The Hindu Business Line : Some myths about wealth creation

Vandana Shiva, the feisty green-activist, organic farming enthusiast-cum-practitioner and thinker, in the course of a recent interview in the Top Shot programme of Doordarshan Lok Sabha Channel, wondered whether the stock markets really create wealth.

What she left unsaid was: When a Rs 10 share of a blue-chip company zooms to an unthinkable Rs 45,000 over a period of, say, six months, has any wealth been created? and

When real estate prices in a city catapult from Rs 2,000 a sq.ft. to Rs 30,000 a sq.ft. in a matter of couple of years, is it a palpable reflection of the growth of the economy resulting in wealth creation?

Liquidity-driven boom

The stock market and real estate boom in India in recent times have been to a large extent fuelled by foreign money chasing plum assets; this is described by economists as a liquidity-driven boom.

When there is excess liquidity in the economy, they rightly warn of inevitable inflation if the increase in liquidity is not matched by a concomitant increase in production of goods and services. But when it comes to the stock market, it is evaporation of wealth when the market tanks that takes up the spotlight.

How can there be dual standards — one for goods and services and another for the more esoteric share market? If bloated prices for goods and services should not be equated with ‘wealth’, then bloated valuations for shares in the bourses should not be equated with wealth as well.

When the share market sobers down and market prices fall from unrealistically high levels, does anybody except the risk taker to lose wealth? No market admittedly can maintain a unidirectional course.

In the event, if one has purchased a Rs 10 share for Rs 2,000 which rallies to Rs 3,000 in a matter of, say, three months and then comes down sharply to Rs 2,200 on heightened selling pressure, it would be wrong to say that this investor has lost Rs 800 of his wealth.

If every notional gain has to be translated into wealth, then one has to actually realise that gain, which is possible only if one actually sells the shares at every spike.

Wealth then is not ‘created’ by the stock market, it is created by assets built by businesses, which may be funded by markets.

In this context, a surge in funds mobilised in the primary market may create wealth if it sooner or later translates into investments into plant and machinery and other assets, resulting in increase in production in the economy.

A facilitator

To be sure, the stock market greatly facilitates wealth creation because the exit route provided by it and for the transparent price discovery mechanism provided by it, make up the foundations of the stock market.

An FII is only as much committed to India as a demagogue is to principles. And it makes no bones about it. In the event, if it books profits and remits the proceeds to its home country, no wealth accrues to the country. For the same reason, a real estate boom does not mean direct wealth creation unless the gains realised from the boom are used productively to bring about greater economic prosperity, not essentially through the housing sphere.

In short, the wealth created in the stock market is largely for and by individual investors/operators with no part of it going into the company’s coffers. Yes, wealth creation takes place at the company level when it rewards the various stakeholders associated with it.

Transfer vs creation

In the secondary market, there is no wealth creation but only transfer of wealth between two parties involved in buying and selling. When the market is buoyant and there is a sustained rising trend, it may appear that it is not a zero sum game as long as each successive buyer is able to sell at a profit.

But a deeper reflection would show that even this is only transfer of wealth and not wealth creation because at the end of the day it is the original seller who has missed out on the opportunity to make all these profits which he would have made had he clung on to the shares.

That markets transfer and do not create wealth, applies equally to the real estate market — a 1,000 sq.ft. house which was originally constructed for, say, Rs 1 lakh might have changed hands ten times with the last consideration being Rs 50 lakh. This signifies transfer of Rs 49 lakh worth of wealth during this period. The economy itself has nothing to show because the 1,000 sq.ft. house remains the same.

Another analogy is in order. Let us say a fertiliser plant was set up fifty years ago for Rs 20 crore and today it is estimated that a similar capacity plant would cost 50 times more. The first company which has had a head-start might even restate the asset value in its balance sheet to reflect the new realities.

But in reality, its superior wealth creation ability vis-À-vis the new entrant arises from its cost advantage rather than from the notional savings in the cost of setting up the plant.

(The author is a Delhi-based chartered accountant.)

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