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Problems With Democratic Choice

It's often nothing but 'rule by crowds'. They see what they want to see. They are always over-confident, derisive of a minority view and incapable of assimilating new information

It is increasingly becoming a received wisdom to talk about democracy as the final, superior way of life. Most political scientists would have you believe that we have experienced all the other possible variants, i.e., from Fascism to Totalitarianism and Communism.

After the fall of the Berlin wall, there seems to be a growing consensus that 'Democracy' (often used interchangeably with 'Capitalism' provides free choice. Freedom being a virtue that nobody wants to argue against, any system that promotes freedom is considered virtuous. Hence, in any trade-off, the option that is based on free and popular choice should be chosen.

But we know that 'crowds' of people form again and again. A crowd need not be a physical collection of people, but a psychological 'clustering' of opinion around a consensus. We also know that crowds understand simple messages, eschewing complexity. They are always over-confident, derisive of a minority view and incapable of assimilating new information. They see what they want to see. Democracy is often nothing but 'rule by crowds".

Crowds are given to extremes of greed and fear. Both these emotions stem from our anthropological roots; greed takes over when we seek to invest under conditions of great confidence (which happens when our survival instinct is at rest, ie, we are confident about our survival. This if often called 'feel good'). But our emotions alternate…fear happens when our survival instinct is under threat. It is a much more powerful emotion than greed, but that should be obvious. Both states of being are rife with a large number of irrational patterns of behaviour.

Behavioral economists know that freedom is nothing but the ability to give vent to a baser instinct. Taken to its logical conclusion, that freedom will be used to service your 'anthropological' needs.

We see many examples of this in democratic Governance. One of the best-known irrationalities observed in humans is 'risk/ loss aversion', i.e., the tendency to postpone current pain. Power reforms were delayed because current pain would have to be endured in order to get future benefits.

So also with fiscal reform, where pain aversion, a classic 'anthropological' irrationality, is demonstrated very clearly. The government would much rather inflate away its deficits, than raise taxes and cut back consumption in the economy. Inflation tends to re-distribute wealth away from savers and consumers, in favour of producers and borrowers. Savers, especially those who invest in debt, get a low real (inflation-adjusted) return, sometimes a negative real return. The new cash that is pumped in by the government's deficit financing, is re-distributed among producers (ie, businesses). That is why in a high-inflation economy, there is a disincentive for savings and businesses with pricing power get richer.

We see this in stock markets everyday where investors, once committed to a view of the company/ scrip/ economy, are loathe to change such a view because it would mean giving up the potential for profit. Investors are also voters, which is why a government would want to pander to this 'need' for investors to postpone pain.

Companies want to perpetuate bull markets to infinity. The government. today is caught in a cleft stick. If it does anything to dislocate the current bull run, it will be inflicting current pain (on the investors) to mitigate a future unknown disaster. The benefit accruing from avoiding such a disaster is immeasurable. But the pain that the govt. inflicts (a tightening of liquidity or an interest rate hike or an administrative mandate to banks to cut back lending) will be hardly remembered as a popular move.

This is a classic example of how democratic regulation is actually counter- productive. With everybody knowing that we are headed towards disaster, nobody does anything about it. Because, nobody is willing to stand apart and take responsibility for inflicting pain on the larger populace. In the last column I had mentioned how the arrack shop owner needs a bouncer to stop a man after his 12th peg. It would take a singularly strong person to stand up and say that he will give the people what they need, not what they want.

Take the current oil imbroglio. The government finds itself wanting to postpone pain, by holding back oil price hikes that need to pass through from the international oil market. This is distorting correct price discovery, with overheated India (and China) pushing up oil demand, regardless of the fact that oil prices are going into the stratosphere.

We have the Left actually supporting the holding back of the price hikes, in a mindless reaction typical of the olden days…when bus fare hikes were accompanied with the burning of buses. Nobody realizes that the prices of oil will not reverse till there is a physical reduction in the quantum of oil, in the 84 mn barrels of oil that are getting consumed. This 3-4 mn barrels increase per year has to reverse, and the chief cause of this is India/ China.

The momentum of increase in oil demand can only be reversed with great pain. And that pain cannot be inflicted on their people by democratic governments. China may, in typical fashion, show great firmness and will in taking the right actions to deflate the bubbles in their economy, but India (as usual) will wait till the water is 6 feet over their heads. This the 'pain aversion' phase of the asset bubble that is reflected in different parts of the economy.

By absorbing the oil-related deficit, the government will feed inflation and then interest rates. This will redistribute the pain from the consuming class (of oil, which is mostly the affluent class) to the entire economy, which includes the poor innocents. The longer this is delayed, the bigger the cost for the economy. Does anybody believe that more oil will somehow spurt out of the ground, in response to higher oil prices? The correct response needs to be: to inflict pain on the populace, then have the economy (ie, private initiative) work to see the pain alleviated in the normal 'economic' way. Private entrepreneurs will find either low-energy applications in industry and transport, or find alternative energy sources that lower the effective cost of energy. What would happen (I ask rhetorically) if oil goes to $200 per barrel, and we have to shift to mopeds…what the car industry loses, the 2-wheeler industry will probably gain. What the transportation industry loses, maybe the Video Conferencing/ Telecom/ VOIP industries segments will gain….who knows?

See how the Kyoto Protocol is already mitigating the carbon problem. Once CERs were introduced and made tradeable, the price of CERs went up sharply. That is what we see embedded in the stock prices of cos that have carbon-negative projects (refrigerant gases, sugar, IPPs, etc).

Now look at the pain side of the equation. Utilities in Germany have hiked up prices by a third, to reflect the increased cost of Carbon credits that they have to buy, to bring down their 'carbon cost' to the environment. Oil consumption has dropped by about a tenth in some major European economies and the rush for low-energy applications has started in those countries.

The Carbon credit system is a democratic mechanism that inflicts pain on the cause (of environmental pollution)…it also creates unearned profits somewhere else, but that is incidental. The pain will now be alleviated by the normal economic mechanism of entrepreneurs locating the 'pain points' in the economy and developing applications to mitigate pain.

Increasingly, the supply of carbon-negative projects will increase dramatically, given the incredible profitability of such projects. And the consumption of carbon will drop, given the costs attached to it.

Now look at how most people interpret this. Instead of taking on targets of its own, govts all over the world are trying to avoid it. This pain aversion will cost them in the long run, as they will delay conversion to low-carbon energy systems while the aggressive converters will be ahead on newer applications.

With great speed, the tables will be reversed. Countries that are today carbon-negative will have preponed the pain (of conversion), while countries that are lower on the table (as polluters) will have continued with older systems, effectively perpetuating the technology leadership that the former enjoy.

(Sanjeev Pandiya is a contrarian who invests, teaches at XIM and works in the auto ancilliary sector. He can be contacted at [email protected])