Main

The capital requirement is a bank regulation, which sets a

framework on how banks and depository institutions must handle their
capital. The categorization of assets and capital is highly standardized so that
it can be risk weighted (see Risk-weighted asset). Internationally, the Basel
Committee on Banking Supervision housed at the Bank for International
Settlements influence each country's banking capital requirements. In 1988,
the Committee decided to introduce a capital measurement system
commonly referred to as the Basel Accord. This framework is now being
replaced by a new and significantly more complex capital adequacy
framework commonly known as Basel II. While Basel II significantly alters
the calculation of the risk weights, it leaves alone the calculation of the
capital. The capital ratio is the percentage of a bank's capital to its risk-
weighted

The capital market deals with capital. Capital Market is generally

understood as a market for long term funds and investments in long term
instruments available in this market. However now this market also includes
short-term funds. Capital markets mean the market for all the financial
instruments, short term and long term as so commercial industrial and
government paper.

The capital market is a market where borrowing and lending of long

term funds takes place. Capital market deals in both, debt and equity. In
these markets productive capital is raised and made available to the
corporate. The governments both central and state raise money in the capital
market through the issue of government securities. Capital market refers to
all the institutes and mechanisms of raising medium and long-term funds,
through various instruments available like shares, debentures, bonds etc.

Thus the capital market plays a very important role in promoting

economic growth through the mobilization of long-term savings and the
savings get invested in the economy for productive purpose. The capital
market in India is a well integrated structure and its components include
stock exchanges, developed banks investment trusts, insurance corporations
and provident fund organization. It caters to the varied needs for capital of
agriculture, industrial and trading sectors of the economy. There are two
important operations carried on in these markets. The raising the new capital
and Trading in the securities already issued by the companies.

With the pace of economic reforms followed in India, the importance

of capital markets has grown in the last ten years. Corporate both in the
private sector as well as in the public sector raise thousands of crores of
rupees in these markets. The governments, through Reserve Bank of India,
as well as financial institutes also raise a lot of money

from these markets. The capital market serves a very useful purpose by
pooling the savings.

The capital markets encourage capital formation in the country. The

capital markets mobilize savings of the households and of the industrial
concerns. Such savings are then invested for productive purposes. Capital
markets also facilitate the growth of the industrial sector, as well as the other
sectors of the economy. The capital markets provide funds for the projects in
backward areas. Thus, Capital markets generate employment in the country.

They also facilitate the development of stock markets. Due to capital

markets, the public has alternative sources of investment. The public can
invest not only in bank deposits, but also in shares and debentures issued by
public companies. The commercial banks and FIs provide timely financial
assistance to viable sick units to overcome their industrial sickness. The
banks and FIs may also write off a part of loan, or they re-schedule the loan,
so as to offer payment flexibility to the weak units, which in turn helps the
weak units to overcome financial crisis.
INTERMEDIARIES IN CAPITAL MARKET

Capital market requires many intermediaries who are responsible to

transfer funds from those who save to those who require these funds for
investments. The efficiency of the markets is dependent on the specialization
attained by these intermediaries. Some of them are as follows:

1. Stock Exchanges.
2. Banks.
3. Investment Trusts and Companies.
4. Specialized Financial Institutions or Development Banks.
5. Mutual Funds.
6. Non-Banking Financial Institutions.
7. International Financial Investors and Institutions.
INVESTORS IN CAPITAL MARKET

The supply in this market comes from savings from different sectors
of the economy. These savings accrue from the following sources:

1. Individuals.
2. Corporate.
3. Governments.
4. Foreign countries.
5. Banks.
6. Provident Funds.
7. Financial Institutions.

All these entities contribute to savings in the economy part of these

savings naturally flow in the capital markets. Individuals invest in these
markets directly by investing in shares or debentures of companies through
bond issues of public sector units or through mutual funds. Corporate who
have more savings than their requirement for funds also are participants in
this market.
GROWTH OF CAPITAL MARKET IN INDIA

There has been considerable growth in the capital markets in India.

The following are the factors responsible for the growth of capital markets in
India.
 1. Growth of Stock Exchanges in India
2. Growth of Financial Institutions
3. Growth of Mutual Funds
4. Growth of Merchant Banking in India
5. Growth of Multinationals Growing Public Confidence
6. Growth of Entrepreneurs
7. Development of Venture Capital Funds
8. Development of Credit Rating Agencies
9. Setting up of SEBI
10.Setting up of National Securities Clearing Corporation
11.Setting up of Corporate Governance
12.Setting up of Clearing Corporation of India Limited
General Awareness

SCENARIO OF INDIAN CAPITAL MARKET

Indian Stock Markets are one of the oldest in Asia. Its history dates
back to nearly 200 years ago. The earliest records of security dealings in
India are meagre and obscure. The East India Company was the dominant
institution in those days and business in its loan securities used to be
transacted towards the close of the eighteenth century. By 1830's business on
corporate stocks and shares in Bank and Cotton presses took place in
Bombay. Though the trading list was broader in 1839, there were only half a
dozen brokers recognized by banks and merchants during 1840 and
1850.The 1850's witnessed a rapid development of commercial enterprise
and brokerage business attracted many men into the field and by 1860 the
number of brokers increased into 60.

In 1860-61 the American Civil War broke out and cotton supply from
United States of Europe was stopped; thus, the 'Share Mania' in India begun.
The number of brokers increased to about 200 to 250. However, at the end
of the American Civil War, in 1865, a disastrous slump began (for example,
Bank of Bombay Share, which had touched Rs2850/-, could only be sold at
Rs.87/-).

At the end of the American Civil War, the brokers who thrived out of
Civil War in 1874, found a place in a street (now appropriately called as
Dalal Street) where they would conveniently assemble and transact business.
In 1887, they formally established in Bombay, the "Native Share and Stock
Brokers' Association" (which is alternatively known as “The Stock
Exchange"). In 1895, the Stock Exchange acquired a premise in the same
street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay
was consolidated.

In the era of globalization and liberalization, the capital market

assumes a greater importance. The smooth functioning of the capital market
depends on the regulators,

participants and investors. The past decade has been a golden age for capital
markets in India. It is now a far more important source of finance than
traditional financial intermediaries for corporate sector. It is poised to
dominate the future of corporate finance in India. Over the past several years
the capital market has witnessed a sea change. The market has become more
in terms of infrastructure, adoption of best international practices and
introduction of competition.

Reforms in the capital market, particularly the establishment

empowerment of SEBI, market determined allocation of resources, screen
based nation-trading, dematerialization and electronic transfer of securities,
rolling settlement and ban on deferral products, sophisticated risk
management and derivatives trading, have greatly improved the regulatory
framework and efficiency of trading and settlement. Indian market is now
comparable to many developed markets in terms of a number of quantitative
parameters.

The process of reforms has led to a pace of growth of markets almost

unparalleled in the history of any country. Capital market in India has grown
exponentially as measured in terms of amounts raised from the market,
number of stock exchanges and intermediaries; the number of listed stocks,
market capitalization, trading volumes and turnover on stock exchanges and
investors population. Along with this, the profiles of the investors, issuers
and intermediaries have changed significantly. The market has witnessed
fundamental institutional changes resulting in drastic reduction in
transaction cost and significant improvements in efficiency, transparency
and safety. Indian market is now comparable to many developed markets.
There are few countries, which have higher turnover ratio than India, market
capitalization as percentage of GNP compares favorably even with advanced
countries and is much better than emerging market.
ROLE OF CAPITAL MARKET IN INDIA

1. CAPITAL FORMATION
The capital market encourages capital formation in the country. Rate
of capital formation depends upon savings in the country. Though the banks
mobilize savings, they are not sufficient to match the requirements of the
industrial sector. The capital market mobilizes savings of households and of
the industrial concern. Such savings are then invested for productive
purposes. Thus savings and investment leads to capital formation in country.

2. ECONOMIC GROWTH
Capital market facilitates the growth of the industrial sector as well as
other sectors of the economy. The main function of the capital market is to
transfer resources (funds) from masses to the industrial sector. The capital
market makes it possible to lend funds to various projects, both in the private
as well as public sector.

3. DEVELOPMENT OF BACKWARD AREAS

The capital markets provide funds for the projects in backward areas.
This facilitates the economic development of backward areas.

4. GENERATES EMPLOYMENT
Capital market generates employment in the country:
i) Direct employment in the capital markets such as stock markets,
financial institutions etc.
ii) Indirect employment in all sectors of the economy, because of the
funds provided for developmental projects.
 5. LONG TERM CAPITAL TO INDUSTRIAL SECTOR
The capital market provides a permanent long-term capital for the
companies. Once, the funds are collected through issues, the money remains
with the company. The company is left free with the funds while investors
exchange securities among themselves.

6. GENERATION OF FOREIGN CAPITAL

The capital market makes possible to generate foreign capital. Indian
firms are able to generate capital from overseas markets by way of bonds
and other securities. Such foreign exchange funds are vital for the economic
development of the nation.

7. DEVELOPING ROLE OF FINANCIAL INSTITUTIONS

The various agencies of capital market such as Industrial Financial
Corporation of India (IFCI), State Finance Corporations (SFC), Industrial
Development Bank of India (IDBI), Industrial Credit and Investment
Corporation of India (ICICI), Unit Trust of India (UTI), Life Insurance
Corporation of India (LIC), etc. have been rendering useful services to the
growth of industries. They have been financing, promoting and underwriting
the functions of the capital market.

8. INVESTMENT OPPORTUNITIES
 Capital markets provide excellent investment opportunities to the
members of the public. The public can have alternative source of investment
i.e. in bonds, shares and debentures etc.

Executive Summary
India offers high & uncorrelated returns to FIIs against low returns in
developed markets.
This coupled with interest rate differentials and positive India sentiment,
remains the
overwhelming cause of inflows in Indian capital markets and the recent
rally. Equity markets
have fared well compared to debt on eight systems (market processes)
parameters.
However Indian Capital markets are
• As yet, not a barometer of the performance of the Indian corporate sector
• Currently, they are not the most important source of funds to Indian
economy.
There is case for making capital markets more relevant to the overall
growth of the
Indian economy. We examine if capital markets can provide the economy
with a growing
mean rate of capital supply without sudden shocks and thus being more
integral to the
Indian growth story. To analyze if capital markets stand on verge of
explosive growth, we
ask the following questions and attempt to answer them.
Paragraph

Both points of view are right and wrong. Let me explain.

I was delighted when in this year’s Budget speech, our finance minister said
the manufacturing sector has been the growth engine for the economy. It
marked a recognition that at this stage of our industrial development, when a
large number of unskilled and semi-skilled people will migrate from rural to
urban areas, creating manufacturing jobs is critical for absorbing these vast
numbers.
 But is manufacturing growth creating
these jobs? The last two decades has
seen India’s manufacturing sector
growing at six to seven per cent a
year, second only to China. In this same period the growth in formal
employment in the sector has been, at best, marginal. It is not that the capital
intensity or labour productivity has dramatically increased. Most of the
employment has grown in the informal sector. So the notion that
manufacturing growth equates formal employment growth is not strictly
true.

Two critical indicators cause concern. First, manufacturing productivity is

not growing fast enough. Between 1995 and 2008, productivity growth has
been in low single digits. By comparison China’s productivity has grown at
around 13 per cent in the same period.

Second, we are not “deepening” our economy fast enough. The fact is that
India imports most of its capital goods requirements. In the five-year period
from 2003 to 2008 manufacturing GDP has grown by about 1.5 times, but
net imports of industrial machinery and equipment have grown nearly 7.5
times.

Although the recent performance of the capital goods sector is heartening, I

believe we have reached a cross-road in the development of our industrial
base. India needs over 220 million jobs between now and 2025. The
manufacturing sector has to provide at least 100 million of these. We all
know that the labour intensity can vary dramatically from one industry to
another. The paper and wood products industry requires 45 times more
people than the metals industry for the same output in value terms. Do we
need to make specific choices on the industries to incentivise and support to
create more jobs? Clearly, industries like paper and wood products, textile,
leather and food products have a much higher capacity to create jobs for the
same level of investments than, say, transportation equipment or chemicals.

But we also need to create jobs in the formal sector where there is better pay
and greater protection of workers’ rights. It is paradoxical that the labour
laws our trade unions fight to protect from change have resulted in not more
but less potential membership. The government has appointed numerous
commissions to study the labour laws and recommend changes. The issue is
not what to do but whether we have the political will to do it.
The demographic advantage of India’s low-cost abundant labour has been
touted by one and all. It is an advantage only if this labour is productive and
competitive. In 1995 India’s manufacturing sector had a higher labour
productivity (measured in value of output to labour cost) than China. By
2000 China’s overall labour productivity had overtaken us, and now it is
improving annually at nearly double India’s improvement rate.

Five factors have contributed to this: (i) better infrastructure which allows
bigger scale plants; (ii) higher availability of lower cost funds which also
support larger plants; (iii) faster project execution which means faster time-
to-market and higher revenues; (iv) government-induced consolidation and
phasing out of low-tech plants; (v) strong clustering actively promoted by
the government.

A plant in a competitive cluster can have as much as an eight per cent lower
operating costs compared to a plant outside a cluster. Our industrial clusters
like the pharma cluster in Hyderabad or the automotive cluster in Chennai
have largely evolved on their own. Clusters are not only about physical co-
location of plants or supply chain partners. Having a knowledge centre in the
form of a university is equally critical. We have the choice to move forward
with the policies of “asset play” in the form of SEZs and the proposed
National Manufacturing Zones or to a more integrated “knowledge play” to
build and sustain competitive clusters.

My final agenda is on strengthening the fundamental building blocks of

industrial economy — the capital goods industry. It is no surprise that the
global leaders of telecom, power, construction equipment and several other
industries are now Chinese players. These sectors are part of their policy of
creating “pillar” industries. They have actively designed and implemented
policies to build global competitiveness of specific industries of national
importance. Having served their own economy well, these players are now
playing an increasingly important role in the global market.

The choice facing us is whether we are happy to simply grow our industrial
capacity to feed domestic demand or whether the government should
actively influence the type and quality of these investments as a prerequisite
to building a globally competitive industrial base.

A well-known CEO of an Indian manufacturing company told me the story

of an Indian player setting up a plant in China as base for exports to Africa.
He lamented the reasons that force our industry players to take such
decisions. This may be a one-off example, but it forces us to take notice of
the underlying challenges facing the manufacturing sector today. Unless we
demonstrate leadership and make the right choices to create the 100 million
jobs and build sustainable global competitiveness, I fear we will find it
difficult to sustain our celebrations!

7
All this confirms that the crisis did not originate in any sudden refusal of
consumers to consume or in
any surge in unemployment. To the extent that unemployment is growing
and consumption is
declining, they are both the consequence of the economy's loss of capital.
The loss of capital is what
precipitated a reduction in the availability of credit and a widening wave of
bankruptcies, which in
turn has resulted in growing unemployment and a decline in the ability and
willingness of people to
consume. The collapse in home prices and the more recent collapse in the
stock market have also
contributed to the decline in consumption, and probably to an even greater
extent, at least up to
now. Both of these events are also an aspect of the loss of capital and
accumulated savings.
What Economic Recovery Requires
What all of the preceding discussion implies is that economic recovery
requires that the economic system rebuild its stock of capital and that to be
able to do so, it needs to engage in greater saving relative to consumption.
This is what will help to restore the supply of credit and thus help put an end
to financial failures based on a lack of credit.
Recovery also requires the freedom of wage rates and prices to fall, so that
the presently reduced
supply of capital and credit becomes capable of supporting a larger volume
of employment and
production, as I explained in "Falling Prices Are Not Deflation but the
Antidote to Deflation,"w hich
was my first article in this series. Recovery will be achieved by the
combination of more saving,
capital, and credit along with lower wage rates, costs, and prices.
In addition, recovery requires the rapid liquidation of unsound investments.
If borrowers are unable
to meet their contractual obligation to pay principal and interest, the assets
involved need to be sold
off and the proceeds turned over to the lenders as quickly as possible, in
order to put an end to
further losses and thus salvage as much capital from the debacle as possible.
In the present situation of widespread financial paralysis, firms and
individuals can be driven into
bankruptcy because they are unable to collect the sums due them from their
debtors. Thus, for
example, the failure of mortgage lenders would be alleviated, if not perhaps
altogether avoided in
some cases, if the mortgage borrowers who were in default on their
properties lost their houses
quickly, with the proceeds quickly being turned over to the lenders.
In that way, the lenders would at least have those funds available to meet
their obligations and thus
might avoid their own default; in either event, their creditors would be better
off. In helping to
restore the capital of lenders, or what will become the capital of the creditors
of the lenders, quick
foreclosures would serve to restore the ability to originate new loans.
Recovery requires the end of financial pretense. There are banks that do not
want to see the
liquidation of various types of assets that they own, notably, "collateralized
debt obligations" (CDOs).
These are securities issued against collections of other securities, which in
turn were issued against
collections of mortgages, an undetermined number of which are in default or
likely to go into
default. The presumably low prices that such securities would bring in the
market would likely serve
to reveal the presence of so little capital on the part of many banks that they
would be plunged into
immediate bankruptcy. To avoid that, the banks want to prevent the
discovery of the actual value of
those securities. At the same time, they want creditors to trust them. Yet
before trust can be
established, the actual, market value of the banks' assets must be established,
even if it serves to
bankrupt many of them. The safety of their deposits can be secured without
the banks' present
owners continuing in that role.
8
When these various requirements have been met and the process of financial
contraction comes to
an end, the profitability of business investment will be restored and recovery
will be at hand.
The Nature of Stimulus Packages
As was shown earlier, economic recovery requires greater saving and the
accumulation of fresh
capital, to make up for the losses caused by credit expansion and the
malinvestment and
overconsumption that follow from it. Yet the imposition of "stimulus
packages" results in the further
loss of capital. The Keynesians not only do not know this, but would not
care even if they did know it.
Because of their ignorance of the role of capital in the economic system and
resulting inability to see even the clearest evidence that suggests it, the
Keynesians can conceive of no cause of a recession or depression but an
insufficiency of consumption and no remedy but an increase in
consumption. This is the basis of their calls for "stimulus packages" of one
kind or another.
They assume that the economic system always has enough capital, indeed,
that it is in danger of
having too much capital, and that the problem is simply to get it to use the
capital that it has. The
way that this is done, they believe, is to get people to consume. Additional
consumption will be the
"stimulus" to new and additional production. When people consume, the
products of past
production are taken off the shelves and disappear from the stores. These
products, the Keynesians
believe, now require replacement. Hence, the shops will order replacement
supplies and the
manufacturers will turn to producing them, and thus the economic system
will be operating again
and recovery will be achieved, provided the "stimulus" is large enough.
The essential meaning of a "stimulus package" is the government's financing
of consumption, indeed, practically any consumption, by anyone, for almost
any purpose, in the conviction that this will cause an increase in employment
and production as the means of replacing what is consumed. Despite talk of
avoiding wasteful spending and being "careful with the taxpayers' money,"
the truth is that from the point of view of the advocates of economic
stimulus, the bigger and more wasteful the project, the better.
This was made brilliantly clear many years ago by Henry Hazlitt, who chose
the example of
government spending for a bridge. It is one thing, Hazlitt showed, if the
government builds a bridge
because its construction is necessary to facilitate the flow of traffic. It is a
very different matter, he
pointed out, if the government builds the bridge for the purpose of
promoting employment. In the
first case, the government wants the best bridge for the lowest possible cost,
which implies the
employment of as few workers as possible, both in the construction of the
bridge and in the
production of any of the materials that go into it.
In the second case, that of stimulating employment, the government wants a
bridge that requires as
many workers as possible, for their employment is its actual purpose. The
greater the number of
workers employed, of course, the greater must be the cost of the bridge.
Indeed, no one could be more clear or explicit concerning the nature of
government "fiscal policy" and its "stimuli" than Keynes himself, who
declared (on p. 129 of his General Theory) that "Pyramid building,
earthquakes, even wars may serve to increase wealth, if the education of our
statesmen on the principles of the classical economics stands in the way of
anything better."
Acts of sheer destruction, such as wars and natural disasters, appear as
beneficial to Keynes and his
followers for the same reason that the "stimulus" of government-financed
consumption appears
beneficial. This is because they too create a need for replacement and thus
allegedly result in an
9
increase in employment and production. So widespread is this view that one
can very often hear people openly express favorable opinions about the
alleged economic benefits of such things as earthquakes, hurricanes, and
even wars.
Stimulus Packages Mean More Loss of Capital
Despite the fact that what the economic system needs for recovery is saving
and the accumulation of
new capital, to replace as far as possible the capital that has been lost, the
effect of stimulus
packages is further to reduce the supply of capital, and thus to worsen the
recession or depression.
The reason that stimulus packages cause a further loss of capital is that their
starting point is the
consumption of previously produced wealth. That wealth is part of the
capital of the business firms
that own it. The stimulus programs offer money in exchange for this wealth
and capital. But the
money they offer does not come from the production of any comparable
wealth by the government
or those to whom it gives money — wealth which has had to be produced
and sold and thus put into
the economic system prior to the withdrawal that now takes
11
However, as I say, such an outcome is highly unlikely. If for no other
reason, this is because, as I have
already pointed out, the stimulus packages take place in an environment in
which investors fear to
invest in private firms. As a result, they use not only whatever new and
additional savings they might
make, for the purpose of buying "safe" treasury securities but also even
funds they earn that are
required for the replacement of capital goods. In this way, savings are
diverted into consumption
rather than capital accumulation.
(It is ironic that while, if it did manage to occur and was not diverted into
consumption, such saving
might mitigate the effects of a stimulus package, it is attacked as
undermining the process of
recovery. Thus, for example, Paul Krugman, the 2008 Nobel Prize winner in
economics, writes:
"Meanwhile, it's clear that when it comes to economic stimulus, public
spending provides much
more bang for the buck than tax cuts…because a large fraction of any tax cut
will simply be saved."
New York Times, January 26, 2009, p. A23.)
In addition to the diversion into consumption of such new savings as might
occur subsequent to a
"stimulus," there is the fact that the source of any such saving, namely, the
net product produced, is
likely to be greatly diminished. The net product is the excess of the product
produced over the capital
goods used up in order to produce it. It is what is available for consumption
or saving out of current
wage, profit, and interest income.
The net product is diminished to the extent that production is made to take
place in accordance with methods requiring the employment of unnecessary
capital goods per unit of output. Environmental and consumer product safety
legislation provide numerous instances of this kind.
For example, requiring gas stations, dry-cleaning establishments, and many
other types of businesses
to substantially increase their capital investments merely in order to placate
the largely groundless
fears of the environmental movement. Similarly, requiring safety features in
automobiles,
dishwashers, display cases, ice machines, stepladders, and countless other
goods — features that the
market does not judge to be worth their cost — adds to the cost of the
materials and components
that enter into the production of products without increasing the perceived
value of the products. In
both instances, the result is a larger consumption of capital goods but no
increase in production, and
thus a reduction in the size of the net product produced and thus in the
ability to engage in saving
out of current income.
As indicated earlier in this article, the effect of capital decumulation,
whether caused by stimulus
packages or anything else, is a reduction in the ability of the economic
system to produce, to employ
labor, and to provide credit, for each of these things depends on capital. The
reduced ability to
produce and employ labor may not be apparent in the midst of mass
unemployment. But it will
become apparent if and when economic recovery begins. At that point, the
economic system will be
less capable than it otherwise would have been, because of the reduction in
its supply of capital. Real
wages and the general standard of living will be lower than they otherwise
would have been. And all
along, the ability to grant credit will be less than it otherwise would have
been.
Stimulus Packages Are a Drain on the Rest of the Economic System
Even though stimulus packages may be able to generate additional economic
activity, they cannot
achieve any kind of meaningful economic recovery. Their actual effect is the
creation of a system of
public welfare in the guise of work. That is in the nature of employing
people not for the sake of the
products they produce but having them produce products for the sake of
being able to employ them.
12
But stimulus packages are much more costly than simple welfare. On top of
the welfare dole that
allows unemployed workers to live, stimulus packages add the cost of the
materials and equipment
that the workers use in producing their pretended products.
The work created by stimulus packages is a make-believe work that is
carried on at the expense of
the rest of the economic system. It draws products and services produced in
the rest of the economic
system and returns to the rest of the economic system little or nothing in the
way of goods or
services that would constitute value for value or payment of any kind. In
other words, stimulus
packages and the needless work they create cause the great majority of other
people to be poorer.
I've already shown how they cause them to have less capital. Shortly, I will
show how they also cause
them to consume less. (For elaboration on this point, please see the
forthcoming republication of my
article "Who Pays for 'Full Employment'?")
Rising Prices in the Midst of Mass Unemployment
If economic recovery is to be achieved, the first thing that must be done is to
stop "stimulus
packages" and undo as far as possible any that are already in progress. This
is because their effect is
to worsen the problem of loss of capital that is the underlying cause of the
economic crisis in the first
place.
Unfortunately, they are not likely to be stopped. If they are implemented,
especially on the scale already approved by Congress, the effect will be a
decumulation of capital up to the point where scarcities of capital goods,
including inventories of consumers' goods in the possession of business
firms, start to drive up prices.
Higher prices of consumers' goods will result not only from scarcities of
consumers' goods (which, of
course, are capital goods so long as they are in the hands of business firms),
but also from scarcities
of capital goods further back in the process of production. Thus a scarcity of
steel sheet will not only
raise the price of steel sheet, but will carry forward to the price of
automobiles via the higher cost of
producing automobiles that results from a rise in the price of steel sheet.
Likewise, a scarcity of iron
ore will carry forward to the price of steel sheet, which, again, will carry
forward to the price of
automobiles. And, of course, the pattern will be the same throughout the
economic system, in such
further cases as oil and oil products, cotton and cotton products, wheat and
wheat products, and so
on.
A rise in the prices of consumers' goods is capable of stopping further
capital decumulation
stemming from the stimulus packages. When the point is reached that
additional funds spent on
consumers' goods serve merely to raise their prices, then no additional
quantities of them are sold.
The same quantities are sold at higher prices. This ends the decumulation of
inventories. From this
point on, the buyers who obtain their funds from the government consume at
the expense of people
who have earned their incomes but now get less for them.
Once inventories become scarce in relation to the spending for goods, all of
the funds that the
government has been pouring into the economic system become capable of
launching a major
increase in prices. This rise in prices can take place even in the midst of
mass unemployment. This is
because the abundance of unemployed workers does nothing to mitigate the
scarcity of capital
goods that has occurred as the result of the attempts to stimulate
employment.
Even though rising prices can deprive stimulus packages of the ability to
cause further capital
decumulation, the inflation of the money supply by the government results
in continuing capital
decumulation. In large part, this occurs as the result of the fact that the
additional spending resulting
13
from a larger money supply raises business sales revenues immediately
while it raises business costs
only with a time lag. So long as this goes on, profits are artificially
increased.
Despite the fact that most or all of the additional profits may be required
simply in order to
replace assets at higher prices, the additional profits are taxed as though they
were genuine
gains. This impairs the ability of firms to replace their assets. The
destructive consequences
of this phenomenon can be seen in the transformation of what was once
America's
industrial heartland into the"rust be lt."
At the same time, throughout the economic system, starting long before
today's stimulus
packages and continuing on alongside them, regular, almost year-in, year-
out government
budget deficits do their work of destruction. They cause a continuing
diversion into
consumption not only of a considerable part of whatever savings might be
made out of
income but also of the replacement allowances for the using up of plant and
equipment and
all other fixed assets. Generations of government budget deficits have
sucked up trillions of
dollars of what would have been capital funds and have gone a long way
toward turning
America into an industrial wasteland.
The blind rush into massive "stimulus packages" is the culmination of
generations of
economic ignorance transmitted from professor to student in the guise of
advanced,
revolutionary thinking — the "Keynesian revolution." The accelerating
destruction of our
economic system that we are now experiencing is the product of a prior
destruction of
economic thought. Our entire intellectual establishment has been the victim
— the willing
victim — of a massive intellectual con job that goes under the name
"Keynesianism." And we
are now paying the price.
I say,willing victims of an intellectual con job. What other description can
there be of those
who were ready to hail as a genius the man who wrote, "Pyramid building,
earthquakes,
even wars may serve to increase wealth…."
Only a brave few — most notably Ludwig von Mises and Henry Hazlitt —
stood apart from this madness, and for doing so, they were made intellectual
pariahs. But the time is coming when it will be clear to all who think that it
is they who have had the last word.

Q2 –Should firms raise capital abroad (ADR/GDR) or in India? Which

would be
followed by the majority in the future?
Foreign investors require a lower rate of return from Indian equities due to
low
correlation, reducing the cost of capital in India. We conclude that there is
now no
CRISIL Young Thought Leader 2005 Apurv Parashar
liquidity premium to be enjoyed in ADR/GDR listing by Indian companies
and that such
issuances actually incur an opportunity cost of not raising capital in
India (except for
Bond financing). We infer that in the next 10-15 years, Indian firms will
consolidate all
their liquidity in India and will avoid fragmentation of their liquidity,
and obtain
the lowest possible cost of capital.

Q1 – Is FII inflow a reliable source of capital? Is it based on economic

fundamentals
or is it a short term bargain hunt?
It is concluded that FIIs are currently operating on a more short term volatile
strategies (in
equity as well as debt) resulting in potential volatility. In the Two –
Dimensional Reward to
Risk framework developed by this author to analyze the nature of FII
inflow, it can be seen
that FII inflow will most likely plateau out when interest rate differentials
disappear and the
Indian markets become more correlated with developed markets. The
framework also
concludes from macro variables (ignoring future externalities) that other
emerging markets
(e.g. Mexico) will emerge more attractive as high uncorrelated returns in
India recede.

Q2 – What is the role (long term) of domestic financial institutions in

capital market
development in such a scenario explored in Q1?
After FII investments stabilize, it is the role of domestic institutions to
replace the FII inflow
as the engines of capital market development. FII exit would be much easier
after 5-10 years
due to lower impact and transaction costs in the future. Therefore, domestic
investment
capabilities must be developed to lead market development at that time.
In addition to
the current reforms launched by the government allowing banks/life/pension
funds to invest
CRISIL Young Thought Leader 2005 Apurv Parashar
in capital markets, further steps could involve them being allowed a wider
range of
investment and new derivative instruments to manage risk along with an
active mortgage
market. To enable domestic investment across the board (not just blue chip
firms), we
need a paradigm shift in handling efficient capital deployment and
contract failure.

Conclusion
• We conclude that at least in equity markets, our systems are robust for
market
development to be built on top of them. Indian capital markets will grow at a
high
rate on account of FII investments for about 5-10 years as long as Indian
returns are
uncorrelated and interest rate differential persist.
• What is important however, that domestic capabilities should be built up
to take
over from FIIs, when their rate of capital infusion slows down in next 10-
15 years.
This will determine the growth of the economy after this period as the
capital
markets by then would have become a more important source of funds for
the
economy. For this we examined the crucial roles of market liquidity,
instrument
innovation (debt), more companies raising capital in India by policy
incentives and a
paradigm shift in the way Indian industry handles failure (bankruptcy).

Introduction
India’s growth story is creating unparalleled opportunity in today’s tight
returns global
environment as it is positioned to grow regardless of the world economic
landscape in the
short term. In this euphoria, it is necessary to question some assumptions
and understand the
current nature of Indian capital markets before analyzing their prospects of
development and
acting as growth engines of the economy.
• Assumption 1: Capital Markets are barometers of the corporate sector
– Only
9,000 odd companies are actually listed out of more than 500,000
companies. Out
of these, on average, 60% are traded not more than two times in a year1.
About 10
companies form 40% of total turnover. Corporate debt markets remain
shallow,
when it comes to differentiating high-quality firms from low-quality ones
(and
lowering capital costs for the former). Bond financing has not occurred to
any
significant degree for many other types of firms (e.g., old, export-oriented
and
commercial paper-issuing ones).
• Assumption 2: Capital Markets are helping in channeling savings in
India2 –
Financial instruments form less than 5% of household savings in the last 5
years.
Most of these are invested in banks and Postal/Provident/Pension or Life
Insurance
funds. Only now have some restrictions been removed on pension and life
insurance funds to actually invest in capital markets.
1 Prof. R Vaidyanathan, IIM Bangalore- Stock Markets: Are they
barometers of the economy?
2 RBI Handbook of Statistics on the Indian economy
CRISIL Young Thought Leader 2005 Apurv Parashar
In this context, we observe how Indian capital markets still lack depth and
thus are still not
the most influential source of funds for the economy. This paper examines
the current state
of the Indian capital markets as a whole (equity & debt) and raises the key
questions, the
answers to which shall dictate their growth and make them more relevant
in
development of the economy. This is done while realizing that it is not the
role of
regulators to affect security valuations but only proving access to investors
and their
protection. Therefore certain steps suggested are role of the government
rather than
regulators.

Foreign Institutional Investment (FII)

Net FII Inflows in India
-1000
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
2001 2002 2003 2004 2005
Year
Million $
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
BSE Sensex
FII - Equities
FII - Debt
BSE Sensex
(Market Cap)
Fig -1: Net FII inflows in India in Equity and Debt Markets and BSE
Sensex4
As is evident from figure 1, I argue that foreign investment, (in form of
around 800 and
growing registered FIIs), will continue to chart the growth of Indian capital
(equity)
markets for at least 10-15 years until domestic institutions catch up. Hence
there is a need
to attract and spread low volatility reliable capital from FIIs across
sectors while
developing domestic institutional investment capabilities to take over.
The total market capitalization on BSE on 7th October, 2005 was Rs
2,245,005 Crore (over
510 billion $). The recent stock market rally saw FII investment reach 8.65
billion $ in
2005 till date compared to 8.51 billion $ in whole of 2004. In addition,
India’s GDP
growth rate is expected to be around 6.5-7% in the next two years. The most
important
requirement is to make the capital markets more integral to the Indian
growth story. To
4 Figures for 2005 are till 7th October, 2005. All FII and Sensex data are
from SEBI and BSE respectively
CRISIL Young Thought Leader 2005 Apurv Parashar
sustain, match and accelerate this growth, the Indian economy needs a
growing mean rate
of capital supply without sudden shocks. To analyze whether capital
markets are poised
to grow and play a more important role in this growth, we ask these key
questions
classified in three categories.

What is the role (long term) of domestic financial institutions in capital

market
development in such a scenario explored in Q1?
Current State - As we concluded earlier, FII inflows will stabilize when
India no longer
provides uncorrelated returns. It is then the role of domestic institutions to
replace the FII
inflow as the engines of capital market development. Also, FII exit would
be much easier
after 5-10 years as currently, if FIIs want to sell even one-tenth of their
holdings - there will
be no buyers and the stock market will crash significantly. Thus FIIs find it
cheaper to stay
put than exit at such a huge loss. In the future, exit and transaction costs will
fall, making exit
easier.
An Example - On May 17, 2004 (last general election), FIIs pulled out 1
billion $ but
investor wealth fell by 28 billion $ as there was no domestic capability to
handle such supply
of paper causing sudden low valuations. Thus domestic financial institutions
are needed to
lead the market in 10-15 years when FII inflow rate slows down.
Thus while domestic institutions pumped only 1 billion $ in 2004, this figure
needs to match
FII inflows for stable growth of markets after 10-15 years. Hence the recent
steps by
government for encouraging investment by insurance/pension funds are a
right step in this
direction. What is needed is the realization that our domestic investment
capabilities
must be developed to lead market development in time to come.
CRISIL Young Thought Leader 2005 Apurv Parashar
Future steps which could be taken are
• An active mortgage market in India as a new source of capital
• Insurance/Pension/Banks allowed a wider range of investment while new
derivative
instruments are introduced to manage risk
The only way to successfully ensure domestic investment is to reasonably
safeguard them
from default and other risks in Indian corporate sector (other than blue-chip
firms).
Otherwise domestic investment will also be narrowed in only on blue chip
firms. This
brings the much bigger issue of handling contract failure in India to enable
investment
across the board and development of a vibrant domestic capital market.
Bibliography
Websites
1. www.iciciresearchcentre.org
2. www.sebi.gov.in
3. www.rbi.gov.in
4. www.nseindia.com
5. www.bseindia.com
6. www.thehindubusinessline.com
7. www.outlookmoney.com
Reports & Surveys
1. The carry to risk approach in emerging markets – JP Morgan Securities
Ltd, London
2. Portfolio Investments in India – Do fundamentals matter? IMF working
Paper (2003)
3. New directions in Indian financial sector policy (2003) – Ajay Shah,
Raghuram Rajan
4. Policy issues in India’s capital markets (2000) – Ajay Shah, Susan
Thomas
5. Capital Control liberalization & Market development – World Bank
research study (1996)
6. Contemporary Concerns Study: Measuring Emerging Market Risk &
Attractiveness
(2005) – Apurv Parashar, Hemang Mehta (IIM Bangalore)
7. Institutional change in India’s capital markets (1998) – Ajay Shah
8. Development of a robust debt derivatives market in India – Issues and
possible
approaches (2004) - Gautam Ravi Narayan (IIM Ahmedabad)
9. Prevention of Insider Trading and Corporate Good Governance (2003) –
Sandeep
Parikh, IIM Ahmedabad
CRISIL Young Thought Leader 2005 Apurv Parashar
10. Capital Market Development, Corporate Financing Pattern and
Economic Growth in
India - R.N.Agarwal, Institute of Economic Growth

Economic Growth
by Paul M. Romer
(From The Concise Encyclopedia of Economics, David R. Henderson, ed.
Liberty Fund,
2007. Reprinted by permission of the copyright holder.)
Compound Rates of Growth
In the modern version of an old legend, an investment banker asks to be paid
by
placing one penny on the first square of a chess board, two pennies on the
second
square, four on the third, etc. If the banker had asked that only the white
squares be
used, the initial penny would have doubled in value thirty-one times, leaving
$21.5
million on the last square. Using both the black and the white squares would
have
made the penny grow to $92,000,000 billion.
People are reasonably good at forming estimates based on addition, but for
operations such as compounding that depend on repeated multiplication, we
systematically underestimate how quickly things grow. As a result, we often
lose
sight of how important the average rate of growth is for an economy. For an
investment banker, the choice between a payment that doubles with every
square on
the chess board and one that doubles with every other square is more
important
than any other part of the contract. Who cares whether the payment is in
pennies,
pounds, or pesos? For a nation, the choices that determine whether income
doubles
with every generation, or instead with every other generation, dwarf all other
economic policy concerns.
Growth in Income Per Capita
You can figure out how long it takes for something to double by dividing the
growth
rate into the number 72. In the 25 years between 1950 and 1975, income per
capita
in India grew at the rate of 1.8% per year. At this rate, income doubles every
40
years because 72 divided by 1.8 equals 40. In the 25 years between 1975 and
2000,
income per capita in China grew at almost 6% per year. At this rate, income
doubles
every 12 years.
These differences in doubling times have huge effects for a nation, just as
they do
for our banker. In the same 40-year timespan that it would take the Indian
economy
to double at its slower growth rate, income would double three times, to
eight times
its initial level, at China's faster growth rate.
From 1950 to 2000, growth in income per capita in the United States lay
between
these two extremes, averaging 2.3% per year. From 1950 to 1975, India,
which
started at a level of income per capita that was less than 7% of that in the
United
States, was falling even farther behind. Between 1975 and 2000, China,
which
started at an even lower level, was catching up.
China grew so quickly partly because it started from so far behind. Rapid
growth
could be achieved in large part by letting firms bring in ideas about how to
create
value that were already in use in the rest of the world. The interesting
question is
why India couldn't manage the same trick, at least between 1950 and 1975.
From The Concise Encyclopedia of Economics, David R. Henderson, ed.
Liberty Fund,
2007. Reprinted by permission of the copyright holder.
Growth and Recipes
Economic growth occurs whenever people take resources and rearrange
them in
ways that are more valuable. A useful metaphor for production in an
economy comes
from the kitchen. To create valuable final products, we mix inexpensive
ingredients
together according to a recipe. The cooking one can do is limited by the
supply of
ingredients, and most cooking in the economy produces undesirable side
effects. If
economic growth could be achieved only by doing more and more of the
same kind
of cooking, we would eventually run out of raw materials and suffer from
unacceptable levels of pollution and nuisance. Human history teaches us,
however,
that economic growth springs from better recipes, not just from more
cooking. New
recipes generally produce fewer unpleasant side effects and generate more
economic
value per unit of raw material.
Take one small example. In most coffee shops, you can now use the same
size lid
for small, medium, and large cups of coffee. That wasn’t true as recently as
1995.
That small change in the geometry of the cups means that a coffee shop can
serve
customers at lower cost. Store owners need to manage the inventory for only
one
type of lid. Employees can replenish supplies more quickly throughout the
day.
Customers can get their coffee just a bit faster. Such big discoveries as the
transistor, antibiotics, and the electric motor attract most of the attention, but
it
takes millions of little discoveries like the new design for the cup and lid to
double
average income in a nation.
Every generation has perceived the limits to growth that finite resources and
undesirable side effects would pose if no new recipes or ideas were
discovered. And
every generation has underestimated the potential for finding new recipes
and ideas.
We consistently fail to grasp how many ideas remain to be discovered. The
difficulty
is the same one we have with compounding: possibilities do not merely add
up; they
multiply.
In a branch of physical chemistry known as exploratory synthesis, chemists
try
mixing selected elements together at different temperatures and pressures to
see
what comes out. About a decade ago, one of the hundreds of compounds
discovered
this way—a mixture of copper, yttrium, barium, and oxygen—was found to
be a
superconductor at temperatures far higher than anyone had previously
thought
possible. This discovery may ultimately have far-reaching implications for
the storage
and transmission of electrical energy.
To get some sense of how much scope there is for more such discoveries, we
can
calculate as follows. The periodic table contains about a hundred different
types of
atoms, which means that the number of combinations made up of four
different
elements is about 100 × 99 × 98 × 97 = 94,000,000. A list of numbers like 6,
2, 1,
7 can represent the proportions for using the four elements in a recipe. To
keep
things simple, assume that the numbers in the list must lie between 1 and 10,
that
no fractions are allowed, and that the smallest number must always be 1.
Then there
are about 3,500 different sets of proportions for each choice of four
elements, and
3,500 × 94,000,000 (or 330 billion) different recipes in total. If laboratories
around
the world evaluated 1,000 recipes each day, it would take nearly a million
years to
go through them all. (If you like these combinatorial calculations, try to
figure out
From The Concise Encyclopedia of Economics, David R. Henderson, ed.
Liberty Fund,
2007. Reprinted by permission of the copyright holder.
how many different coffee drinks it is possible to order at your local shop.
Instead of
moving around stacks of cup lids, baristas now spend their time tailoring
drinks to
each individual palate.)
In fact, the previous calculation vastly underestimates the amount of
exploration
that remains to be done because mixtures can be made of more than four
elements,
fractional proportions can be selected, and a wide variety of pressures and
temperatures can be used during mixing.
Even after correcting for these additional factors, this kind of calculation
only begins
to suggest the range of possibilities. Instead of just mixing elements together
in a
disorganized fashion, we can use chemical reactions to combine elements
such as
hydrogen and carbon into ordered structures like polymers or proteins. To
see how
far this kind of process can take us, imagine the ideal chemical refinery. It
would
convert abundant, renewable resources into a product that humans value. It
would
be smaller than a car, mobile so that it could search out its own inputs,
capable of
maintaining the temperature necessary for its reactions within narrow
bounds, and
able to automatically heal most system failures. It would build replicas of
itself for
use after it wears out, and it would do all of this with little human
supervision. All we
would have to do is get it to stay still periodically so that we could hook up
some
pipes and drain off the final product.
This refinery already exists. It is the milk cow. And if nature can produce
this
structured collection of hydrogen, carbon, and miscellaneous other atoms by
meandering along one particular evolutionary path of trial and error (albeit
one that
took hundreds of millions of years), there must be an unimaginably large
number of
valuable structures and recipes for combining atoms that we have yet to
discover.
Objects and Ideas
Thinking about ideas and recipes changes how one thinks about economic
policy
(and cows). A traditional explanation for the persistent poverty of many less
developed countries is that they lack objects such as natural resources or
capital
goods. But Taiwan stared with little of either and still grew rapidly.
Something else
must be involved. Increasingly, emphasis is shifting to the notion that it is
ideas, not
objects, that poor countries lack. The knowledge needed to provide citizens
of the
poorest countries with a vastly improved standard of living already exists in
the
advanced countries. If a poor nation invests in education and does not
destroy the
incentives for its citizens to acquire ideas from the rest of the world, it can
rapidly
take advantage of the publicly available part of the worldwide stock of
knowledge. If,
in addition, it offers incentives for privately held ideas to be put to use
within its
borders—for example, by protecting foreign patents, copyrights, and
licenses, by
permitting direct investment by foreign firms, by protecting property rights,
and by
avoiding heavy regulation and high marginal tax rates—its citizens can soon
work in
state-of-the-art productive activities.
Some ideas such as insights about public health are rapidly adopted by less
developed countries. As a result, life expectancy in poor countries is
catching up with
the leaders faster than income per capita. Yet governments in poor countries
continue to impede the flow of many other kinds of ideas, especially those
with
commercial value. Automobile producers in North America clearly
recognize that they
can learn from ideas developed in the rest of the world. But for decades, car
firms in
From The Concise Encyclopedia of Economics, David R. Henderson, ed.
Liberty Fund,
2007. Reprinted by permission of the copyright holder.
India operated in a government-created protective time warp. The Hillman
and
Austin cars produced in England in the 1950s continued to roll off
production lines in
India through the 1980s. After independence, India's commitment to closing
itself off
and striving for self-sufficiency was as strong as Taiwan's commitment to
acquiring
foreign ideas and participating fully in world markets. The outcomes—
grinding
poverty in India and opulence in Taiwan—could hardly be more disparate.
For a poor country like India, enormous increases in standards of living can
be
achieved merely by letting in the ideas held by companies from
industrialized
nations. With a series of economic reforms that started in the early 1990s,
India has
begun to open itself up to these opportunities. For some of its citizens such
as the
software developers who now work for firms located in the rest of the world,
these
improvements in standards of living have become a reality. This same type
of
opening up is causing a spectacular transformation of life in China. Its
growth in the
last 25 years of the twentieth century was driven to a very large extent by
foreign
investment by multinational firms.
Leading countries like the United States, Canada, and the members of the
European
Union cannot stay ahead merely by adopting ideas developed elsewhere.
They must
offer strong incentives for discovering new ideas at home, and this is not
easy to do.
The same characteristic that makes an idea so valuable—everybody can use
it at the
same time—also means that it is hard to earn an appropriate rate of return on
investments in ideas. The many people who benefit from a new idea can too
easily
free-ride on the efforts of others.
After the transistor was invented at Bell Labs, many applied ideas had to be
developed before this basic science discovery yielded any commercial value.
By now,
private firms have developed improved recipes that have brought the cost of
a
transistor down to less than a millionth of its former level. Yet most of the
benefits
from those discoveries have been reaped not by the innovating firms, but by
the
users of the transistors. In 1985, I paid a thousand dollars per million
transistors for
memory in my computer. In 2005, I paid less than ten dollars per million,
and yet I
did nothing to deserve or help pay for this windfall. If the government
confiscated
most of the oil from major discoveries and gave it to consumers, oil
companies
would do much less exploration. Some oil would still be found
serendipitously, but
many promising opportunities for exploration would be bypassed. Both oil
companies
and consumers would be worse off. The leakage of benefits such as those
from
improvements in the transistor acts just like this kind of confiscatory tax and
has the
same effect on incentives for exploration. For this reason, most economists
support
government funding for basic scientific research. They also recognize,
however, that
basic research grants by themselves will not provide the incentives to
discover the
many small applied ideas needed to transform basic ideas such as the
transistor or
web search into valuable products and services.
It takes more than scientists in universities to generate progress and growth.
Such
seemingly mundane forms of discovery as product and process engineering
or the
development of new business models can have huge benefits for society as a
whole.
There are, to be sure, some benefits for the firms that make these
discoveries, but
not enough to generate innovation at the ideal rate. Giving firms tighter
patents and
copyrights over new ideas would increase the incentives to make a new
discovery,
but might also make it much more expensive to build on previous
discoveries.
From The Concise Encyclopedia of Economics, David R. Henderson, ed.
Liberty Fund,
2007. Reprinted by permission of the copyright holder.
Tighter intellectual property rights could therefore be counter-productive
and slow
growth down.
The one safe measure that governments have used to great advantage has
been to
use subsidies for education to increase the supply of talented young
scientists and
engineers. They are the basic input into the discovery process, the fuel that
fires the
innovation engine. No one can know where newly trained young people will
end up
working, but nations that are willing to educate more of them and let them
follow
their instincts can be confident that they will accomplish amazing things.
Meta-Ideas
Perhaps the most important ideas of all are meta-ideas. These are ideas about
how
to support the production and transmission of other ideas. The British
invented
patents and copyrights in the seventeenth century. North Americans invented
the
modern research university and the agricultural extension service in the
nineteenth
century, and peer-reviewed competitive grants for basic research in the
twentieth
century. The challenge now facing all of the industrialized countries is to
invent new
institutions that encourage a higher level of applied, commercially relevant
research
and development in the private sector.
As national markets for talent and education merge into unified global
markets,
opportunities for important policy innovation will surely emerge. In basic
research,
the United States is still the undisputed leader, but in key areas of education,
other
countries are surging ahead. Many of them have already discovered how to
train a
larger fraction of their young people as scientists and engineers.
We do not know what the next major idea about how to support ideas will
be. Nor do
we know where it will emerge. There are, however, two safe predictions.
First, the
country that takes the lead in the twenty-first century will be the one that
implements an innovation that more effectively supports the production of
new ideas
in the private sector. Second, new meta-ideas of this kind will be found.
Only a failure of imagination—the same one that leads the man on the street
to
suppose that everything has already been invented—leads us to believe that
all of
the relevant institutions have been designed and that all of the policy levers
have
been found. For social scientists, every bit as much as for physical scientists,
there
are vast regions to explore and wonderful surprises to discover.
About the Author
Paul M. Romer is the STANCO 25 Professor of Economics in the Graduate
School of
Business at Stanford University and a Senior Fellow at the Hoover
Institution. He
also founded Aplia, a publisher of web-based teaching tools that is changing
how
college students learn economics.
Further Reading
Easterly, William. The Elusive Quest for Growth. Cambridge: MIT Press,
2002.
From The Concise Encyclopedia of Economics, David R. Henderson, ed.
Liberty Fund,
2007. Reprinted by permission of the copyright holder.
Helpman, Elhanan. The Mystery of Economic Growth. Cambridge: Harvard
University
Press, 2004.
North, Douglass C. Institutions, Institutional Change, and Economic
Performance.
Cambridge: Cambridge University Press, 1990.
Olson, Mancur. “Big Bills Left on the Sidewalk: Why Some Nations are
Rich, and
Others Poor,” Journal of Economic Perspectives. Vol. 10, No. 2. Spring
1996. pp. 3-
23.
Rosenberg, Nathan. Inside the Black Box: Technology and Economics.
Cambridge:
Cambridge University Press, 1982.
Romer, Paul. "Endogenous Technological Change," Journal of Political
Economy. Vol.
98, No. 5, Oct. 1990. pp. S71-S102.

SLUMS IN INDIA-AN OVERVIEW

A slum, as defined by the United Nations agency UN-HABITAT, is a run-
down area of a
city characterized by substandard housing and squalor and lacking in tenure
security.
According to the United Nations, one billion people worldwide live in slums
and will
likely grow to 2 billion by 2030.The characteristics associated with slums
vary from
place to place. Slums are usually characterized by urban decay, high rates of
poverty, and
11
unemployment. They are commonly seen as "breeding grounds" for social
problems such
as crime, drug addiction, alcoholism, high rates of mental illness, and
suicide. In many
poor countries they exhibit high rates of disease due to unsanitary
conditions,
malnutrition, and lack of basic health care.
For the first time in 2001 Census data was collected for slums. Slum data
was collected
for cities/towns having 50,000 population or more based on 1991 census. It
is unfortunate
that the number of people living in slums in India, Asia's fourth largest
economy, has
more than doubled in the past two decades, the government said on
Thursday. According
to this population of slums all over India is 40,297,341 (40 million) from the
607
cities/towns reporting slums. This comes to ~4% of total Indian population
(assuming
Indian population of 1000 million). More interestingly it comes to ~22% of
the total
population of these cities (178,393,941).This means that almost quarter of
Indian cities
live in slums. And sadly 5,531,062 (5 million) of this population are young
children (0-6
age group). The numbers for the richest state in India, Maharashtra are even
worse.
Almost 32% of the state's population live in slums. And > 5 million
(5,823,510 to be
precise) are in the financial capital of India, Mumbai. About 49% of
Mumbai's population
live in slums.
It is vicious cycle of population growth, opportunities in the cities (leading
to migration
to the cities), poverty with low incomes, tendency to be closer to work hence
occupying
any land in the vicinity etc. The key reason out of all is the slow economic
progress.
After independence in 1947, commercial and industrial activity needed
cheap labor in the
cities. Plentiful was available in the rural area. They were encouraged to
come to cities
and work. People, who migrated to the cities and found work, brought their
cousins and
rest of the families to the cities. Unable to find housing and afford it, they
decided to
build their shelter closer to work. First, one shelter was built, then two and
then two
thousand and then ten thousand and on and on.
Poverty, slums and urban squat are not going to go away in next 20 to 25
years. Reversal
of this phenomenon will begin after sufficient economic progress had been
made. Eight
percent GDP growths is a good sign. With quadrupled GDP in 25 years,
there is a good
chance that the new and upcoming generation may stay away from slum
dwelling. It may
take another 25 years before the slums are vacated.
EFFECTS OF LIBERALIZATION ON PRODUCTION AND
EMPLOYMENT
Liberalization of Indian economy has yielded many positive results. But
considering the
overall socio economic impact of liberalization in Indian context the
scenario is still not
something to cheer about.
It was widely believed that a liberal economy will eventually lead to better
production
and more employment generation, the two most important features of any
successful
economy. Although India has not fared badly in the first category,
employment
generation fore the targeted section is still not satisfactory.
Considering production of goods, today Indian markets are full of white
goods, i.e, goods
12
required and used by the upper strata of the society and produced by
multinational
companies, refrigerators, washing machines, inverters, air conditioning
machines are to
name a few. This has resulted in the growth of consumer culture with
international
companies dominating the market because of their high brand value, large
expenditure on
product development and marketing strategies. The domestic companies in
the face of
tough competition are losing the battle and are on the verge of extinction.
Thus, though
India boasts of having high mobile density, producing the cheapest car in the
world,
farmers still commit suicide in the countryside, more than 20% of the
population still live
below the poverty level. It would be, therefore, not wrong to say that the
benefits of
liberalization have not percolated down the social strata to enrich the poorer
section of
the country.
Considering employment generation, liberalization has created more white
collared jobs
ignoring the needs of the poor, rural people. More and more call centers are
being
opened, state of the art, sophisticated IT offices are being built. But
beneficiaries? The
privileged, educated sections of the society. But the miserable plight of the
unskilled
workers, poor farmers, daily wage earners is still the same. It seems the
growth rate of
Indian economy has not done justice to the weaker section of the society.
Therefore care has to be taken to ensure a balanced development so that
domestic
companies can also flourish along with their multinational counterparts,
economic
development results in social growth and the young Indians are free from the
menace of
unemployment.
NOTE: THIS ARTICLE CAN BE USED FOR ANSWERING
QUESTIONS LIKE
"GLOBALISATION ON POVERTY ALLEVIATION IN INDIA".

Capital Markets are helping in channeling savings in India2 –

Financial instruments form less than 5% of household savings in the last 5
years.
Most of these are invested in banks and Postal/Provident/Pension or Life
Insurance
funds. Only now have some restrictions been removed on pension and life
insurance funds to actually invest in capital markets