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Parable of the shopkeeper

Parable of the shopkeeper
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First Published: Wed, Feb 28 2007. 12 57 PM IST
Updated: Wed, Jul 25 2007. 06 24 PM IST
A few hours before the finance minister delivers his Budget speech and you prepare to get drowned in a torrent of post-Budget analyses, let us play a mind game.
Suppose you plan to open a shop on a street that is lined with houses. These houses are evenly distributed along the street. There are two things you know at this point of time. There is a competitor who is patiently waiting to open a shop just next to yours. And the customers who live along this street will walk into the shop that is nearest to their homes.
So, where will you build your store?
Assume you build your store at one end of this street. (It could be any end.) The competitor will set up his shop just next to yours, but just a little closer to the centre of the street.
What happens?
Most of the people living along this street will go to the competitor’s shop because it is closer to their homes. The only people who will walk into your shop will be those few staying at the very end of the street where you are located. This will happen irrespective of which end of the street you choose. Most people will avoid you.
Locating your shop at the extreme end of the road is not a good idea. So what do you do? The best strategy for you is to build at the centre of the street, so that you have an equal chance of getting customers.
A similar dynamic operates in politics: These shopkeepers do better when they stay close to the ideological centre because voters prefer to choose those politicians who are closest to their own ideological position. Take a position at the extreme left or the extreme right, and people will gravitate to the opponent who is slightly less extreme. He walks away with most of the votes, just as the other merchant in our example walks away with most of the customers.
The parable of the shopkeeper was used by the economist and statistician Harold Hotelling, and is fairly well known in the theory of public choice (or what is sometimes described as the economics of politics). Knowledge of this parable has some practical advantages on the last day of February because it can help you understand some of the nuances in the finance minister’s Budget speech.
After all, he is the shopkeeper and we are the men and women on the street.
Finance ministers tend to stick to the middle path, where they are not too far away from our common beliefs—or prejudices. But some of these prejudices are vehemently anti-reform. Most people still believe that foreign competition is bad, or that the government should provide jobs, or that others should be taxed heavily. This is the virus that 50 years of statism has planted in our minds. Economic reform would have made no progress if the recent lot of finance ministers had behaved like Hotelling’s shopkeepers and stuck to the middle.
And that is precisely why Budget speeches can be so much fun to listen to. The finance minister will announce a reform that tests the tolerance of the median voter, and he will then balance it out by making some empty statements to assuage fears. The economics takes the discourse to an extreme, while the politics drags it back to the centre.
That’s why every Budget speech is peppered with meaningless homilies suggesting that the mai-baap sarkar will look after you. Rarely is there actual money put on the table to back these statements. The economics and politics are often at odds.
Budget speeches tend to be duplicitous because the average citizen is woefully ignorant about economics—and expects the government to solve problems that it cannot. Such are the compulsions of democratic politics. In a way, Budget speeches are a measure of our own economic ignorance.
The real challenge then is to convince the average citizen that economic reform is not some conspiracy against him; and that capital, productivity and markets are the solution to his long-term problems, not government spending.
The centre of the street has to be redefined. A first step would be to think less of governments. Milton Friedman once made an acerbic and insightful comment on the nature of government spending.
There are four ways to spend money, he said. One, you spend your money on yourself, and you try to put the money to the best use. Second, you spend your money on somebody else, and you try to control costs. Third, you spend someone else’s money on yourself, and you try to have a good time but not care much about costs. Fourth, you spend somebody else’s money on somebody else—and then you don’t care about either the efficiency of the spending or the price.
“And that’s government,” added Friedman.
It’s a comment worth remembering on Budget Day.
Your comments are welcome at cafeeconomics@livemint.com
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First Published: Wed, Feb 28 2007. 12 57 PM IST