The dream of cashless economy : challenges

(An interview of Zulfiqar Sheth (PhD Research Scholar, Department of Economics, Aligarh Muslim University, on “The dream of cashless economy : challenges ” published in Dainik Jagran Dated 6 December 2016. )

Zulfiqar sheth argued the major challenges are financial illiteracy, low bank account penetration,  poor internet connectivity and dependency of informal sector on cash.

The large no. of Indians still depend on agriculture and lives in rural areas. According to 2011 census nearly 30% Indians can’t read and write their name. Out of many who are literate they do not know banking and are habituated to do their all transactions in cash.Without financial literacy the dream of cashless economy is not possible.

Approx. 28%-32% of Indians have access to financial institutions, including post offices and banks. Further, 33% of the 138,626 bank branches are in 60 Tier-1 and Tier-2 cities, leaving rural India at a huge disadvantage. Migrants laborer, and other weaker sections do not posses ID card and other documents require for KYC norms of banks. Moreover the cumbersome process of account opening keeps many people away from banking.

Internet connectivity is also a problem that we have to solve before we set for complete cashless economy.

India’s economy is largely dependent on unorganized sector. Most of our employment are created here and this sector is heavily dependent on cash transactions. In Cashless economy cycle-rickshaws / autos will be replaced by cabs and small vendors / shopkeepers will be replaced by large shopping malls.

Thus, the dream of cashless economy can only be achieved  once we promote financial literacy at all level, increase bank account penetration,  maintain good internet connectivity  and assure cyber security. We also need to pay heed towards problems faced by informal sector. Here the role of government, administration, policy makers, youth, students, teachers, civil society organizations, and  NGOs become crucial.

Read here the full interview in Hindi.

cashless-economy-opinion-dainik-jagran
An interview of  Zulfiqar Sheth, (PhD Research Scholar, Department of Economics, Aligarh Muslim University) on “The Dream of cashless economy : challenges” published in Dainik Jagran dated 6th December 2016

 

Why MMS reminded “In the long run we are all dead” – ZULFIQAR SHETH

manmohan-621x414

Zulfiqar Sheth*

Today, speaking in Rajya Sabha (upper house) former Prime Minister of India Dr. Manmohan Singh commented by using John Maynard Keynes’ quotation “In the long run we are all dead” to suggest the government’s claim “decision of demonetisation is taken in the interest of the country in the long run” is misleading and ignoring present distress faced by common people.

keynes
John Maynard Keynes

The quotation “In the long run we are all dead” comes  from British economist JM Keynes’ earlier work, The Tract on Monetary Reform, in 1923. He wrote ;

“The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

Many commentators use John Maynard Keynes’ quotation “In the long run we are all dead” to suggest that that what is true about the short run cannot necessarily be inferred from what must happen in the long run, and we live in the short run.

Dr. Manmohan Singh a reputed economist who also served as governor of the Reserve Bank of India (the central bank of India) and architect of 1991 economic reforms posed serious questions on government’s decision to demonetize Rs 500 and Rs 1000 currency notes by terming it “monumental mismanagement had been undertaken.”

The popular argument by the ruling Bharatiya Janta Party (BJP) and government in the favor of demonetization is that this step will cause distress and inconvenience to the people in short run but it will benefit in long run. Prime minister Narendra Modi also emotionally urged people to give him 50 days speaking at the event  in Goa last week.

However Manmohan Singh, today in Rajya Sabha seemed not hopeful. By quoting Keynes’ famous quotation he said “It is important to take note of the grievances of the people and ordinary people who have suffered by the imposition of currency ban overnight. The PM has said wait 50 days, it is a short period, but for the poor and deprived, even 50 days can bring about disastrous effects,”. He also pointed that ” (in the long run) this step will weaken and erode our peoples’ confidence in the currency system and in the banking system”

The point Manmohan Singh made here is very clear that we simply can not ignore the present distress which he called “torture” to agriculture laborers , farmers, small industries and people associated with informal economy. By raising serious concern cover the way demonetization has been implemented in the country, he asked the prime minister “I would like to know from the prime minister to name any country he may think of where people have deposited their money in the banks but not allowed to withdraw their money ?”  He went on saying “this alone I think enough to condemn what has been done in the name of greater good to the people in the long run”

  (The author is a doctoral fellow at the Department of Economics, Aligarh Muslim University and can be reached at shethzulfi@yahoo.com)

 

Demonetization – Who wins and who loses? – NIDA FATIMA

demonetization-currency-lock

 

By Nida Fatima * 

 

Introduction

On 8th of November 2016,two semi historic moves were in the making. The Americans were making the uncanny choice to elect Mr. Donald J. Trump as the President of United States. In India, Prime Minister Mr.Narendrabhai Modi was announcing the demonetization of Rs.500 & Rs.1000 with effect from midnight, stripping such notes off the ‘legal tenders’.

Demonetization of higher denomination notes is not new, at least for India, where such steps have been taken in 1946 and then again in 1978.This is technically the third time. But, there exists a huge difference in then and now. The present India has a larger stash of black money but it also has an acutely active media. Let us look at the interrelations which some of the diverse components of the present socio-economic moment shall undergo due to this demonetization.

Manipulating opinions

Looking at the appreciative opinions given by the captains of various banks in The Times Of India (dated 10.11.2016), one realises the power media has in moulding the public opinion. The newspaper even in its editorial(Shock Therapy :To target black money),only highlighted the merits of the act of demonetizing Rs.500 & Rs.1000 notes ,on the part of the government.(The editorial went to the extent of pointing out the political cost which PM Modi is ready to suffer by this executive action. )

Obvious merits

Demonetization of these high denomination notes has manifold effect-positive and negatives both. Some obvious merits ,for instance are ,it will give boost to formal channels of payment ,thus helping them to grow. The shadow economy is 19% of the total Indian economy with black money in circulation being 14% of the total GDP, which will come under threat by this act of demonetization. Reverberations of it shall be heard in the form of terror financing getting curbed. This, in turn will reduce crime and drive growth. Also, counterfeited currency will be squeezed out of the system. And lastly, this step speeds up the achievement of the vision of cashless economy for India and also facilitates the achievement of financial inclusion. But India follows a law which makes the government duty bound to not justify the means for the aim to be achieved. That, the due process (of law) ,which must be just,fair and reasonable and not merely the procedure established by law ,is to be followed,is a long accepted principle imbibed by all the organs of Indian democracy so as to secure procedural justice for the citizens of India; demonetization, as is being done, interalia, challenges this very principle.

The happy banker

It should be noted that bankers would always be supportive especially in the present times when the crisis caused by the NPAs is so heightened. As per the Government direction, people will exchange and deposit the 500 & 1000 Rupee notes with the banks. This shall lead to increase in the lending capacity of the banks, thereby bringing them back to healthy business!

The capitalists will also tender support, since this move hardly hurts their interest. This class does not keep it’s unaccountable money in notes of 500 & 1000.The move of government has worked in diverting the attention from exceptionally large amount of money parked outside Inida, to the lesser amount available with the lower rung of the black money ladder; the real difference makers still go unabated.
The people:money makers and money earners divided

Common masses have undergone another division, with business class and entrepreneurs being one group and salaried class being divided into a satisfied salaried people & the disgruntled salaried people.The innovators will resent the government move for the obvious reason,i.e becoming accountable and ultimately getting penalised for the creation of wealth which resulted from their entrepreneurial skills.The satisfied salaried class shall remain unafffecte,because they do not have anything to hide.The third group is the one which intends to protect itself and its resources by exploiting the loopholes created by the difference in the law, in theory and the law,in practice.In the third group also comes the various levels of administrative machinery,which find themselves rightfully entitled in asking for financial and non-financial favours from the people they are meant to serve.

Informal economy

The harshly negative impact would be suffered by the large rural and informal economies of India,which are largely cash based.The average consumer may also suffer for his lack of technological knowledge,resultingly he might fail to use ATM or other non-cash modes of payment.

Black money doesn’t always remain in money form;it is generally converted into substance of value like gold,land,securities,etc.Some of the small but not so negligible effects,thus,are the appearance of unauthorised intermediaries in rural areas to facilitate the collection & exchange of notes from the people who fail to have any government identification proof or access to a bank.Market of gadgets and white goods seems to be hyper active at the moment,as the people with unaccountable money look for means to make something good from it,before it is put to destruction by the obligation to exchange the notes at the banks or post offices.Super market and such other chain stores would see an increase,howsoever marginal,because many of the consumers to buy goods of daily consumption show a change in preference from easy cash to the cashless modes of payment,option for which is generally not available at the local grocery stores. Online stores will also be seeing a surge in their sales because of them being able to offer alternatives to cash payment.

Financial awareness or the lack thereof

A good portion of the urban poor or the lower strata of the towns is at the mercy of their well aware fellow citizens,who may choose to either help the former by facilitating the exchange process or exploit them by not making them aware of the crucial ongoing of the Indian political economy.Here,need of functionaries like the Bank mitra or similar auxiliaries would be deeply felt.

What is doing rounds among the critics is that demonetization appears to be a step to calm the raising passions among the public against the excesses committed by various State agencies or against the failure in doing their duty,as it can be seen the public attention gets completely diverted from discussing the political abrasions to,either criticizing or applauding the government for its latest action.Moreso,demonetization has turned the politico-economic attention away from the Swiss bank & Panama paper-characters involved wherein,won’t be keeping truck loads of 500s & 1000s in their houses- to the comparatively small players in the game of black money.
Creating popular legitimacy

Linking the black money narrative with terrorism,has developed popular support of a nationalist fervor,which further shrouds the deeper issues involved in this strategic step of the government.

Testing the prudence

The cash to GDP ratio in India is 12% where as the global average is 4%, if demonetization plays well,the Indian ratio shall experience a decrease. The circulation of higher denomination notes in India has a value of 1.5 lakh crore; positive result of demonetization shall mean decrease in this amount. Lastly, whether the demand for gold and thus its import sees an increase or not also points towards the success or otherwise of this strategic action of the government. These three parameters can be considered to gauge the economic wisdom put to use in this surprise move by the government.

Conclusion

Demonetization, like many other governmental moves, has both merits and demerits, which vary as per one’s perspective or one’s role in the economy. Media plays a crucial role both in agitating people’s sentiments as also in keeping them calm. But it is also ethically obliged to play these roles for nothing but the interest of reason and truth and only then shall it be called an unbiased component, which is essential for the proper functioning of the polity. The practice of popularising what is not the absolute truth and that of delineating the public attention from what is supposed by many as an important matter for their civil personality needs to be questioned. Similarly, the joy spreading among some sections of the society with regard to demonetization and the impact thereof on terrorism & corruption needs a reality check especially when, the disruptive side effects of this demonetization, for the informal economy as well as for the public order in the cities have started to weigh heavily on the common man. Whether ‘demonetization2016’ was a risk worth taking or not? Only time will tell.

 

*The author is a civil services aspirant and studies law at Aligarh Muslim Uiniversity. 

Image credit: http://pragativadi.com/wp-content/uploads/2016/11/demonetization.jpg

How Just is the Demonetisation ‘Masterstroke’ in the World’s Largest Democracy? Lessons from Rawls and Gandhi – SARTHAK GAURAV

1000-rs-notes-banned

By Sarthak Gaurav*

 

Abstract

The recent demonetisation ‘masterstroke’ of the Government of India violates two simple principles of justice that are normatively appealing, namely Rawlsian ‘difference principle’, and Gandhi’s Talisman. While both the principles stress on evaluating the impact of one’s action on the ‘least advantaged’ or the ‘weakest’ in society, in its laudable and bold attempt to curb the problem of black money and counterfeits in currency circulation, the government has failed to pay heed to some fundamental ideas of justice that are central to democratic policy making.

Introduction

The institutions and laws of a society determine how resources are distributed among members of the society. Institutions are not an Act of God, nor are they the outcomes of an Artificial Intelligence (AI) algorithm. Institutions, however, are the acts of members of the society within an unambiguous acceptability of what the norms of that society comprise. Over millennia, citizens of different societies have devised several mechanisms to determine how resources would be distributed, and how the benefits and costs from economic activities would spread across members of the society. Political processes are one such mechanism.

In a society, a dictator might decide not only how a pie is made but also how it is distributed among the members of the society. In another society, a benevolent leader of the masses who was democratically elected by a certain format of electoral process may decide another way of how a pie is made and how it is distributed among the masses. How fair is the framework of distribution of the pie? This is an important question that comprises the idea of distributive justice. In doing so, we have to understand which distribution processes are morally acceptable and which are less acceptable. In essence, we rank the distribution processes from the most acceptable to the least acceptable. How do we go about achieving this? In order to address the aforementioned phenomena, some wise members of several societies have agreed upon certain principles of justice – political philosophical frameworks with well-argued moral guidelines that help choose one pie distribution process over another. Let us look at some of these in evaluating the recent demonetisation decision of the central government of the largest democracy in the world.

One intuitive framework for distributive justice is where each member of the society gets an equal share of the pie. This seemingly egalitarian mechanism is called ‘strict egalitarianism’. This ensures an equality of outcomes in society. While the strict egalitarian notion is somewhat Utopian, one may settle for a weaker version where members of the society agree to accept a greater degree of equality of the distribution of the pie (income or wealth or even a pie). For a society to be just, in modern democracies, it is more or less a norm that there is some form of egalitarianism at work. While the French accepted it in their motto of ‘liberte, egalite, fraternite’, the Preamble to the Constitution of India clearly emphasizes the solemn resolve of the people of the nation to secure to all its citizens justice: social, economic, and political, along with equality of status and opportunity; among other lofty ideals. Another intuitive framework for distributive justice is utilitarian in principle.[i] If members of the society can distribute the pie among themselves so that it maximizes the welfare in society, that process is fair enough. While the utilitarian ethic varies in choosing over achieving the highest total welfare to maximizing the average utility (say satisfaction, happiness irrespective of how it is measured) of society, there has been a quest to arrive at alternative pie cutting mechanisms that make sense.[ii] As a critique of the utilitarian principles (among the many that have been propounded), one of the most popular one is that of Rawls (1971, 1993).[iii]

The principle of justice offered by Rawls is called the Difference Principle. The essence of the principle is that deviations from strict equality in society is permissible as long as the resulting inequalities result in ‘least advantaged’ in society being better off than they would be under strict equality. Gandhi, on the other hand gave a simple talisman that offered a mechanism to evaluate the implications on one’s potential action(s) on the weakest in the society. Together, the two principles offer a simple framework to evaluate how morally just the recent policy manoueuvre of the central government is.

Rawlsian Difference Principle and the Demonetisation Policy

In his seminal work Theory of Justice, Rawls (1971) proposed two principles of justice 1. Each person has an equal claim to a fully adequate scheme of equal basic rights and liberties, which scheme is compatible with the same scheme for all; and in this scheme the equal political liberties, and only those liberties, are to be guaranteed their fair value. 2. Social and economic inequalities are to satisfy two conditions: (a) They are to be attached to positions and offices open to all under conditions of fair equality of opportunity; and (b), they are to be to the greatest benefit of the least advantaged members of society While principle (1) pertains to distribution of liberties, (2) is relevant from a distributive justice context. 2(b) in particular, is the ‘difference principle’. There is a preference ordering in terms of priority of the two principles that is worth noting. Rawls argues that if there is a conflict between the two principles, (1) is preferred to (2), and (2a) is preferred to (2b).[iv] This ensures that in a well-ordered society, basic liberties cannot be sacrificed in order to generate greater equality for even the worst off in society.

For our conceptualisation of distributive justice of the recent demonetisation policy of the Government of India, we focus on (2b) – the difference principle. In this conceptualisation, the absolute position of the least advantaged group is of importance, instead of their relative position. If a policy improves the absolute position of the least advantaged or least well-off by having some inequalities, then as per the difference principle, such inequality is acceptable as long as the least advantaged can be made no more better-off. This is where the current demonetisation policy fails. If one weighs the evidence (journalistic as well as experiential) on the inconveniences caused to the least-advantaged in terms of the negative liquidity shock or loss of income and peace of mind due to time spent on long queues outside banks and ATMs, the policy is likely to have adversely affected the absolute position of the least advantaged. Even if the middle-class as well as high net worth individuals are affected, by putting higher weight on the position of the least advantaged, this principle offers an insight into how one could examine the parameters for accepting inequalities in society. Whether or not the policy has improved the absolute position of the least advantaged in society, irrespective of the laudable and bold attempt to curb black-money and counterfeit currencies notes in the economy, is anybody’s guess.

Gandhi’s Talisman and the Demonetisation Policy

In one of his last notes, Mahatma Gandhi, he left behind a simple framework that provides an intuitive test to morally evaluate how just or unjust one’s potential action would be. The note is popularly known as Gandhi’s Talisman, and it is as follows: “I will give you a talisman. Whenever you are in doubt, or when the self becomes too much with you, apply the following test. Recall the face of the poorest and the weakest man [woman] whom you may have seen, and ask yourself, if the step you contemplate is going to be of any use to him [her]. Will he [she] gain anything by it? Will it restore him [her] to a control over his [her] own life and destiny? In other words, will it lead to swaraj [freedom] for the hungry and spiritually starving millions? Then you will find your doubts and your self melt away.” (Pyarelal, 1958, p.65) In the context of the demonetisation policy that is being lauded as a ‘masterstroke’ of Prime Minister Modi’s government, applying Gandhi’s Talisman, one is compelled to wonder if the step the government has taken is going to be use to the poorest and the weakest in our society. Will she or he gain anything from the masterstroke? Will it restore the individual control over her or his life and destiny? Given the observations as one steps out on to the streets of the country since the implementation of the policy, the answers to these questions are justifiably in the negative.

Concluding Remarks

The recent demonetisation ‘masterstroke’ of the Government of India, although laudable in the government’s attempt to curb black-money and counterfeit currencies in cash stocks, fails in two simple tests of principles of justice, namely Rawlsian ‘difference principle’, and Gandhi’s Talisman. Since both the principles stress on the impact of the actions on the ‘least advantaged’ or the ‘weakest’ in society, the inconveniences caused to these sections of society leads to an outright failure of the policy in terms of it being just. While this note offers a few perspectives among reasonable plural alternatives, it also offers food for thought in terms of where we are headed as a nation when it comes to arriving at socially acceptable norms of justice and fairness. In terms of more immediate response to the problems faced by the citizens and lesson for future precision strikes on the relatively better off sections that are party to the black-money system, putting oneself in the shoes of the least-advantage and weakest of society might offer a more pragmatic solution to the pressing problems of our times.

References

Dworkin, R., 1981a, “What is Equality? Part 1: Equality of Resources,” Philosophy and Public Affairs, 10: 185–246.

–––, 1981b, “What is Equality? Part 2: Equality of Welfare,” Philosophy and Public Affairs, 10: 283–345.

Pyarelal, 1958. Mahatma Gandhi – The Last Phase. Vol 2. Available at http://www.mkgandhi.org/ebks/last-phase-vol-9-part-one.pdf

Rawls, J., 1971, A Theory of Justice, Harvard, MA: Harvard University Press. –––, 2001, Justice as Fairness: A Restatement, Cambridge: Harvard University Press.

Roemer, J. E., 1996, Theories of Distributive Justice, Cambridge, MA: Harvard University Press.

Notes

[i] Thinkers such as Shaftesbury, Hume, and Hutcheson had utilitarian principles in their accounts of morality whilst the classical tradition may be attributed to the work of Bentham, Mill, and Sidgwick

[ii] In spite of the several ways of conceptualising utilitarian welfare, there are libertarian principles that critique the distributive aspects of material goods on the grounds that emphasis on such material or economic goods is inferior to that of liberty.

[iii] There are schools of thought that argue about the importance of luck as well as responsibility (desert-based or who deserves what outcomes based on their effort) in moral evaluation of economic outcomes (see Dworkin 1981a, 1981b; Roemer 1996 for a detailed discussion on these topics).

[iv] In a lexical or lexico-graphic preference ordering sense.

Disclaimer: The views expressed in article are the author’s personal views, and do not represent that of the institute he is affiliated to. Usual disclaimers apply.

The author is assistant professor at Indian Institute of Technology, Mumbai. Previously he has worked with London School of Economics. 

Can demonetisation tackle the menace of black economy ?

black-money-supreme-court-of-india

By Saumen Chattopadhyay 

In the wake of the demonetization, it is an imperative that we distinguish between the two concepts, black money and black economy. Black money is a stock concept measured at a particular point of time like, bank deposits, or, supply of money measured as on 31st March. Black economy thrives on black income generation. Black incomes are generated mainly by the self-employed and the business. Salaried are paid after taxes are deducted at source. Black incomes are generated mainly with the purpose of evading taxes on profits. Black profits are generated either by under-reporting output and/or prices, therefore, revenue and/or artificially escalating costs so that reported profit (on which taxes are paid) is lower than the actual profit. Demonetisation, therefore, is unlikely to have a major dent on the black income generation but will be able to unearth black incomes held in the form of cash which may be actually a fraction of total black incomes earned in the past as black investments can assume various forms. A significant part of black incomes generated in the past have already been invested in land, gold or other forms of assets. A part of it also leaks out of the economy and is held in the tax havens. Transfer pricing which is notional shifting of profit constitutes 2/3rd of capital flight in the world. This practice has also come under the surveillance of our government.

Fighting corruption is therefore not similar to fighting black income generation. Therefore, corruption as commonly understood as the abuse of public office is to be distinguished from the illegal tax evasion resorted to by the self-employed and the business, mainly in the services sector. No less menace is the black income generation as indicated by its very size which is argued to be 50% of GDP consisting of black income generation in line with the GDP concept. Bribes are transfers and are not included in the estimation of GDP. Bribes or illegal transfers are associated with corruption mainly which would be far less than the size of the black economy.

Sooner or later, this one time measure will gradually cease to matter and the economy will settle at a new equilibrium with the new currency notes. The Indians have been master ingenious and have the potential circumvent any challenge posed to their ways of living, legal and illegal. This confusion continues to remain in the minds of the policy makers, even the experts and the people as the government gives the impression of fighting corruption while the black income generation can continue as the propertied class remains largely immune to demonetization. The illegal economy which is mainly cash based will face problems in sustaining the illegal activities in the short run for sure. In 1978, the high denomination notes of Rs 1000 and Rs 5000 were demonetized. There were only Rs 165 crore worth of these high value currency notes in circulation (Kumar, Arun (2002): The Black Economy in India). Black income generation continues unabated, however.

( The author is a professor at Zakir Husain Centre for Educational Studies School of Social Sciences, Jawaharlal Nehru University, New Delhi) 

 

Image Credit : http://www.livelaw.in/cms/wp-content/uploads/2015/09/Black-Money-Supreme-Court-of-India.jpg

To stop black money, Indian government withdraws Rs 500 and Rs 1,000 currency notes from circulation.

currency_notes_515204f

Zulfiqar Sheth

Taking the nation by surprise, Prime Minister Narendra Modi on Tuesday night announced demonetisation of Rs. 1000 and Rs. 500 notes with effect from midnight, making these notes invalid in a major assault on black money, fake currency and corruption.

In his first televised address to the nation, Mr. Modi said people holding notes of Rs. 500 and Rs. 1000 can deposit the same in their bank and post office accounts from November 10 till December 30.

Here are the highlights from his address:

  • Corruption and black money are diseases rooted in this country, they are obstacles to our success.
  • We are among fastest-growing economies, but we also rank so high in global corruption rankings.
  • We need to take a new solid step to fight black money. From now on, Rs. 500 and Rs. 1000  notes will not be used. Have 50 days to turn them into banks and post offices.
  • On November 9 and in some places on November 10, ATMs will not work.
  • Respite for people for the initial 72 hours, government hospitals will accept old Rs. 500 and 1000 notes till 11 November midnight.
  • Petrol pumps and retail outlets will have to keep every single entry of cash transaction with 500 and 1000 notes till November 11.
  • Crematoriums and cemeteries will also be allowed to transact 500 and 1000 notes till November 11.
  • There will be no change in any other form of currency exchange be it cheque, DD, payment via credit or debit cards etc.
  • Those unable to deposit Rs. 1000, Rs. 500 notes by December 30 for some reason, can change them till March 31, 2017 by furnishing ID proof
  • Notes of Rs. 2000 and Rs. 500 will be circulated soon, RBI has decided to limit the notes with higher value.

This is not the first time this has happened in India, at least technically. Earlier, Rs 1,000 and Rs 10,000 banknotes, which were in circulation, were demonetized in January 1946, primarily to curb unaccounted money. The higher denomination banknotes in Rs 1,000, Rs 5,000 and Rs 10,000 were reintroduced in the year 1954, and these banknotes (Rs 1,000, Rs 5,000 and Rs 10,000) were again demonetized in January 1978. So that makes it the last time demonetisation was done in India. (Source :RBI)

 

Meet 2016 Nobel Laureates in Economics

nobel-prize-economists

By Zulfiqar Sheth

The Royal Swedish Academy of Sciences has decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2016 to Oliver Hart, Harvard University, Cambridge, MA, USA and Bengt Holmström of Massachusetts Institute of Technology, Cambridge, MA, USA for their contributions to contract theory.

Brief Biography of  Oliver Simon D’Arcy Hart 

1476093816_bengt-homstrom-oliver-hart68 years old Oliver Simon D’Arcy Hart  is a British-born American economist and the Andrew E. Furer Professor of Economics at Harvard University, where he has taught since 1993. Hart works mainly on contract theory, the theory of the firm, corporate finance, and law and economics. He obtained his PhD degree from Princeton University in 1974 , MA(Economics) from Warwick University in 1972 and B.A. in Mathematics from Cambridge University (King’s College) in 1969. His research centers on the roles that ownership structure and contractual arrangements play in the governance and boundaries of corporations. He has published a book (Firms, Contracts, and Financial Structure, Oxford University Press, 1995) and numerous journal articles. He has used his theoretical work on firms in two legal cases as a government expert (Black and Decker v. U.S.A. and WFC Holdings Corp. (Wells Fargo) v. U.S.A.). He is a Fellow of the Econometric Society, the American Academy of Arts and Sciences, the British Academy, and the American Finance Association, a member of the National Academy of Sciences, and has several honorary degrees. He has been president of the American Law and Economics Association and a vice president of the American Economic Association.

Oliver Simon D’Arcy Hart Detailed CV

Brief Biography of Bengt Robert Holmström

4 R

Bengt Robert Holmström is the Paul A. Samuelson Professor of Economics at Massachusetts Institute of Technology, where he also was head of the Economics Department from 2003-2006. He holds a joint appointment with MIT’s Sloan School of Management. He is an elected fellow of the American Academy of Arts and Sciences, the Econometric Society and the American Finance Association, and an elected foreign member of the Royal Swedish Academy of Sciences and the Finnish Academy of Sciences and Letters. He is a research associate of the National Bureau of Economic Research and a member of the executive committee for the Center of Economic Policy Research. In 2011, he served as President of the Econometric Society. He received his doctoral degree from Stanford University in 1978. He has served as an associate professor at the Kellogg Graduate School of Management at Northwestern University (1979-82) and as the Edwin J. Beinecke Professor of Management at Yale University’s School of Management (1983-94). Holmström is a microeconomic theorist, best known for his research on the theory of contracting and incentives especially as applied to the theory of the firm, to corporate governance and to liquidity problems in financial crises.

Bengt Robert Holmström Detailed CV

 Contracts and contribution of Hart and Holmström

Modern economies are held together by innumerable contracts. The new theoretical tools created by Hart and Holmström are valuable to the understanding of real-life contracts and institutions, as well as potential pitfalls in contract design.

Society’s many contractual relationships include those between shareholders and top executive management, an insurance company and car owners, or a public authority and its suppliers. As such relationships typically entail conflicts of interest, contracts must be properly designed to ensure that the parties take mutually beneficial decisions. This year’s laureates have developed contract theory, a comprehensive framework for analysing many diverse issues in contractual design, like performance-based pay for top executives, deductibles and co-pays in insurance, and the privatisation of public-sector activities.

In the late 1970s, Bengt Holmström demonstrated how a principal (e.g., a company’s shareholders) should design an optimal contract for an agent (the company’s CEO), whose action is partly unobserved by the principal. Holmström’s informativeness principle stated precisely how this contract should link the agent’s pay to performance-relevant information. Using the basic principal-agent model, he showed how the optimal contract carefully weighs risks against incentives. In later work, Holmström generalised these results to more realistic settings, namely: when employees are not only rewarded with pay, but also with potential promotion; when agents expend effort on many tasks, while principals observe only some dimensions of performance; and when individual members of a team can free-ride on the efforts of others.

In the mid-1980s, Oliver Hart made fundamental contri-butions to a new branch of contract theory that deals with the important case of incomplete contracts. Because it is impossible for a contract to specify every eventuality, this branch of the theory spells out optimal allocations of control rights: which party to the contract should be entitled to make decisions in which circumstances? Hart’s findings on incomplete contracts have shed new light on the ownership and control of businesses and have had a vast impact on several fields of economics, as well as political science and law. His research provides us with new theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned.

Through their initial contributions, Hart and Holmström launched contract theory as a fertile field of basic research. Over the last few decades, they have also explored many of its applications. Their analysis of optimal contractual arrangements lays an intellectual foundation for designing policies and institutions in many areas, from bankruptcy legislation to political constitutions.

Source : Press Release: The Prize in Economic Sciences 2016

 

(Zulfiqar Sheth is a doctoral fellow at the Department of Economics, Aligarh Muslim University, India. Can be reached at shethzulfi@yahoo.com)