PPP in Indian schools

Outlook (Feb 18) reports that the MHRD has plans to experiment with PPP in the provision of schools shortly. It wants to open 2500 schools all over the country alone the lines of Kendriya Vidyalayas, the central schools that have some reputation for standards.

The details are yet to be worked out but it seems three models are being considered:

• Fully-managed private schools.

• A joint venture where the state invests in infrastructure and frames the syllabus. The industry takes care of providing tuition to students and managing the welfare of teachers.

• Limited role for the industry under which it will provide and maintain school infrastructure.

What do we make of the proposal? PPP is all the rage today and I'm certain that it is only a matter of time before it finds its way into education. But we need to be clear as to the rationale for private sector participation and what we can realistically expect.

Why private sector?: Government lacks resources to set up schools with adequate facilities. Government cannot run these schools well- witness, the high rates of teacher absenteeism and dropouts amongst students and also the low level of skills that many students display. The private sector can do a better job of running such schools.

There is a certain smugness about such arguments as though the problem and the solutions are self-evident. Public sector is bad, so let in the private sector. It is possible to disagree.

First, there could be other answers to teacher absenteeism, such as empowering parents or the local community. Secondly, high student dropout rates may have to do with socio-economic compulsions which won't go away even if the private sector steps in. (How many successful private schools exist in the remote rural areas, I would like to know).

Thirdly, the problem could the insistence of state governments on providing education in the local tongue when the clamour all round is for education in English. Parents and students don't see value in local language education provided by state schools. The preference for private schools in metros amongst the lower strata of scoeity could be just a preference for English education.

What value would the private sector add?: Krishna Kumar of NCERT has a critique of the PPP model in education in EPW (January 19-25, 2008). He says that if funding or facilities are the problem, the private sector could step in with financial support. Why can't telecom companies provide rural schools with free telephone facilities, for instance? The private sector could help not just with physical infrastructure but with 'software' such as teacher training on a big scale, given that there is hug gap in this area today.

But, no, these are not things that interest the private sector. Krishna Kumar also makes the point that PPP is something of a misnomer for what its advocates have in mind. They are not thinking of collaboration with government as the word 'partnership' suggests- meaning, the government provides the infrastructure and the private sector manages the school, so that government schools become more efficient.

What is meant by PPP more often than not is simply allowing the private sector into schools in a bigger way with generous government support. If this is intended, why make a big deal about it? We have had government-aided schools for decades now, so the idea itself is not novel. Calling it PPP is simply a way to give it greater acceptability.

The key issue in PPP is whether the private sector is willing to go with the second model mentioned above- the government provides the infrastructure and the private sector runs the school well. Also key is whether the private sector is willing to run it without wanting to make profit. Several snall-scale NGOs may be willing to do so but not necessarily corporate NGOs.

Arguments about private sector 'quality' can be easily overdone- as I keep asking all the time, how come, despite all the opportunities given to them, the private sector has not been able to produce quality in higher education comparable to what the IITs and IIMs have done? I would like to hear from readers about a quality schools run by the private sector in remote rural areas and that also offers education in the regional language.

State's role in education: Krishna Kumar points out that nowhere in the world has the state abdicated its responsibility for primary education. It should not happen that PPP here just becomes a euphemism for the state not living up to its duty to provide basic education to all. If there is any conclusion to be drawn from the proliferation of private institutions in higher education, it is that the profit orientation in the private sector tends to lead to escalating fees and under-hand payments that, in turn, lead to the exclusion of the economically disadvantaged.

We have a huge youth population that needs education. Any model of education that is non-inclusive can result in a social explosion.

Regulatory lessons from sub prime crisis

What are the regulatory lessons from the sub-prime crisis? In the barrage of comment, I flagged the following:

• Liquidity risk needs more attention than hitherto
• Rating of securitisation tranches needs to be put under the scanner
• How much of securitisation is permissible- and how much of the loans should remain with the originator- may need thinking through
• We need better pricing of risk although where the models have gone wrong is not clear
• Greater transparency is required in respect of derviatives exposures- in credit default swaps, for instance, the total volume of contracts written on an underlying credit must be known

Fair enough but let me mention two others that I think require even closer attention. One is higher capital at banking. In my ET column, Revisiting bank regulation, I argue that this is required not so much for the conventional reason, as a first line of defence against risk, but for containing incentives in banking. High leverage is creating incentives for managers to take undue risks and one way to rein this in is to impose a higher capital requirement.

But this is not enough. We need a more direct attack on incentives- and this may require regulatory action because I doubt that the banking industry will want to do anything about it once the crisis blows over. I have written about this in earlier posts but, very briefly, three steps are in order:

• the magnitude of bonuses needs to be contained
• bonuses at the top must be in the form of stock options that vest over a period of at least five years
• bonuses must not be paid out in full for a given year of performance; a big percentage must be held over for, say, five years and it must be used for adjustment against any losses that a manager inflicts on the bank.
  

Banking bonuses

Incentives in banking have emerged as a key regulatory risk. Daniel Heller, writing in FT, has three proposals for dealing with bonuses in the banking sector. (Heller is director at Swiss National Bank). The first of these is one that I had myself proposed a couple of months ago:

First, bonus schemes need to be more long-term oriented. Instead of being primarily based on last year’s performance, the bonus should take the performance of several years into account. One way is to pay out only part of the bonus in profitable years. The non-distributed part would be set aside as “reserves” that could be used to cover any losses in the future.

.....Second, the level of the average bonus in investment banking should be reduced in order to take into account that potential losses are not borne by the employee. One way is to limit the maximum bonus in a bank to the bonus of the chief executive. The fact that in the past some rewards exceeded that of the chief executive illustrates that schemes were not designed in an economically efficient way. In a profit-maximising, privately owned company the chief executive is supposed to be the employee with the most skills, who adds the most value.

Third, guaranteed bonuses should be abolished. They are a contradiction in terms, since a bonus is by definition the variable component of the compensation. Guaranteeing bonuses releases the employee from the requirement to make at least a small contribution to cover the losses he may generate.

Global economic outlook

The IMF has revised downwards its projections for global growth for 2008- from 4.9% estimated last year to 4.1%. US economic growth is pegged at 1.5% instead of the earlier forecast of 1.9%. My own forecast for 2008 made in December was a little lower than 4.4%, the trend growth before the recent boom, the IMF's revised figure is in line with my forecast.

The IMF sees US growth at only 0.8% in the fourth quarter of 2008, which implies a slow recovery from the present problems. I am rather more optimistic on this count, so global growth might end up a little higher than the IMF's revised forecast.

The IMF sees China's growth decelerating moderately from 11.4% to 10% but the World Bank sees a steeper decline- to 9.4%. Decelerating exports will contribute to this, according to the Bank. My reckoning is that the severe snowstorms in recent days will be an equally big factor.

On balance, I think the US will do better than the IMF thinks and China a little worse, so I see global growth in the region of 4-4.4% for this year.

Student fees and subsidies

There is a clamour all the time to reduce subsidies in higher education. Higher fees are perfectly okay as long as loan finance is available- this is the new mantra of those sold on market economics. The IIMs have been raising fees over the past several years and the coming year will see a big jump in fees in some of the IIMs, including IIMA.

When former HRD minister MM Joshi sought to peg fees at Rs 30,000 there was a huge uproar. What was overlooked subsequently was that the IIMs quitely accepted under Arjun Singh the principle of a big subsidy in fees for those coming from families with income upto Rs 200,000.

Those who advocate the proposition that fees should be market-related or that fees must recover costs of education overlook one crucial fact: nowhere in the world, certainly not in quality institutions, is this proposition rigidly adhered to. On the contrary, as a story in the Economist points out, top universities in the US are stepping up subsidies.

Formidable financial-assistance policies have eliminated fees or slashed them deeply for needy students. And last month Harvard announced a new plan designed to relieve the sticker-shock for undergraduates from middle and even upper-income families too.

Since then, other rich American universities have unveiled similar initiatives. Yale, Harvard's bitterest rival, revealed its plans on January 14th. Students whose families make less than $60,000 a year will pay nothing at all. Families earning up to $200,000 a year will have to pay an average of 10% of their incomes. The university will expand its financial-assistance budget by 43%, to over $80 mn.

Harvard will have a similar arrangement for families making up to $180,000. That makes the price of going to Harvard or Yale comparable to attending a state-run university for middle- and upper-income students. The universities will also not require any student to take out loans to pay for their tuition, a policy introduced by Princeton in 2001 and by the University of Pennsylvania just after Harvard's announcement.

Why would Harvard and Yale want to provide subsidies to "middle and even upper income families"? After all, anybody who studies at these places should be able to earn to repay student loans?- the point that is made ad nauseam with respect to IIMs. I can think of several reasons.

One, to attract the broadest possible range of talent. High fees, it is implicitly conceded, constitute an entry barrier for some talented students at least. Two, even in the US, where young people are on their own from an early age, it is families that bear some part of the burden of fees. This would be even truer in India where the graduating student has responsibility for his or her larger family even after taking up a job.

Three, quality institutions do not operate on the principle that they must recover costs (plus profit) through student fees. Just as newspapers recover costs through ads, not the sticker price, so also educational institutions get their funding from other sources- either government (as in much of Europe) or through endowments (as in much of the US). The idea of a subsidy is thus built into higher education, the only issue is the source of subsidy. It follows that if the leading IIMs are loath to accept government assitstance, they must find ways to generate endowments. Higher fee is not the answer.

Four, when we talk of a subsidy, we should know exactly what the costs are. To simply say that costs are rising and therefore fees need to rise is not enough- the costing of a particular programme must be done rigorously with proper allocations of overheads and this must be certfied by an appropriate authority.

One final thought. I recall my days at IIT Bombay at a time when the fees were laughably low. The one thing that astonished me was the number of people who had come from small towns- these constituted the raw, intellectual firepower of the school and many went on to make waves in the US. They came in because the fee was eminently affordable (student loans were hard to come by at the time). I have little doubt that high fees would have acted as a deterrent to many of these families even if loan finance had been available.

That experience gives me the utter conviction that escalating fees in higher education are the route to exclusion and elitism and the snuffing out of great talent.

Dalai Lama at IIMA

He came, he was seen, he conquered. Ahmedabad has the reputation of being a Hindutva haven. IIMA is no great affinity towards matters religions. Yet, when the Dalai Lama came calling a couple of weeks ago, we had a full house, with some of the leading celebrities in the city in attendance. He is not completely at ease in the English language but he has an accomplished interpreter to supply him the necessary word or phrase whenver he fumbles.

I tend to put a safe distance between Godmen and myself but, then, the Dalai Lama's attraction is that the does not pose as a Godman at all- he's quick to repudiate the familiar description of him as the 'living incarnation of the Buddha'.

No, the Dalai Lama commands respect more on account of his moral stature- as the leader of an oppressed people and as the propagator of a secular version of ethical living. As he said at IIMA, ethics can be founded on theistic religion, on non-theistic religion and on a wholly secular basis. As far as he was concerned, any version was fine. The Dalai Lama is refereshingly from dogmatism.

The Dalai Lama gives the impression of being completely down to earth- his laughter is infectious- but his whole persona suggests that the appearance is deceptive. He is relaxed, energetic and exudes a certain serenity- for all his attempts to downplay his holiness, he comes across as an evolved soul.

The Dalai Lama did mention Tibet and his hopes for it during his interaction at IIMA. As China grows in strength, the aspirations of Tibetans or at least the Dalai Lama's flock appear to wane. Politics in recent decades has been full of surprises- the break up of the Soviet union, the return of East Europe to democracy and capitalism, the crumbling of apartheid were all sudden and dramatic events. Likewise, a sudden twist in Tibet's fortunes cannot be ruled out. But it's hard to visualise one in the near future.

I have more impressions on the Dalai Lama in my ET column.

Indian growth rate on a high

Travel and other commitments have kept me away from my blog for a week.

I return to highlight the growth peak of 9.6% the Indian economy touched n 2006-07- this is said to be the highest growth rate in 18 years.

My immediate responses:

• The achievement is all the more remarkable because it comes on top of three years of high growth prior to 2007-08.
• For four years now, the actual growth rate has exceeded most forecasts. For 2007-08, the forecast was in the range of 8.5-9% and the earlier estimate 9.2%. For 2007-08, the RBI forecasts 8.5% and the Economic Advisory Council 9%. These two forecasts rested on the previous estimate for 2006-07. Now that we have a higher base for 2006-07, will the forecast growth for 2007-08 materialise? Going by recent experience, yes it will!
• More interesting is the outlook for 2008-09. The EAC, the RBI, the Deputy Chairman of the Planning Commission and the Finance minister are all sanguine about growth prospects despite the enveloping gloom arising from financial market turbulence. In government, it is fair to say, the consensus forecast remains close to 8.5% for 2008-09. More than the growth rates of the earlier years, it is an 8.5% growth rate in 2008-09- if it materialises, as I think likely- that will define in emphatic terms the turnaround in the Indian economy. The high growth rates upto now have been ascribed to the global bloom. To grow at the same rate in the midst of global turbulence will be some achievement.
  
• Higher than expected growth in 2006-07 changes one key fiscal number- the fiscal deficit as a proportion of GDP. It means that the fiscal deficit so defined was lower than shown earlier in 2006-07 and the forecast for 2007-08 will be surpassed. My guess is that despite the impact of the Sixth Pay Commission, the fiscal deficit target of 3% of GDP by 2008-09 will be achieved, although the off-budget subsidies on food, oil and fertilisers do understate the fiscal deficit.
  

Explaining the Indian stock market's fall

Business Standard carries a report on how margin requirements contributed to the steep fall in the Indian stock market earlier this week:

According to stock brokers, the real pain in markets started with the over-zealousness on the part of stock exchanges in collecting margin money after the 700 points fall on January 18 and another 14,00 points fall on January 21.

The trading terminals of nearly 90 per cent stock brokers were shut on Tuesday when the markets hit the lower circuit of 10 per cent within a few minutes of opening bell, as the National Stock Exchange doubled the margin money overnight.

"The exchanges wanted stock brokers to pay additional margin money immediately. How can we do this when our clients' cheques take at least two days to clear?" asked a Bombay-based broker who deposited an overdue margin of about Rs 1,000 crore (Rs 10 billion) with the exchanges on Wednesday.

A payment crisis was already looming in the aftermath of the Reliance [Get Quote] Power IPO.

The call for more margin money, from stock exchanges, had a domino effect on the markets.

How far is this explanation valid? Well, increased margin requirements for brokers at a time of falling markets are always a reason for the sharpness of market declines. But, it is not as if the problem will go away if the cheque settlement system is improved.

That's because many of the investors who get into payment difficulties are those who have borrowed in order to speculate in the market. They borrow for day-trading, for IPOs and for any other investment in the stock market. They will have to sell their shares any way in order to meet margin calls. Whether the shares are sold by the brokers on whom margin demands are made or by the investors makes no difference- there will be huge sales and there will be overshooting in the market.

Theoretically, banks can provide finance to investors but they will be wary of lending when markets are in a state of free wall. As the BS report mentions elsewhere, there has to be some proportionality between margin payments made by investors and their brokers- the less stringent the margin requirement, the greater are the chances of a decline in the stock market escalating into a crash.

US crisis does not spell crisis for world economy

I have been saying this for a while now and am glad to have the formidable backing of financier George Soros, writing in the FT:

Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.

The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.

If you accept this, then it follows that what we are seeing in the Indian stock market is an over-reaction and the market should bounce back.

World Bank on brain drain

The World Bank's latest Global Economic Prospects (2008) has a section of emigration of highly skilled professionals from developing countries and its impact. Page 124 in this section has two graphs. One shows the percentage of Ph D students from various countries still living in the US after graduation. China tops with over 90%, followed by India (over 80%). Iran and Argentina also have a share of more than 50%. But a number of other countries including Brazil, Chile, Indonesia and South Korea have a share of under 50%- their doctorates prefer to return home.

Another graph alongside shows that the higher the percentage of Phds returning home, the higher is the per capita national income. But correlation, we know, does mean causality. We cannot conclude that because more Phds come back, a country will be more prosperous. It could well be that when a country become prosperous, its nationals would like to return home after studies.

I say this because the growing brain drain in recent years has gone hand in hand with an accleration in economic growth in both India and China (just as it has gone hand in hand with the decline in the quality of economists in government!). The loss of highly skilled professionals may be notional because the home country is not in a position to utilise talent of a certain order.

Moreover, once highly skilled professionals succeed abroad, they may be in a position to contribute to their parent country- remittances are an obvious way but the creation of knowledge networks and initiation of investments from MNCs abroad are other ways in which non-residents can contribute. In other words, brain drain may less of a loss than is commonly supposed.

Anil poised to overtake Mukesh Ambani

Anil Ambani is poised to overtake Mukesh Ambani as well as Lakshmi Mittal as the richest Indian, FT reports:

Anil Ambani, the controlling shareholder in Reliance Power, is set to leapfrog his brother Mukesh Ambani, as well as steel tycoon Lakshmi Mittal to become the richest Indian on the back of record investor demand for shares in his company.

.....Mr Mittal and Mukesh Ambani topped a list of richest Indians published by Forbes in November, with fortunes worth respectively $51bn and $49bn. But the value of their companies has not risen since, while Anil Ambani is creating billions of dollars of paper wealth overnight.

Reliance Power is listing just over 10 per cent of its shares at Rs450 each on the Indian stock market next month to raise $3bn. The flotation will value the company at about $30bn. Mr Ambani’s interests will be valued at about $13.5bn. He indirectly controls about 45 per cent of the company.

Interesting. When the famous spat occurred between the Ambani brothers, Anil was soon as the loser since he got a smaller portion of the assets and Mukesh walked away with the flagship, Reliance Industries. But, in the stock market, asset size is not everything. Earnings growth is what matters. Communications, finance, infrastructure- the areas that Anil inherited or is moving into are hotter areas than chemicals. They are seen as high growth areas and will attract greater interest from institutional investors, that is why Anil Ambani is forging ahead.

Bottomline for businessmen: don't be obsessed with size, think earnings growth. Go for mergers and acquisitions not if you believe it will boost earnings growth, not because you will have a larger company in your stable.

Reining in bankers's incentives

Martin Wolf weighs in on the side of those believe that incentives in banking are flawed and need to be reined in:

By paying huge bonuses on the basis of short-term performance in a system in which negative bonuses are impossible, banks create gigantic incentives to disguise risk-taking as value-creation.

We would be better off with Jupiter’s 12-year “year”, since it takes about that long to know how profitable strategies have been. The point is that a year is an astronomical, not an economic, phenomenon (as it once was, when harvests were decisive). So we must ensure that a substantial part of pay is better aligned to the realities of the business: that is, is made in restricted stock redeemable over a run of years (ideally, as many as 10).

Yet individual institutions cannot change their systems of remuneration on their own, without losing talented staff to the competition. So regulators may have to step in. The idea of such official intervention is horrible, but the alternative of endlessly repeated crises is even worse.

.....all bonuses and a portion of salary for top managers should be paid in restricted stock, redeemable in instalments over, say, 10 years or, if regulators are feeling generous, five.

Yes, locking in rewards over a long period will help as will payment in stock. If rewards are to be in made in cash, only a portion of the rewards announced for a year should be paid out; the rest should be held back over the business cycle and adjusted for losses bankers' run up. When one bank poaches people from another, the vesting period of options assumed by the hiring bank should remain unchanged.

China's economy not that export-dependent!

China is not as dependent one exports for its growth as is made out to be, according to the Economist. Investment accounts for 40% of China's growth. This won't be heavily affected by a drop in exports because over half of it is domestically driven- it has to do with infrastructure and property. It cites a research report that forecasts that a downturn in the US economy will result in China's growth slowing down from 11.5% to 10%- hardly catastrophic. The US may be more export-dependent than China- exports contribute 30% to US growth.

The high share of exports to GDP- 40%- in China may be deceptive. Exports are measured as gross revenues whereas GDP is the value added. A UBS analyst has attempted to measure China's exports in value added terms and measure these as a proportion of GDP. The ratio is much lower- 10%. This, the analyst suggests, is a measure of "true" export dependency of the Chinese economy.

I guess this reinforces my position that growth in China and India will help mitigate the effects of a US downturn on the world economy.

The price of dissent in the CIA

The Iraq war under the junior President George Bush highlighted how intelligence agencies could be pressure to produce reports that satisfied their bosses. Evidence is now emerging that much the same thing happened in respect of Pakistan's pursuit of nuclear weapons under the now disgraced scientist A Q Khan.

The Economist has a review of a recent book, The Nuclear Jihadist, that details how the US disregarded reports about Pakistan's flouting non-proliferation laws in order to secure the bomb. Worse, an intelligence agent who protested about the cover-up of the growing evidence ended up paying a heavy price:

The book's most revealing passages are about America's role in the affair. The authors argue that successive American administrations knew a lot about Mr Khan's activities, but for larger strategic foreign-policy reasons, chose to do nothing about them. Mr Khan was able to flout international rules on nuclear non-proliferation because American policymakers thought that securing Pakistan's assistance in defeating the Soviet Union in Afghanistan—and, more recently, President Pervez Musharraf's help in fighting terrorism—were more important than limiting the spread of nuclear bombs.

The story of Richard Barlow, a CIA agent who once worked in its directorate of intelligence on proliferation, sums up the American attitude. Mr Barlow had protested that intelligence was being manipulated by the Pentagon to suit the policy adopted by President Bush senior's administration of turning a blind eye to Pakistan's nuclear development. He lost his job. The authors find Mr Barlow at the end of the book denied his state pension, living with two dogs in a motor home.

World Bank optimistic on growth outlook

I have placed myself unambiguously in the optimists' camp when it comes to the economic outlook for the world in 2008- I've said that we will see a sharp slowdown in the US but not a recession and a deceleration in the world economy that will still leave emerging markets in good shape.

The World Bank takes much the same line, I'm heartened to note, in its latest Global Economic Prospects. The world economy slowed from 3.9% in 2006 to 3.6% in 2007; the Bank sees a further slowdown to 3.3% in 2008- in other words, a soft landing. Growth in developing countries will moderate only somewhat over the next couple of years- in 2008, the Bank expects growth of 7.1%. For India, the Bank projects growth of 8.4% and 8.5% in 2008 and 2009 respectively, down marginally from 9% in 2007.

The Bank does see the risk of a US recession and its impact on the rest of the world but does not appear to think this is the likely scenario. It thinks that the impact of the housing sector on the US economy will be mitigated by export growth; it also thinks that the financial markets crisis will be contained as risks are not likely to be concentrated in a few institutions.

Why neither the banking channel nor the consumption channel is likely to lead on to a recession in the US is an issue I address in my latest ET column, Liquidity, not solvency the issue.

Bankers' pay

I have written in an earlier post and in other posts about how the incentive system at banks and investment banks needs to be overhauled if recurring financial crises are to be avoided.

The problem I have been highlighting is the heads-I-win-tails- the- firms- loses syndrome. Bankers rake in bonuses when they do well. When they run up losses, it is for the firm to pick up the pieces. At the most, bankers may lose their jobs and a portion of stock options that have not vested. But they would still have the accumulated bonuses of the past to enjoy life.

I have argued that only a portion of bonuses due should be paid out in a given year; the rest should be credited to an account in which there will be entries for bonuses for profits and negative bonuses for losses. At the end of, say, five years, the balance would be paid out to managers.

I note with satisfaction that my view finds endorsement from Raghuram Rajan, former Chief Economist of the IMF. Writing in the FT, Rajan says:

Compensation structures that reward managers annually for profits, but do not claw these rewards back when losses materialise, encourage the creation of fake alpha. Significant portions of compensation should be held in escrow to be paid only long after the activities that generated that compensation occur.

Rajan also makes the point that excess returns- that is, returns in excess of that warranted by a given level of risk- are rarely achieved. What a manager claims as excess return is actually a level of return for which the appropriate risk has not been factored in. Very often, the risk shows up much later in the form of a loss, not in the year in which performance is being measured. That's why a big chunk of bonuses must be deferred.

Anti-business bias in European text books

High school text books in Germany and France take a dim view of business enterprise, says Stephen Theil, Newsweek's European economics correspondent in an article in a Foreign Policy article reproduced in FT. This, the writer says, must explains the profound mistrust towards the free enterprise economy in those countries- in France, only 36% of the people supported free enterprise in a 2005 poll and in Germany support for socialist ideals was running at a high of 47% in 2007.

Theil cites intances:

Economic growth imposes a hectic form of life, producing overwork, stress, nervous depression, cardiovascular disease and, according to some, even the development of cancer,” asserts Histoire du XXe siècle, a text memorised by French high-school students as they prepare for entrance exams to prestigious universities. Start-ups, the book tells students, are “audacious enterprises” with “ill-defined prospects”. Then it links entrepreneurs with the technology bubble, the Nasdaq crash and massive redundancies across the economy. Think “creative destruction” without the “creative”.

In another widely used text, a section on innovation does not mention any entrepreneur or company. Instead, students read a treatise on whether technological progress destroys jobs. Another briefly mentions an entrepreneur – a Frenchman who invented a new tool to open oysters – only to follow with an abstract discussion of whether the modern workplace is organised along post-Fordist or neo-Taylorist lines. In several texts, students are taught that globalisation leads to violence and armed resistance, requiring a new system of world governance. “Capitalism” is described as “brutal”, “savage” and “American”. French students do not learn economics so much as a highly biased discourse about economics.

German textbooks emphasise corporatist and collectivist traditions and the minutiae of employer-employee relations – a zero-sum world where one loses what the other gains. People who run companies are caricatured as idle, cigar-smoking plutocrats. They are linked to child labour, internet fraud, mobile phone addiction, alcoholism and redundancies. Germany’s rich entrepreneurial history is all but ignored.

I do not know how far the material in textbooks can influence and explain popular attitudes. After all, there is the mass media as well. Are the media too hostile to business enterprise in Germany and France? I doubt that would be the case because they would not be able to survive commercially if that were so. US text books, one would imagine, are not ill disposed, yet popular distrust of at least big business is widespread there.

I don't know that Indian text books have much to say either way but celebration of business is common today among the intelligentsia- so much say that many want government to vacate even education and health.

The Indian electorate has been either indifferent or negatively disposed towards a big chunk of economic reforms even though most of the media is pro-reform. People cannot be brainwashed through school text books, certainly not beyond a point. They can think for themselves. It is somewhat facile to ascribe popular attitudes in France and Germany to biases in school text books.

Priorities for the next US president

Strobe Talbott, Deputy Secretary of state in the time of Bill Clinton, spells out the priorities for the next US president in FT. It's reassuring to see that sane voices are not absent from US political discourse. But I have serious doubts as to whether the agenda that Talbott outlines has any chance of being implemented in full- the Conservative strangehold on policy-making is far too strong to permit it.

the next president should, shortly after coming into office, affirm full adherence to the Geneva and UN torture conventions, restore the right of habeas corpus for US-held detainees, and “re-sign” the treaty establishing the International Criminal Court, which the Bush administration “un-signed” in 2002..

To make up for lost time, the next administration should undertake an array of initiatives, starting with one directed to Moscow. Drastic reductions in the American and Russian nuclear stockpiles are important as an example to other countries....The US should also resume negotiations with Russia on anti-missile missiles.

....The US should work with all the current nuclear-weapon states to impose a moratorium on the production of fissile material, pending a formal, verifiable, universal and permanent ban. To attain that goal, America should join its principal allies and partners in direct, sustained negotiations with Iran and North Korea to bring them back into the NPT as fully compliant non-nuclear weapons states.

...Kyoto will expire in 2012. That means the next US president will have fewer than four years to play a decisive role in the design of an effective successor to the treaty. The US must do this through diplomacy and by example. Only if it passes legislation imposing stringent limits on itself, while offering other countries – especially developing ones – substantial incentives to be part of a global effort, will Kyoto be replaced by an accord mandating universal reductions.

Exaggerating sub-prime losses

Many expect sub-prime related losses to rise sharply. But some of the estimates appear to be on the wilder side- the figure of $400 bn, which is the upper end of present estimates, for instance.

Bloomberg columnist Jonh Barry explains why:

There are two reasons why the losses aren't likely to be so large.

First, the mortgages are backed by collateral, a house or condominium, and in a foreclosure a home typically retains significant value. When it is sold, the lender often will get 50 percent to 60 percent or more of the loan amount after foreclosure expenses.

Second, most subprime borrowers aren't going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.

To reach a $300 billion loss would require foreclosures on about half of all subprime mortgages with a 55 percent recovery upon sale of the property. And a $400 billion loss would take about a 60 percent foreclosure rate with recovery of about half the value from the sale.

Credit crisis- a managerial failure?

The sub-prime crisis in the US and its impact on financial markets are seen as a failure of regulation to keep pace with innovation. Securitisation is good but we need to ensure that the risks inherent in it are properly understood and priced. Rating agencies are seen as contributing to the failure.

This is now common wisdom but it's interesting to look at the issue in managerial terms. I wrote in my previous blog about how a clever manager can emulate Mao Zedong's methods to achieve rewards not commensurate with his success. In many ways, the financial sector provides fertile ground for such managers. That's because banks are hugely leveraged. This creates huge incentives for managers to take high risks- if they succeed, there are large bonuses; if they fail, the shareholders get wiped out. Managers may lose out on stock options not cashed in but, by the time failure reflects in financial results, they will have made their pile.

John Kay has an interesting point on this in an article in FT. Managers typically go unsung and, perhaps, unrewarded when they take premptive action to avoid disaster. It is those who take calculated risks and win who get all the laurels.

Al Dunlap of Scott Paper declared his admiration for Rambo: “Here’s a guy who has zero chance of success and always wins.” But Mr Dunlap’s company was acquired by Kimberly-Clark, whose chief executive for 20 years, Darwin Smith, avoided the storm by taking the company out of the competitive coated paper businesses and into high-value-added consumer products. Mr Dunlap was a celebrity but Mr Smith is little known.

We prefer to read about Lee Iacocca and Lou Gerstner, who held the helm in the storm, or Jack Welch, ho managed the ship through turbulence largely of his own creation.

How do we deal with this syndrome? We need to encourage risk-taking, of course. But incentives for top management must be more carefully designed, as I have argued earlier, to take care of possible losses down the road than they are today. Secondly, the degree of leverage in financial firms must come down- I think this will happen in banks with the implementation of Basel II. Thirdly, the media must celebrate the triumphs of the quiet leader as often as they do those of the flamboyant variety.

Mao the management guru

The Economist year-end issue is a delight with its collection of articles on several topics other than economics. This year's issue has articles on, among other things, life in the Dharavi slum, the Koran and the Bible and the state of the Mormons. The piece that caught my eye is the one on Mao Zedong as management guru.

The Economist contends that Mao is the sort of guru that mediocre or non-performing CEOs might want to emulate- after all, not every CEO can aspire to be an Alfred Sloan. Most management books talk about how to emulate the peaks attained by the likes of Sloan. But the run- of- the-mill CEO needs something more practical to survive and prosper. Mao fits the bill.

The four key lessons that "under-performing, overcompensated" CEOs might learn from Mao are:

1. A powerful, mendacious slogan: Mao's slogan was "Serve the people". He hardly lived up to it, says the Economist, but that's not the point- he was able to justify everything he did in relation to an attention-grabbing slogan.

2. Ruthless media manipulation: Promote yourself ruthlessly- it may termed "personality cult" but it " is hard to distinguish from the modern business practice of building brand value."

3. Sacrifice of friends and colleagues: Don't let people stay close to you for too long- they may want your job. Also, do not hesitate to blame failures on others and get rid of them. Mao practised this dictum faithfully- and this is what sensible superiors at investment banks do after a bad quarterly result.

4. Activity substituting for achievement: Think big and keep coming up with plans and initiatives- they may flounder in the long run but you will be gone by them.

How true is the above description of Mao? It is true but it not the whole truth. Mao may have been a bad leader once he came to power but he was capable of sacrifice, heroism and genuine achievement on the way to the top- the Long March was not a delusion and he did succeed in toppling a discredited regime. His early achievements were also not inconsiderable- land reforms, for instance.

It is the record of substantial achievement with an element of personal sacrifice, however collosal the failures, that must explain why Mao has a standing in China today that Stalin lacks in Russia. Stalin too faithfully acted on the four lessons but he is a reviled figure in Russia today. He was not bereft of achievement- his successful defence of the Soviet Union against Hitler, for instance. But he lacked a comparable record of sacrifice- he is seen merely as a grabber and wielder of power.

That said, the Economist's lessons certainly hold true for non-performing CEOs in the corporate world. An individual may have earned the CEO's job or may have hacked his way to the top. But, once there, he can get away with non-performance and worse if he faithfully sticks to the four lessons. Sloganeering, projection in the media and creating an illusion of results are undoubtedly useful in making one's stay at the top productive- for oneself.

Ethics or self-interest?

Tarun Das of CII has a piece in today's TOI in response to Swaminathan Aiyar's column earlier in the month. Aiyar had faulted the Tatas for their pusillanimity in not favouring hostile takeovers - the context was Rata Tata's comments about not wanting to force a deal on Orient Express Hotels, the international hotel group in which the Tatas have a minority stake. The management of Orient Express had stirred up a controversy with what are believed to be racist comments about the desirability of having an Indian group as owner for an international hotel brand.

Das takes Aiyar to task for not appreciating that Indian business groups are driven by values , not just commercial goals.

On the business and commercial side, Tatas follow the practice of negotiated mutually acceptable acquisitions and mergers. They have said it repeatedly that hostile takeovers are not their policy for growth and expansion. This is a value system of the group, which earns it respect, not hostility. Therefore, Aiyar’s opinion that these values and traditions be dropped is unfortunate. This is not what Indian industry should be known for. In fact, his advice leads one to think of trying to evolve an informal code to be followed by Indian corporations with regard to mergers and acquisitions, the cornerstone of which should be: No hostile takeovers.


........Business is not only about accumulating wealth and glory. It is not about growth for the sake of size. It is about being a good corporate citizen. This is the model to follow for corporate India. Orient Express may come and go, but the Tatas will go on forever. So, too, will responsible Indian companies.

Das protests too much, methinks. Hostile takeovers are a means of getting rid of inefficient management and creating value for shareholders. Management will want to hang on to companies for their own reaons which may not be in the interests of shareholders. Hostile takeovers and the market for corporate control are an excellent cleansing mechanism.

Now, there may commercial reasons why the Tatas or any business group may not want to go down the hostile takeover route in a given reason- they may think, for instance, that they will generate too much ill- will in a given community or they may not have the cooperation of senior managers. But to tout opposition to hostile takeovers as a 'value' is a bit thick.

I don't think a company or a business group is at all being a 'bad corporate citizen' by using hostile takeovers- it is making an important contribution to the efficient utilisation of society's assets. Students of corporate finance would take this as a given.

Das's outburst and his suggestion that the Indian corporate sector should adopt a code against hostile takeovers makes me wonder: is it about values or about protecting Indian business groups? After all, if the Tatas use hostile takeovers today, they and other business groups cannot oppose such takeovers aimed at them tomorrow.

Room for optimism about the world economy

I know I'm sticking my neck out on this but I do believe that the world economy will ride out the present storm, bruised but not knocked out. I believe central bank intervention combined with fiscal policy will help limit the damge of the sub-prime crisis.

The critical problem today is banks' unwillingness to lend to each other because no bank is sure how badly damaged the other guy is. They will know pretty soon- once the first and second quarter results are in and the losses are accounted for. After that, things should be more normal in the banking sector and for the world economy. Remember, there is no generalised threat to world economies (of the sort posed by, say, a huge oil shock). There is a downturn in the US caused by factors specific to the US economy. That is part of the reason the impact on the world economy, I believe, will be limited.

See my relatively bullish views in the ET, Cheer up, the outlook is not so bad.

The Chinese are a-coming!

Am back from a longish trip, hence this gap in my blog writing.

Bear Stearns, Citigroup, UBS, Morgan Stanley.... the list of American firms offering equity stakes to Chinese and Asian firms is growing. Another troubled firm, Merrill Lynch, is getting an infusion from Temasek, the Singapore investment firm.

What does this mean? First, large overseas investors clearly think that the world's investment banks, although in trouble at the moment, are a good investment bet. The sub-prime crisis will end sooner or later- in my view, sooner rather than later- and banks with a fundamentally sound franchise will bounce back.

Secondly, the absence of hostility towards acquisitions by Chinese or Asian firms in blue-blooded western financial firms is striking. That's clearly because large funds are required- and the Chinese seem to have the filthy stuff. Considering how closed China's own financial market is to foreign firms, it is interesting that Chinese funds are now in a position to breeze into western firms. Remember, they acquired an over 10% stake in Barclays during the year and also a stake in Blackstone, the private equity firm.

We are clearly seeing sovereign wealth funds flex their muscles. They are sitting on assets of around $3 trillion and this is expected to rise to $10 trillion soon. Should India too follow suit? There are a couple of issues that economist Gary Becker has highlighted. One, these funds lack transparency and hence monitoring of performance becomes difficult. Secondly, being goverment-owned, they may not deliver the sort of performance one associates with private sector funds.

Becker thinks the funds should simply return some of the excess they have to their citizens as a national dividend or the government should cut taxes. Individuals will then be left with more surpluses which they will manage more efficiently than sovereign funds will manage theirs.

I am not sure about the second proposition, that government ownership is necessarily inimial to efficient fund management- UTI Mutual Fund has done pretty well in recent years. Lack of transparency is the real issue. In India, we do have excess forex reserves but nowhere near what China has. These excess reserves are better spent on developing infrastructure. China has first-rate infrastructure, so it can think of other uses for its reserves. For us, infrastructure spending should be the priority, not passive fund management.

Dangers of rupee appreciation

In today's ET, Swaminathan Aiyar pooh-poohs the claim that rupee appreciation is causing job losses in millions. He says he toured Gujarat and found little evidence of big job losses in its export oriented sectors. He is right.

But the big problem posed by rupee appreciation to date is not an export slowdown and the resultant job losses. The problem is that it entrenches the belief among market players that the rupee has become a one way bet. Combine that with higher interest rates in India compared to other countries and you have a recipe for Big Trouble- there will huge capital inflows in expectation of windfall gains and this will cause the sort of rapid appreciation in rupee that could spell serious trouble for the real economy. Then, you will have a serious export slowdown, the possibility of overheated assets and, finally, a sharp reversal in capital flows that could cause the economy to collapse.

Central bank blitzkrieg

Central banks showed what sort of fire power they are capable of on Tuesday when the European Central Bank injected a massive Euro 350 bn into the markets. This follows coordinated injection earlier by various western central banks and the US Fed in a bid to ease liquidity fears. Banks have been shy of lending to each other because they don't quite know how creditworthy the counterparty is and they are also hoarding cash to deal with the deepening impact of the sub-prime crisis. This has caused the inter-bank rate to rise sharply over central bank's bechmark rates.

Will it all work? Well, the intervention is certainly better than sitting idle. It reduces the possibility of bank collapse arising from liquidity problems in the short-run. Long-run, conditions will return to normal only when there is clarity about where a given bank stands in terms of losses. Over the next two quarters, once accounts are finalised and released, a measure of clarity should return.

The criticism against these moves and also against any cuts in interest rates is that these increase moral hazard- they benefit traders who are eyeing their year-end bonuses. There is merit in this criticism but this is not a problem we can focus on for now- it should be dealt with at the firm-level by restraining bonuses for people who took foolish risks. The costs to the wider economy from doing nothing are huge. But central banks should certainly tighten regulation once conditions in the world economy stabilise.

Remembering Ravi Mathai

December 11 is Institute Day on the campus. The community foregathers at Louis Kahn Plaza. Awards are handed out to those who have completed 20 years of service, to children of staff and faculty who have done well in studies or in other activities. There is an entertainment programme with contributions from campus kids as well as students. There is a certain vibrancy in the air. In its 46th year, IIMA retains a spring in its stride. My thoughts drifted towards the man who made much of our success possible, IIMA's legendary founder-director, Ravi Mathai. I devoted my last ET column to him.

There's a puzzle I haven't been able to crack. How on earth did Vikram Sarabhai zoom in on Mathai as the first director? He was a BA from Oxford who had then joined the corporate world. Only two years prior to joining IIMA, he had switched to IIM Calcutta. He was all of 38. And he was called to preside over the collection of dons Sarabhai had already assembled. (IIMA was founded in1961, Mathai was appointed director in 1965). Says something about Sarabhai's talent spotting abilities.

When Mathai came in, he had a bit of a student revolt on his hands. The PGP had been started in 1964 and discontent was brewing amongst the students. Every evening, he would sit with the students in the open ground for hours, listen to them patiently and reason with them. The revolt died down. This is one of many nuggets about the man in a two volume collection of tributes to Mathai that is available in our library.

Amongst MBA students, there is insufficient appreciation of the 'soft' aspects of management. It is much easier to relate to the number crunching part. If you want proof that the 'soft' aspects matter, that culture and process have a lot to do with an institution's success, IIMA is proof. Mathai thought through these aspects carefully and he came up with something that can be called truly world-class. How to run an organisation of knowledge workers is an art- management guru Peter Drucker wrote a great deal on this subject. Academic institutions represent an extreme in the class of knowledge workers, so if you can make things happen there, you have achieved something. That is what Mathai achieved.

My column mentions some of the elements. I did not have a chance to mention how Mathai went about grooming talent. That was a time when it was not easy to bring in too many doctorates in management. Mathai's solution was to find people with a basic aptitude for academics and then send them over to Harvard Business School for a doctorate. They signed a bond, came back and served and, of course, had the option of leaving thereafter. C K Prahalad (a PGP product who joined IIMA as faculty thereafter) was one of the beneficiaries. Mathai reckoned that some people would leave. But even if a few stayed backed, that would be a big gain. And a few did stay back.

As I mention in my column, one of the astonishing things Mathai did was to step down a little after completing seven years on the job. He had everything going for him. Age was on his side. His record had been spectacular. He had terrific equations with all the major stakeholders. Kasturbhai Lalbhai, then chairman, and Sarabhai pleaded with him to continue as director. He could have been director until retirement. Yet the man chose to walk away from the job. Because he had thought through the governance implications very carefully.

Mathai had been careful to distance the Institute from government. This he did by making government one of many stakeholders with local businessmen and the state government being other stakeholders. IIMA is nominally accountable to the IIMA Society and it has an MoU with the government. That's how autonomy was ensured. He also made sure that the Board of governors did not dictate matters nor, for that matter, the director himself. He devolved power to the faculty by making the Faculty Council the principal instrument for decision-making. All key matters (even today) have to be brought to the Faculty Council for deliberation.

Which is all fine as long as there is a Ravi Mathai in the saddle. But not every director can be expected to be an angelic Ravi Mathai. In the present scheme of things, it is possible for a director to concentrate powers in himself with little accountability to anybody in particular since both the Ministry and the Board have been distanced from the decision-making process. Mathai found an answer to this problem: a single term for the director, after which the director reverts to a faculty role. This substantially addresses the problem of checks and balances on the office of director. All this is clear as crystal today. But for Mathai to have thought of it over three decades ago at the height of his success!

In relinquishing his job, Mathai lived up to the highest traditions of self-abnegation so greatly revered in this country. In many other ways, he set almost impossible standards of conduct. He instituted a rule (since waived) that the director should not be involved in consulting. He declined to seek reimbursement of his travel and medical bills. He never projected himself, it was always the Institute that got projected. I have heard that he was rather reclusive, locking himself in his house at the end of the day and mentally reviewing the events of the day.

The great thing about people like Mathai is that not only do they create the foundations for durable success, they also set standards for those who follow. It is impossible for anybody sitting in the director's chair to escape comparison with Mathai.

Bengalooru Bangalore-d

These are not the rosiest of times for IT companies. Their profits are being squeezed by a rising rupee, they face high rates of employee attrition, they have come in for sharp criticism from the Health minister for the working conditions to which BPO employees are subjected and their stocks have lost some of their sizzle.

Now, they are coming for in flak from the city with which they have come to be associated and which they claim to have placed on the international map, Bengalooru. Outlook magazine has an interesting story by Sugata Srinivasulu on how IT companies and their employees are being viewed with disfavour by many in Bangalore.

The world's most celebrated IT city is now considering that privilege to be a curse. Infosys and Wipro are no longer considered gateways to heaven, but more as roads to hell. When Infosys's Narayana Murthy was charged with showing 'disrespect' to the national anthem, there was a glaring absence of sympathy for the IT czar in the public domain, whereas earlier there would have been a tidal wave of support. Likewise for Wipro, when it was charged by a government panel of encroaching upon Bellandur lake to build its guest house. Another time, when the state government proposed to set up an education training and management institute with the Azim Premji Foundation, there was a letter campaign against it. There is now a perceptible change in the way the public in Bangalore looks at Murthy and Premji, the two most revered symbols of its IT industry—that they're no different from other businessmen who merely make profits for their company and their shareholders.

Well, well. What precisely are the grievances that people in Bangalore have against IT folk? The litany of complaints includes: rising property prices thanks to the IT employees' purchasing power, grabbing of prime land by IT companies, the bar and disco culture and IT employees being preferred in the bridal market.

There is a clear divide between other middle-class professionals, including the many in the public sector, and the IT employees. Those on the former side resent the rise to prominence of the latter.

The feature set me thinking. There are other professions that pay even more- the financial services sector, for instance. How come we do not see a similar resentment towards investment bankers and private equity people in Mumbai? I guess that's because partly the city is not yet identified with these professionals, they are not that numerous and, besides, in Mumbai, there are other sectors that absorb people and pay well.

IT dominates Bengalooru in a way in which other sectors do not dominate any metropolis and, also, the disparity between a dominant sector and other sectors in any city is not as great. If the proposed International Finance City materialises in Mumbai, we can expect an even greater backlash than what we are seeing in Bengalooru today.

A second reason could be that IT does not have the same linkages with the domestic economy. Finance professionals create prosperity in companies they take public, the stock market benefits thousands of shareholders. IT is seen to benefit only the people in the sector and nobody else. True, as Subroto Bagchi points out, IT creates benefits (such as declining telecom costs) but these effects are indirect and not as visible, hence the resentment.

Thirdly, to some extent, the prosperity of IT and its employees is seen as coming at the expense of the economy. IT companies have benefited from huge allotments of land at concessional prices, they benefited from an undervalued rupee for over a decade and they benefited from tax concessions as well. The charities made by some IT personalities are seen as poor compensation for the benefits earned.

So, what do we do? Throw IT out? Not at all. Can greater philanthropy help? To some extent, maybe- for instance, a classy university run at affordable prices on IT endownments might help assuage popular sentiment.

But the biggest corrective, I reckon, will come from the very economic environment that created IT's prosperity- no more concessional land, a decline in profitability from a rising rupee and its attendant costs (including layoffs in the IT sector) and a greater focus on the domestic economy on the part of IT firms in the face of a rising rupee.

Goldman's success

I had a post yesterday on Goldman's success. I said it wasn't just luck or skill but the uniqueness of its business model that explained its success.

In today's FT, John Gapper argues that the firm benefits from the edge it gets by engaging in activities that involve conflicts of interest:

Big investment banks run advisory, securities and investment businesses but keep them walled off from each other to avoid conflicts of interest and trading on inside information. Goldman has been more aggressive than any other bank in putting the three together – it often advises a company on a transaction, finances it and invests its own money.

That regularly puts Goldman in delicate spots. It swaps from advising on a sale to bidding for the property, or its private equity arm co-invests with another fund in a company its bankers have found for sale. It often faces accusations of conflicts of interest over its overlapping roles but it brushes them off by saying that its job is to “manage conflicts”.

It has got away with this because it is too powerful to ignore. Private equity firms grumble that Goldman advises them on deals and competes with them but they accept it because it has such a big network of corporate clients that they cannot cut it off. One day, however, this balancing act will blow up in its face.

Goldman’s skill, luck and edge have combined this year to produce its great escape. The three will not always align so well.

This is an argument that others have made, notably Philip Augar in his book, The Greed Merchants. Point is: such conflicts of interest are not unique to Goldman. Perhaps the conflicts are more acute in the case of Goldman because of its higher involvement in activities that entail its own capital.

Maybe Goldman benefits more from the access to information it has as a giant investment bank. But how come the others are not seeing such benefits? Because they are not as much into proprietary activities or have not developed as much expertise in these.

Does better governance explain Goldman's success?

Goldman Sachs is one firm that has defied the meltdown in the financial sector. It has sub-prime exposures but it hedged these by shorting mortgates, so it has come out of the present turmoil smelling of roses. What explains Goldman's success at a time of widespread risk management failure?

John Plender, writing in FT, contends this is because of superior governance:

Much of it is down to culture. Until recently, Goldman was a partnership, which is one of the best risk-control mechanisms invented. The culture of partnership, which entails a high degree of mutual surveillance in the common interest, still survives in spite of Goldman’s status as a listed company.

......Most importantly, Goldman ascribes as much status, prestige and pay to people engaged in control functions as to those running businesses. It constantly rotates human capital back and forth between risk control and business operations.

...The structure of boards is also relevant. In the US governance model, the chairman and CEO roles tend not to be split, while the boards are dominated by non-executives who too often lack expertise in risk. Over the recent credit cycle, these non-executive directors permitted a huge escalation of risk across the banking system. They also sanctioned pay deals for CEOs, complete with rewards for failure, that encouraged risk escalation.

....In contrast, Mr Blankfein (CEO of Goldman) is accompanied on the board by two other executive directors, together with Stephen Friedman, a former senior partner of the firm. So there is a core group on the board steeped in the disciplines of risk. And Goldman’s managing directors include Gerald Corrigan, a former head of the Federal Reserve Bank of New York, who is regarded as the pre-eminent expert on financial plumbing.

I am not entirely persuaded. The risk management systems and structures that Plender associates with Goldman are to be found at other Wall Street firms as well- and yet they have done badly. I should know: I have worked for a Wall Street firm myself.

Assigning as much importance to control functions as to managing businesses, for instance, is not unique to Goldman although rotation between the two may be. I also doubt that a superior quality of board has to do with better risk management: it's next to impossible for a board to assess and monitor risk at a large investment banking firm.

What, then, is the explanation for Goldman standing out- apart from the luck factor? My guess is that Goldman's business model may have something to do with it. It is more heavily into deriving income by using its own capital than many others and it has the advantage of long experience in these - proprietary trading, hedge funds, private equity, etc. At a time when the global economy has been booming, private equity especially has a huge upside. Merrill's drive into these businesses is relatively recent and this may explain why it has stumbled badly.

Having a unique business model may help at the margin more than better governance. Macquarie Bank is a fabulous success. That is because its business model was unique- I doubt that better governance is the factor.

Wall Street bonuses- skewed against shareholders?

Goldman Sachs will be handing out huge bonuses even in what is a miserable year for Wall Street. No question, Goldman has done well. It has hedged subprime risks, has reported healthy profit for the third quarter and is expected to do well in the last quarter as well. Enough reason for its CEO to walk away with something in excess of the $54 mn he earned last year.

But people at the top at Goldman know that huge payouts in times such as these are bound to attract hostility. They have sought to preempt it by announcing the creation of a charity, Goldman Gives., to which senior executives will contribute a part of their compensation. Each contributing partner will have his or her own account in the charity and will have say in determining beneficiaries.

In this, Goldman people are doing what the Narayana Murthys and Aziz Premjis have done long back as also Bill Gates and Warren Buffet (although both Gates and Buffet seemed to need some prodding). It helps if you are seen to give back to worthy causes; it also helps if you are seen to have a not very flamboyant lifestyle.

The problem arises with bonuses at firms that have not done well. How do you justify bonuses at firms that have seen an erosion in shareholder value? I address this in my latest ET column, Sorry, you can't touch my bonus.

There are two reasons why Wall Street might think this is justified. The first is that variable pay is a big piece of compensation on Wall Street - and this has to do with individual, not firm performance. If you don't have variable pay, then base pay will have to go up - and Wall Street firms would like to avoid that. The second reason is that performance is easilly measurable unlike in non-financial firms.

Fair enough. However, in financial firms, including banks, there is an issue of rewards not taking into account losses to the firm down the road. Firms pay when the individual performs but don't expect him to pay back when he inflicts losses on the firm. This does seem to be a problem given the scale of bonuses.

True, stock options that vest over a longish period go some way towards addressing the problem. But several problems remain. What if options vest in the third year and the individual
causes a loss in the fourth? What about payments that are made in cash? And what about rival firms taking care of options that are yet to vest when they poach a high performer?

Banks and investment banks are highly leveraged and banks enjoy a security net at the expense of the taxpayer. High leverage can result in high returns to equity and high bonuses when the going is good. It can result in bankruptcies when the going is bad. Incentives in financial firms seem to be skewed in favour of the individual and against the shareholder. The problem needs to be addressed.

Private equity disclosure

Opacity in private equity is a vexed issue. We don't know much about returns that private equity firms make out of businesses they run, who are the ultimate owners, how value is created.

Private equity justifies this lack of transparency essentially by saying: returns and other financial information are for owners, others have no business to demand information. Following criticism of the ways of private equity firms, the industry in UK responded recently with a voluntary code of disclosure.

In an analysis in FT, Chris Higson, a professor at London Business School, says the disclosure offered is inadequate. In particular, the industry is willing to disclose how value was created in the aggregate but is unwilling to do at the level of a particular unit. That would have meant shedding light on which stakeholders lose out when shareholders gain hugely.

Higson is scathing about the industry's stand that financial information is meant for owners. Not so, argues Higson. Almost any business has an obligation to practice a certain level of transparency because several stakeholders are involved, not just owners or shareholders:

As a matter of fact, both US Generally Accepted Accounting Principles and international accounting standards emphasise that financial statements are aimed precisely at those people who do not have the close and easy access to the business that private equity partners do; also, that investors, creditors, managers and employees all have similar information needs since they all make risky investment decisions. Moreover, the entitlement of all to receive its financial statements is long-established in UK law, whether a company is public or private.

....Of course, privacy concerns apply with equal force to acquisitions by sovereign wealth funds, private individuals or families. The working assumption in the 20th century was that most businesses of any importance would be public, with the disclosure and scrutiny that brings. But the eclipse of public equity markets challenges those assumptions. Critics talk about companies “going dark” after private equity acquisition. Unless we understand the importance of transparency, and unless there is political will to protect it, more business activity will pass into shadow.

Homeopathy- cure or delusion?

Lancet, the British medical journal, is set to place itself firmly in the anti-homeopathy camp, a British GP, Margaret McCartney writes in FT.

“There are five homeopathic hospitals in the National Health Service, 40 per cent of GPs refer patients for homeopathic treatments,” he (Richard Horton, editor-in-chief, Lancet) told listeners, “and there’s not one shred of evidence to support homeopathic efficacy for any disease.”

McCartney herself is forthright in denouncing homeopathy:

The bottom line, and no homeopath with half an eye on the evidence can ignore it, is that homeopathic remedies are no better than taking a placebo. Homeopathy does not work. We should accept this and move on.

McCartney argues that homeopathic hospitals under the NHS must be closed down. However, that the placebo effect of homeopathy- the effectiveness of treatment that is chemically inactive- is worth focusing on. Homeopathy doctors tend to give more time and attention to a patient than their allopathic counterparts. This 'caring' factor itself may have beneficial effects and should be captured in some way in allopathic treatment.

How can this be achieved under NHS? McCartney has one concrete suggestion: ensure that patients meet the same GP on a continuing basis instead of being bounced from one GP to another.

When I read stuff like this, I thank heavens for the quality of medical care in India. Most of us have GPs we stay with for years. They know our ailments inside out, the treatments they have prescribed- and, not least, are willing to come home at short notice.

Banks' losses and gains in sub-prime crisis

Goldman Sachs estimates that financial institutions will take a hit of $400 bn due to the turmoil in financial markets. But the impact varies widely across institutions. Goldman, Lehman and Morgan Stanley have come out relatively unscathed while Bear Stearns, Merrill, Citigroup and Bank of America have suffered big losses.

For some banks, there is a big offset coming from stakes in Chinese banks. The increase in market value of the stakes of top international banks in Chinese banks - FT's Lex column places this at $70 bn- exceeds the sub-prime write-offs that banks have announced so far.

The difficulty, as Lex points out, is that international banks will be able to augment their capital only if they actually sell their stakes in Chinese banks. So far, they have been reluctant because they view these as strategic investments that will help them gain access to the Chinese market. But, as capital is progressively impacted by sub-prime exposures, the case for selling these stakes will become strong.

Two pieces of good news from the above. One, the banking system as a whole is better placed to weather the impact on capital of sub-prime losses than many would suppose. Capital may shrink but it is not likely to turn negative- in other words, a generalised banking crisis appears a remote prospect. That augurs well for the world economy.

Two, because there are good performers among banks, the bonus pool for 2007 is estimated to be slightly higher than for 2006 even though shareholders have seen their value eroded. How to explain this?

Well, there is an asymmetry in rewards and penalties in banking. In all banks, including underperforming ones, the divisions that have done well need to be rewarded generously. Those that have done badly will be penalised through job losses but there will be no negative payments, so to speak, for employees. Heads you win, tails you don't lose- that's the story for employees.

Om Shanti Om

I saw OSO. The first half is entertaining, especially the spoofs on Bollywood. Had the film remained a spoof throughout, one could have related to it. The trouble arises because there is a
more serious part to it. That makes the second half a drag.

The degeneration towards the end is precipitous. As though it's not bad enough that Shah Rukh and Deepika both appear in a reincarnation, there is a lookalike of Deepika who rescues Shah Rukh. She then disappears into nothingness. It's a bhoot, you see, not the reincarnated Deepika! That really got my goat.

OSO simply does not deserve the hype surrounding it. There are a couple of decent songs. Deepika has the makings of a superstar but she's under-utilised. The film is all about Shak Rukh- his endless baring of his chest is not funny at all, not least because he shows clear signs of ageing.

I believe OSO is a box-office success. That tells me what clever marketing of films can achieve. You build a brand out of a film- everybody wants it, never mind the content. Will this work in general? I doubt it. You can't fool all the people all the time. Ultimately, the test of a film is: do you want to recommend it to somebody? With me, OSO fails the test.

Drumbeat on Iran grows louder

Western experts warn that Iran could be in a position to develop nuclear weapons way ahead of the 2010-2015 period estimated earlier. Some believe that Iran may be just 12-24 months way, according to a report in the FT.

“It looks like they could be there in a year,” said Richard Garwin, one of the designers of the US’s first H-bomb, referring to the possibility that Iran could build up a sufficient stockpile of enriched uranium in the next 12 months. That would mean it could produce enough weapons-grade material for a bomb at a few further months’ notice.

Prof Garwin said the IAEA report showed that Iran was stepping up uranium enrichment. The report says that between February and November this year Iran fed 1,240kg of uranium feedstock into its enrichment facility in Natanz, south of Tehran, up from 690kg between February and August.

This means that in the last three months Iran has pushed almost as much uranium through the system – 550kg – as it did in the preceding seven months. It also indicates that Natanz has not only expanded in size but may also now be operating more smoothly.

Prof Garwin said the figures signified that Iran would now have more than 100kg of fuel-grade uranium, which could be fed back into the system to produce weapons-grade material in a matter of months.

I don't know what to make of these reports- remember also those warnings about WMD in Iraq? I do know one thing: the appearance of such reports makes a US attack on Iran more likely. I had thought that such an attack would happen in 2007. I think the probability is even higher in 2008. That is part of the reason oil prices inched up to the $100 mark recently. They receded after a top US general warned against the risks of such an attack.

Defence experts have been saying that the US would lauch a comprehensive air attack on Iran's nuclear and physical infrastructure with as many as 1500 targets. Very few ground troops would be involved. The idea would be to bomb Iran back into the stone age.

Customer service in Indian banks

I quoted from an ET story sometime back about the poor quality of services in London, including in banking. Why would a competitive, modern banking system deliver shoddy customer service?
You get an answer when you look at the Indian banking system. After having opened up to competition in a big way over a decade and a half ago, we are getting serious complaints.

That's because customer service is not just about speed or promptness, nice-looking branches or even a choice of diverse channels such as ATMs and internet. Pricing and charges are always an issue- and it hurts when you find that the marble interiors in bank branches are being paid for by extortionate lending rates, hidden charges and lack of transparency in pricing.

One other item in customer service that is in the news is the methods used by banks to effect loan recovery. Private banks mostly use recovery agents and these agents do not hestitate to use force and intimidation to effect recovery. Bankers say this is necessary when borrowers wilfully resort to default. But, I argue in my ET column,A fair deal for bank customers, that problems in recovery often have to do with bad lending practices and that tighter regulation is needed. Credit information bureaus and better rules for repossession will also help.

But, under no circumstances can the regulator allow banks to resort to coercion. The ordinary citizen already has a sense of living in a lawless environment where he has little recourse against powerful individuals and institutions. Imagine what would happen as banks fan out further into the smaller cities and towns. The cooption of the underworld into the banking system is the ultimate nightmare.

IIMs through FT's lens

I read the story on IIMs in FT by Della Bradshaw with a sense of disbelief. The FT's correspondent seems to have bought whatever a few people in positions of authority at the IIMs told her especially about lack of autonomy at the IIMs and the government's "counter-productive intervention".

Let me take up some of her key statements one by one:

1.After five years as director of IIM Ahmedabad, in Gujarat, Bakul Dholakia had to step down from the top job, in spite of the hopes of many at the school that this forward-looking figure would be allowed to serve a second five-year term.

It is a time-honoured convention at IIMA for directors to serve only one term. This convention owes to the legendary founder-director of IIMA, Ravi Mathai, who chose to step down after one term after a spectacular record and despite fervent entreaties from the board as well as the IIMA community to stay on. If Prof Dholakia had indeed been given another term, that would have come as a shock to the community. I do not know who the "many at the school" are whom the FT correspondent refers to.

2....under the Indian system of academic appointments, it is the Indian prime minister who decides who will be the next director and the politically controversial Prof Dholakia had spent much of his time in office spearheading the IIM campaign against government dictates.

Only on paper does the PM decide the next director. The choice of director was left to a search committee of which the IIMA Chairman was member. The IIMA Chairman had extensive interactions with IIMA faculty on the basis of which he drew up a three person short-list. The search committee seems to have gone by the short-list given to it by the Chairman and it proposed two IIMA faculty for consideration by the government. It is a travesty of the truth to suggest that it was the PM's office that decided who would succeed Prof Dholakia.

3. On a practical level, it (the method of choosing the director of IIMs) has hampered the IIMs in their efforts to become world-class business schools

Not true. Prof Dholakia himself emerged through the same selection process the last time.

4."We've been arguing - with not much success - that as we don't take money from the government, we should be able to decide salaries," he (Rishikesha Krishnan of IIM Bangalore) says. "What we're hoping for, but seems unlikely to happen, is that we will get more autonomy for deciding salaries."

IIMs are part of a much broader fraternity of government sponsored institutions- and the list includes such heavyweights as SBI, ONGC, BHEL and BSNL- whose salaries are part of the government framework.

There is room for improvement in salaries in these institutions but it is a moot question whether greater autonomy for IIMs will translate into superior salaries. Do IIMs have the capacity to pay a lot more? I am not sure. At IIMA, which leads the others by a wide margin in revenues, there is concern today over the impact of the Sixth Pay Commission, leave aside paying anything more!

5. Trying to attract new faculty is one of the biggest issues affecting the six IIMs - located in Ahmedabad, Calcutta, Bangalore, Lucknow, Indore and Kozhikode. (A seventh IIM has been created in Shillong, near the Chinese and Burmese borders.) And the biggest problem in faculty recruitment is salaries. ......"Attracting international faculty? You can forget it," says Prof Krishnan.

I have said this before in my blog: the notion of attracting international faculty on the strength of superior salaries at IIMs is bogus. Universities in Europe, Hong Kong and Canada offer a premium to those in the US and are yet unable to draw the best faculty. The IIMs cannot hope to get anywhere near those packages whatever the improvements they effect. When IIM faculty say, 'please let us make salaries more attractive', they do not seriously mean they can attract better faculty. They mean: let us get richer.

Note, however, that at IIMs salaries for many faculty are only a small part of the total compensation. Dholakia is quoted as saying that his top faculty earn seven or eight times the government stipend. If that is true, them comparing the salary alone with corporate salaries
(the ratio is said to be 1:10) is incorrect. One should compare average total compensation for IIMA faculty with corporate salaries.

6. With India's top business schools eager to establish themselves as leading global brands, government control is hugely restrictive, says Prof Dholakia.

This statement is often made but without substantiation. Government intervention is felt mainly in respect of salaries for faculty. As I have said earlier, this is only notional because it's not clear IIMs have the capacity to pay a great deal more. Other than this, I am not aware of anything the government does that comes in the way of developing a global brand.

Developing such a brand is not just about globe-trotting- pitching a tent in Nigeria or Oman- but developing teaching and research capabilities that can compare with those in the top schools abroad. There are hundreds of business schools in India, including the Indian School of Business, that are free from government interference. Not one of them has been able to attain even the level of the IIMs.

The limitations are inherent in our situation. The top B-schools in the US have had a head-start and their financial and academic strengths today are overwhelming. It makes as much sense to talk of the IIMs catching up with them as it does to talk of India catching up with the US in defence capability- not even China or Russia harbour such a delusion.

FT, I am disappointed, one expects a better critical sense of a world-class daily.

Accountability of the judiciary

How to make the judiciary accountable is undoubtedly one of the most important questions in governance today. Whether it is the media or the IIMs or the medical fraternity or the judiciary, one key principle should be upheld: self-regulation is simply not the answer. The merchant bankers used to say the same thing: leave it to us, we will set standards. Stock exchanges used to say that. Accountants in the US claimed it worked for them. Every body of professionals would rather not have somebody from outside looking closely into what they are upto. Sorry, this cannot be permitted.

In an article in EPW, Prashant Bhushan lays out the case for judicial accountability. Today, the only recourse against an errant judge is the process of impeachment. To initiate this requires the signature of 50 MPs. For this, in turn, to happen, there must be conclusive evidence against a judge; and the evidence must be published so that it assumes the proportions of a scandal. But because the media is afraid of publicising charges against a judge and politicians do not wish to invite the wrath of the judiciary, these conditions are almost impossible to satisfy. Bhushan adds that it is virtually impossible to register an FIR against a sitting judge because, under a 1991 Supreme Court judgement, no judge can be prosecuted without the written consent of the CJI.


On top of this, Bhushant points out, courts have been trying to insulate themselves from the Right to Information Act. The application fee in many courts is Rs 500 instead of the Rs 10 that is normally required. Many courts have framed rules that prohibit the disclosure of information on administrative and financial matters. They have done this in the knowledge that any petition that challenges these rules will have to come up before the judges themselves!

The response to the rising clamour for accountability is the Judges Inquiry Act Amendment Bill 2006 under which an in-house procedure will be created for taking cognisance of charges against errant judges. Bhushan argues this won't work because it requires complainants to disclose the source of information for charges and it also provides for action against complaints that the judges believe are mala fide.

Bhushan argues in favour of a National Judicial Commission. The chairman will be selected by the judges of the Supreme Court. Other members will be selected by each of several groups: judges of high courts; the cabinet; a committee comprising the speaker of the Lok Sabha and the leaders of the Opposition in the two houses of parliament; and a fifth member selected by the chairman of the National Human Rights Commission, the CVC and the CAG.