Saurabh Mukherjea’s Four Must-Reads On EconomicsBloombergQuintOpinion
If you care about making money, you might be interested in economics.
Just as it is not easy to play cricket at the highest level, it is not easy to practice economics – whether macroeconomics (which pertains to how countries function) or microeconomics (which pertains to how companies function) – at the highest level. If you want to build more mental muscle regarding how economics informs decision-making (for companies and for nations), here are four super books.
Book 1: ‘Why Nations Fail’ (2012)
By Daron Acemoglu and James A. Robinson
The overarching theme of ‘Why Nations Fail’ is the relevance of “inclusive economic institutions” i.e. a combination of the state and the free markets working together, where the people’s voice is actively heard and acted upon by the leaders of the state. Acemoglu and Robinson believe that inclusive economic institutions encourage development, whereas an extractive economy can generate growth in the short term but ultimately ends up being poverty-stricken as a tiny elite squeezes the juice out of the bulk of the population.
Looking at different pairs of countries such as Mexico versus America as well as North versus South Korea, the authors illustrate that institutional differences which have been put into place over the last couple of decades have set the precedent for the country’s development or lack thereof.
For example, when looking at America and Mexico, the authors focus on a city named Nogales which lies partly in Arizona, U.S., and partly in Sonora, Mexico, with pretty evident differences in average income, percentage of graduates, infrastructure as well as the health of the population, even though factors like geographical location, culture, climate, etc., are more or less similar for the two halves of the city. The Mexico part of the city has an average income that is roughly 1/3rd of the American part.
The authors explain that the root of this disparity is the enslavement of Mexico by the Spanish colonialists. The Spaniards used slavery to their benefit to extract large amounts of gold and silver from Mexico and left behind a government that carried forward this legacy. The colonial elite was simply replaced by a Mexican elite which perpetuated the extractive institutions. Egypt, North Korea, Sierra Leone, and Zimbabwe are similar to Mexico in this regard.
In contrast, in countries like the United Kingdom, the United States, Japan, and Botswana, citizens were able to overthrow the elites and make their voices heard in the corridors of power.
Book 2: ‘Other People’s Money’ (2016)
By John Kay
In this critique of investment bankers, fund managers, and other characters who hang around global capital markets, John Kay has captured the problems bedevilling contemporary financial systems.
Growing up in Edinburgh, John noticed that a typical male bank manager 50 years ago was meant to be skilful at chatting to clients on the golf course. Fast forward to today, says John, and these very managers are highly paid, smart alpha males and females. However, John finds that doing business at the nineteenth hole was far better than what is going on in British banks today. For example, today only 3% of British banks’ total assets are loans to entities engaged in the production of goods and services. The vast majority of loans are loans to other banks, thus showcasing the fact that the primary business activity of large-scale banks today is not financing and expanding the real economy but merely “exchanging bits of paper” with their fellow bankers.
Financial products such as derivative instruments, which are based on market liquidity and complex structure, have helped the wealthy and educated business class while swift and efficient payment systems have helped the masses but not at the same scale.
At its core, finance is an information business and, therefore, those who are in the know of have been, and always will be better off than those who are not.
50 years ago bank managers had a personal interest in ensuring that the banks lent only to those who were able enough to repay the borrowed amount, in the sense that a considerable amount of their own money (bank managers’) was invested with the bank. In the case of a default, the brunt would have been borne by the managers of the bank too. Today, however, this is not true. Bank managers (both retail and investment bankers) do not have to invest any of their own ‘skin in the game’. They mostly handle other people’s money and are thus incentivised to take greater risk with that money. This dynamic ultimately climaxes in episodic financial crises like 2008.
Book 3: ‘Information Rules’ (1998)
By Carl Shapiro and Hal Varian
“Information Rules”, by Carl Shapiro & Hal R. Varian (now the chief economist at Google), illustrates the difference between information and physical goods. In particular, information goods are typically more expensive to produce, and almost free to reproduce. Think of a code designed to use artificial intelligence to detect locations that would face famines. The software development might incur costs (hiring a coder, investment in technology, etc.). However, once the software is ready to use, subject to copyright, it is almost free to reproduce if the technology is available with the party hoping to replicate it. This makes it increasingly difficult to price such products, given that their subsequent costs of production are often zero or negligible.
This simple concept in turn leads to the first major strategy as espoused by the book: Price Discrimination. Using price discrimination, we can attempt to price the good in proportion to the propensity of the buyer to pay for the good. There are different ways of implementing differential pricing such as personalised pricing, group pricing, or versioning.
Versioning is a specific type of price discrimination wherein the company creates different versions of the same product at different price points, for example, a hardback, paperback, and a Kindle version of the same book. An important aspect of versioning is selecting aspects of the product that are more important to some users and less so to others. For example, when a major artist releases a new song, at first, they only release one song as a teaser. However, they make all their listeners purchase their album to listen to any of the other songs. This way they are able to attract more listeners and make money.
The second major business strategy espoused by the book is that of Network Effects. For example, in the case of Facebook, the more people join the better is it for their friends. Facebook is only valuable to me when people I know are also using it. Hence the more valuable it becomes to its users, the larger its user base grows, the better it is for its owners – more users mean more advertising revenue.
Linked to the preceding business concept is the third major business strategy highlighted by the authors: Switching Costs. Switching costs are those associated with moving a consumer from one product/service to another. Even small switching costs can have a large effect. Consider when people have to move to iTunes from MP3 or vice versa. They will only do this if the new service is going to be significantly better. Switching costs in turn lead to “standard wars” when two incompatible technologies clash.
For instance, Android and iOS (Apple) can be seen as two operating systems that do not work well together. When one technology is incompatible it signifies a “revolution” strategy, against an “evolution” strategy when backward compatibility exists. Winners of standard wars are those who can keep up with the growing and advancing technology, paying attention to one’s products, its complementary goods, and how these can be used to build a monopoly franchise.
Book 4: ‘Money and Government’ (2018)
By Robert Skidelsky
Robert Skidelsky’s book is a survey of the main ideas driving macroeconomics over the last three hundred years, specifically how governments’ perception of the use of fiscal and monetary policy to steer the economy has changed over the last three centuries. Skidelsky says that recessions should be solved through a combination of the government using fiscal and monetary policy tools. These tools cannot be global, in the sense that no one size fits all, and they need to be tailored to a country’s specific requirements.The Keynesian innovation was that the government should influence the level of total spending though the fiscal policy, with monetary policy made consistent with the aims of fiscal policy. By contrast, in new classical economics, monetary policy – keeping the economy supplied with the right amount of money – is the whole of macroeconomic policy, since fiscal policy cannot influence the total spending, only its direction.”
Another concern for Skidelsky is policy intervention that helps the elite rather than the masses.
For example, Skidelsky takes the view that what the U.S. Federal Reserve did after the crash of the Lehman Brothers helped the American elite rather than the economy because quantitative easing achieved little besides a sharp increase in the prices of housing and financial assets. Overall, quantitative easing has become a platform to bail out banks and enabling bankers to help reward themselves continuously.
Therefore, Skidelsky repeatedly reiterates in the book that using a clever combination of fiscal and monetary policy can help the masses, and not just the top tier of the population: “The Keynesian innovation was that the government should influence the level of total spending through the fiscal policy, with monetary policy made consistent with the aims of fiscal policy. By contrast, in new classical economics, monetary policy – keeping the economy supplied with the right amount of money – is the whole of macroeconomic policy, since fiscal policy cannot influence the total spending, only its direction.”
In contrast to what was done after the 2008 financial crisis, in the wake of the Covid-19 crisis governments the world over have combined quantitative easing with fiscal largesse i.e. money transferred into the pockets of the public. If Skidelsky’s book is anything to go by, this should lead to an almighty economic boom over the next 3-5 years.
Saurabh Mukherjea and Nandita Rajhansa are part of the Investments team at Marcellus Investment Managers.
The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.