Category: Sub-Prime & Recession



Could a mere tulip bulb be worth $76,000? It is, if people are willing to pay for it. It may sound preposterous, but this is exactly what happened during the Dutch Tulip Mania or Tulipomania of the 1630′s.

The Semper Augustus which was considered the rarest, most valuable and the greatest tulip ever found, was valued at 10,000 Florence at a time where an average Dutch worker survived with a family with only 300 Florence a year. Another irrational incident witnessed was 12 acres of land being offered for a Semper Augustus bulb. Such was the madness at the peak of Tulipomania.

 

So this is how it all began….

Initially, only true connoisseurs (a person who is especially competent to pass critical judgments in an art) bought tulip bulbs, but the rapidly rising price quickly attracted speculators looking to make a profit. It didn’t take long before tulip bulbs were traded on local market exchanges, which were similar to modern stock exchanges. By 1634, tulip mania had spread to the Dutch middle classes and soon practically everybody was trading tulip bulbs, looking to make a quick fortune.

The majority of tulip bulb buyers had no intention of planting these bulbs – the name of the game was to buy low and sell high, just like in any other financial market. The entire nation was caught in a sweeping mania and some people even traded in their land, livestock, farms and life savings to acquire a single tulip bulb.

After some time, a few tulip bulbs contracted the non-harmful mosaic virus, which caused tulips to grow petals with beautiful “flames” of color. This unique effect increased the value of the already rare and highly exclusive tulip bulb triggering the bubble to build up.

At the peak of the mania, the price of tulip bulbs went up twenty-fold in just one month. To put that into perspective, a person who had invested $1,000 in tulip bulbs would have seen their investment balloon to $20,000. With gains such as these, it is not hard to understand the mad rush to buy tulip bulbs at any cost.

By 1636, tulips were trading on the Amsterdam Stock Exchange as well as on exchanges in other nearby European countries. These exchanges started to offer option contracts, which allowed speculators to trade in the tulip bulb market for a fraction of the price of a real tulip bulb.

Dutch traders aggressively speculated in tulip bulb options due to the common belief that the tulip market was immune to falling and that it would “ALWAYS GO UP”.

And the mania ends….

After some time, the Dutch government started to develop regulations to help control the tulip mania. It was at this point that a few informed speculators started to liquidate their tulips bulbs and contracts to lock-in their profits. In addition, more tulip bulbs were added to the supply due to increasingly large tulip bulb harvests. Suddenly, tulip bulbs weren’t quite as rare as they were before. Tulip prices began to ease, gently at first, and then started to plummet at a much faster rate than prices rose. Suddenly, the market experienced a widespread panic as traders rapidly began to realize that tulips were not worth the prices people were paying for them. A default on a tulip bulb contract by a buyer was the main bubble-popping catalyst and caused the tulip bulb market to violently implode as sellers overwhelmed the market and buyers virtually disappeared altogether. Within just a few days, tulip bulbs were worth only a hundredth of their former prices, resulting in a full-blown panic throughout Holland. Dealers refused to honor contracts, further damaging confidence in the tulip bulb market. In less than six weeks, tulip prices crashed by over 90%, causing vast fortunes to be lost.

The traumatic tulip bulb crash resulted in a suspicion toward speculative investments in Dutch culture for a very long time after. The tulip bulb crash threw the Dutch economy into an economic depression that lasted for many years.

Investors came to know that it is better to stop and smell the flowers than to stake your future upon one.

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In the last 20 years the warriors of globalisation have been fighting for free trade and business policies against various protectionist arguments from both sides of the globe. The western protectionists and labour groups say that globalisation is exporting their own people’s jobs and livelihoods, leading to unemployment and some argue even the recession of 08’ is in-effect the result of jobs being shipped to China and India, the kind of jobs “sub-prime” Americans would have. The Obama Administration has been opposed to IT and manufacturing jobs and has increased visa restrictions, giving heed to the popular demand. On the other side the eastern politicians believe that foreign companies setting shops near their homes would be “Colonialisation part 2”. These companies would displace their domestic counterparts which can’t compete; many fearing “what the East India Company did two hundred years back would happen again if these Multinational Corporations would be allowed in India”. The recent debates on FDI in multi-brand retail brought up the dangers of destruction of the indigenous retail sector – the small scale kirana stores.  Even free market supporters oppose these measures saying that first the Indian Industries need to be developed and be made competitive before opening up the Economy to the competition from the foreign giants like Wal-Mart, Carrefour etc. Summing it up, the socialists in the developed world argue that their labour cannot compete with the cheap labour from India and China, and the ones in the developing world argue their indigenous industries cannot compete with the advanced and cash rich companies from the other side of the globe. Basically the rich say they cannot compete with the poor and the poor say they cannot compete with the rich!

I really want to ask these people that how can free and voluntary trade and commerce be detrimental to both the developed as well as the developing economies? I mean after all when both parties trade for goods and services they both mutually and voluntarily agree to trade because they both are better off after the agreement. No one party, the buyer or the seller is the beneficiary of the transaction, in fact they both are. This should also be the case when these parties are different countries with specialised strengths in certain industries. And this is exactly what happens but the policymakers cannot see. World trade and commerce is not a zero sum game. When cheaper Chinese exports flush the world markets people as well as policymakers tend to think that their own manufacturing industry is at a competitive disadvantage. Yes it is, indigenous manufacturing gets shipped to locations with cheap labour advantage. However this is because relatively unproductive jobs gets transferred to developing nation and new much more productive jobs like of programmers are created. People simply climb up the productivity ladder. Previously agrarian economies are now becoming more productive manufacturing economies and previously manufacturing economies are becoming “Knowledge economies” thereby increasing productivity.

The graph shows annual growth in labour productivity in United States during certain periods.

It shows growth being averagely high during periods of commercial realisation of rapid technological developments. During 1947-73 post WW2 technological advancement had helped increase labour productivity greatly for over a long period of time. The US economy was generally open promoting free international trade.  Contrary to popular beliefs, even during the years of the worst recession since 1929 the 2007’-10’ had again seen exceptional productivity growth despite a slowing economy and large concerns over outsourcing of both service and manufacturing jobs.  Obviously the internet and other computing technologies were increasing labour productivity mostly because of the access which was available to large majority of the population as against the developing economies where only the elite had access to it.

Coming back to India, due this approach of “protecting against the next East India company” we have already lost 65 years of productivity growth and economic development. Most of the development that has taken place has been in the last 20 years after the forceful opening of the economy. As a comparison of the two nations in today’s scenario where our Government says that India has been relatively insulated from the worldwide economic slowdown with much higher growth rate around 6.5% in the current fiscal than the west’s 2%. As estimated Indian economy would grow at 6.5 % meaning an addition of 117 billion dollars in production of goods and services  with per capita increase in productivity of around $93, the American economy on the expected lines after the recession growing at a slow 2.5% would add 380 billion dollars in production of goods and services  with per capita increase in productivity of around $1214 per person, 13 times more than that of India even after a full blown economic recession. This is because of the productivity ladder the American economy has climbed due to their competition with the Chinese. The Chinese work at cheap wages at factories, the Americans just changed the game.

-Keshav Khanna


Recent comments of president Obama regarding outsourcing saw shivers running through the spines of Indian IT industry, our flagship export to the rest of the world. Worried about the steep rise in unemployment in the US, president Obama told the Congress that he shall be putting sanctions on the companies that outsource jobs outside the boundary of the US. But what is to be seen is how harsh his sanctions would impact IT industry in India

See how money makes the world go round. The most vehement supporter of free trade, the US, marred by century’s worst financial crisis and high unemployment rates, is now resorting to such overtly protectionist measures. Our IT industry is reasonably cautious about it. It nevertheless has put up a brave face and says it’s optimistic about the future. The apex body for IT and ITeS industry – NASSCOM, that such measures in the bigger picture won’t affect India‟s $50 billion IT industry and it also criticized such moves saying that we should face this economic crisis by increasing global cooperation rather than such protectionist measures.

While industry leader INFOSYS argued that outsourcing has increased the efficiency and hence the competitiveness of US companies. It has helped them access the best resources of the world thereby encouraging innovation, which has again lead to job creation in US. Anyhow there is no denying in the fact that if any such restriction is implemented, it shall be met with strong criticism and shall be denting US‟ international image. Also there is fear that other countries may also follow suit.

If talking about its direct impact on India‟s outsourcing and IT firms, these changes wouldn’t be large enough to match the 20-30% benefits that they are getting now. Tax breaks won‟t be able to compete with this kind of deal. But it would also be accompanied with stricter restrictions on H1-B visas given to highly skilled manpower. And the number of our engineers going to US for short projects or permanently settling there would see a sharp decline. Although it’s not too big a case for concern.

In the overall scenario, these set of events won’t prove to be a big setback to our ever expanding IT industries. Our image of the world‟s back office is here to stay. IT shall continue to grow bigger and better…

– Shreyank Jamar