Author: shyam

In 2010, a pair of Harvard economists published a paper, “Growth in a Time of Debt” that concluded that countries with a debt exceeding 90% of their annual GDP experienced slower growth than their thriftier peers. It was a statistic to which pro-austerity policymakers could cling and Germany, with a “never again” attitude towards Weimar Republic era hyperinflation, got much of Europe to sign-off on austerity to obtain bail-out funds.

However, biggest problem with austerity is that it can potentially kick-off a deflationary spiral that might actually increase indebtedness. And the latest euro-zone stat is proof of that: In the euro area the government debt to GDP ratio increased from 87.3% at the end of 2011 to 90.6% at the end of 2012. Besides, how is growth going to come about if both the public and private sectors contract at the same time?

The latest manufacturing PMI numbers are showing that the slow-down has now spread to the “core” Euro-zone economies. “The renewed decline in Germany will also raise fears that the region’s largest growth engine has moved into reverse, thereby acting as a drag on the region at the same time as particularly steep downturns persist in France, Italy and Spain.”

Bill Gross, of PIMCO fame, who had once warned that UK debt levels were too high, leaving gilts “resting on a bed of nitroglycerine” has recently changed his tune: “The UK and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth. It is not. You’ve got to spend money.”

And last week, Reinhart and Rogoff’s most famous finding has been debunked by a 28-year-old student. Earlier this month, Thomas Herndon, a graduate in the economics department at Amherst College in Massachusetts, found that they had made fundamental mathematical errors in the study – and all because of a flubbed Excel spreadsheet.

Will Europe’s policy makers change their stance and resort to a looser monetary policy and ease up on the austerity principle? Markets in europe (London +1.88%, Germany +2.23%, France +3.14%) started rallying as soon as the dismal PMI numbers came in – at least they seem to believe that the liquidity spigot is soon going to be let loose.

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• Who Is Defending Austerity Now?
• Austerity is Based on Fear and Greed, Not Theory
• Pimco’s Bill Gross blasts Europe’s focus on austerity
• The Strongest Evidence Yet That The Austerity Movement Has Suffered A Huge Blow

Atanu Dey has an interesting post where he outlines the three lessons of development economics:

1. Economic policies matter
2. The objectives of the policymakers matter in the choice of economic policies
3. The public determines what policies the politicians choose

He concludes:

The problem is that the general population does not know the basics of good economic policies. That’s the great challenge we face.

 

People need to know because if they did know, the policymakers would know that they cannot fool the public any more of their self-serving policies. That would bring about the conditions for the policymakers to choose good policies.

However, I feel that decades of socialism has corrupted the Indian soul. Deep within us, we know that current policies are setup to enrich those in power. And we also know what is to be done. But we don’t force our policymakers to make those changes because we, as a nation, are morally bankrupt. We are happy fighting between ourselves for the scraps that are thrown at us. And secretly, we all want the dole.

Source: Three Lessons of Development Economics, or Why Utsav Mitra is Mistaken

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Contingent liabilities are serious future obligations like lawsuits, warranties, etc. that may or may not be a problem. For example, if your parents guarantee your home loan, then if you make all your payments on time and do not default on your mortgage, there is no contingent liability on your parents. If you fail to make the payments, your parents will incur a liability.

Maybe its not a problem yet, but it appears the Indian IT companies are getting into riskier contracts in search of revenue. It used be that Indian IT companies were predominantly “body shops”, i.e., most of the contracts were labor based. An hourly or monthly labor rate was assigned to different skill levels and the contract outlined the total labor anticipated and quality of service goals. However, over the last 3-4 years, there has been a significant uptick in “gain sharing” contracts where the service provider obtains a share in the savings when outsourcing creates permanent cost savings. A gain-sharing contract better motivates the provider to innovate and to reduce operating costs.

The problem is that these contracts are not transparent to investors. How much of the anticipated revenue has been booked upfront? What if there are no “gains”? What if provider has a windfall year and the client decides to renegotiate the formula? Also, are investors aware of the risk-mismatch in contracts between what the provider has with its employees and its clients?

Investors should demand greater disclosure of these contingent liabilities before taking revenue numbers at face value.