In the economic sphere, the defining characteristic of the 1990s was the rise of the ‘net economy’ as technology enabled a whole host of new transactions globally and within economies. This trend accelerated after 2000 and the 2008 global recession, while world trade in manufactured goods has remained stagnant in terms of share of global gross domestic product (GDP), with trade in services being the only growing segment. In fact, the ‘net economy’ led to a dramatic drop in the cost of transaction services nationally and internationally. To that extent, digital technology did the same thing in promoting trade in services (e-commerce) as it did for trade in manufacturers between 1950 and 1990 by cutting shipping/air and land transportation costs.
Compared to manufacturing and services, however, there is a difference: digital transactions can lead to infinite subdivisions of service in a particular sector, unlike manufacturing. For example, while the automotive sector can be subdivided into automobiles, parts and components, there is a limit. You cannot produce spark plugs with 1,000 small sub-components. On the other hand, in principle, no such limits exist in many service sectors. What I would argue is that the rapid pace of technological change in digital technology and its impact on the services sector has led to a disconnect between the real and financial economies, which finds expression in the stock markets. This was seen in other economies and is now seen in India. It can’t last.
Especially in the new millennium, we have seen the replacement of many traditional manufacturing industry giants (IBM, GM, etc.) with new-wave leaders such as Apple, Facebook, Amazon, etc. In India, this has found expression in the service boom. -Sector ‘Unicorns’, such as Grofers, Droom, Zomato and other diverse sectors ranging from automobiles to food. However, all these unicorns have one thing in common: they are all aggregators. Let’s look at it in a little detail.
The purpose of any market mechanism (e.g. Adam Smith’s ‘invisible hand’) is to coordinate an infinite number of transactions to determine a single transaction price. But the implied assumption is the existence of such a market and that there is correct information on the part of both buyers and sellers. However, in the case of asymmetric information, that market mechanism breaks down. Aggregators aim to create exactly such markets.
Consider the market for used cars. If I could collect all the information about the demand and supply of used cars and match them at one price while ensuring quality, I would solve the famous ‘lemon problem’; The nature of the transaction is such that the seller can never know the exact quality of any car. The limiting factor is the need to hold stock for sale/purchase. However if I can sync the sale and purchase digitally, I can effect the transaction without incurring any cost of holding the stock. I need to authenticate quality and complete transactions only through digital fund transfer. Net technology allows me to coordinate these across a large national market and buy/sell transactions digitally and with no inventory costs. The consumer is a clear beneficiary, with access to a near-perfect market for used cars, where in fact multiple service providers can participate. In the last few years such service aggregators have grown in areas like food delivery, product distribution, taxi services, education etc.
What such aggregators sell to investors is an idea rather than a specific product. These ‘ideas’ are funded and many aggregators have become unicorns. This technology driven economy has some inherent problems. For one, ‘ideas’ have no fixed cost and almost anyone can aspire to build a unicorn. Look at the age groups and profiles of most of today’s unicorn leaders. Second, very few of these service-sector startups are profitable today, as they skimp on profits to grow their business in the face of ever-increasing competition. But seed investors will need to recover their invested money at some point. Typically, this is done by floating new shares in a booming stock market so that the risk of business failure is passed on to shareholders, and early investors can move on to the next idea. The problem is that these aggregators can only promise delivery of real-economy products to consumers (cars, food, electronic goods), whose growth is determined by the real economy. But, unlike the manufacturing sector, the growth of this financial (services) sector is not limited by the physical economy.
Recent data from Mint (13 October 2021) shows that the ratio of stock market valuations to actual revenues varies from 2,000 (Bharat Pay) to 50 (Grofers). It is also observed that the share of founders is very less as compared to the initial investors (less than 25%).
Optionality of services is a benefit and a liability at once: the growth of financial services is unlimited, while that of the real sector is not. This is exactly what happened in the ‘sub-prime’ crisis in the US in 2008, which led to the global recession. Thus there is a fair element of risk in the recent surge of initial public offerings in India. As the Indian middle class rushes to run out of low-profit bank financial assets, it may be appropriate to watch out for ‘irrational enthusiasm’ in our stock markets.
Manoj Pant is Professor of Economics and Vice Chancellor of the Indian Institute of Foreign Trade
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