Dr Rajiv Desai

An Educational Blog

ECONOMY FOR PEOPLE

ECONOMY FOR PEOPLE:

 

Prologue:

Despite being an intelligent doctor, I could not become rich because I did not compromise between my way of thinking and the thinking of others in my environment no matter whether others include spouse or family members or patients or friends or courts. I could not become corrupt no matter how many opportunities came in life. I know of many doctors who became rich by simply buying and selling lands rather than medical acumen but I could not even do that. I was perceived to be weak in economics by both friends and foes alike. I work in government hospital on contract basis and get rupees 30,000 per month as salary wages. I earn this money because I got MD degree and 23 years of experience in treating human illnesses. The money is paid by the people of India. Do all the people pay? No. 70 % Indians survive on less than rupees 20 per day and obviously they can not contribute to my salary. So it is the remaining 30 % population belonging to middle class & rich class who pay taxes which reimburse my salary. Those 30 % population hardly ever come for free treatment in government hospital but the remaining 70 % population who did not contribute to my salary always come to me for treatment. So the hard working tax paying class pays for treatment of poor. Who benefits? The politicians who get votes from these poor people for free treatment given from money of tax paying class. Electoral statistics from most democratic nations shows that only 50 to 60 % of population votes and out of them, majority are poor. Politicians exploit poor people to grab their votes under pretext of helping them. So the net result is that I earn money from tax paying class and the benefit goes to poor who votes for politicians so that they make such policies in future to give poor more and more benefits without hard work like subsidized kerosene and subsidized rice etc. So the vicious cycle continues. Poor remains poor but get all the subsidies and therefore votes for politicians to continue subsidies and in return, politicians keep on making policies that give benefit to poor from hard earned money of tax paying class. Then, corruption sets in. The same politicians, bureaucrats and businessmen extract money from this vicious cycle to become rich. So poor remains poor, middle class remains middle class and elite remain elite, and tax payer’s money is distributed to those who do nothing since morning to evening and those who are corrupt. Is this the way economy should develop? So I decided to go in the detail of economy. Even though I am a student of science, I decided to venture into an unknown area with curiosity and caution. With this article, I am trying to break my jinx in economics. I would not be dismayed if I am not successful in this endeavor as I have no knowledge or experience in economics. People who could not become rich despite being intelligent & hard working can learn something from this article.

 

Economy means the production, exchange, distribution, and consumption of goods & services of an area; using labor, capital and land resources; and the economic agents that participate in the process. The economy functions within conditions & parameters of various factors like technological evolution, history, social organization, geography, natural resource endowment, and ecology. Practical fields range from engineering to management and from business administration to applied science to finance. The English words “economy” and “economics” can be traced back to the Greek words meaning  “one who manages a household”. The most frequently used current sense, “the economic system of a country or an area” seems not to have developed until the 19th or 20th century.

 

Economics is the social science that analyzes the production, distribution, and consumption of goods & services with the theory and management of economies or economic systems. Economics aims to explain how economies work and how economic agents interact. Economics per se, as a social science, is independent of the political acts of any government or other decision-making organization, however, many policymakers or individuals holding highly ranked positions that can influence other people’s lives by arbitrarily using plethora of economic concepts. An economist is a professional in the social science discipline of economics. The first economist in the true meaning of the word was the Scotsman Adam Smith (1723–1790). He defined the elements of a national economy: products are offered at a natural price generated by the use of competition – supply and demand – and the division of labour. He maintained that the basic motive for free trade is human self interest. The so-called self interest hypothesis became the anthropological basis for economics. Thomas Malthus (1766–1834) transferred the idea of supply and demand to the problem of overpopulation. The Industrial Revolution was a period from the 18th to the 19th century where major changes in agriculture, manufacturing, mining, and transport had a profound effect on the socioeconomic and cultural conditions starting in the United Kingdom, and then subsequently spreading throughout Europe, North America, and eventually the world. The period today is called industrial revolution because the system of production and division of labour enabled the mass production of goods. After the chaos of two World Wars and the devastating Great Depression, policymakers searched for new ways of controlling the course of the economy. It was John Maynard Keynes (1883–1946), who argued for a stronger control of the markets by the state and the theory that the state can alleviate economic problems and instigate economic growth through state manipulation of aggregate demand. In the late 1950s the economic growth in America and Europe (economic miracle) – brought up a new form of economy: mass consumption economy. 

 

The primary textbook distinction exits between the microeconomics which examines the behavior of basic elements in the economy including individual markets and agents (such as consumers & firms, buyers & sellers) and the macroeconomics, which addresses issues affecting an entire economy including unemployment, inflation, economic growth, and monetary & fiscal policy. Microeconomics is the study of decisions that people & businesses make regarding the allocation of resources and prices of goods & services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply & demand and other forces that determine the price levels seen in the economy and how prices, in turn, determine the quantity supplied and the quantity demanded of goods and services. Macroeconomics, on the other hand, is the field of economics that studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. The bottom line is that microeconomics takes a bottoms-up approach to analyzing the economy while macroeconomics takes a top-down approach.  

 

The four basic laws of supply and demand are:

1) If demand increases and supply remains unchanged then higher equilibrium price and quantity.

2) If demand decreases and supply remains the same then lower equilibrium price and quantity.

3) If supply increases and demand remains unchanged then lower equilibrium price and higher quantity.

4) If supply decreases and demand remains the same then higher price and lower quantity.

 

At least two assumptions are necessary for the validity of this standard model: first, that supply and demand are independent; and second, that supply is “constrained by a fixed resource”.  If these conditions do not hold, then the above model cannot be sustained. The intent of mass production is to produce in extremely large quantities at the lowest possible cost so as to drive down price and create demand. In the case of mass production, both the assumptions of supply and demand being independent and constraints on supply are not applicable.

 

An economic system is the structure of production, allocation of economic inputs, distribution of economic outputs, and consumption of goods and services in an economy. Examples of contemporary economic systems include capitalist systems, socialist systems, and mixed economies.

 

Capitalism:

Capitalism is an economic system in which the means of production are privately owned and operated for a private profit; decisions regarding supply, demand, price, distribution, and investments are made by private actors in the market rather than by central planning by the government; profit is distributed to owners who invest in businesses; and wages are paid to workers employed by businesses and companies. There is no consensus on the precise definition of capitalism, nor how the term should be used as an analytical category. There is however little controversy that private ownership of the means of production, the creation of goods & services for profit in a market, and private decisions regarding prices & wages are elements of capitalism. Economists usually emphasize the degree that government does not have control over markets and on property rights.

 

A product is any good produced for exchange on a market. There are two types of products: capital goods and consumer goods. Capital goods (i.e. raw materials, tools, industrial machines, vehicles and factories) are used to produce consumer goods (e.g., televisions, cars, computers, houses) to be sold to others. The three inputs required for production are labor, land (i.e., natural resources) and capital goods. Capitalism entails the private ownership of the latter two – natural resources and capital goods – by a class of owners called capitalists, either individually, collectively or through a state apparatus that operates for a profit or serves the interests of capital owners. Money is primarily a standardized medium of exchange and final means of payment, which serves to measure the value all goods and commodities in a standard of value and besides that, money is also having a store value, similar to precious metals. Individuals engage in a capitalist economy as consumers, laborers, and investors. As laborers individuals may decide which jobs to prepare for, and in which markets to look for work. As investors they decide how much of their income to save and how to invest their savings. These savings which become investments provide much of the money that businesses need to grow. An economy grows when the total value of goods and services produced rises. This growth requires investment in infrastructure, capital and other resources necessary in production. In a capitalist system, businesses decide when and how much they want to invest.

 

In a capitalist economy, the prices of goods and services are controlled mainly through supply and demand and competition. Supply is the amount of a goods & service produced by a firm and which is available for sale. Demand is the amount that people are willing to buy at a specific price. Prices tend to rise when demand exceeds supply, and fall when supply exceeds demand. In theory, the market is able to coordinate itself when a new equilibrium price and quantity is reached. Competition arises when more than one producer is trying to sell the same or similar products to the same buyers. In capitalist theory, competition leads to innovation and more affordable prices. Without competition, a monopoly may develop. A monopoly occurs when a firm supplies the total output in the market; the firm can therefore limit output and raise prices because it has no fear of competition. In a capitalist system, the government does not prohibit private property or prevent individuals from working where they please. The government does not prevent firms from determining what wages they will pay and what prices they will charge for their products. Many countries, however, have minimum wage laws and minimum safety standards.  

 

Advantage of capitalistic economy is sustained economic growth, political freedom and self-organization. Criticism of capitalistic economy include the unfair distribution of wealth and power; a tendency toward market monopoly; imperialism, economic exploitation; repression of workers and trade unionists, and phenomena such as social alienation, economic inequality, unemployment, and economic instability. Environmentalists have argued that capitalism requires continual economic growth, and will inevitably deplete the finite natural resources of the earth.

 

Capitalism is characterized by the division of labor between worker and capitalist, in which the means of production are separated from the direct producers and are instead owned by a parasitical capitalist class. Marx and Engels believed that under capitalism, the working class produces surplus value, of which only a small percentage is returned to workers in the form of wages to provide for their bare subsistence. The rest of the surplus value is kept as profit, and is reinvested into the commodity cycle by the capitalist. The competitive forces of the market will drive capital to constantly accumulate “for the sake of more accumulation”, resulting in monopolies, economic crisis, imperialism and  wealth accumulation with capitalist on one hand; and mass poverty, starvation, urbanization & pauperization for much of the population on the other hand. The declining living conditions of the working class would drive workers to collectively fight back as part of a class struggle, eventually overthrowing the capitalist state in a proletarian revolution and establishing a democratically planned economy, in which production is controlled by the direct producers themselves – the proletariat – in order to satisfy human needs, not accumulation of profits. The first centrally planned economy was established after the Russian Revolution of 1917, led by the Bolshevik Party, in which production (and social life) was organized around workers’ councils called soviets and  subsequently, similar councils of democratically elected recallable worker delegates have existed in subsequent revolutions and revolutionary situations throughout the 20th Century in other countries.

 

Communism & socialism:

Communism is a sociopolitical movement that aims for a stateless and classless society structured upon common ownership of the means of production, free access to articles of consumption, the end of labour wages & private property on the means of production and real estate. Even though the term communism and socialism are used interchangeably, Marxist theory contends that socialism is just a transitional stage on the way to communism. Primary criticisms of socialism and by extension communism are distorted or absent price signals, slow or stagnant technological advance, reduced incentives, reduced prosperity & feasibility and its social and political effects. The policies adopted by one-party states ruled by communist parties have lead to worst human right violations and plenty of deaths from famines, purges and warfare, far in excess of previous empires, capitalist or other regimes. Market mechanisms have been utilized in a handful of socialist states, such as China and Cuba to a very limited extent. If you put too much socialism in any capitalist system, capitalist economic system will collapse. This happens due to the overburden of socialism or too much money being taken out of the private sector and redistributed to other sectors of the economy that isn’t producing anything. There is always a tipping point and socialist nations have reached it. Socialism has never worked in any shape or form. Here’s some really big proofs were socialism has been tried for many years and failed miserably right from the start. First look at Russia. They ran a communist economic system for 70 years and their people lived in severe poverty. Then they changed into a capitalist system and their standard of living increased by 500%. Then we have to take a look at communist China. They tried communism for over 30 years and for 30 years their people lived in severe poverty just as Russia. Once they changed over to capitalism, they too experience the same 500% increases in their standard of living. So it’s a choice whether you want to live in severe poverty under socialism or you want live through high standard of living that people have in western nations. The example I have narrated in the Prologue of this article clearly demonstrate socialism in India where overpopulating poor who do nothing are fed & treated from the money of tax paying class by socialist economic policies. This will not work. This will not bring prosperity. The only way out is to control population and give jobs to poor so that they can earn their money and not survive on subsidies & welfare.

 

Mixed economies:

Mixed economy means a largely market-based economy consisting of both public ownership and private ownership of the means of production. A mixed economy is a mixture of capitalism and socialism.

 

Market economy versus planned economy:

A market economy is a term used to describe an economy where economic decisions such as pricing of goods and services are made in a decentralized manner by the economy’s participants and manifested by trade. This can be seen as a “bottom-up” approach to organizing an economy (self-organization). It is in contrast to a planned economy, where economic decisions are made by a central agency which can be equated to a “top-down” approach. The key difference between market economies and planned economies lies not with the degree of government influence but with how that influence is used. In a market economy, if the government wants more steel, it collects taxes and then buys the steel at market prices. In a planned economy, a government which wants more steel simply orders it to be produced. In the real world, market economies do not exist in pure form as societies and governments regulate them to varying degrees rather than allow self-regulation by market forces. The term free-market economy is sometimes used synonymously with market economy. The term market economy is not identical to capitalism where a corporation hires workers as a labor commodity to produce material wealth and boost shareholder’s profits. Basic criticism of market economy is that markets inherently produce class division; divisions between conceptual & manual laborers, and ultimately managers & workers, and a de facto labour market for conceptual workers.

 

A social market economy is a nominally free-market system where government intervention in price formation is kept to a minimum, but the state provides for moderate to extensive provision of social security, unemployment benefits and recognition of labor rights through national collective bargaining schemes.

 

Private sector & public sector:

In economics, the private sector is that part of the economy which is run by private individuals or groups, usually as a means of enterprise for profit, and is not controlled by the state. The private sector employs the majority of the workforce in western nations but in some countries such as the People’s Republic of China, the public sector employs most of the workers. The Public Sector (state sector) is a part of the state that deals with the production, delivery and allocation of goods & services by and for the government or its citizens; whether national, regional or local/municipal. Examples of public sector activity range from delivering social security, administering urban planning and organizing national defenses. In general, socialists favor a large public sector consisting of state projects and enterprises, social democrats tend to favor a medium-sized public sector that is limited to the provision of universal programs and public services. The economic libertarians & minarchists favor a small public sector with the state being relegated to protecting property rights, creating & enforcing laws and settling disputes. The public companies (public limited) are not part of the public sector; they are a particular kind of private sector companies that can offer their shares for sale to the general public.   

  

The ancient economy was mainly based on subsistence farming. The industrial revolution lessened the role of subsistence farming, converting it to more extensive and mono-cultural forms of agriculture in the last three centuries. The economic growth took place mostly in mining, construction and manufacturing industries. In the economies of modern consumer societies, there is a growing part played by services, finance, and technology – the (knowledge economy). Over the past millennium, world population rose 22 – fold, per capita income increased 13 – fold and world GDP nearly 300 – fold. This contrasts sharply with the preceding millennium, when world population grew by only a sixth, and there was no advance in per capita income.

 

In modern economies, there are four main sectors of economic activity.

1) Primary sector of the economy: The primary sector of the economy involves changing natural resources into primary products. Most products from this sector are considered raw materials for other industries. Major businesses in this sector include agriculture, agribusiness, fishing, forestry and all mining and quarrying industries. For example, this sector is involved in the extraction and production of raw materials such as corn, coal, wood and iron. A coal miner and a fisherman would be workers in the primary sector. Primary industry is a larger sector in developing countries. In developed countries primary industry becomes more technologically advanced, for instance the mechanization of farming as opposed to hand picking and planting.   

 

2) Secondary sector of the economy: The secondary sector of the economy includes those economic sectors that create a finished & usable product. This sector generally takes the output of the primary sector and manufactures finished goods or where they are suitable for use by other businesses, for export, or sale to domestic consumers. This sector is often divided into light industry and heavy industry. Many of these industries consume large quantities of energy and require factories and machinery to convert the raw materials into goods and products. They also produce waste materials and waste heat that may pose environmental problems or cause pollution. For example, this sector is involved in the transformation of raw or intermediate materials into goods like cars from steel, clothing from textiles etc. A builder and a dressmaker would be workers in the secondary sector. Among developed countries, it is an important source of well paying jobs for the middle class to facilitate greater social mobility for successive generations on the economy.

 

3) Tertiary sector of the economy: This sector is involved in activities where people offer their knowledge and time to improve productivity, performance, potential, and sustainability. The basic characteristic of this sector is the production of services instead of end products. Services include attention, advice, experience, and discussion.  For example, this sector involves the provision of services to consumers and businesses such as baby-sitting, cinema and banking. A shopkeeper and an accountant would be workers in the tertiary sector. Services may involve the transport, distribution and sale of goods from producer to a consumer, as may happen in wholesaling and retailing, or may involve the provision of a service such as in pest control or entertainment & restaurant industry. The tertiary sector is now the largest sector of the economy in the Western world, and is also the fastest-growing sector. 

 

4) Quaternary sector of the economy: The quaternary sector of the economy is a way to describe a knowledge-based part of the economy which typically includes services such as information generation & sharing, information technology, consultation, education, research & development, financial planning, and other knowledge-based services. For example, this sector involves the research and development needed to produce products from natural resources. A logging company might research ways to use partially burnt wood to be processed so that the undamaged portions of it can be made into pulp for paper. Note that education is sometimes included in this sector. This sector evolves in well developed countries and requires a highly educated workforce.

 

There are a number of ways to measure economic activity of a nation. These methods of measuring economic activity include: Consumer spending, Exchange Rate, Gross domestic product (GDP), GDP per capita, GNP, Stock Market, Interest Rate, National Debt, Rate of Inflation, Unemployment, Balance of Trade etc.

 

GDP:

The gross domestic product (GDP) or gross domestic income (GDI) is the sum total of market value of all final goods and services made within the borders of a country in a year. It is often positively correlated with the standard of living. GDP per capita is not an accurate measurement of the standard of living in an economy because all citizens would not benefit equally from their country’s increased economic production. However, the major advantage of GDP per capita as an indicator of standard of living is that it is measured frequently, widely and consistently.   

 

GDP = private consumption + gross investment + government spending + (exports – imports)         

 

Gross National Product (GNP) is the market value of all goods and services produced in one year by labor and property supplied by the residents of a country.

Gross national product (GNP) = GDP + (income receipts from the rest of the world – income payments to the rest of the world).

 

GDP (PPP) is GDP calculated by purchasing power parity which is believed on the concept that any good/service has same price in all countries and therefore compare living standard of all nations by taking into consideration cost of living and inflation. GDP (nominal) calculated by current exchange rates considers value of all goods with respect to international currency exchange rates and this nominal GDP is lower than GDP(PPP) in a country like India where Indian currency rupee is weaker as compared to dollar. GDP (PPP) of India is 3319 billion dollars. Nominal GDP by exchange rate of India is 1237 billion dollars. India is 4?th largest economy in the world by GDP (PPP). India is 12?th largest economy by GDP exchange rates. 

 

Even though GDP is widely used by economists to gauge the health of an economy, this logic has many criticisms.

1) GDP does not take into account the disparity in incomes between the rich and the poor.

2) GDP excludes activities that are not provided through the market, such as household production and volunteer or unpaid services. As a result, GDP is understated.

3) Official GDP estimates may not take into account the underground economy, in which transactions contributing to production such as illegal trade and tax-avoiding activities are unreported, causing GDP to be underestimated.

4) GDP omits economies where no money comes into play at all, resulting in inaccurate or abnormally low GDP figures.

5) GDP ignores externalities or economic bads such as damage to the environment. By counting goods which increase utility but not deducting bads or accounting for the negative effects of higher production, such as more pollution, GDP is overstating economic welfare.

6) One main problem in estimating GDP growth over time is that the purchasing power of money varies in different proportion for different goods, so when the GDP figure is deflated over time, GDP growth can vary greatly depending on the basket of goods used and the relative proportions used to deflate the GDP figure.

7) It is just a measurement of economic activity and does not measure what is considered the sustainability of growth.

8) By not adjusting for quality improvements and new products, GDP understates true economic growth.

9) GDP ignores subsistence production.

 

Economic growth:

Real GDP growth rate country-wise

 

Economic growth is a positive change in the level of production of goods and services by a country over a certain period of time. Nominal growth is defined as economic growth including inflation, while real growth is nominal growth minus inflation. The simplest definition of economic growth is an increase in real gross domestic product (that is, GDP adjusted for inflation).  Economic growth rate means economic growth from one period to another in percentage terms. This measure does not adjust for inflation and it is expressed in nominal terms. In the United States, for example, the long-term economic growth rate is around 2-5%, this lower rate is seen in most highly industrialized countries. Fast-growing economies, on the other hand, see rates as high as 10% although this rate of growth is not likely to be sustainable over the long term. It can not be overemphasized that there is a very strong relationship between the increase in oil prices and real growth in the economy. Oil demand hit all time high of 88.3 million barrel a day in the last quarter. The growth in demand for this commodity is mainly led by fastest growing economies of India and China. With such a huge demand, it’s no wonder that prices have reached a rather uncomfortable level of US$ 90 a barrel. For purposes of evaluating how economic growth can feed into economic development it is often helpful to focus on the growth rate of GDP per capita – that is, output per person – rather than simply on overall output. For example, an economy that has a GDP growth rate of 4% and a population growth rate of 2% would have a per capita GDP growth rate of 2%. The per capita GDP growth rate is especially important because it indicates the actual increase in average income being experienced by the people of the country. If a country had a 2% GDP growth rate, but a 3% population growth rate, its per capita GDP growth rate would actually be negative, at -1%. The people would on average be getting poorer each year, even though the overall economy is growing. A more positive way of putting it is that, for people’s incomes on average to increase over time, the GDP growth rate must exceed the rate of population growth. I will give classical example of India. The Indian economy expanded at better than expected pace of 8.9 per cent in the second quarter of the current fiscal (July-September 2010), helped by strong performance of the farm and service sectors. From 2004 until 2010, India’s average quarterly GDP Growth was 8.37 percent reaching an historical high of 10.10 percent in September of 2006 and a record low of 5.50 percent in December of 2004. The inflation rate in India was last reported at 9.82 percent in September of 2010. From 1969 until 2010, the average inflation rate in India was 7.99 percent reaching an historical high of 34.68 percent in September of 1974 and a record low of -11.31 percent in May of 1976.  Population growth rate is the average annual percent change in the population, resulting from a surplus (or deficit) of births over deaths and the balance of migrants entering and leaving a country. Current India population growth rate is 1.38 %.  The real economic growth rate is the GDP growth on an annual basis adjusted for inflation and expressed as a percent. The Indian real GDP growth rate is 7.4 % for year 2010. This is valid provided India has a zero population growth rate but India has indeed 1.38 % population growth rate and therefore people are not getting richer as expected from GDP growth.

 

There is a difference between economic growth and economic development. Economic growth implies only an increase in quantitative output of goods & services while economic development refers to social and technological progress. Economic growth is measured by rate of change of GDP while economic development is measured by variety of indicators such as literacy rates, life expectancy, and poverty rates.    

 

Job creation:

A job is the outcome of a business investing funds that create a need for a person to do some activity. According to search-matching theory, job creation in a firm should depend on the availability of workers (unemployment) and on the number of job openings in other firms (congestion). However, a study found that the job creation is an index of product-demand and not unemployment. The more is the demand for a product, more jobs will be created. More the demand of a product, more investment will be made in business and more jobs will be created to produce more goods & services to meet the growing demand. Of course, more demand for a product occurs when a consumer buys more products by spending more money. So increased consumer spending will lead to more demand for a product and more demand will lead to more investment and thence more jobs created. Remember, no middle-class person create employment out of thin air other than the successfully self-employed. Private sector jobs are created by private sector wealth. As wealth is invested back into the economy, jobs are necessarily created as economic activity increases, and the investors realize profits which they reinvest to continue the cycle.  

 

Outsourcing:

A practice used by different companies to reduce costs by transferring portions of work (service & products) to outside suppliers rather than completing it internally. Companies that decide to outsource do so for a number of reasons, all of which are based on realizing gains in business profitability and efficiency. Principal merits of outsourcing include cost saving, minimize the fluctuations in staffing, focus on core competencies, financial flexibility, access to new technology and outside expertise, training current employees etc. However, major potential disadvantages to outsourcing include poor quality control, decreased company loyalty, a lengthy bid process, bad publicity, tied to the financial well-being of that company, loss of managerial control, hidden cost and a loss of strategic alignment. Also, outsourcing often eliminates direct communication between a company and its clients. This prevents a company from building solid relationships with their customers, and often leads to dissatisfaction on one or both sides. Indian Prime Minister Dr. Manmohan Singh made a strong statement on US criticism of sending US jobs to India. He stated, ‘India is not in the business of stealing jobs from the US.’ Outsourcing may be viewed by Indians as if the foreign companies are appreciating their expertise in the particular area. Sure they are, but more important to them is their cost reduction, and it’s an articulate statement given by them that countries like India can be hired very cheaply, even though their skills are world class. This is nothing but ridicule, but then outsourcing is a major reason for the boom of the service sector in India, and we cannot overlook the employment it provides. In fact, total work outsourced to India accounts for less than 1 percent of the country’s GDP. Outsourcing brings cost savings and increase in profits not only to business firms, but also benefits in macro-economic terms to the host country. According to McKinsey Global institute, out of the full $1.45 to $1.47 of the value created globally from off-shoring $1 of US labor cost, the US alone captures $1.12 to $1.14 of value while receiving countries like India capture on an average just 33 cents. This negates the most important argument against outsourcing that it results in loss of jobs in the host country as the activities which were performed in host countries or organizations are transferred to other locations.

 

Money:
Money is any object that is generally accepted as payment for goods & services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; of a store value; and, occasionally, a standard of deferred payment. The money supply of a country consists of currency (banknotes and coins) and demand deposits or ‘bank money’ (the balance held in checking accounts and savings accounts). These demand deposits usually account for a much larger part of the money supply than currency. Money is the most liquid asset because it is universally recognized and accepted as the common currency. In this way, money gives consumers the freedom to trade goods and services easily without having to barter. The control of the amount of money in the economy is known as monetary policy. Monetary policy is the process by which a government, central bank, or monetary authority manages the money supply to achieve specific goals. Usually the goal of monetary policy is to accommodate economic growth in an environment of stable prices. The tools used by central bank & government to control the money supply include: changing the interest rate at which the central bank loans money to (or borrows money from) the commercial banks, currency purchases or sales, increasing or lowering government borrowing, increasing or lowering government spending, manipulation of exchange rates, raising or lowering bank reserve requirements, regulation or prohibition of private currencies and taxation or tax breaks on imports or exports of capital into a country. A failed monetary policy can have significant detrimental effects on economy & society including hyperinflation, stagflation, recession, high unemployment, shortages of imported goods, inability to export goods, and even total monetary collapse and the adoption of a much less efficient barter economy. Electronic money (e-money) refers to money or scrip which is only exchanged electronically. Typically, this involves the use of computer networks, the internet and digital stored value systems. Electronic Funds Transfer (EFT) and direct deposit are all examples of electronic money.

 

Interest:

In economics, interest is considered the price of credit. Interest is a fee paid on borrowed assets. It is the price paid for the use of borrowed money, or, money earned by deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The percentage of the principal that is paid as a fee over a certain period of time (typically one month or year), is called the interest rate. Economically, the interest rate is the cost of capital and is subject to the laws of supply and demand of the money supply. Interest is compensation to the lender for a) risk of principal loss, called credit risk; and b) forgoing other useful investments that could have been made with the loaned asset. These forgone investments are known as the opportunity cost. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of using the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege.

 

Inflation:

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Inflation’s effects on an economy are manifold and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment & savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Today, most mainstream economists favor a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. Inflation is usually estimated by calculating the inflation rate of a price index, usually the Consumer Price Index. High inflation can prompt employees to demand rapid wage increases, to keep up with consumer prices. Rising wages in turn can help fuel inflation. High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. The Nobel Prize winning economist James Tobin at one point argued that a moderate level of inflation can increase investment in an economy leading to faster growth or at least a higher steady state level of income. This is because inflation lowers the real return on monetary assets relative to real assets, such as physical capital. To avoid this effect of inflation, investors would switch from holding their assets as money (or a similar, susceptible-to-inflation form) to investing in real capital projects. There is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of money supply. Inflation can be controlled by various methods. The primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level; normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. A fixed exchange rate is usually used to stabilize the value of a currency and can be used as a means to control inflation. In India, when inflation spikes, the single focus of the government becomes controlling inflation. This is not how mature market economies work. In all mature market economies, the task of controlling inflation – and only the task of controlling inflation – is placed with the central bank. In mature market economies, inflation crises do not arise because the full power of monetary policy is devoted to this one task. With a sound monetary policy framework (for e.g. in India, stronger rupee & lower interest rate) inflation would be stabilized, inflation crises like the current one would not periodically hijack the government, and distortionary short-sighted initiatives such as banning exports of certain goods would not arise. In general, wage and price controls are regarded as a temporary and exceptional measure, only effective when coupled with policies designed to reduce the underlying causes of inflation. Salaries are typically adjusted annually in low inflation economies.

 

In context of economic development, inflation is desirable for two reasons: These are:

1)  Inflation acts favorably upon the inducement of investment. The higher the price, the higher the expected price and the higher is the marginal efficiency of capital. As a result of this, the inducement to invest is higher too. Inflation thus boosts investment.

2)  Inflation generates the necessary resources for investment. It forces people to save.

 

Inflation is inevitable in a developing economy because of the following reasons:

1) It can be shown that in a developing economy it is very difficult to obtain balanced growth (in the sense of equality between demand for and supply of consumer goods). Impossibility of balanced growth makes inflation inevitable.

2) In a developing economy there is an absence of an appropriate national consumption and wage policy. Thus a chaotic increase in wages leads to increase in demand for consumer goods. This disturbs the balance between supply and demand which eventually results in inflation;

3) In a developing country agricultural production is not very stable. There are periods of shortages and surpluses (though rarely). This results into higher prices. To avoid this , buffer stocks of food grains are built, but then this requires building of warehouses at strategic points, which in itself presents many problems including those of time-lag;

4) The impact of international prices (especially crude oil) cannot be avoided in developing countries, and this is therefore, also responsible for inflation in these countries.

 

Deflation:

In common usage deflation is generally considered to be “falling prices”. But there is much more to it than that. Often people confuse deflation with disinflation or with Depression (as in “the Great Depression”). These three terms are related but not synonymous. Deflation occurs when the annual inflation rate falls below 0% (a negative inflation rate). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money – the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.

 

Deflation is a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Lower prices might sound appealing, making the cost of everything from cars to food to vacations cheaper. But prices decline because of a lasting drop in demand, which also means employers lower wages and consumers slow spending. It’s a combination that can drag down an economy for years.  Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy, exactly the opposite of inflation.  

 

So there are four causes for Deflation.

1)  Decreasing Money Supply

2)  Increasing Supply of Goods

3)  Decreasing Demand for Goods

4)  Increasing Demand for Money

 

Actually, deflation itself is neither good nor bad. It depends on the cause of the deflation whether people will suffer or rejoice. If the cause is increasing supply of goods that would be good. Another example of this is in the late 1800’s as the industrial revolution dramatically increased productivity. However, if deflation is caused by a decreasing supply of money as in the great depression, that would be bad. The stock market crash sucked all the liquidity out of the market place, the economy contracted, and people lost their jobs and then banks stopped loaning money because people were defaulting. The problem compounded as more people lost their jobs and money supply fell further causing more people to lose their jobs, etc. etc.

 

Inflation versus deflation:

The following points bring out the fact that inflation is a lesser evil than deflation:

1) Inflation, though it redistributes income and wealth in the community in an unjust manner, does not reduce the national income of the community. Deflation, on the other hand, reduces the national income of the community and pauperizes society as a whole.

2) Deflation increases the level of unemployment in the economy, whereas inflation at least implies that all factors are employed in some way or another. Inflation is a post-full employment phenomenon; deflation is an under-employment phenomenon aggravating the problem of unemployment.

3) It is easy to control inflation by a clear money policy, coordinated by appropriate fiscal policy, but it is difficult to recover from deflation. Once a deflationary tendency starts, it increases business pessimism, the marginal efficiency of capital diminishes, and investment is contracted, and ultimately a severe depression sets in. Monetary policy becomes helpless here, and no amount of increase in the money supply can revive the price level and business expectations or marginal efficiency or capital in the economy during depression. On the other hand, an inflationary spiral can be reflated by controlling credit and money supply.

4)  A mild inflation could stimulate economic development. The poverty in the midst of plenty can be overcome by raising the price level through the injection of more purchasing power by way of deficit financing of public investment programs.

 

Unemployment:

Unemployment as defined by the International Labor Organization occurs when people are without jobs and they have actively looked for work within the past four weeks. The unemployment rate is a measure of the prevalence of unemployment and it is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labor force. In the year 2010, Indian unemployment rate is 10.7 % and the U.S. unemployment rate is 9.9%.  The official unemployment rate in the 16 EU countries that use the euro rose to 10% in December 2009.

 

 

Factors responsible for unemployment are:

1)  Rapid changes in technology

2)  Recessions

3)  Inflation

4)  Disability

5)  Undulating business cycles

6)  Changes in tastes as well as alterations in the climatic conditions. This may in turn lead to decline in demand for certain services as well as products.

7)  Attitude towards employers

8)  Willingness to work

9)  Perception of employees

10)  Un-recognized Employee values

11)  Discriminating factors in the place of work (may include discrimination on the basis of age, class, ethnicity, color and race).

12)  Ability to look for employment

13)  Welfare payments

14)  Job dissatisfaction

15)  Changes in work force due to baby-boom

 

Classical or real-wage unemployment occurs when real wages for a job are set above the market-clearing level, causing the number of job-seekers to exceed the number of vacancies. Most economists have argued that unemployment increases the more the government intervenes into the economy to try to improve the conditions of those with jobs. For example, minimum wage laws raise the cost of laborers with few skills to above the market equilibrium, resulting in people who wish to work at the going rate but cannot as wage enforced is greater than their value as workers becoming unemployed. Cyclical or Keynesian unemployment, also known as deficient-demand unemployment, occurs when there is not enough aggregate demand in the economy to provide jobs for everyone who wants to work. Demand for most goods and services falls, less production is needed and consequently fewer workers are needed, wages are sticky and do not fall to meet the equilibrium level, and mass unemployment results. Classical economists reject the conception of cyclical unemployment and alternatively suggest that the invisible hand of free markets will respond quickly to unemployment and underutilization of resources by a fall in wages followed by a rise in employment. Unemployment caused by supply-side factors results from imperfections in the labor market. A perfect labor market will always clear and all those looking for work will be working – supply will equal demand. However, if the market doesn’t clear properly there may be unemployment. This may happen because wages don’t fall properly to clear the market. Supply-side unemployment may also happen because there is occupational or geographical immobility. It may happen because there is poor information about job opportunities. Unemployed individuals are unable to earn money to meet financial obligations. Failure to pay mortgage payments or to pay rent may lead to homelessness through foreclosure or eviction.  Unemployment increases susceptibility to malnutrition, diseases, mental stress, and loss of self-esteem, leading to depression and high divorce rates.  High unemployment can encourage xenophobia and protectionism as workers fear that foreigners are stealing their jobs. Efforts to preserve existing jobs of domestic and native workers include legal barriers against “outsiders” who want jobs, obstacles to immigration, and/or tariffs and similar trade barriers against foreign competitors. High unemployment can also cause social problems such as crime. High levels of unemployment can be causes of civil unrest, in some cases leading to revolution, and particularly totalitarianism. Adolf Hitler’s rise to power, which culminated in World War II and the deaths of tens of millions and the destruction of much of the physical capital of Europe, is attributed to the poor economic conditions in Germany at the time, notably a high unemployment rate of above 20%. However, unemployment may have advantages notably; it may help avert inflation, which is argued to have damaging effects, by providing a reserve army of labor, which keeps wages in check. Demand side solutions include many countries aid the unemployed through social welfare programs. These unemployment benefits include unemployment insurance, unemployment compensation, welfare and subsidies to aid in retraining. The main goal of these programs is to alleviate short-term hardships and, more importantly, to allow workers more time to search for a job. In return, the country gets benefited from giving the jobless aid as the unemployed spends every dollar received from these helps which in turn drive the economy of the country as more cash flows into the business. However, unemployment benefits are spent on essentials. When you’re out of work, that’s all you can afford but they add to the deficit, whereas increased taxable income generated by more private sector jobs does not; and the only jobs created by unemployment benefits are in the deficit-fueled federal government and therefore to say that unemployment benefits boost economy is an overstatement. Supply side solutions include removing the minimum wage and reducing the power of unions. Supply-siders argue that such reforms increase long-term growth. This increased supply of goods & services requires more workers and so increasing employment. A study found that each 10 percent increase in the minimum wage is associated with a two to four percent decline in state GDP generated by lower-skilled industries. Although some economists tout minimum wage hikes as a form of stimulus to economy, the evidence shows otherwise. In fact proposal like minimum wage increases will fail to boost the economy and will certainly cause further job loss. It is argued that supply-side policies, which include cutting taxes on businesses and reducing regulation, create jobs and reduce unemployment. Other supply-side policies include education to make workers more attractive to employers.

 

What drives the machine of capitalism? It is a demand for goods & services and a return on investment, isn’t it? If people are unemployed, production of goods and provision of services falls off, and simultaneously, the people who are unemployed lack the finances to purchase goods and services. People who still have money, the investors, are reluctant to invest any money in the production of goods or the provision of services because when production and consumption are down, there is no opportunity to get a return on the investment. So unemployment leads to deflation and deflation worsens unemployment and the vicious cycle continues.  

 

According to classical economic theory, markets reach equilibrium where supply equals demand; everyone who wants to sell at the market price can sell. Those who do not want to sell at this price in the labor market will cause classical unemployment. Increases in the demand for labor will move the economy along the demand curve, increasing wages and employment. The demand for labor in an economy is derived from the demand for goods & services and if the demand for goods & services in the economy increases, the demand for labour will increase, increasing employment and wages. Monetary policy and fiscal policy can both be used to increase short-term growth in the economy, increasing the demand for labor and decreasing unemployment.

 

Poverty:

Poor is not he, who has less, but poor is he, who wants more. So a “yogi” who has renounced whole world may be called “Rich “than a “King” who desires more. This is philosophy but reality is indeed bitter.

 

Is it enough to blame poor people for their own predicament? Have they been lazy, made poor decisions, and been solely responsible for their plight? What about their governments? Have they pursued policies that actually harm successful development? The poorest people will also have less access to health, education and other services. Problems of hunger, malnutrition and disease afflict the poorest in society. The poorest are also typically marginalized from society and have little representation or voice in public and political debates, making it even harder to escape poverty.

 

 

Absolute poverty means standard of living is sufficiently low to meet basic requirement of food, housing, clothing, health etc. Relative poverty is poverty of one person relative to richness of another person. A middle class person is poorer as compared to a rich person.

 

Poverty is the lack of basic human needs such as clean water, nutrition, health care, education, clothing and shelter, because of the inability to afford them. About 1.7 billion people live in absolute poverty in this world with near three-quarters of the world’s poor are rural farmers. Almost half the world – over 3 billion people – lives on less than $2.50 a day. 1 billion children live in poverty. The GDP of the 41 heavily indebted poor countries (567 million people) is less than the wealth of the world’s 7 richest people combined.  

 

Below Poverty Line (BPL) is an economic benchmark and poverty threshold used by the government of India to indicate economic disadvantage and to identify individuals and households in need of government assistance and aid. Internationally, an income of less than $1 per day per head of purchasing power parity is defined as extreme poverty. Income-based poverty lines consider the bare minimum income to provide basic food requirements; it does not account for other essentials such as health care and education. That is why some times the poverty lines have been described as starvation lines. Different countries have different parameters to define BPL and even in a single country like India, different states have different parameters for BPL. The planning commission of India has calculated income-based BPL in the year 2005-06 and it was rupees 368 (8 dollars) per head per month in rural area and rupees 560 (13 dollars) per head per month in urban areas. This income is bare minimum to support the food requirements and does not provide much for the other basic essential items like health, education etc. Western nations will find these figures shocking.

 

World Bank’s definition of poverty:

Poverty is pronounced deprivation in well-being, and comprises many dimensions. It includes low incomes and the inability to acquire the basic goods and services necessary for survival with dignity. Poverty also encompasses low levels of health and education, poor access to clean water and sanitation, inadequate physical security, lack of voice, and insufficient capacity and opportunity to better one’s life. The World Bank defines extreme poverty as living on less than US $1.25 (PPP) per day, and moderate poverty as less than $2 a day. It estimates that in 2001, 1.1 billion people had consumption levels below $1 a day and 2.7 billion lived on less than $2 a day.

 UN’s definition of poverty:

“Fundamentally, poverty is a denial of choices and opportunities, a violation of human dignity. It means lack of basic capacity to participate effectively in society. It means not having enough to feed and cloth a family, not having a school or clinic to go to; not having the land on which to grow one’s food or a job to earn one’s living, not having access to credit. It means insecurity, powerlessness and exclusion of individuals, households and communities. It means susceptibility to violence, and it often implies living on marginal or fragile environments, without access to clean water or sanitation”

 

 

Causes of poverty:

Before the industrial revolution, poverty had been mostly accepted as inevitable as economies produced little, making wealth scarce. In modern times, food shortages have been reduced dramatically in the developed world, thanks to agricultural technologies such as nitrogen fertilizers, pesticides and new irrigation methods. Also, mass production of goods in places such as China has made what were once considered luxuries, such as vehicles or computers, inexpensive and thus accessible to many who were otherwise too poor to afford them. Poor people spend a greater portion of their budgets on food than richer people. Threats to the supply of food may be caused by price rise, droughts, floods, natural disasters, and the water crisis. Overpopulation and lack of access to birth control methods drive poverty. However, the reverse is also true, that poverty causes overpopulation as it gives women little power to plan childhood, have educational attainment, or a career. The unwillingness of governments and feudal elites to give full-fledged property rights of land to their tenants is cited as the chief obstacle to development. Land reforms and giving land to landless farmers have helped significant segment of Indian population to come out of abject poverty. Poor economic development due to corruption, weak rule of law and excessive bureaucratic burdens promote poverty. Lack of industrialization result in poverty and also result in migration of people to other states to find jobs to alleviate poverty. Poor health and education severely affects productivity. Similarly substance abuse including alcoholism and drug abuse can consign people to vicious poverty cycles. Infectious diseases such as Malaria and Tuberculosis can perpetuate poverty by diverting health and economic resources from investment and productivity. War, political instability and crime including violent gangs and drug cartels, also discourage investment. Cultural factors, such as discrimination of various kinds, can negatively affect productivity such as age discrimination, stereotyping, gender discrimination, racial discrimination, and caste discrimination. Cutbacks in health, education and other vital social services around the world have resulted from structural adjustment policies prescribed by the International Monetary Fund (IMF) and the World Bank as conditions for loans and repayment. In addition, developing nation governments are required to open their economies to compete with each other and with more powerful and established industrialized nations. All of these enhance poverty. To attract investment, poor countries enter a spiraling race to the bottom to see who can provide lower standards, reduced wages and cheaper resources. This has increased poverty and inequality for most people. It also forms a backbone to what we today call globalization. As a result, it maintains the historic unequal rules of trade. Free, subsidized or cheap food, below market prices undercuts local farmers, who cannot compete and are driven out of jobs and into poverty. So primary factors that may lead to poverty include overpopulation, the unequal distribution of resources in the world economy, inability to meet high standards of living and costs of living, inadequate education and employment opportunities, environmental degradation, certain economic and demographic trends, and welfare incentives.

 

Increasingly, people talk about the ‘cycle of poverty’ that keeps the poor locked into poverty. Basically, because of the poverty that the poor are already experiencing, they and their children are not able to break out. Imagine that you are a six-year-old child in an impoverished family in India. Your parents might want to send you to school but are unable to do so because they need you to work so your family can be supported. Later on in life, when you try and get a job, you will be limited to low-paying occupations because of your lack of education. You will be forced into poverty once more.  

 

Effects of poverty:

The effects of poverty may also be causes as listed above, thus creating a “poverty cycle” operating across multiple levels, individual, local, national and global. Hunger, disease, and less education describe a person in poverty. In my article on ‘The Intelligence’, I have shown that large segments of human populations are caught in the vicious cycle of poverty, higher fertility and lower intelligence. My own personal experience with the poor people of India & Saudi Arabia suggests that majority of poor people indeed live life in a rather uncivilized way. One third of deaths – some 18 million people a year or 50,000 per day – are due to poverty-related cause. According to the World Health Organization, hunger and malnutrition are the single gravest threats to the world’s public health and malnutrition is by far the biggest contributor to child mortality, present in half of all cases. Nearly half of all Indian children are undernourished. Poverty increases the risk of homelessness. There are over 100 million street children worldwide. Increased risk of drug abuse may also be associated with poverty. Research has found that there is a high risk of educational underachievement for children who are from low-income housing circumstances. Also, children who live at or below the poverty level will have far less success educationally than children who live above the poverty line. Poor children have a great deal less healthcare and this ultimately results in many absences from the academic year. Additionally, poor children are much more likely to suffer from hunger, fatigue, irritability, headaches, ear infections, flu, and colds. Poverty leads to poor housing. Slum-dwellers, who make up a third of the world’s urban population, live in poverty no better, if not worse, than rural people, who are the traditional focus of the poverty in the developing world, according to a report by the United Nations. According to a UN report on modern slavery, the most common form of human trafficking is for prostitution, which is largely fueled by poverty.  Drug abuse can result in a community shouldering the impact of many nefarious acts such as stealing, killing, theft, sexual assault, and prostitution. Drug abuse is synonymous with poor performance in school & work, and a general malaise of intra-personal intelligence.

 

Poverty reduction:

Poverty reduction occurs largely due to economic growth which occurs due to industrial revolution and agricultural green revolution. In China and India, noted reductions in poverty in recent decades have occurred mostly as a result of the abandonment of collective farming in China and the cutting of government red tape in India. However, ending government sponsorship of social programs is sometimes advocated as a free market principle with tragic consequences. For example, the reconfiguration of public financing in former Soviet states during their transition to a market economy called for reduced spending on health and education which sharply increasing poverty. Empowering women has helped some countries increase and sustain economic development. Trade liberalization increases the total surplus of trading nations. Remittances sent to poor countries, such as India, are sometimes larger than foreign direct investment. Investments in human capital in the form of health are needed for economic growth. Nations do not necessarily need wealth to gain health. Human capital in the form of education is an even more important determinant of economic growth than physical capital. Many estimates suggest that a year of education raises earnings by about 10 percent or perhaps $80,000 in present value over the course of a lifetime. So education does reduce poverty. UN economists argue that good infrastructure, such as roads and information networks, helps market reforms to work. China claims it is investing in railways, roads, ports and rural telephones in African countries as part of its formula for economic development. It was the technology of the steam engine that originally began the dramatic decreases in poverty levels. Cell phone technology brings the market to poor or rural sections. With necessary information, remote farmers can produce specific crops to sell to the buyers that bring the best price. Technology also makes financial services accessible to the poor. Mobile banking addresses the problem of the heavy regulation and costly maintenance of saving accounts.

 

Efficient institutions that are not corrupt and obey the rule of law make and enforce good laws that provide security to property and businesses. Examples of good governance leading to economic development and poverty reduction include Thailand, Taiwan, Malaysia, South Korea, and Vietnam, which tends to have a strong government, called a hard state. Multinational corporations are regulated so that they follow reasonable standards for pay and labor conditions, pay reasonable taxes to help develop the country, and keep some of the profits in the country, reinvesting them to provide further development. Countries like India and Pakistan are soft states where lawlessness & corruption prevail upon business and lack of good governance leads to poverty.

 

Poverty in India:

India has 2.4 % of world’s area and less than 1.2 % of world’s income with 16.7 % of world’s population. Since 1972 poverty in India has been defined on basis of the money required to buy food worth 2100 calories in urban areas and 2400 calories in rural areas. According to a recent Indian government committee constituted to estimate poverty, nearly 38% of India’s population (380 million) is poor. This report is based on new methodology and the figure is 10% higher than the previous poverty estimate of 28.5%. Poverty is widespread in India, with the nation estimated to have a third of the world’s poor. According to a 2005 World Bank estimate, 42% of Indians falls below the international poverty line of US$ 1.25 a day (PPP). Despite significant economic progress, one quarter of the nation’s population earns less than the government-specified poverty threshold of 12 rupees per day (approximately US$ 0.25).  A 2007 report by the state-run National Commission for Enterprises in the Unorganized Sector (NCEUS) found that 77% of Indians, or 836 million people, lived on less than 20 rupees (approximately US$0.50 nominal; US$2 PPP) per day. The average income in India was not much different from South Korea in 1947, but South Korea became a developed country by 2000s. At the same time, India was left as one of the world’s poorer countries. Causes of poverty in India include caste system, British rule, License Raj & red tape, over-reliance on agriculture, over-dependence on monsoon, population explosion, high illiteracy (35 % of adult population), corruption, lawlessness, bad governance etc.The Indian government and non-governmental organizations have initiated several programs to alleviate poverty, including subsidizing food and other necessities, increased access to loans, improving agricultural techniques and price supports, and promoting education and family planning and implementing number of antipoverty programs. However, late Indian Prime Minister Rajiv Gandhi once said that out of 100 paisa allocated for poor, only 14 paisa reaches them. In the year 1999-2000, the total subsidies provided by the central government were Rs 25,690 crore (Rs 256.9 billion), of which Rs 22,680 crore (Rs 226.8 billion) were for food and fertilizer. During the same year the central and state governments together spent another Rs 28,080 crore (Rs 280.8 billion) on “Rural Development,” “Welfare of SC, ST & OBCs” (Indian backward castes) and “Social Security and Welfare”.  Given that poverty was between 26.1 per cent and 28.6 per cent, either of these if transferred directly to the poor & disadvantaged would have eliminated poverty but it did not. In 1991, after the International Monetary Fund (IMF) had bailed out the bankrupt state, the government of P. V. Narasimha Rao and his finance minister Manmohan Singh started breakthrough reforms. These new neo-liberal policies included opening for international trade and investment, deregulation, initiation of privatization, tax reforms, and inflation-controlling measures. The fruits of liberalization reached their peak in 2007, when India recorded its highest GDP growth rate of 9%. With this, India became the second fastest growing major economy in the world, next only to China. Due to economic liberalization in India, as of 2009, about 300 million people – equivalent to the entire population of the United States – have escaped extreme poverty. However, while only 5% of the 600,000 villages in the country have a commercial bank branch, half of India’s population is still financially excluded.

 

Aid:

Aid in its simplest form is a basic income grant, a form of social security periodically providing citizens with money. Critics argue that some of the foreign aid is stolen by corrupt governments and officials, and that higher aid levels erode the quality of governance. Policy becomes much more oriented toward what will get more aid money than it does towards meeting the needs of the people. Aid in the form of Immunization Programs for children such as against polio, diphtheria and measles have save millions of lives. A major proportion of aid from donor nations is tied, mandating that a receiving nation spend on products and expertise originating only from the donor country. Aid amounts are dwarfed by rich country protectionism that denies market access for poor country products while rich nations use aid as a lever to open poor country markets to their products. Most aid does not actually go to the poorest who would need it the most.  One of the proposed ways to help poor countries has been debt relief. If poor countries do not have to spend so much on debt payments, they can use the money instead for priorities which help reduce poverty such as basic health-care and education.

 

Subsidy:

A subsidy is a form of financial assistance given either directly to a business & economic sector or indirectly to people by subsidizing price of kerosene, cooking gas and food. Subsidies can be regarded as a form of protectionism or trade barrier by making domestic goods and services artificially competitive against imports. Subsidies may distort markets, and can impose large economic costs. Subsidies to people by reducing prices of essential commodities may bring down cost of living but increase budget deficit.

 

Overpopulation & economy:

The ecosystem’s capacity for humans has been exceeded by a factor of ten and the amount of stored energy from the sun (including fossil fuels) used by humans is the equivalent of ten earths’ intake of usable solar energy for photosynthesis. So for a healthy ecosystem, only one tenth of today’s population is what thereby could survive sustainably. Basic economics would tell us that an increase in population ensures an increase in generation and consumption, providing stability. As simple as that sounds, what happens when we are consuming more than the earth can yield?  If the world population continues to explode, the global economy will eventually have a serious problem with supply and demand as a result of our enormous per capita consumption of materials. Overpopulation has a definite effect on a country’s economy.  First of all, when countries are overpopulated, the hardly have enough food to support themselves, never mind the hope of having a surplus to sell. This can contribute to a low GDP per capita which is the effect overpopulation has on the economy. In an attempt to save the people from the starvation, the government will most likely have to rely on foreign debt. This puts the country in debt at stretches the government’s already meagre resources. Furthermore, when a country is overpopulated, there is a high rate of unemployment because there just aren’t enough jobs to support the population. This results in a high level of crime because the people will need to steal things in order to survive. Governing an overpopulated country presents problems. The economy is stretched beyond belief, and civil wars break out.

 

Overpopulation leads to following economic effects:

1)  Decreased per capita GDP and reduced standard of living due to ever increasing population.

2)  Unemployment problems of serious dimension both in urban and rural areas leading to reduced per capita earning, poverty etc.

3)  Increased inflation.

4)  Increased borrowings from international organizations.

5)  Difficulties encountered in implementation of all national and state developmental programs.

6)  Increased government expenditure.

7)  Drag on the social services (schools, hospitals, etc.) of the country.

 

However, some economists believe that poverty and famine are the result of greed and poor economic policies by governments around the world rather than from overpopulation. It isn’t that the earth doesn’t have the resources to feed the people on the planet, but that the elite have mishandled the resources and are the actual cause of poverty and famine throughout the world and not overpopulation. I disagree. Yes, it is true that greed & corruption steals money from economic development but overpopulation is equally bad. Let me put it differently. Overpopulation leads to increased demand for jobs which in turn leads to unemployment and high degree of unemployment leads to underground economy & crime as people have to support their families. We the honest taxpayers take a substantial double hit due to overpopulation because we pay more for our share of infrastructure, schools, hospitals & subsidies and we pay more for police, security agencies, jails and prisons to regulate and control illegal activities and warehouse lawbreakers. Also, overpopulation itself leads to corruption and corruption leads to poverty and poverty leads to overpopulation and so vicious cycle continues indefinitely. The only way to break this vicious cycle is to control population and good governance which the largest democracy India lacks at this moment in history.

 

Informal economy (parallel economy), black market & black money:

An informal economy is economic activity that is neither taxed nor monitored by a government, contrasted with a formal economy. Parallel economy includes those activities that go unreported or are unmeasured by the society’s current techniques for monitoring economic activity. By its nature, it is necessarily difficult to observe, study, define, and measure. No single source readily or authoritatively defines informal economy as a unit of study.  The informal economy is thus not included in that government’s Gross National Product (GNP). Although the informal economy is often associated with developing countries, all economic systems contain an informal economy in some proportion. The terms “under the table” and “off the books” typically refer to this type of economy. People or business entities when do not show their exact income as per government rules the income comes under parallel economy. The informal economy includes unreported income from the production of legal goods & services or unreported income from illegal activities like human trafficking, prostitution, narcotic trafficking, smuggling, gambling, arms sell, hawala & money laundering, corruption, currency exchange etc. The term black market refers to a specific subset of the informal economy. Black markets can form part of border trade near the borders of neighboring jurisdiction if there are substantially different tax rates, or where goods are legal on one side of the border but not on the other and products that are commonly smuggled like this include alcohol and tobacco.  

 

Goods acquired illegally take one of two price levels:

They may be cheaper than legal market prices. The supplier does not have to pay for production costs or taxes. This is usually the case in the underground economy. Criminals steal goods and sell them below the legal market price, but there is no receipt, guarantee, and so forth.

Or

They may be more expensive than legal market prices. The product is difficult to acquire or produce, dangerous to handle or not easily available legally, if at all. If goods are illegal such as some narcotics, their prices can be vastly inflated over the costs of production.

 

The international drug mafia is estimated to be involved in a business whose total transactions cross $600-800 billion a year according to Drug Report 2009 released by United Nations Office of Drugs & Crime on June 24, 2009. Over $1 trillion is being laundered every year by drug dealers, arms traffickers and other criminals in India, according to a report by audit and consulting firm KPMG released in the year 2008. The amount of money laundered in the whole world is close to $2.85 trillion per year. As per an estimate of International Monetary Fund the aggregate size of this underground and illegitimate market is between 2 to 5 percent of world’s gross domestic product. Most developed western nations have black economy size of 10 to 20 % of GDP while India has black economy size of 50 % of GDP.

 

It is very difficult to measure the size of a black market because by nature, they are hidden. One method is to determine the quantity of cash in circulation in a country and then subtract the amount of money (cash) that is required for legal, open business. Another method of measuring a black economy is to subtract the amount of electricity consumption that is required for legal uses from the total electricity consumption in a country.     

 

Country-wise money laundering

As we can see that from the above pie chart that United States has the highest Amount in terms of money laundering. It is no surprise because it is from there that a huge amount of money is transferred illegally to Caribbean and Latino nations especially Mexico. That is why recession has a worst effect in the U.S. There are many reasons behind the huge amount that has been laundered from USA. Firstly we all know that dollar has a prestigious value in world wide economy, secondly the exchange rate of dollar is very high when compared with other currencies. After carefully studying the parallel economy, money laundering and recession, it as been found that they are all are interconnected and parallel economies has a negative influence on a countries economy because it hinders the actual growth and shows a fall of GDP of a country where there is high possibility of existence of fiscal budget

 

Black money is defined as money which is not accounted for in the official records, either earned through legitimate sources without paying income tax or through illegal activities. So black money is the money that is generated by activities that are kept secret in the sense that these are not reported to the authorities. As such this money is also not accounted to the fiscal authorities i.e., taxes are not paid on this money. A recent estimate puts the size of black money at over 50 per cent of GDP in India. It is also stated that the annual rate of growth of black money is higher than the annual growth-rate of GDP. The present size of black money is thus very large indeed. The circulation of black money has adversely affected the Indian economy in several ways.

1)  It leads to the misdirection of precious national resources.

2)  It has enormously worsened the income-distribution, and has thereby undermined the fabric of the fixed income salary class which finds itself ever be at the lower rung of the income-ladder. Many high placed official and honest employees earn much less than an average small shopkeeper in big cities like Bombay and Delhi.

3)  The existence of a big-sized unreported segment of the economy is a big handicap in making a correct analysis and formulation of right policies for it. For example, it is not possible to calculate accurately the vital indicators of progress like saving-income ratio, sectorial composition of national income, etc. Nor is it possible to monitor the developments in the economy with precision.

4)  Black money results in transfer of funds from India to foreign countries through clandestine channels. Such transfers are made possible by violations of exchange regulations through the device of under – invoicing of exports and over-invoicing of imports thus finds itself in a paradoxical situation; where the country becomes a de facto lender of aid & capital to the economically advanced & wealthier nations, with the concealed outflow of funds.

5)  Black money requires for its protection, proliferation & expansion, a service organization composed of musclemen, touts, lawyers and brokers to combat the forces of law and order on the one hand and on the other hand, there are income t ax advisers, or chartered accountants on the pay-roll of black money operators. Then there are contact men, better known as liaison officers who negotiate favors from top bureaucracy and political bosses through bribes of black money. This has developed a new black money culture in the business world.

6)  Black money has corrupted Indian political system in a most vicious manner. At various levels, MLAs, MPs, Ministers, party functionaries openly and shamelessly go on collecting funds. The classical example is 2G spectrum scam in India which deprived Indian exchequer of 1.7 lakh crore rupees (39 billion dollars) and there are other innumerable corruption scams right from commonwealth games scam to UP food scam. I do not know how many schools and hospitals would have been built with this money.

According to the Global Corruption Barometer, 2010, published by Transparency International, more than half (54%) of the Indian public offered a bribe to avail of services. This is much above the world average of 25%. India has also left its emerging market peers far behind. Little wonder that most of the scams that hit Indian markets in the past few weeks were bribery linked.    

 

Market:

Market is a medium in commercial world where forces of demand and supply operate, and where buyers and sellers interact (directly or through intermediaries) to trade goods, services, or contracts or instruments, for money or barter. The market may be in one specific place or not exist physically at all because market can exist over telephone lines, online and in emails as long as what happens involves buyers and sellers in a business transaction. In mainstream economics, the concept of a market is any structure that allows buyers and sellers to exchange any type of goods, services and information. The exchange of goods or services for money is a transaction. Market participants consist of all the buyers and sellers of a good who influence its price. The market facilitates trade and enables the distribution and allocation of resources in a society. Markets allow any tradable item to be evaluated and priced. Financial markets facilitate the exchange of liquid assets. Most investors prefer investing in two markets, the stock markets and the bond markets. Currency markets are used to trade one currency for another, and are often used for speculation on currency exchange rates. The money market is the name for the global market for lending and borrowing. In economics, a market that runs under laissez-faire policies is a free market. It is “free” in the sense that the government makes no attempt to intervene through taxes, subsidies, minimum wages, price ceilings, etc. Market size can be given in terms of the number of buyers and sellers in a particular market or in terms of the total exchange of money in the market, generally annually (per year). Market Types most commonly prevailing in the World Economy are Consumer market, Industrial Market, Stock market, Real estate market, Food market, Commodity Market, Financial Market, Foreign exchange market (forex) and others.

 

Stock market:

A stock market (equity market) is a public market for the trading of company stock (shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The size of the world stock market was estimated at about $36.6 trillion at the beginning of October 2008. The total world derivatives market has been estimated at about $791 trillion face or nominal value, 11 times the size of the entire world economy. So the derivative value is much higher than actual value because of betting on stocks. Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial system functions. People can invest in stock market either directly or through mutual funds. Riskier long-term saving requires that an individual possess the ability to manage the associated increased risks. Stock prices fluctuate widely, in marked contrast to the stability of (government insured) bank deposits or bonds. This is something that could affect not only the individual investor or household, but also the economy on a large scale. The stock market, as with any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. A stock market crash is often defined as a sharp dip in share prices of equities listed on the stock exchanges. In parallel with various economic factors, a reason for stock market crashes is also due to panic and investing public’s loss of confidence. Often, stock market crashes end speculative economic bubbles. The movements of the prices in a market or section of a market are captured in price indices called stock market indices.

 

Stock:

A “stock” is a share in the ownership of a company. A stock represents a claim on the company’s assets and earnings. As you acquire more stocks, your ownership stake in the company becomes greater. Note: Some times different words like shares, equity, stocks etc. are used. All these words mean the same thing. Holding a company’s stock means that you are one of the many owners (shareholders) of a company and as such, you have a claim to everything the company owns. This means that technically you own a tiny little piece of all the furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company’s earnings as well. These earnings will be given to you. These earnings are called “dividends” and are given to the shareholders from time to time. A stock is represented by a “stock certificate”. This is a piece of paper that is proof of your ownership. The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets. Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. It’s really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions. In case of liquidation, you’ll receive what’s left after all the creditors have been paid. Another extremely important feature of stock is “limited liability”, which means that, as an owner of a stock, you are “not personally liable” if the company is not able to pay its debts. Owning stock means that, no matter what happens to the company, the maximum value you can lose is the value of your stocks. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.

 

Asset:

An “asset” is something that generates money. Just to give you an example. If you buy a flat for rupees 400,000 and then rent it out for Rs.2000 a month then you have created an asset. An “asset” that generates Rs.2000 a month. The idea is that once you invest your money in enough assets, you can stop working. All your assets will make money for you. You can then use this money to enjoy life. Or, you can use this money to invest in more assets that generate more money! So all this gives us the phrase, “Let your money work for you!” This is the main aim of investing. Always remember that wealth-creating assets are those that increase in value over time and provide a return. For example, your investment in a piece of land, a house, gold, fixed deposits, provident fund, mutual funds and shares. However, a car or a consumer durable likes a washing machine or a refrigerator, although important milestones do not create wealth, simply because they depreciate in value. Also, in the process of wealth creation, you might have borrowings and owe money to others, be it individuals or lending bodies. It is only loans like home loans that add to your wealth while loans for assets like cars are a drain on your wealth.

 

Derivative trading:

Many people are talking about the Stock Market. But hardly anyone is talking about Derivatives. Strange – because the size of the Stock Market is the size of a mouse as compared to Derivatives that have a size of an elephant. The term “Derivative” indicates that it has no independent value, i.e. its value is entirely “derived” from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future option or any other hybrid contract of pre-determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. A derivative is basically a bet. Yes, the stock market is also a bet, but at least when you buy stock, you own part of a company that provides goods or services, so it usually has some intrinsic value. When you own a derivative, you own nothing. In Feb 2009 the total world derivatives market expanded to 1000 trillion dollars. Note that the total amount of world derivatives is sixth times the total world GDP.

 

Financial Institution Total Assets
($ billions)
Total Notional Derivatives ($ billions) % Interest Rate Contracts % FOREX Contracts % OTC Contracts % Exchange Contracts
             
CHASE $ 320.5  $ 13,927.6 86.5 % 12.0 % 92.8 % 7.2 %
JP MORGAN 173.6 9,535.3 79.9 12.4 90.9 9.1
B of A 604.7 6,991.0 82.3 14.4 89.5 10.5
CITIBANK 356. 8 4,702.4 55.3 41.2 95.7 4.3
BANC ONE 95.8 964.6 96.7 2.7 62.4 37.6
FIRST UNION 147.3 892.7 86.9 11.9 96.3 3.7
BANK OF NY 74.2 377.2 82.5 16.7 69.3 30.7
             
AVERAGE         85.3 % 14.7 %

The top seven banks in the US account for over 95 % of total derivatives exposure in the US banking system.  As with imbalances in other areas such mutual fund holdings of individual stocks, the top four banks in the US (Chase, JP Morgan, Bank of America and Citibank) account for 89.4% of total banking system derivatives exposure. The concentrated exposure is striking, if not chilling.

 

Saving:

Saving is income not spent, or deferred consumption. In a primitive agricultural economy savings might take the form of holding back the best of the corn harvest as seed corn for the next planting season. If the whole crop were consumed the economy would deteriorate to hunting and gathering the next season. Methods of saving include putting money aside in a bank or pension plan. “Saving” differs from “savings.” The former refers to an increase in one’s assets, an increase in net worth, whereas the latter refers to one part of one’s assets, usually deposits in savings accounts, or to all of one’s assets. Saving refers to an activity occurring over time, a flow variable, whereas savings refers to something that exists at any one time, a stock variable. By not using income to buy consumer goods and services, it is possible for resources to instead be invested by being used to produce fixed capital, such as factories and machinery. Saving can therefore be vital to increase the amount of fixed capital available, which contributes to economic growth. However, increased saving does not always correspond to increased investment. If savings are stashed in a mattress or otherwise not deposited into a financial intermediary like a bank, then there is no chance for those savings to be recycled as investment by business. This means that saving may increase without increasing investment, possibly causing recession rather than to economic growth. The interest rates is adjusted to equate saving and investment, avoiding a general overproduction. A rise in saving would cause a fall in interest rates, stimulating investment. However, some economists argued that neither saving nor investment were very responsive to interest rates so that large interest rate changes were needed.

 

Consumer spending:

Consumer spending is known as personal consumption expenditure. It is the largest part of aggregate demand or effective demand at the macroeconomic level. Taxes are known for being a potent tool in the adjustment of the economy by altering consumer spending. Consumer sentiments are the attitudes of households and entities toward the economy and the health of the fiscal markets, and they are a strong constituent of consumer spending. Sentiments have a powerful ability to cause fluctuations in the economy, because if the attitude of the consumer regarding the state of the economy is bad, then they will be reluctant to spend. Therefore sentiments prove to be a powerful predictor of the economy, because when people have faith in the economy or in what they believe will soon occur, they will spend and invest in confidence. In times of economic trouble or uncertainty, the government often tries rectify the issue by distributing economic stimuli, often in the form of rebates or checks. However, people are many times intelligent enough to realize that economic stimulus packages are due to economic downturns, and therefore they are even more reluctant to spend them. Instead they put them into savings, which can potentially also help spur the economy. By putting money into savings and increasing banks profit, it is able to decrease the interest rates, which then encourage others to save less and promote future spending.  In 1929 the US consumer spending was 75% of the nation’s economy. This grew to 83% in 1932, when business spending dropped. Then consumer spending dropped to about 50% during World War II due to large expenditures by the government and lack of consumer products. It has risen since 1983 to about 70%, as the result of relaxed consumer credit. Spending again dropped in 2008 as the result of consumer fears about the economy. Consumers saved instead of spending. So higher the consumer spending greater is the demand of goods & services and stronger is the stimulus for economic growth. However, instead of spending, if people start saving, even though saving itself is good for economy, it is not a strong stimulus for economic growth. On the other hand, over-spending leads to bankruptcy & poverty. So what we need is the balance between consumer spending, saving and investment for a better economy.

 

Balance of trade:

The balance of trade is the difference between the monetary value of exports and imports of output in an economy over a certain period in a country. It is a trade surplus if it consists of exporting more than is imported and converse is referred to as a trade deficit or a trade gap. The balance of trade is sometimes divided into a goods and a services balance. An early statement appeared in Discourse of the Common Weal of this Realm of England in the year 1549: ‘We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and enrich them.’ Over the long run, nations with trade surpluses tend also to have a savings surplus. The U.S. generally has lower savings rates than its trading partners which tend to have trade surpluses. Germany, France, Japan, and Canada have maintained higher savings rates than the U.S. over the long run. Few economists believe that GDP and employment can be dragged down by an over-large deficit over the long run. Others believe that trade deficits are good for the economy. Some economists have pointed out that a large trade deficit (importation of goods) signals that the country’s currency is strong & desirable and a trade deficit simply meant that consumers had opportunity to purchase and enjoy more goods at lower prices; conversely, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received. Trade deficits are paid for out of foreign exchange reserves, and may continue until such reserves are depleted.

 

Budget deficit & government debt:

A deficit is the amount by which a sum of money falls short of the required amount. The primary deficit is defined as the difference between current government spending and total current revenue from all types of taxes. The total deficit (which is often just called the ‘deficit’) is spending plus interest payments on the debt, minus tax revenues. Budget Deficit occurs when the spending of a government exceeds that of its financial savings. In fact, budget deficit normally happens when the government does not plan its expenses, after taking into account its entire savings. Deficits occur because cash is not available to cover expenses. Sources of cash might include tax collections, the sale of assets, investment income, or receipts from planned long-term financing. In India, a price hike in petroleum product can immediately reduce budget deficit by generating funds.A budgetary deficit when accrued for a very long span of time, say for several decades or centuries is termed as Government Debts. Government debt (also known as public debt, national debt) is money (or credit) owed by any level of government; either central government, state government, municipal government or local government. Government debt can be categorized as internal debt, owed to lenders within the country, and external debt, owed to foreign lenders. A broader definition of government debt considers all government liabilities, including future pension payments and payments for goods and services the government has contracted but not yet paid. Under such circumstances, a certain portion of the governmental expenditure is then utilized for repayment of such debts with some maturity. This maturity is capable of being re-financed, through the issuance of fresh bonds on governmental level. However, it must be noted that while a budget deficit is considered to be a flow, a government debt amounts to a stock. In fact, government debts are nothing but an accrued flow of budget deficits.

 

National budget deficits (year 2004)

National Government Budgets for 2004 (in billions of US$)
Nation GDP Revenue Expenditure Exp divided by GDP Budget Deficit/Surplus Deficit divided by GDP
US (federal) 11700 1862 2338 19.98% -25.56% -4.07%
US (state) 900 850 7.6% +5% +0.4%
Japan 4600 1400 1748 38.00% -24.86% -7.57%
Germany 2700 1200 1300 48.15% -8.33% -3.70%
United Kingdom 2100 835 897 42.71% -7.43% -2.95%
France 2000 1005 1080 54.00% -7.46% -3.75%
Italy 1600 768 820 51.25% -6.77% -3.25%
China 1600 318 349 21.81% -9.75% -1.94%
Spain 1000 384 386 38.60% -0.52% -0.20%
Canada (federal) 900 150 144 16.00% +4.00% +0.67%
South Korea 600 150 155 25.83% -3.33% -0.83%

 

Britain’s public deficit is one of the highest among developed economies, running at 11.5 per cent of its total economic output, compared to 10.7 per cent for the US and 5.4 per cent for Germany. Common sense suggests that with increasing budget deficit, government tries to reduce the deficit by spending cuts. However, occasionally, the converse is implemented known as deficit spending. The excess spending is financed through borrowing, internal or external. The increased government spending can help stimulate the economy as more money flows in, but the jump in borrowing can have an adverse effect by raising interest rates. During a recession, increased government spending can stimulate business activity, create jobs and spur consumer spending. This creates a multiplier effect in which $1 of government spending helps increase GDP by more than $1. Under certain conditions, governments can stimulate the economy by intentionally running a deficit. However, it is not good to have a high deficit in a growing economy.

 

With a population of just over 1 billion, India is the world’s largest democracy. In the past decade, the country has witnessed accelerated economic growth, emerged as a global player with the world’s fourth largest economy in purchasing power parity terms. In 2007, Indian Petroleum Minister announced that the nation had 16.6 billion tons of oil reserves. Even so, with its 1.1 billion populations, the per-capita reserves in India are only 1.5 tons, less than 1/42 of the world average. India’s current dependency on foreign oil exceeds more than 75 percent. According to estimates by India, if oil prices rise for every $5, India’s economic growth rate will drop 0.5 percent, and its inflation rate would increase by 1.4 percent. Oil has become a key factor for India to sustain its economic development. As India’s Prime Minister Manmohan Singh said: “Energy security has become a serious problem, second only to food security”. India’s fiscal deficit would be among the highest in the world and likely to be 10.3 per cent of GDP in the current fiscal and 10 per cent in the next fiscal. However, according to Indian finance ministry, Indian fiscal deficit will be only 5.5 % of GDP this year. There are many areas where it can cut the deficit, like fuel subsidies — and especially diesel and kerosene — because global oil prices are going to go up again. The other thing I find hard to understand is the proposed Food Security Bill, which is expanding food subsidies to a larger chunk of the population at the cost of worsening budget deficit. The deficit would not come down substantially over the next few years due to increase in spending, especially on higher wages and unemployment benefits as well as a large increase in the government’s interest burden. Yet, India is doing rather well. Its economy is expected to expand by 8.5% this year. There are worries that high crude oil prices and runaway inflation will slow down growth. It has a long way to go before it is as rich as China – the Chinese economy is four times bigger – but its growth rate could overtake China’s by 2013, if not before. Given the choice between doing business in China or India, most foreign investors would probably pick China. The market is bigger, the government easier to deal with, and if your supply chain for manufactured goods does not pass through China your shareholders will demand to know why. However, India is expected to be the world’s fastest growing economy by 2018, according to Economist Intelligence Unit (EIU), the research arm of the Economist magazine. India, the second largest growing economy will overtake China as the fastest growing major economy with an average of eight per cent in the next five years, another report stated earlier this year. Due to India’s limited dependence on external demand and strong fiscal and monetary stimulus measures, the global economic and financial crisis of 2008-2010 had a relatively muted effect on the country.

 

Financial & economic crisis:

A situation in which the economy of a country experiences a sudden downturn brought on by a financial crisis. An economy facing an economic crisis will most likely experience a falling GDP, a drying up of liquidity and rising/falling prices due to inflation/deflation. An economic crisis can take the form of a recession or a depression.The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value and are associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults.  Financial crises directly result in a loss of paper wealth; they do not directly result in changes in the real economy unless a recession or depression follows.

 

The financial crisis of 2007 to the present was triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It contributed to the failure of key businesses, declines in consumer wealth estimated in the hundreds of billions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. The financial crisis was based on the accumulation of debt. The main cause of this has been growing recognition that the quantity of bad debt in the system was much larger than was previously thought. This in turn led to confusion amongst the US ruling class about the way to respond to the rising number of loan defaults. This threw the banking system into a deeper crisis in three ways. First, the rising tide of bad debt threatened the solvency of the banks. Second, the apparent change in Federal Reserve policy from the earlier rescue efforts created a panic in the inter-bank lending market. Uncertain of which banks would survive, banks ceased to lend to anyone at all in this market causing the system as a whole to seize up. Thirdly, stock market investors also panicked sending bank shares into freefall. Since bank regulation is based on the idea that loans can only be a certain multiple of bank capital and since the decline in shares reduced capital significantly, this looked likely to lead to a massive decline in bank lending, which would have further threatened the stability of the system. Federal Reserve chairman Ben Bernanke has begun implementing his strategy to combat deflation. This is de facto devaluation of the dollar and its goal is to create some inflation so people will spend. Another side effect of devaluation is making American goods cheaper for exports. The thinking is that cheaper American goods will lead to demand for these products and thus create jobs. However, this may not work in today’s environment as the US doesn’t produce much for export anymore.

 

The world economy grew 5.2% in 2007 powered by growth in China (11%), India (9%) and Russia (8%). The Emerging Markets, led by the giants of China, India, Russia and Brazil (the BRIC countries) had been posting 7%-10% grow rates for years. It is predicted that world peak oil production will be reached sometime between 2000 and 2010, and will decline thereafter. This impending oil crisis has also helped to raise the price of food, since increasing amounts of land are being devoted to bio-fuel crop development, and higher oil prices raise the cost of fertilizer (for which petroleum is a key ingredient) and food transportation. Energy runs the world, and when the oil price increases rapidly, the economic engine slows down until producers of goods can adjust to the new cost of doing business. After all, oil is an input for almost every good that is produced in a modern economy. The spike in the price of oil in 2008 created a supply shock that played an underrated role in creating economic recession. In a free economy, market adjustments can overcome the change. In controlled state dominated economies, technically ignorant & innovation challenged bureaucracy just sits dumbfounded as economy worsens. Increasingly, European countries support solar power and raise their level of implementing renewables. In Germany, solar cell prices fell and demands increased because the government decided to subsidize anyone who produces solar power. Now, solar power produces up to a tenth of Germany’s electricity on sunny days. A transformation of the power sector based on 100 percent renewable energy would address energy security and supply concerns, while decarbonizing electricity generation and, at the same time, contributing to a substantial reduction in energy poverty. It seems increasingly likely that a massive investment in renewable energy sources will be needed in order to avert another stagflationary period in the world economy, or even a global recession.

 

Between 2007 and the end of 2009, at least 30 million jobs were lost worldwide as a result of the global financial crisis according to a UN report. With economic growth projected to be a meager 3.1 per cent in 2011, followed by 3.5 per cent in 2012 in the global economy – rates that are insufficient to spur the recovery of the jobs that were lost during the economic crisis. Suggestions offered in this UN report that might lead to sustainable recovery include providing additional fiscal stimulus and redesigning the stimulus and other economic policies to lend a stronger orientation towards measures that directly support job growth, reduce income inequality and strengthen sustainable production capacity on the supply side. Other options include finding greater synergy between fiscal and monetary stimulus, while counteracting damaging international spill-over effects in the form of increased currency tensions and volatile short-term capital flows; ensure that sufficient and stable development finance is made available for developing countries; and finding ways for credible and effective policy coordination among major economies.

 

Economic recession:

It is defined simply as a period when GDP falls (negative real economic growth) for at least two quarters. The GDP, employment, investment spending, capacity utilization, household incomes, business profits and inflation all fall during recessions; while bankruptcies and the unemployment rate rise. This definition is unpopular with most economists because this definition does not take into consideration changes in other variables like changes in the unemployment rate or consumer confidence. A recession is generally considered less severe than a depression, and if a recession continues long enough it is often then classified as a depression. There is an old joke among economists that states: A recession is when your neighbor loses his job. A depression is when you lose your job. Double Dip recession is the recession happening two times with the small gap in between. A recession is marked by rising unemployment, increasing debt burden of the state, reducing the share and stock prices and under investment. All these features affect people. Recessions generally occur when there is a widespread drop in spending often following an adverse supply shock or the bursting of an economic bubble. When a recession is about to occur, there will be overproduction, and supply will exceed the demand for products. This will force the companies to increase prices, which will then cause a loss in confidence in the consumers who will be uncertain in purchasing products. In the end, consumers will stop buying products altogether. Over-consumption can also be a major factor in a recession. When people start spending more than what is required, it will lead to recession and poverty. For example, the US is spending billions of dollars in conflicts such as Iraq and Afghanistan. Many economists are worried that this spending will eventually bankrupt the US, which will lead to a huge recession in the future and likely a depression. Recessions also start with high federal government deficit spending, which will lead to higher interest rates. Higher interest rates slow the economy down as barrowing money becomes more expensive for home buyers and businesses big and small.  Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply, increasing government spending and decreasing taxation. A recession generally lasts from six to 18 months, and interest rates usually fall in during these months to stimulate the economy by offering cheap rates at which to borrow money. Recession is a normal (albeit unpleasant) part of the business cycle; however, one-time crisis events can often trigger the onset of a recession. The global recession of 2008-2009 brought a great amount of attention to the risky investment strategies used by many large financial institutions, along with the truly global nature of the financial system. As a result of such a wide-spread global recession, the economies of virtually all the world’s developed and developing nations suffered extreme set-backs and numerous government policies were implemented to help prevent a similar future financial crisis.

 

Economic inequality in between nations & within a nation:

As Robert A. Heinlein said, “Throughout history, poverty is the normal condition of man. Advances which permit this norm to be exceeded — here and there, now and then — are the work of an extremely small minority, frequently despised, often condemned, and almost always opposed by all right thinking people. Whenever this tiny minority is kept from creating or (as sometimes happens) is driven out of a society, the people then slip back into abject poverty.”

 

 

There are many reasons for economic inequality within societies. These causes are often inter-related. Acknowledged factors that impact economic inequality include: the labor market, innate ability, education, race, gender, culture, wealth condensation, development patterns and personal preference for work, leisure and risk. A study published in 2009 has shown that negative social phenomena such as shorter life expectancy, higher disease rates, homicide, infant mortality, obesity, teenage pregnancies, emotional depression and prison population correlate with higher socioeconomic inequality.  

 

Many factors constrain economic inequality – they may be divided into two classes: government sponsored, and market driven. The relative merits and effectiveness of each approach is a subject of debate

 

Typical government initiatives to reduce economic inequality include:

1)  Public education: increasing the supply of skilled labor and reducing income inequality due to education differentials.

2)  Progressive taxation: the rich are taxed proportionally more than the poor, reducing the amount of income inequality in society.

3)  Minimum wage legislation: raising the income of the poorest workers (though probably increasing unemployment).

4)  Nationalization or subsidization of products: providing goods and services that everyone needs cheaply or freely (such as food, healthcare, and housing) and thereby governments can effectively raise the purchasing power of the poorer members of society.

 

Market forces outside of government intervention that can reduce economic inequality include:

1)  Propensity to spend: With rising wealth & income, a person must spend more. For example, if  few persons owned everything, they would immediately need to hire people to maintain their properties, thus reducing the wealth concentration

2)  Unionization: Although not a market force per se, labor organizations may reduce inequality by negotiating standard pay rates (though probably increasing unemployment). As union power has declined, and performance related pay has become more widespread, economic inequality has mirrored productive inequality

 

Economic differences between rich and poor countries are considerable. According to the United Nations Human Development Report 2004, the GDP per capita in countries with high, medium and low human development (a classification based on the UN Human Development Index) was 24806, 4269 and 1184 PPP$ respectively (PPP$ = purchasing power parity measured in United States dollars). The richest 1% of adults alone owned 40% of global assets in the year 2000, and that the richest 10% of adults accounted for 85% of the world total. The bottom half of the world adult population owned barely 1% of global wealth. An American having the average income of the bottom US decile is better-off than 2/3 of world population. Switzerland, one of the world’s richest nations in GDP per capita terms, now has over 400 times the per capita income of Ethiopia, one of the world’s poorest countries. Japan’s GDP per capita, at $ 34,715, is 53 times higher than Pakistan’s, at $ 650. Adjusted for purchasing power parity, or what a dollar will buy in the respective economies, Japan’s GDP per capita, at $ 23,480, is still 15 times higher than Pakistanis, at $ 1,570.  Moreover, the gap between rich and poor nations has been progressively widening. In 1939, the average American factory worker’s income was 16 times higher than the average Indian factory worker’s income. By 1969, it was 40 times higher. Today, it is 78 times higher.

 

Gap between rich and poor nations:

1)  Rich countries often have high GDP and income per capita compared to the poor ones.

2)  Rich countries have bigger employment opportunities and mostly have citizens with a positive outlook in life.

3)  Rich countries have an aging population that usually dies of chronic diseases whereas poor countries have a younger population base that die of preventable or much simpler illnesses.  

 

A recent report by the World Bank found that businesses in poor countries face much higher regulatory burdens than those in rich countries. The combination of the presence of higher administrative costs and the absence of property rights can have a devastating effect. It takes 153 days to start a business in Maputo, but just 2 days in Toronto. There are 21 procedures to register commercial property in Abuja, but only 3 procedures in Helsinki. It costs 126 per cent of the value of a debt to enforce a contract in Jakarta, but 5.4 per cent of the value of a debt to do so in Seoul. If a debtor becomes insolvent and enters bankruptcy, creditors would get 13 cents on a dollar in Mumbai, but more than 90 cents in Tokyo.

 

Political freedom and economic progress are natural partners. How a conflict-ridden, grossly over-populated place with no resources whatsoever gets rich is simple. The British colonial government turned Hong Kong into an economic miracle. On the other hand, in terms of natural resources, Africa is the world’s richest continent. It has 50 percent of the world’s gold, most of the world’s diamonds and chromium, 90 percent of the cobalt, 40 percent of the world’s potential hydroelectric power, 65 percent of the manganese, millions of acres of untilled farmland as well as other natural resources. Despite the natural wealth, Africa is home to the world’s most impoverished and abused people because in majority of African nations, there is no political freedom. The poor of India are far better off than they would have been if India’s economic liberalization had not taken place, and there are far less of them than there would have been.

 

Developed vs. Developing countries:

Developed countries also called industrialized countries or more economically developed countries.

Reasons why they are called developed countries

1)  Form of government (democracy)

2)  Free market economy

3)  Low level of corruption

4)  More dependent on manufacturing than agriculture

5)  Prevalent technology

6)  High standard of living

Examples include United States, Japan, Germany and France

Developing Country (third world countries):

1)  Country with low standard of living.

2)  Undeveloped industry

3)  Lack modern technology

4)  Low levels of Education ,Healthcare and Life expectancy

Examples include Mexico, Brazil, South Africa and Thailand.

 

Even though India is a largest democracy with free market economy and prevalent technology, it may not become a developed nation due to lack of good governance, lawlessness, overpopulation, caste based reservation bypassing merit and overwhelming corruption. Also, Indian parallel economy dominates over mainstream economy.

 

Brain drain:

“Brain drain” is the phenomena whereby nations lose skilled labor because there are better paid jobs elsewhere. In recent years, this has affected poorer countries more so, as some rich countries tempt workers away, and workers look to escape bleak situations in their poor home countries. For its World Health Report 2006, the World Health Organization (WHO) noted that there is a global shortage of 4.3 million doctors, midwives, nurses, and support workers. This is because rich countries are hiring medical staff from abroad as they are far cheaper. The British Medical Association and the Royal College of Nursing have described this as “poaching” because “staff migration from developing nations is killing millions and compounding poverty.” Other industries also suffer due to this issue. Some countries are able to afford this loss. For example, during the tech boom in the US around 2000, many IT workers from India were attracted to the US under the H1-B visa program. At that time, concerns were raised in India that this was a form of brain drain as highly skilled workers were being lost. However, some Indian politicians confidently claimed that this was not a problem because there were so many tech workers in the pool. Indeed, today India is a major off-sourcing center for technology. Also, 11.4 million Indians working overseas send more money back home than any of their global counterparts. The remittances in 2010 were to the tune of $55 billion as per the World Migration Report 2011. This too despite a worldwide economic slowdown and anti-immigration measures adopted by industrialized countries. However, most poor countries are not of the size of India and per person lost, the impact can be more severe. A major reason for the declining health services in the poorer countries has been the structural adjustment programs imposed by richer countries & international institutions, which then contributes to this brain drain, thus twisting the knife in the back, so to speak. The small amounts that rich countries do allow the poor to spend on health is now lost to the already rich, and the poor have to bear the burden.

 

Caste based reservation in education & employment in India bypassing merit has forced ‘forward’ castes to evolve a strategy for survival, namely emigration where the best & the brightest look abroad for their future. Also, it is understandable that people in poorer countries will want to get away from poverty and corruption, and if they can afford to do so, why should they be denied the ability to try? The World Health Report 2006 from the WHO summarized a number of reasons why health workers moved to richer countries:

Workers’ concerns about

1)  Lack of promotion prospects,

2)  Poor management,

3)  Heavy workload,

4)  Lack of facilities,

5)  A declining health service,

6)  Inadequate living conditions,

7)  High levels of violence and crime.

 

Prospects for

1)  Better remuneration,

2)  Upgrading qualifications,

3)  Gaining experience,

4)  A safer environment,  

5)  Family-related matters

 

Knowledge economy:

For the last two hundred years, neo-classical economics has recognized only two factors of production: labor and capital. This is now changing. Information and knowledge are replacing capital and energy as the primary wealth-creating assets, just as the latter two replaced land and labor 200 years ago. In addition, technological developments in the 20th century have transformed the majority of wealth-creating work from physically-based to “knowledge-based.” Technology and knowledge are now the key factors of production. With increased mobility of information and the global work force, knowledge and expertise can be transported instantaneously around the world, and any advantage gained by one company can be eliminated by competitive improvements overnight. In an agricultural economy land is the key resource. In industrial economy natural resources such as coal & iron ore and labor are the main resources. A knowledge economy is one in which knowledge is the key resource. It is not a new idea that knowledge plays an important role in the economy, nor is it a new fact. All economies, however simple, are based on knowledge about how, for example, to farm, to mine and to build; and this use of knowledge has been increasing since the Industrial Revolution. But the degree of incorporation of knowledge and information into economic activity is now so great that it is inducing quite profound structural and qualitative changes in the operation of the economy and transforming the basis of competitive advantage. The rising knowledge intensity of the world economy and our increasing ability to distribute that knowledge has increased its value to all participants in the economic system. The implications of this are profound, not only for the strategies of firms and for the policies of government but also for the institutions and systems used to regulate economic behaviour. The knowledge economy is the story of how new technologies have combined with intellectual and knowledge assets – the “intangibles” of research, design, development, creativity, education, brand equity and human capital – to transform our economy. My own website is a part of knowledge economy where information, knowledge and ideas are communicated to people to improve their quality of life. Of course, I get nothing in return. So it is as good as money-free knowledge economy.

 

Green economy:

To many, a green economy is nothing but an economy where costs of environmental protection are included in production, but to a few, it also reflects a new perspective of managing the economy where we are living. To scholars, a green economy is a domain of economic development addressing a notion that growth has to be hand in hand with social and environmental justice, as they are an inseparable fundamental part of a whole – sustainable development.

 

Healthy eating harmful to economy?

A new study suggests a healthy diet may not make for a healthy economy. As reported by the Associated Press (AP), researchers found that the widespread adoption of a healthier diet may have a negative impact on the economies of some developing nations. For example, the adoption of a vegetarian diet in Brazil could cost the country’s economy, in which the meat industry is highly profitable. I am not suggesting people not eat a healthy diet…I am just trying to point out that healthier eating can have unintended consequences.

 

Money-free economy:

Money-free economy is term that was used in 1960s but has only recently come into large scale existence. Wikipedia itself is a prime example. Thousands of people are prepared to work for nothing editing Wikipedia on the condition that they can also play for nothing (as they do on YouTube etc), listen to music for nothing (as they have on LimeWire etc). Communication technology and computers in particular have been important in creating an environment suitable for a money-free economy. As an economy becomes money-free, tax revenues are likely to decline, and economic sanctions such as fines or subsidies become less important in dictating people’s course of action. A switch to a money-free economy is likely decrease the power of national governments and central banks as it increased individual freedom and autonomy.

 

DISCUSSION:

This discussion is meant for common people to improve their standard of living and live a better life utilizing the same resources & intellect that they possess. This discussion is not meant for elite class who come on television oblivious of ground realities and talks big things.

Why should you save money?

1) Emergencies – unemployment, disasters, bad investments, illness can occur and it’s nice to be prepared for them;

2) Debt prevention – paying cash as you go instead of running up high-interest credit cards is more efficient and saves lots of money;

3) Planning for the future – planning for your children’s education, a new car, or retirement can cost a lot of money which a good savings account or investments can help you pay and lessen your loan obligations.

 

Money saving tips:

1)  Spend Less. This is not over simplifying the best way to save money.

2)  Establish a personal budget. You will instantly see your incomings and outgoings once you create your budget. You will not be able to save money unless you know how much money you have coming in, and how much money you have going out.

3)  Start a saving plan.

4)  Open a savings account.

5)  Bulk is good. Think about shopping and buying in bulk.

6)  ‘Buy one get one free’, “50% off”, and “Huge Discount” will only help you save money if the actual price you pay is lower than you would pay somewhere else for exactly the same product.

7)  Buy used. Sure, we all like to buy new. But there are huge money savings to be made in buying used. Look for ways to buy “as good as new” items and save money. Typical products you might consider buying used to save money include: cars, clothes, electrical goods, garden items… tools and sheds, household items… pots and pans etc.

8)  Don’t carry excessive debt. Credit Card debt is typically the most expensive debt we may carry. Kill your debt first.

9)  Each week or each month, get into the habit of putting an amount, however small into your savings.

10)  Shop Wisely.

11)  Eat in rather than out.

12)  Use less. We live in a consumer society where waste is a huge problem. Use less electricity.

13)  Always overestimate your expenses and underestimate your income.

14)   Keep a record of your expenses.

15)  Investing is not just for people who have more money. Even a person with moderate amount of money can invest. If you are interested in buying share, go ahead, provided you know about it. You can invest in something less risky as well like gold. You can invest in retirement plans and insurance policies as well.

16)   Quit smoking and alcohol.

17)   Acquire assets.

18)   Know the Power of Compounding. Did you know that if you invested just $5,000 per year at an average return of 7% from the age of 25, you’d be a millionaire by the time you hit 65.

19)  One of the keys to getting out of the rat race and creating financial independence is knowing the secret of leveraging other people’s time (OPT) and other people’s money (OPM).

20)  Making money and becoming wealthy can be a bit like learning a foreign language. There are lots of terms like: Assets, Liabilities, Liquidity, Net Worth, Gearing, Leverage, etc and you must know what these terms mean in order to become a good investor. True wealth and abundance come from having an affluent psychology. You have got to remove any disempowering beliefs you have about yourself or money.

 

Why should you invest?

The worth of money gradually reduced over time due to inflation. Never keep your money stagnant. If you just save money by putting it your safe it will loose value over time. If you have Rs.1000 in your safe today and you keep it there for 10years or so, it will be worth a lot less after 10 years. If you can buy something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years from now. So do not keep money locked up in your safe. Always invest money. If you can’t think where to invest your money, then put it in a bank. Let it grow by gaining interest. When investing, you have to make sure that the rate of return on your investment is higher than the rate of inflation. For example, if you invest Rs.100 in the bank today and you make money at a 7 % interest in one year you will have Rs.107. But now, since the rate of inflation is at 10 %, an item costing Rs.100 today will cost Rs.110 a year from now. So what you can buy with today’s Rs.100, you will only be able to buy with Rs.110 a year from now. But the Rs.100 that you invested has grown only at a 7 % rate of return and so it is worth Rs.107. In effect, you are loosing money! So in conclusion, the rate of return on your investments has to be higher than the rate of inflation. So now you know how silently inflation eats into your money. You would not even know about it that your money would sit loosing value for no fault of yours. Besides inflation, you also lose money in brokerage and taxes. As a general rule, just for the sake of simplicity, your investments must grow at a minimum rate of 15% per year to stay ahead of inflation, tax and brokerage!! Remember this when making all your investments.

 

Before you decide to invest in anything, three points are considered.

1)   How much money you want to accumulate and what is the time limit?

2)  What is your risk profile? The higher the risks the higher the returns. The lower the risks the lower the returns.

3)  Can you end up losing all the money you invested? Or is a safe or “sure-shot” investment? Generally young people can take up more risk because they have time on their side! Even if something bad happens and they loose money, they can always recover it since they are young.

 

Zero risk investments include fixed deposits in banks, national savings certificates, PPF etc. Because they are zero risk investments, they also give low returns. Investment in stocks is high risk investment but it also gives high returns. For example, you buy X Company’s shares at Rs 100 per share and the price increases to Rs 150, you have earned a profit of 50 per cent on your investment, if you sell at that price. Also, you get dividend from investment in stocks. Equities have historically proved to be a great tool to wealth creation. However, like all high-return investments, it entails a high degree of unpredictability. The hindsight bias is a very common problem with most investors. This makes them see events that have occurred as being more predictable than they were before they took place. This is one of the biggest mistakes that investors make. Because they can see the past clearly, they tend to believe that they have a similar ability to tell the future as well. But as history suggests, the future in stock markets is most often not what is generally expected.

 

Stock Investing Golden Rules:

1)  Choose the right broker after conducting basic research in the market.

2)  Invest for at least three to five years, based on fundamentals of companies.

3)  Track your portfolio and follow news on the companies’ financials and performance regularly.

4)  Understand basic performance indicators like earnings per share (EPS), book value, price to earnings ratio (PE ratio), net profit, and dividend payout.

5)  Do not overexpose your portfolio to one stock.

6)  Keep investments small and simple.

7)  Have courage to buy on lows and sell when the markets move up.

8)  Fix an upward target price and a stop-loss before you buy the stock.

 

In between zero risk investment and high risk investment, there is a scope for medium risk investment like mutual funds. A pool of money collected from various investors and invested with a common specified investment objective is called a mutual fund. While you own the investments collectively, your money is managed by a team of professionals hired specifically for the purpose. The managers try to deploy your money collectively into assets like equities and bonds that will ensure optimum returns. Mutual fund investing gives you the benefit of collective investing, diversification of risk and professional management, coupled with liquidity.

 

So now people know how & why to save and how & why to invest to become wealthy.

 

Why pay taxes?

We live in a democratic country with the rule of law. To pay taxes to the government is just abiding by the laws enacted by the parliament elected by us. If you want to change the law, then change the parliament but till then just pay your taxes. You have to basically pay a portion of what you earn to the Government as tax. Suppose you do a job and you earn Rs.20000 every month, then you will have to pay a part or a “percentage” of that money to the Govt. What is the percentage that you have to pay? That depends on the “tax bracket” you fall in. The Govt. feels that rich people can afford to give more money towards the development of the country and poor people cannot give much. Also the really poor people cannot give anything at all since they are struggling financially. So the Govt. has decided whether you are “very poor” or “poor” or “rich” or “very rich” depending on how much income you make. If you fall in the “very rich” category, then you have to pay a big percentage of your money towards the county. If you fall in the “very poor” category, then you do not have to pay anything to the country.  The govt. spends tax payer’s money in building infrastructure like roads & electricity, for health & education, for police and defense, for judiciary as well as subsidies for poor people. Remember, by not paying taxes, you are hurting national interest and creating black economy. The Govt. also wants us to invest for our own good and for the good of the nation. So to encourage people to invest their money to boost economy, the Govt. says that, “If you invest your money in these things, you do not have to pay ‘income tax’ for earning that money!”  Now this is a legal way of paying less tax than what you are supposed to pay. And this way is through “investments”. If you invest part of your income into Govt. bonds, infrastructure bonds, life insurance etc. then your income will reduce and you will have to pay less to the Govt. through income tax.  Also, govt. may announce tax cuts to increase investments to boost economy. A tax cut is a reduction in taxes. The immediate effects of a tax cut are a decrease in the real income of the government and an increase in the real income of those whose tax rate has been lowered. In the longer term, however, the loss of government income may be mitigated, depending on the response that tax-payers make. Depending on the original tax rate, tax cuts may provide individuals and corporations with an incentive for investments which stimulate economic activity. Tax cuts are an economic stimulus to the economy, along with interest rate intervention and deficit spending.

 

If you want to become rich, then you have to make changes. And the first changes you need to make will be those that focus on self-improvement.   

1)  Time is Gold. The truly wealthy don’t waste this precious commodity. 

2)  Get your Priorities straight. Be honest with yourself and decide which tasks are important and which ones are not.

3)  Start Planning Ahead.

4)  The only failure in life is failing to try. Of course, you will likely encounter obstacles that may stop you from reaching your goal temporarily, but the only time you will truly fail is when you don’t try at all.

5)  Give and Take. Be prepared to both ask for favors and give something in return.

6)  Do not be too proud or stubborn to take advice. There will always be something new to learn. This lesson can not only help you get rich, but it can help you stay rich and become richer as well.

7)  Trust that gut of yours – it doesn’t lie.

8) Guard your reputation – it’s all you’ve got.

9)  Keep going when the going gets tough – it makes the difference.

10) Expect gains and expect losses too.

 

Should people trust markets or government?

In the nations where the people trust the market more, such as in the United Kingdom and the US, you can see market economies with less government intervention than in those where people have less trust in the corporations and the impersonal strength of the market, such as is the case in Germany for example. A study concluded that public trust in government is basically just driven by economic statistics. The better the economy, the more the public trust in government. On the other hand, it has been found that economy can overcome recession when people start trusting government policies. Nonetheless, republicans in the US have been consistent in saying for thirty years that the bad economy is big government’s fault and the solution is to shrink government. At the end of a day, public trust is dependent on past experience and it is the public trust that determines whether they buy goods or save money or invest money. 

 

Goods & services are produced by humans and goods & services are consumed by humans. The more human work hard, the more goods they produce. The only thing which creates any wealth at all is hard work. More the goods are consumed; more will be the demand to produce goods and greater the need to invest more to live a better life. The only way to provide funds to invest to boost economic growth is to have a pool of savings to draw upon. The only way we can ensure that investment funds are properly allocated is to discipline the speculators and reward the careful investors. Good economy means people work hard to produce more goods and consume more goods to stimulate more production and invest more for better life. So good economy means you work hard and spend more and invest more. The economic policy implemented by government should encourage hard work by giving incentive for better work; reduce taxes on income & taxes on goods to enhance spending and offer incentives to promote investment. The creation of jobs and economy-boosting investment is the cornerstone of healthy economy. Any economy which is not geared towards rewarding hard work, savings & careful investment is an irrational economy and doomed to ultimate collapse.

 

THE MORAL OF THE STORY:

1)   As far as economy is concerned, most of the people all of the time; and all of the people most of the time don’t know what they are talking about.

 

2)   When economy is for the people, by the people and of the people, it works for the benefit of people. Unfortunately, it is often hijacked by politicians, bureaucrats and businessmen for their own benefit.

 

3)   Subsidies on food & petroleum products and social welfare programs harm nation’s economy. Politicians want such a dependent population because it will certainly vote for them at the cost of hard working tax paying class. Create more jobs for the poor & the unemployed rather than subsidizing essential commodities & provide welfare benefits. Charity can never be a substitute for hard work.

 

4)   Augmented & sensible spending on health & education does reduce poverty.

 

5)   Controlling population & good governance are the basic requirements for economic progress.

 

6)   For a better economy, every adult human must earn and every earning human must spend, save and invest in a balanced way. Too much spending without saving harms and too much saving without spending also harms.

 

7)   Low inflation rate, low interest rate, low tax rate, low unemployment rate, low economic inequality and low government meddling are the signs of a healthy economy. This is the “rule of low” enunciated by me.

 

8)   Energy runs the economy and the more you invest in renewable energy, the better will be your economic future.

 

Dr.Rajiv Desai. MD.

December 13, 2010

Postscript:

The year 2010 has been a significant year as far as educating students & people through internet is concerned. I have done my best by covering those subjects that concern people in their everyday life. I wish Merry Christmas and a happy & prosperous New Year 2011 to everybody.

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