Costs of being risk-averse

Costs of being risk-averse

Our education system seems to focus excessively on memory and speed, i.e., efficiency. It seems irrelevant to us that many real-life situations have little to do with split-second quantitative decision making and high memory power.

Globally, we have the third largest pool of scientists. India produces approximately 400,000 engineers every year. We have abundant natural resources. It is strange that with this combination of human and natural resources, we end up with poor African countries at the bottom of human development indices.

One major problem is that Indians have little appetite for risk, be it financial or non-financial.

The pursuit of innovation is a very risky business. It requires capital. Investors must have risk appetite to invest in innovation. But this is a necessary and not a sufficient condition. For example, West Asia is not a major innovator though it has an abundance of financial capital. America, in contrast, has a healthy appetite for risky assets.

On the other hand, the rest of the world invests in its less risky bond (including government bonds) market. Consider the risk appetite of Indian investors: on the world stage the most significant position taken by Indian investors is likely to be almost perpetually long in gold. Gold, being the traditional hedge against inflation, indicates the low risk appetite of Indian investors. At least a small portion of the money invested in gold could be attracted into floating rate deposits indexed to consumer price indices.

Indians can invest in real estate, with its manipulation and inflated prices, because it offers high returns without any significant perceived risk. Why would Indian investors invest in innovation or in new ventures when apparently easy returns seem to be available in real estate? The problem is partly due to inefficient allocation of domestic private capital in gold and real estate. This is compounded by the use of quantitative measures by the central bank to curb credit growth. These measures are inherently biased against new ventures. If the funds that a bank can lend (for both capital investment and working capital) are curtailed (say, by increasing bank reserve requirements), then the bank is likely to lend to existing borrowers rather than to new borrowers.

In general, the value of financial assets to real assets should be greater than one. This is because the value of financial assets is derived from the real value added by the real assets in the future along with the present value of the real asset. The lack of financial deepening (the ratio of financial assets to real assets) is another cause for scarce capital.

These problems adversely affect new ventures and new ventures with innovative products/solutions much more. Unless we solve this problem we may not be able to effectively utilize an outstanding trait in India: the willingness of the middle class to invest in its children’s education.

We can also look at non-financial risk appetite. Americans and some other Western nations have shown phenomenal resolve. The Salk polio vaccine trials involved 1.8 million children from the US, Canada and Finland. Fortunately, the vaccine worked. We see a tremendous resolve to find solutions even when they entail a huge risk. The Challenger and Columbia shuttle disasters did not cause calls for abandoning manned space travel altogether.

It may be a good strategy to piggyback on the innovations of the rest of the world. But if we want to build an honest innovative society respectful of efforts which may have resulted in failures, and which has sufficient financial and non-financial risk appetites, then we need to act now.

A.M. Godbole is an executive assistant, A.V. Rajwade & Co. These are his personal views.Comments are welcome at