The Contract Theory

Having majored in Economics in college, I took keen interest in the subject for which this year's Nobel Prize in Economics was awarded.

The Contract Theory, while highlighting the basic essentials of commercial transactions in our economic system, does not really fit well within the realm of Economic Sciences. It actually pertains to Law, for which there is no Nobel Prize.

Secondly, while contracts spell out the broad contours of a commercial relationship, yet the key factor governing lasting commercial relationships now, is relationships, which need to go beyond the 'ifs' and 'buts' as spelled out in contracts.

Thirdly, one of the key assumptions of Economic Theory is 'Rationality', that is, the key participants in an economic system, be it a consumer, or a producer/firm, etc try to maximize their utility (satisfaction), or profit etc. Now, while negotiating contracts, the entities in question may not be able to act rationally, but may have to compromise over a 'satisfying' outcome, as elaborated in the particular contract, due to factors such as hidden limitations of the entities concerned.

My objective here is just to highlight some other aspects of Contracts, and certainly not to challenge the decision of the learned jury, which decided the coveted Prize.

Goods and Services Tax – Some Thoughts

The Constitutional Amendment Bill enabling Goods and Services Tax (GST), which was passed by our Parliament, is indeed a milestone, as it truly represents the biggest economic reform post the economic liberalization of 1991.

The basic idea of ‘one country, one market, and one tax’ is now set to become  a reality.

That it would eventually see the light of the day is a foregone conclusion. But some thoughts that need to be considered are:

1. In the pristine world of textbooks unsullied by demands of politics, a good tax rate is one that is low and covers the widest possible base. However, states have already negotiated for a number of exemptions on items such as petroleum, electricity duties, alcohol, and on stamp duties on property.

One way of looking at it is that let the process begin, and gradually, as benefits of GST become visible to all the stakeholders, such exemptions can be gradually withdrawn and brought under the fold of GST. But, a reality of Indian states is that, the development needs and the financing needs vary from states to state. Local levies on alcohol, petroleum, electricity, and stamp duties on property are among the common sources of revenue for the states. The challenge of eventually financing the development needs only with the resource mobilization through GST leaving central grants aside, would be a herculean one,

Furthermore, these are heavy hitters on revenue front, and excluding them from the taxable pool need not push up the rate that will ensure that the transition from the current to the new regime keeps revenues neutral. This is possible provided both the centre and the states, are transparent in the total revenues being currently realized from different categories of goods and services

2. Two case studies which have been quoted in the newspapers include that of New Zealand and Canada. New Zealand introduced GST in 1986 that followed the copy book model with low GST rate and minimum exemptions. This led to a quick pop in the GDP growth and revenue buoyancy. The other case study pertains to Canada which introduced GST in 1991, and was riddled with exemptions and riders. Canada saw a sustained dip in GDP growth right after that.

Our tryst with GST appears to be akin to the Canadian experiment, and it is only prudent for the GST council comprising of :  the Union Finance Minister (as Chairman),  the Union Minister of State in charge of Revenue or Finance, and the Minister in charge of Finance or Taxation or any other, nominated by each state government. to deliberate upon the Canadian experiment to iron out possible problem areas, which could have have a negative impact on our GDP in the initial phases. Similarly, it would also be worthwhile to identify the factors which contributed to the GDP growth in the case of New Zealand. One possible factor that comes to mind here is a robust structure and backbone to implement GST in its intended letter and spirit, backed by an equally robust administrative machinery that acted as a catalyst to facilitate  the ease of doing business  by reducing the number of disputes with private citizens and businesses to the extent possible. Thus they were left with more time and motivation to concentrate on their respective businesses, rather than devoting most of their energies in manipulating the system and disputes resolution,

3. Besides the fact that the Modi government would be facing the electorate in three years from now, the fact remains that currently we badly need to focus on employment generation via investments by the private sector. Hence, the GST rate structure initially has be such that facilitates such macro objective of the government. Revenue losses for the states will be compensated by the centre, and the Finance Minister will have to ask the states to take a leap of faith along-with him.

Now, assuming that there is complete transparency by the states in declaring their revenue losses, and the Centre with all its noble intentions decides to compensate the states in their revenue losses, then what are the sources of finance available to it besides the collections from the GST? Furthermore, what would be the relevance of the Finance Commission? This commission acts as an instrument to divide proceeds of divisible taxes between the states and the Union government, or in cases of taxes that are collected by the centre but the proceeds of which are allocated between the states, to determine the principles of such allocation,

4. To quote Swaminomics which appeared in Times of India dated 7^th August, “ Trucks in India average just 270 kms a day against 800 kms a day in the US, because of check-post delays at the borders, and GST could slash these. Economic optimists hope GDP will improve by over Rs. 100,000 crores.” 

Removal of delays at the check-posts due to the implementation of GST can certainly lead to quicker turnaround times for order fulfillments, but this would be only one of the key factors in improving the GDP by a phenomenal Rs. 1 lakh crores. The other key factors would be the overall macro environment of the country, speedier decision making not only at the political level, but also at the bureaucratic level to translate the vision of the political leadership to reality without any dilution,                

5. Then to quote Swaminomics again, “The slogan ‘one India, one tax, and market’ sounds terrific but may mislead non-experts. GST does not provide for one rate across India. Different committees have suggested different tax bands for different sets of goods and services. Chief Economic Advisor Arvind Subramanian headed one such committee, which suggested four tax bands – zero for essentials, 12% for merit items, 17-18% as the standard rate for other items, and 40% for luxuries. The GST council could set completely different bands. Besides alcohol and petroleum products are outside GST with each state free to set its own rate.                                                                

                                                                   

While it is expected that the committee headed by the Chief Economic Advisor has indeed deliberated upon the definitions of “essentials, merit items, and luxuries”, besides specifying the various goods and services which would fall  in each of these categories, it is up-to the GST Council to arrive at a unanimity on the same,

6. To quote another eminent personality Swapan Dasgupta in Times of India dated 7^th August, “Politically however, the suggestion that this will force the pace of economic centralization is a half truth. In his speech, finance minister Jaitley referred to “pooled sovereignty”. What these catchy phrase implies is that both the centre and the states have agreed to shed some of their own sovereign powers over revenue mobilization. However, both entities have simultaneously acquired exta-territorial rights. Once GST comes into force, the Centre’s rights to determine the rate of national taxes will cease to be absolute. The proposed GST Council, in which the states together have two- thirds voting rights, will now have a direct say in the rates of taxation. In effect, this implies that the states have a potential veto on the centre’s powers of taxation.”

The keyword above is “potential veto”because notwithstanding the two-thirds voting rights, the scale in GST Council can tilt in favor of the Centre, if more than half of our states are ruled by the coalition partners which are part of the central government

7. To quote Swapan Dasgupta again, “Once the GST rate is set, then changing it would be a herculean task. This would imply that Union Budgets from 2018 onwards would lose the paramount importance they now enjoy. The FMs principal task would be reduced to determining the pattern of government expenditure. Revenue generation would be by and large run on on auto.”

Now, would the revenue and fiscal deficit be well under control? Perhaps, alongside it would make sense for the Union Government to introduce Zero based budgeting, where each expenditure made in the previous budget is evaluated in terms of the outcomes. Going further, ahead, it would make more sense for the Union Government to undertake a mid year review of all major expenditures earmarked in the budget to determine if the same needs to be continued or the resources need to be reallocated elsewhere.

8.  And finally, GST covers only the indirect taxes. Would that leave the direct taxes vulnerable to the whims and fancies of the Union Finance Ministers to indulge in populism as the general elections draw near?

But notwithstanding these thoughts, there can be no doubt about the fact that the idea of ‘one country, one market, and one tax’ was long overdue, and our respected parliamentarians cutting across their respective political affiliations, certainly deserve a standing ovation from all of us, to have undertaken the first major step in enabling its realization.

Now, one can count upon other key stakeholders such as state assemblies to ratify the same at the earliest, so that the intended deadline of 1^st April 2017 can be met.

Yes, teething troubles post 1^st April 2017, are only to be expected, but nothing can come in way of a steely resolve by all to meet such challenges and ensuring that India is a role model where GST implementation is concerned.                                                    

Microsoft's Acquisition of LinkedIn

It was really exciting to read about Microsoft acquiring LinkedIn for an astronomical sum of $26 billion, translating to 91 times LinkedIn's current EBITDA!!

Well, the basic calculation of Satya Nadella and his team behind this acquisition is to boost sales of Microsoft's Office 365 and Dynamics, to the LinkedIn users, numbering 35 million in India alone.

I am reminded of Microsoft's acquisition of Hotmail in 1999, for a princely sum of $400 million dollars!!! Would anyone care to put a value to Hotmail today?

While the maths behind arriving at a valuation of $ 26 billion is best left to Satya and his team of negotiators, the key question which should now be uppermost in the minds of Microsoft's top brass is :

"How can we convince the various users of LinkedIn to move beyond their key objectives of career moves and networking with like minded professionals, to considering Office 365 and Dynamics as the best of its kind in the field of cloud and CRM space?"

Well, the dominance of Gmail in the email space is well known displacing Hotmail from its premier position. Satya and his team need to be vigilant enough not to let history repeat itself.

Union Budget 2016-17

Post presentation of the budget, the stock markets crashed by over 150 points today, because perhaps they reacted negatively to the 10% tax proposed on dividends earning on Rs 10 lakhs and above per year, and secondly, they were perhaps not convinced of our ability to maintain the fiscal deficit at mandated level of 3.5% of the GDP.

But after hearing the MoS Jayant Sinha's explanation behind the confidence of maintaining this figure, I am convinced that this figure of 3.5% is not too ambitious.

I am not  surprised that today,  the stock markets have rebounded sharply once the fine print became clear to everyone. Yes, coming to the proposed 10% tax on dividends, it is only fair that super rich contribute more generously to the exchequer, and 10% is not a heavy dose of tax.

Focus on rural sector reforms primarily through 100% FDI in food processing, major thrust on infrastructure mainly through roads and railways outlay of over 2 lakh crores, encouraging voluntary disclosure of unaccounted wealth, and low cost housing have been among the key pluses in this budget.

Being a student of Economics, all I can say that this budget aims at process reforms within our system within the constraints imposed by the global scenario, political considerations, and the crying need to boost the rural economy. It is not aimed at effecting massive liberalization a la 1991 budget, presented by the then FM Dr. Manmohan Singh.

Yes, as suggested by Mr. Swaminthan Aiyar in Times of India two weeks ago, wish the FM had imposed heavy custom duty on beedis as well, besides legalizing betting on cricket matches and taxing the same. When betting on horse racing is legal, why can't betting on cricket?

The million dollar question of what this budget has for the key segment of our society, the middle class? Well, apart from the hike in rental allowance and the major thrust in the low cost housing, the only thing which our middle class can look forward to is a highly improved macro environment which offers promising and stable job opportunities to the educated lot, besides a highly conducive environment for those desirous of fulfilling their entrepreneurial ambitions.

All said and done, the devil would now lie in - effective execution of the various provisions in the budget, favorable monsoons this time, global crude prices, and above all stability and improvement in the highly fragile global environment.

GDP Growth of eight per cent when exports are down by five percent

It was a real treat to watch Ruchir Sharma's interview yesterday on NDTV 24x7, which was moderated by Dr. Prannoy Roy. He made a brillant analysis of the top 10 economic trends in the world economy during the last year, and his prognosis for this year, which unfortunately was not too encouraging.

One of thew key prognosis made by Ruchir was - if our exports have shown a decline of 5% in the last year, how can we expect our overall GDP to grow by 8%?

Point well taken. But the answer lies in agrarian reforms, and specifically aggressive push to the farm-to-fork policy, whereby the farmers are encouraged to sell directly to the ultimate consumers through well established mechanisms, thereby ensuring better remuneration for themselves and lower prices for the final consumers.

It does not need too much of an imagination that, while the overall food inflation would see a marked decline, the overall food production would also get a boost, thanks to the market driven incentives for the farmers, who would not have to rely on the government sponsored minimum support prices, to determine their cropping patterns.

In the ultimate analysis, we should aim to become the food basket for the world, which would be a key catalyst in our overall growth story.

Of course, this simple synopsis of the suggested remedy to Ruchir Sharma's malady, requires among other mechanisms, bold political initiatives of wiping out the intermediaries, who are neither serving the interests of the farmers nor of the final consumers.