.
#
It is just a tragedy for society when that asset is sitting there and it's not being used.
#
And that's our failure as society.
#
So, as you said a moment ago, it doesn't matter what colors are painted on the plane.
#
You want the damn plane to fly.
#
So, in economics, we always use this hypothetical concept of an omniscient dictator who knows how to allocate resources.
#
Okay, please note, no economist advocates dictatorship.
#
And no dictator is omniscient.
#
This is just an intellectual device that if you could think efficiently
#
and use all assets and all labor of the country well,
#
then that's like a hypothetical benchmark.
#
And we always would like to build a society that is able to use resources properly.
#
So, it struck me as a glaring failure when there were planes belonging to Kingfisher Airlines
#
which were just sitting idle.
#
And we should ask ourselves, how can we organize society so that this doesn't happen?
#
It should just take a few days for a leasing company to switch a plane from one airline to another airline
#
for a painting job to be done, for new colors to be painted on the plane.
#
And then you're back to business.
#
Finally, what is going on?
#
As you mentioned a moment ago, there's a plane, there's a pilot, there's Bombay, there's Nagpur, there's a passenger.
#
It doesn't matter what is the firm, what is the airline, what are the colors.
#
The same pilot will get a job in that new airline.
#
You just want to get rid of that one ephemeral construct called an airline
#
and hand over that asset, that pilot, to a different ephemeral construct called another airline.
#
And that's our job as a society.
#
Can we create the institutional arrangements through which these things can be done swiftly?
#
Then we don't need to get so stuck up about the bankruptcy of Jet Airways.
#
It is always sad when an organization dies.
#
So for all of us, we've been part of teams, we've been part of organizations.
#
We love organizational capital.
#
We love to build organizations.
#
And I'll come back to that in a moment surrounding the discussion on bankruptcy.
#
But as society, firms are ephemerals.
#
We should use assets well.
#
So, you know, when you say that those assets should immediately have been put to better use
#
and would have been within a few days, you know, some listeners might immediately imagine
#
as Indians tend to look at the government for solutions.
#
They say, how the government should do that?
#
The government should blah, blah, blah.
#
But what really happens is that when you say society wants us,
#
or society wants that, society acts through markets.
#
Markets are the mechanism through which we fulfill each other's needs in society.
#
And typically, the market process would lead to that happening,
#
you know, where the planes are idle for maybe a week and they're repainted
#
and then they're flying and everything's back to normal.
#
Explain to me how that process would work out and explain to me what are the impediments
#
in its way that, you know, what's wrong with the system?
#
Why isn't that happening?
#
So I share what you said a moment ago, 100%,
#
that when we say society, we're looking for the working of markets.
#
We are a self-organizing system.
#
People deal with each other with self-interest and profit motives.
#
And what we're looking for is the rules of the game through which all these nice things will happen.
#
And that takes us to institutions and law.
#
So let's think of the pieces of this puzzle.
#
The first piece of the puzzle is that I'm very happy that a lot of planes are leased and not bought,
#
because it's much easier to move a leased plane from one airline to another.
#
So the airline is supposed to regularly make payments to the leasing company.
#
And when that doesn't happen, the leasing company yanks the plane,
#
and that plane is then available for rent to give it to somebody else.
#
And so that same plane sitting in Nagpur will be captured from the control of one airline,
#
and the leasing company will probably make phone calls to all the airlines and saying,
#
do you want this asset? It's lying right there.
#
So that's one part of it, that leasing is a very good thing.
#
The second important thing is to think of bankruptcy.
#
So the way to think of the bankruptcy process is like this.
#
Imagine there is a company with, say, 100 rupees of assets,
#
out of which there is 30 rupees of equity and 70 rupees of debt.
#
And this company gets into trouble and it is not able to pay either its creditors or its employees or something.
#
So for whatever reason, the company gets into trouble.
#
Now what should happen is the bankruptcy process.
#
Conceptually what happens in the bankruptcy process is we say to a new buyer
#
that I'm willing to write off all the debt of the company.
#
So it's 30, 70, 30 rupees of equity, 70 rupees of debt.
#
Imagine what the bankruptcy process does is it says, look, the 70 is gone.
#
So you as a buyer, I'm giving you a clean slate.
#
I'm giving you an all equity company of just the assets of the company and no debt.
#
So you're not carrying any baggage.
#
That's the glory of the bankruptcy process.
#
That's the beauty of the bankruptcy process that you get a clean slate.
#
It's not like the bad old days where the buyer of a company had to take over all the debt that came with the company.
#
Here, the buyer gets a clean slate. He gets a start.
#
Now suppose the highest bidder says the price I'm willing to pay is 29.
#
Then the lenders who have control of the bankruptcy process will think, you know, what's the point?
#
I might as well just liquidate the assets of the company and I'm not really getting much.
#
But if the bidder sees some value in the organization, in the people, in the processes, in the capabilities of the organization,
#
then he probably bid 40, probably bid 50.
#
And the debtors will take whatever little money they can get that comes in and walk away.
#
So that's the bankruptcy process.
#
Can we run this quickly? Can we do this literally within weeks?
#
It should not be complicated. It should not take forever.
#
So in India, these things go on for years and years.
#
Our puzzle in public policy is how do we make this happen quickly?
#
So we created a new bankruptcy law in May 2016 and we're still in the early stages of figuring this out.
#
But really, in an ideal world, that's what you want to happen.
#
That we like Jet Airways as an organization. It had some genuine capabilities.
#
So somebody should be willing to pay for it.
#
It had some landing slots. It had some very attractive real estate.
#
It had some people. It had some systems. It had some capabilities.
#
So imagine you put it up for auction in the bankruptcy process.
#
Then somebody would pay for it and would pay a good price.
#
And all the debt would get written off and you start over.
#
And that's the glory of bankruptcy. Look around the world.
#
Airlines go bankrupt all the time. It's not new. It's not unusual.
#
Telecom companies go bankrupt all the time. It's not new.
#
So the point is we should not allow these things to become long, slow, painful affairs.
#
We should have the institutional arrangements to do these things quickly.
#
So the assets will be used. So the people will be used.
#
So the organizational capital will be used.
#
But you know what? If nobody feels there is organizational capability of value inside this company,
#
then there won't really be interesting bids.
#
And then, yes, the company deserves to just be cut up into some pieces and sold off.
#
That you sell some land. You sell some planes.
#
And for the rest, the company ceases to exist.
#
And then we should be unsentimental about it.
#
We tried. It didn't work. Move on. Let's give the parts back to society and let's move on to something new.
#
So we do have an IBC insolvency and bankruptcy code, as you pointed out.
#
Where did it fail in this instance?
#
The IBC is still a work in progress.
#
So many of the steps that I have described are an idealized depiction of what a bankruptcy process should be.
#
Many pieces of the IBC are not yet in place.
#
They don't quite have the ability to rapidly set up the committee of creditors, rapidly assemble the information,
#
rapidly do an auction, have a tribunal that will look effectively at these issues
#
without introducing delays, without making mistakes and so on.
#
So this is still a work in progress and we're not there.
#
But I'm just on an idealized world. That's how we should be thinking about this.
#
By the way, as you would have read one of my articles,
#
I think the right answer for Air India, for the government, is to use the bankruptcy code.
#
Yeah, that's what I was coming to.
#
Because that's where you wipe the debts clean.
#
The only way in India where you can wipe the debts clean and start over is IBC.
#
So I want you to break that down for me now.
#
In your specific piece, for example, you gave the instance of say that there is a zombie firm
#
and it has say 200 rupees in debt and the most anybody is willing to pay for it is 50 rupees.
#
But nobody will do that because they pay 50 rupees and they are struck with 200 rupees of debt.
#
So one option is where the government covers the debt.
#
So you have an auction where the winning price is a negative bid, in this case 150.
#
So the government covers 200, the other 50 goes into covering that.
#
And then whoever bids for it has a firm with no debts.
#
But that, of course, then the taxpayer is taking that burden.
#
But it's a one-time fiscal burden and doesn't keep repeating.
#
Is that the kind of scenario that would work for Air India, you think?
#
Well, it would involve the use of taxpayer money and I don't see why.
#
So what's the other option?
#
The other option is to put Air India into the bankruptcy process.
#
So imagine that one of the banks, one of the public sector banks,
#
will have a payment that does not come on time from Air India.
#
So imagine the taxpayer stops putting money into Air India.
#
Air India fails to pay either an employee or a creditor or a bank.
#
And then any of these characters can go to the NCLD and initiate the bankruptcy process.
#
As it turns down, as the course turns down.
#
And what the bankruptcy process does is precisely this.
#
It takes Air India, it puts it up for sale, and it offers the buyer a clean slate.
#
It says all your debts are wiped off.
#
And whatever that buyer puts up the highest, bidder puts up,
#
that's the money that goes to the creditors.
#
It may be less than the full debt that was owed to them, but that's okay.
#
So that's given in a pro rata kind.
#
Yeah, there is a procedure for allocating that.
#
And in the end, you get a clean, unencumbered firm with some assets,
#
with some capabilities, with some software, with some people, with some management systems.
#
Or maybe these organizational capabilities actually don't exist.
#
And nobody really comes up with a half plausible bid for Air India.
#
In this case, it goes to liquidation.
#
Please sell Air India building.
#
Please sell the planes.
#
Please sell the real estate at all the airport counters and so on.
#
Right. You've spoken and you had an article on the IBC as a means of privatization,
#
which would basically be this.
#
You get rid of a zombie firm in this manner.
#
So the question here is that, you know, number one, there are obviously interest groups
#
which would be against this in the political economy,
#
which stop these kinds of reforms from happening.
#
And number two, there might be a mindset problem where, you know,
#
people think of the economy in a particular sort of central planning way
#
that we have to keep these firms alive.
#
And you have zombie banks keeping zombie firms alive, as you described.
#
You know, which of these is more of an issue here?
#
So I think the second one, because we in India have not had experience with the bankruptcy code,
#
we're used to firms that just live and live and live.
#
And we've developed this worldview that a firm essentially lives forever.
#
And I would just like to plead with all of us that, yes,
#
there is something great in the organizational capabilities of many firms,
#
but that doesn't mean all firms have great organizational capabilities.
#
And just like the creation of new firms is very important,
#
the destruction of old firms is also very important.
#
And as a society, we have to move on.
#
A firm is nothing but a collection of people and capital that comes together.
#
And if it doesn't work, then we should just move on,
#
because that same capital, those same people will do other things.
#
Finally, a pilot is going to fly planes.
#
Finally, the Indian passenger will fly from Bombay to Nagpur.
#
So, you know, in the end, it all evens itself out.
#
We don't have to be so stuck on the idea that there will always be an Air India
#
and there will always be a Jet Airways.
#
Maybe these are not the right organizations to have done these things.
#
I'm not here to prejudge whether there is organizational capability or not.
#
But that's for the bankruptcy process to decide.
#
If there are buyers who feel that there is organizational capability in Jet Airways,
#
they'll put up a price for it.
#
And if there isn't, then we should feel a little bit of sadness,
#
And the great economist, Joseph Schumpeter,
#
taught us this whole message about creative destruction,
#
that the glory of the market economy lies in that ceaseless churning,
#
where new firms are born all the time and old firms die all the time.
#
And that's what keeps a market economy energetic.
#
That's what keeps a market economy honest.
#
And I feel we in India have somehow got into this notion
#
that every firm is somewhat like a government job,
#
that I'll have the job forever, the firm will be there forever.
#
And I think that we would all be better off being more equanimous about it,
#
that look, these things happen, they come and go.
#
I would like to narrate two stories in this regard.
#
The first of them is the malls of India.
#
So as an economist, I suffer from two problems.
#
The first is that I rarely get to visit malls.
#
And the second is that when I visit malls each time, my heart overflows with joy,
#
because I see how much change there is between one month and the next month.
#
You walk in any mall in India, there is this constant churn.
#
There will be a new outlet where there was something completely different.
#
People move on. People try something, if it works, great.
#
If it doesn't, they move on. There's that dynamism.
#
Among small firms in India, we know that dynamism.
#
So similarly, you would have heard of the restaurant business in India.
#
People put in a lot of capital thinking it's going to work for a year.
#
So you do your entire business plan, thinking at the end of the year,
#
people will be tired of this restaurant and odds are I'll have to shut it down
#
and move on and do something new. That's the dynamism.
#
Here is a story originally written by my colleague Ela Patnaik.
#
She did this in the Indian Express some years ago.
#
You will remember a time when there were these STD, ISD, PCOs all over the country.
#
So all over the country, we would travel and then we would find our way to some STD booth
#
and we would make a call home.
#
When mobile phones first came, we still used those STD, PCOs
#
because roaming was extremely expensive with your mobile phone.
#
I believe that at the peak, there were more than a million of these PCOs
#
and each of them probably had one, two, three people participating in the production.
#
So probably a labor force of multi-million people was producing these STD, ISD, PCOs.
#
And then one fine day, the roaming cost of cell phones went to zero.
#
And this entire industry vanished in the blink of an eye.
#
This is an industry vastly bigger than the employees of Jet Airways.
#
In the blink of an eye, all these people lost their jobs and they moved on.
#
They went and did other things.
#
And cyber cafes for that matter.
#
Similarly, cyber cafes sprang up and cyber cafes vanished.
#
And this is the glory of a market economy.
#
That at each point in time, entrepreneurs look at the world, firms look at the world.
#
They try to figure, how can I serve the customer?
#
And there is a way of serving the customer.
#
And then the world changes.
#
Preferences change, technology changes.
#
And we should be unsentimental about firm creation and firm destruction.
#
Another example that comes to mind is there used to be an old saying
#
right up to the end of the 90s, a Japanese saying I think,
#
that if you want to make a man bankrupt, give him a camera
#
because film was so expensive.
#
And now you don't find Kodak film developing things anymore.
#
On every street in India, we would have had one little shop,
#
which is a studio, and they would develop your film.
#
And today they are all gone.
#
Except maybe for passport photos, small whatever.
#
And part of this is again that Indian mentality.
#
Like earlier in this conversation when you were talking about
#
how if Air India was to shut down, other airlines would be able to buy pilots cheaper.
#
And I thought a lot of my listeners would react to that by saying,
#
oh, what about the poor pilots?
#
They're going to get paid less.
#
And similarly, those same voices ring up now and say,
#
oh, what about the poor jet employees?
#
You know, whatever, thousands of employees, what are they going to do?
#
And that's the scene effect.
#
And you know, like the show is of course called The Scene and the Unseen.
#
And the unseen effect is that, look, there is value created in the economy
#
and all of these people eventually get absorbed.
#
And see, you can't have it only one way.
#
When markets work and there was a shortage of pilots,
#
the price of pilots went up.
#
And at that point, pilots didn't complain.
#
But it's the same process that over the years,
#
there'll be more and more young people who will earn their wings
#
and there will be supply of pilots and that will impact on the price.
#
So once we get used to the idea that supply and demand determines the price,
#
then we just respect that vast impersonal machine of the market
#
and it will have its own ups and downs for each of us.
#
Now, I also want to talk a bit about the price system and how that affects zombie firms
#
and how that's, you know, how a system where you don't let zombie firms die prolongs downturns.
#
But we'll take a quick commercial break.
#
Hello, everybody. Welcome to another great week on the IVM Podcast Network.
#
If you are not following us on social media, please make sure that you do.
#
We're IVM Podcasts on Twitter, Facebook and Instagram.
#
So we have something really exciting in store for Star Wars fans.
#
After a successful first edition of the Geekfruit Cantina, we're back with another.
#
Come celebrate Star Wars Day with us.
#
That's May the 4th with Geekfruit at the Cuckoo Cafe in Bandra.
#
We have a super fun evening planned with a live podcast featuring special guests,
#
Star Wars merchandise, up for grabs, thinkers games, along with Star Wars themed food and cocktails.
#
You don't want to miss this.
#
On Cyrus says, Cyrus talks to food blogger and restaurateur Parzen Patel,
#
the lady behind Bavi Bride.
#
They talk about the love and evolution of Pasi Cuisine, funny English street names
#
and her new podcast, Not Just Dansak, which you'll be able to listen to on this very network starting this Tuesday.
#
On the second episode of the Rani Skruwala podcast, Dreaming With Your Eyes Open,
#
Rani Skruwala talks to me about the importance of failure,
#
how age shouldn't be a deterrent for entrepreneurship and setting the right expectations for your venture.
#
On Thalle Harate Akanada podcast, Lalita Pulavarti joins Pawan Srinath on episode 20.
#
They talk about the challenges faced by the 470 million plus children in India.
#
On What A Player, Akash Mehta and Siddharth Dideja are joined by sports writer Vivek Krishnan.
#
They talk about why Bangalore should be in the top four spots and a lot more.
#
On Dating Is Garbage, three IVM dudes discuss their dating lives with Jaanam
#
and share their stories around love, friendship and sex.
#
On Simplified, we have the founder of Karanti art theory, Romario Rodriguez.
#
He joins Chuck and Naren as they talk about talent management and integrating various art genres.
#
On Football Total, the boys are back to discuss last game week's EPL results
#
and the heated battle for top four placement.
#
On Golgappa, model turned actress Aditi Govindrakar joins Tripti
#
where she talks about motherhood, practicing psychology and her career as a model.
#
Let's move on with your shows.
#
So I feel that a child can understand the price system
#
and yet so many people seem to not particularly think about the price system.
#
It's just a great recipe for understanding the world.
#
It's like an invisible formula that is running the world and it's a secret that only a few people have.
#
So let me talk a bit about how some of these things work
#
and at once these are trivial observations and yet they are interesting and powerful observations.
#
So let's start with planes once again.
#
So we had some of these Boeing 737 MAX planes being grounded because of safety concerns
#
and at about the same time we had a disruption in jet airways.
#
So the supply of planes, the supply of seats on planes was adversely affected.
#
This is what economists would call a supply shock.
#
Now the fundamental nature of the price system is that the price moves to equate supply and demand.
#
So there is a market and that market is not clearing.
#
There are 100 people trying to buy seats but there are only 80 seats.
#
There is a mismatch. That doesn't work.
#
How the price system deals with it is that prices go up until 20 guys walk away.
#
So the price system rations out the limited seats that are available.
#
So let's visualize that there is a Bombay Delhi ticket which was ordinarily some 7000 rupees
#
and now there is a shortage of supply.
#
So let's just fix numbers. There are 100 people trying to buy seats and there are only 80 available.
#
So think of the price system as running an auction.
#
It says no, instead of 7000 I am going to go to 7500.
#
Some people in the room drop out and they say ok at 7500 I am not going to fly.
#
Does that get you to 20 people dropping out?
#
Let's go to 8000 rupees for the ticket.
#
And you keep raising the price until there are only 80 guys left.
#
That's the imaginary anthropomorphized price system.
#
That's what the price system does.
#
Now you go one deeper into that and you say how much do you think I would have to raise plane tickets
#
to get maybe 5% or 10% of the flyers to drop out?
#
And you know what? Not a lot.
#
Because for many people in India flying is a choice.
#
You may choose to not fly. You may choose to use a train.
#
You may choose to use a Volvo bus.
#
So many people are on that borderline.
#
Flying is not some critical essential thing.
#
It's still something that we have a discretionary expenditure on flying.
#
So my prediction would be that a relatively modest movement in the price would work to clear supply and demand.
#
And so it's not a big disruption. There's no great change in prices that occurs.
#
It's nice. There's a 5-10% move in the prices.
#
That's great for the profitability of Indigo and Go Air and Spicejet and all that.
#
And this is the time they deserve to make money.
#
Once again, there are people who will call this profiteering.
#
And I say, look, this is the joy that these firms get in return for the long slog of fighting it out
#
while Air India was underpricing tickets and Jet Airways was there.
#
And in those years, the other airlines did badly.
#
And this is the moment when you make money.
#
Because when the other guys exit, it is your great opportunity to make money.
#
We should not grudge them this time.
#
We should not be getting angry at the fact that they are gouging customers or they are profiteering.
#
This is markets. This is the normal movement of the price system.
#
If I may take an example from an unrelated industry, let's consider wheat.
#
Now, wheat is a very cheap grain and wheat is a staple.
#
And most of us don't even know the price of wheat that goes into the chapati that we eat,
#
which means that if there was a supply shock, so imagine there was a drought,
#
there was a failure of the Rabi crop in Punjab and Haryana.
#
Now, there is a problem. There is not enough wheat.
#
So if the price of wheat goes up by 5% or 10%, it would not work to clear supply and demand.
#
You would need a large movement in the price of wheat to make people change their behavior,
#
to shift away from wheat to eating rice, to eating bajra, whatever.
#
There would be adjustments.
#
But for many people, you would need a large movement in the price of wheat to elicit a change in behavior.
#
And the term economists use for this is demand elasticity.
#
So the demand elasticity of the wheat consumer is different to the airline flyer.
#
Exactly. So I was particularly comfortable at the prospect of a supply shock in airlines
#
because our elementary intuition into the kind of behavior of flyers is that people are highly sensitive to price.
#
People are always conscious of what they're spending when they buy a plane ticket.
#
So you would expect a given supply disruption to get tidied over with a relatively modest movement in the price,
#
whereas in something like wheat, you would get large movements in the price.
#
Once again, we shouldn't get angry about these movements. This is the price system. This is what prices do.
#
And what a lot of people demand is that if the price of something, especially something essential, goes too high,
#
they say, no, no, the government should control it.
#
But I've had different episodes in price controls, including on Uber.
#
So I'll just kind of illustrate that with an example of two things that letting the price adjust does.
#
One is let's say that there are 100 potential Uber customers at a given point in time who want a taxi,
#
but there are only 50 taxis available.
#
Now, if you fix the price, what happens is that it's first come, first serve.
#
The first 50 people get it. The other 50 are simply stranded.
#
Now, you could be someone who has an urgent need.
#
Maybe you need to take your aging father to the hospital.
#
Maybe you need to catch a flight. You would be willing to pay much more, but you're stranded.
#
And some of the people who happen to get the taxis, the lucky 50, could just be going out for an errand
#
or they could easily walk or take a bus or do something else. It's trivial.
#
Or they could just sit at home and watch Netflix. And they get it instead.
#
Whereas if you allowed the price to adjust, two important things would happen.
#
One is that it would be allocated depending on how desperately someone wanted it
#
because a guy who has to go to the airport, the guy who has to take his dad to the hospital,
#
they'd be willing to pay more. And someone whose need might be trivial, who can just, you know,
#
it's a five minute drive, he can take an auto or walk, would do that.
#
So the price system effectively sort of sorts those guys out.
#
The second and the more important thing that it does, which even applies to airlines or anything,
#
is that it sends information. It sends information to idle Uber drivers that,
#
listen, there is a profit to be made. And for their self-interest,
#
they get into the market to fulfill the needs of the guys who would otherwise be stranded.
#
And this information on both ends to both the buyer and the seller so that they can adjust
#
is something that I think is unintuitive and unseen. And people don't often get it.
#
That if you fix the price, you will have scarcity. It will be first come, first serve.
#
And a price system is beautiful, not just in the short term way of letting people get what they need
#
based on how urgent the requirement is, but also in a long term way of fixing that supply demand shortfall.
#
So I want to talk about two things. If I may do this in reverse order,
#
I'll come to what you just said in a moment. So I'm very happy you brought up Uber
#
because there is something fundamental and profound about the gig economy.
#
And it fits beautifully in our intuition about how markets work.
#
There was a paper done by people at the Center for Civil Society,
#
which did some things that were quite interesting and an eye-opener to me personally.
#
This was about Airbnb. And they found that one of the features of Airbnb accommodations
#
that users valued the most was a kitchenette. And it turns out that this is something quite difficult
#
to do within the normal government regulatory system.
#
So the gig economy is particularly good at discovering products and features in its own way
#
that traditional regulatory structures might fumble at.
#
And I think that's an important lesson to all of us that let that self-organizing system work
#
and discover solutions as opposed to using regulation.
#
That said, there is a role for regulation. And let me talk about your example.
#
So first, I agree with everything you said. But now let me bring the cautionary note
#
about the problem and how we worry about it.
#
The technical phrase we use in the field of the economics of public policy is market failure.
#
A market failure is a situation in which the self-organizing system,
#
the individual decentralized decisions by all of us, does not work so well when something goes wrong.
#
And there are four categories of market failures. And the first of them,
#
and the most important of them in one way, is a monopoly.
#
So when there is market power, when somebody is a monopolist, things don't work so well.
#
The monopolist will gouge the consumer. The monopolist will artificially depress production
#
and will extract consumer surplus. So nobody likes a monopoly.
#
And in a way, a lot of what we do in public policy is designed to combat these monopolies.
#
Now when you go back to the beginning of the taxi industry, which is now like 70, 80 years old all over the world,
#
the situation that was on the mind of everybody was like this, that there is one taxi cab on a street
#
and you are one consumer on the street. And you go up to the taxi cab and say,
#
will you go there? And the guy realizes that you are desperate and he is a monopoly in that brief moment
#
and he can basically charge anything. So the regulation of taxi fares came out of that problem.
#
In that situation, the bargaining power is entirely asymmetric.
#
And when there is only one taxi cab on the pavement, that person gets the ability to charge almost anything.
#
And also if I may interrupt, the problem in India is that the supply of those taxi cabs
#
is also controlled by the government because there are only limited licenses they give out.
#
So that furtherens the scarcity.
#
Same as the New York taxi cabs, which are artificially restricted.
#
But I just want to focus on that point that there is market failure in this problem
#
and that is why there is regulation of taxi cabs.
#
Now in the limit, the Uber surge pricing can potentially collapse into that same problem
#
that in the central systems, Uber sees that many customers are walking on a street with its app open.
#
So Uber has a unique ability to see where its users are.
#
And it knows that on that street there are only three taxi cabs.
#
So you got a little monopoly and now why not charge the moon for that?
#
So everything you said is correct that the price will ration out the users
#
and will allocate the scarce goods to the people who want it the most.
#
The high price will attract more consumers.
#
But we do have a regulatory problem which is that it is perfectly feasible for Uber
#
to turn into just a classic 19th century fear of a monopolist.
#
And I don't have an answer for how you would solve this problem.
#
But I just want to say that good economists do worry about Uber surge pricing as well.
#
So I have like three responses to this.
#
One is of course like you know when we see a market failure we often think of the government has to step in.
#
But I think as you know public choice theory would tell you that government failure is far more endemic
#
and in a sense I would argue even inevitable because of the way the incentives are aligned.
#
But leaving that broader point aside, you know when you point out about your traditional Kali-Pili taxi,
#
how it's a monopoly for a moment when you want to go somewhere and you can charge whatever he wants.
#
I don't know if I'd call it a market failure because the reason that scarcity exists
#
and that monopoly exists for the moment is because the state is interfering in the market entry.
#
Even if entry were open, there will always be these dumb luck situations where,
#
so to use a London analogy, it starts raining.
#
Then suddenly there is a surge of users of taxis and there will be a street where there will be two, three taxis.
#
But the market, there's always a little lag. The market takes time to adjust.
#
Would you call that a market failure per se? It would be a market failure if it persists.
#
So if there is a monopoly where within hundreds of meters of walking distance,
#
I really am down to only one or two producers and they can essentially charge me very high prices,
#
I would call that market power.
#
And my third point is that the big issue with a monopoly of course is that they can charge high prices
#
and expert consumers and so on and competition keeps prices low and all of that.
#
But a lot of the modern monopolies that people tend to worry about like an Amazon, like a Facebook,
#
like even an Uber are actually not doing that.
#
Even if they control the market, you see that the prices are very low and the consumers are benefiting massively,
#
like from Amazon for example.
#
You have to be cautious about that.
#
There is a very plausible scenario that a firm like Amazon or a firm like Uber
#
becomes a monopoly at first with very low prices, drives off the competitors.
#
Then after that you've got a network effect that the only game in town is Amazon
#
or the only game in town is Uber and then they would raise prices.
#
So we should look this gift horse in the mouth.
#
But if that happens surely then other entrants will come in.
#
By that time some of these games will be locked up because their network effects.
#
So the key network effect in these platform economies like Uber is that
#
if I'm a driver and I switch on the Uber app, I've got an order flow coming into that.
#
And if I'm a customer and I open the Uber app, I will find more taxes.
#
Once you've created this network effect, then both sides tend to come to that platform
#
because they don't have a choice and that platform can charge supernormal pricing.
#
So there are genuine concerns about these markets.
#
I am not quick to say we know solutions, but I think we know enough to be concerned.
#
Fair enough. I mean as of now I see Uber and Ola and even you know,
#
Kalipili is playing outside and there's always video conferencing.
#
So why do you even need to go anywhere? But I'm kidding.
#
Right. So to kind of get back to one of the sort of interesting points you made
#
is that if not for state interference, the different ways in which the state keeps
#
zombie firms alive or zombie banks keep zombie firms alive,
#
not just in the public sector but the private sector.
#
And in fact I should ask you to elaborate on that, which I will.
#
But one of the effects of that is that downturns are longer.
#
That if creative destruction is allowed, downturns would be much shorter
#
and you give specific examples of that. Can you take me through that?
#
So the great economist Karl Marx taught us that it is in the nature of the market economy
#
that there are booms and busts.
#
So there are periods of exuberance and a great deal of investment
#
and then the competition hots up and margins go down and some firms get into trouble.
#
We in India have lived this twice in the period after the early 90s.
#
So let me tell the grand Indian story.
#
The grand Indian story is that from 93, 94, 95, 96 we had investment boom
#
and a great deal of entry took place.
#
So new firms were born, new capacities were built.
#
By 97, 98, 99 the world started becoming difficult and a lot of firms got into trouble.
#
And then we played that same story again one more time.
#
So in 2003, 4, 5, 6, 7 we had the most gigantic investment boom in India's history.
#
And then from 2011 onwards we've been doing quite badly.
#
And what's going on there is that there is a surge of entry and then competition hots up.
#
And then what? If you do not think about exit of firms,
#
if you do not think of firms closing down, firms getting sold, firms getting bought,
#
then that misery just drags on for more years.
#
So what we see in our business cycle research in India,
#
so Radhika Pandey and Ela Patnaik and I have papers on measuring the Indian business cycle.
#
And we are struck by how these things take more time in India
#
and we've often wondered what is going wrong.
#
And when we compare with countries like the United States,
#
it seems to us that one difference is that when things go wrong in the United States,
#
they get rapidly cleaned up by the bankruptcy code.
#
So people move fast. This isn't working, you get into trouble, you're down on your payments.
#
I would also underline one more interesting feature here.
#
All these things go faster when there is debt.
#
So imagine I'm an all equity firm, I'm 100% equity.
#
Now I can sustain my own bad behaviour for some time.
#
But when I have debt, I've got a Damocles sword on my head, I have to repay the debt.
#
And when times become tough, when I'm unable to produce the cash,
#
then I will fail on one of my debt repayments.
#
And then you just want to go quickly, move it through the bankruptcy code.
#
Just go as quickly as you can to the bankruptcy code.
#
Either the firm will be closed down or it will be sold to somebody else,
#
very often an existing firm.
#
So market power will develop that some of the survivors will achieve a little more clout in the market,
#
be able to get the price up a little and then profit rates will come back, investment will come back.
#
So this whole cycle of life is playing out slowly in India
#
because we are prolonging the business of firm exit.
#
And how does the state contribute to that?
#
For example, is the NPS problem linked to that in the sense that banks often keep these zombie firms alive
#
by making loans and then servicing those loans and keeping them alive and throwing good money after bad.
#
And that prolongs the process?
#
So this is very much a problem with our banking regulation.
#
What should happen in banking regulation is you see a borrower having distress,
#
you must rapidly mark down the value of that asset.
#
So imagine you gave me a loan of 100, you're supposed to be vigilant, you're the bank,
#
you're supposed to be vigilant, you're supposed to watch me and understand my early signs of distress.
#
Very often you are my payments bank as well.
#
So you're seeing my cash, you're seeing my revenues, you very much know when my life is not going so well.
#
And of course there is beautiful information in the accounting data.
#
We can construct models of firm failure using the accounting data.
#
So put it together, it's not difficult for a bank to know when the borrower is in trouble.
#
Now the bank is supposed to make an estimate of what is the prospective market value of that loan.
#
That if you try to take your loan to me and sell it to somebody else, what would that somebody else be willing to pay?
#
What banking regulation has to do is to force banks to recognize these losses.
#
So if the fair value of the loan on the market is going to go down from 100 to 60,
#
then honestly if I tried to sell this loan, the market would pay me 60.
#
Then the bank should show that loss of 40 right now because you've really lost that money and you should show it right now.
#
Now as you will expect, no bank employee wants to do that.
#
So that's what banking regulation is all about.
#
Banking regulation is about forcing bank employees to face up to the difficulties in their book
#
and recognize these losses and take the losses on the chin.
#
Now we haven't particularly done that.
#
So RBI has long had a history of being kind to banks, of being kind to the borrowers of banks.
#
And so these things just slither on for years and years.
#
So in our calculations, we believe that if the Indian debt crisis and the banking crisis had been dealt with in 2011, 2012, 2013,
#
the cost of equity capital that was required inside Indian banking would have been about 2-3 trillion rupees.
#
Every year of delay has driven up that cost.
#
Today it would cost 8 or 10 trillion rupees to fix all the banks.
#
Because when you don't solve these things, they just become more and more expensive
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because you have to put more money after the old money.
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So these are the sorts of things where a society has to be organized around a philosophy of the market economy.
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That we need all of us to come to grips with these concepts that when there is a loan,
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there will be a fairly tough bankruptcy code in it.
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And the bank will recognize these losses fairly quickly and so on.
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When a bank doesn't work, we will close down a bank.
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These are all the concepts of a market economy, the discipline, the rigor of a market economy.
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And I think we are just at the early stages of learning how these institutional things work.
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And like you said, the incentive of a politician who is always fixed on the short term
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and always fixed on the next election will always be to kick the can down the road.
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You know, bureaucrats will have the same inclination and even bankers, for example,
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will not want to take the, you know, there is policy paralysis when they are worried that
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okay, if I give a haircut on this loan, if I take a haircut on this loan, I could be accused of corruption.
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And all of those factors and those different incentives come into play.
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So we have to solve some of these things.
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So for example, a banker being held responsible when there is a markdown on the loan.
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We have to build the institutions, the machinery to protect people,
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to find ways of determining what is the size of the damage and so on.
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But this is the puzzle that we face that how do we create a society where there is creative destruction?
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We have to figure out, fit under that puzzle that we need to get entrepreneurs
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and employees used to the idea that firms come and firms go.
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We need to get banks used to the idea that they will mark down the losses that have occurred
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and that sometimes banks will go bust.
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We need a banking regulation capacity that will hawkishly monitor banks
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and make sure that they do these things correctly.
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And in return is this very big prize.
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And that very big prize is that we will finish off with downturns quickly.
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And it seems to me like a very big prize that it would be a truly great thing for a country
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that you go through a great investment boom, then there is really tough competition
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within a short time, maybe one year, two years, you work it out and then you restart the next big boom.
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Whereas in India, these things slide on for many, many years.
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So before we end the episode, I'd also like you to elaborate on GST.
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You were obviously, as you mentioned in the early days, involved with designing the GST
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and what eventually got implemented by the Modi government is much more convoluted
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than people like you would have liked.
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And your case was that a good GST, a simple GST with one low tax,
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with a good administrative structure would have helped kill off zombie firms faster.
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Explain that process to me.
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What is happening in India is that we have too many different rates
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and it's become complicated.
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You could be an inefficient firm and take cover in various clauses of the tax code
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or you could take cover in tax evasion.
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So the sophisticated idea is that the low productivity firms of India are hiding
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in violating regulations, in emitting pollution when that should not be done
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and in cheating on taxes.
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So the deep insight is that if we are able to build a simple, clean GST,
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and my idea is very clear about a 10% single rate on everything,
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just a universal base, 8%, 10% on everything, a simple tax administration,
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then a lot of the hassle is taken out and the room for fudging around is taken out.
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The room for discretion by the tax authorities is taken out.
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And what that will do is it will uncover the inefficient firms, the zombie firms,
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the low productivity firms that have been hiding in the woodwork
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based on their ability to cheat on taxes.
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So a big phenomenon we see in India is that we see large, sophisticated,
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high technology firms often tend to have a high compliance culture.
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They meet every pollution regulation, they meet every labour law,
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they meet every tax requirement and that's great.
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We want those kinds of firms to thrive.
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But those firms don't really make the kind of profit margins they ought to
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because they're competing with a low productivity firm that manages to cheat on regulation,
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to cheat on pollution, to cheat on labour law, to cheat on taxation.
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So that's the big idea about the connection between GST and zombie firms.
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And what you also pointed out was that before the GST came into play
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and to some extent maybe still now is that you had taxation of transactions
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which in public finance are called bad taxes.
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And then what that forces companies to do is it creates an incentive towards vertical integration.
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The example you gave was that let's say if you are taxing when the engine of a car is made
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and then when the car is put together and if you're taxing them separately
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then it's in a company's interest to bring it all in-house in this vertical integration.
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Whereas economies advance the more there is specialisation
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and not taxing each transaction separately and a GST basically treats them all as one
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reduces the incentive for vertical integration.
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You have more specialisation and everybody benefits.
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So this is the old Adam Smith idea that each of us specialise and we get to doing something very well.
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And that leads to a very nice intuition in a market economy
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that a sophisticated economy is one in which we transact more.
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So more turnover is the hallmark of a more sophisticated economy.
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So we are arm's length firms. You are an engine producer, I am a car producer.
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But we still do a lot of business with each other separately because I am buying your engine.
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Whereas in a less sophisticated economy we vertically integrate these things into vertically integrated monoliths
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and this is a less efficient way of organising society.
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So it's a very simple public finance idea that never tax transactions.
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A transaction tax is always a bad tax
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because that way you are interfering with the very lifeblood of an efficient society
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which is many, many people doing many, many trades.
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And to end the episode, a final question.
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You've worked for a couple of decades now in public policy.
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You worked within government, you worked with the Ministry of Finance.
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Do you see the thinking on this changing?
#
Obviously it's a good thing that JET was allowed to close down.
#
But do you broadly see the thinking on this changing?
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That we have a GST even if it's not a perfect one.
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We have the IBC even if it's not being implemented perfectly.
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Do you see the mindset changing?
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I am actually a little disappointed.
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So I started out in India in 1993
#
and there was a lot of excitement about the market economy.
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And I felt many people were very self-consciously trying to understand
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what it means to live in a market economy
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and to adapt oneself and one's organisation
#
into the concepts and frameworks of a market economy.
#
I think some of that intellectual construct has gone astray
#
and we are losing sight of the foundations.
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We are losing a sense of the fundamentals.
#
So I feel in some ways we are less equipped
#
in terms of the world view and the framework today
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And it's a bit of a disappointment
#
that this hasn't quite gone as I had hoped it would go.
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This is the policy universe you are talking about.
#
This is the mind of all of us about how we think about markets,
#
how we think about government, how we think about the role of state.
#
And it's interesting because 60% of India is born after liberalisation, right?
#
So you would not expect these kind of reflexive worship of the state
#
I think a reflexive socialism is alive and well.
#
On that extremely hopeful note,
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Ajay thank you so much for coming on the show.
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Yep, you heard me right.
#
We are all in the content business now.
#
Let's not call it news, TV, radio etc etc.
#
It's all content and we are in the middle of this weirdly exciting phase
#
where all the borders and lines that have been drawn over decades
#
has been swept away by this lovely thing called the internet.
#
We are sure we don't dwell on just the stuff that is now
#
but rather the wider stuff about advertising media, content
#
and the whole goddamn circus surrounding it.
#
Tune in every Tuesday for our weekly unboxing of the mystery box
#
we used to call advertising.
#
I am Varun Duggirala, co-founder and content chief at The Grinch
#
and this is my new podcast, Advertising is Dead.
