More on leadership 'lessons'

I had a post earlier in which I expressed scepticism about leadership courses and training sessions. By a curious coincidence, I came across a reference to this subject in HBS professor Rakesh Khurana's recent book, From higher aims to hired hands, a lengthy polemic about how b-schools have changed from aspiring to provide professional education to becoming recruitment agencies for companies.

Khurana notes that somewhere along the line b-schools changed their objective from producing managers to producing leaders. He thinks the latter is a spurious or delusory objective because the entire literature on leadership fails to shed light on what precisely are the ingredients of leadership or how these can be acquired:

Despite tens of thousands of studies and writings on leadership since the days of the Ohio State Leadership Studies, several scholarly reviews of the literature on leadership have found little progress in the field since Chester Barnard observed in the 1930s that leadership in general, and particularly the "Great Man" view of the topic popular in his day, was "the subject of an extraordinary amount of dogmatically stated nonsense".

For example, Ralph Stodgill in 1974 and Bernard Bass in an independent study conducated in 1981, exained more than 4,700 separate studies of leadership and found little ni the way of a conceptual framework or frameworks in this field. Stodgill stated that an "endless accumulation of empirical data has not produced an integrated understanding of leadership" Bernard Bass found a surprising lack of clarity for a subject that was supposedly being examined in a scholarly manner, noting that most studies failed to even define the terms leader and leadership.

NISM chair professorships

I read that the National Institute of Securities Markets, which has been promoted by SEBI and has a collaboration now with Sterns School of Business NYU, is planning to offer 25 chair professorships.

The composition of the search committee is interesting. Neither the director nor the chairman of the board heads the committee- the chairman is M G Bhide, formerly of Bank of India and National Institute of Bank Management. The sole representative of the Institute on the search committee is director G Sethu. All the others are eminent professionals from outside. In governance terms, NISM certainly has made a very good start.

Leadership 'lessons' and all that

Open any issue of the Harvard Business Review and the chances are you will see more than one article on leadership. Executive programs on leadership seldom fail to attract enrolments. Since so much has been preached for so long on leadership, it is fair to conclude that, perhaps, this is something that cannot quite be taught.

But that does not deter management professors and trainers from drawing 'lessons' in leadership all the time. There are lessons from literature, from movies, from the Bhagvad Gita, from war. The implication is that it is possible to distil from various experiences a set of ideas as to what leadership is all about, ideas that any manager can then practise. I recall the Indian cricket team being put through a commando training module. There are leadership programs where you climb mountains, trek across the countryside, spend time in camps and so on.

How refreshing, then, to come across a piece in FT that debunks this whole idea. Stefan Stern ran into a survivor from a plane crash in the Andes mountains. Pedro Algorta was one of 16 (out of 45 people on board) who survived 72 days in the worst possible conditions- -30 C temperatures, avalanches, having to eat the flesh of dead passengers.

He then did his MBA at Stanford and went on to become a successful CEO. You might think the ordeal he went through and the heroism he had displayed earlier contributed. Not at all! Algorta attached very little importance to his experiences and never even talked about these to anybody.

So why the silence until now? “I was busy being a chief executive,” Mr Algorta told me. Did you ever speak to colleagues about your experiences? No, he said. Did you draw on them consciously? I never thought about it, Mr Algorta maintained.

Which leaves me struggling with a paradox. Of course, those events of October to December 1972 were extraordinary. It must have been a terrifying, shattering experience. It was a privilege to hear about it at first hand.

But even Mr Algorta suggests that, for him personally, these events had no specific impact on his business career. (You may or may not believe this. But it is what he says.) He got on with the life he had been planning to lead before the crash happened. And, while many people around the world will queue up to hear his story, Mr Algorta himself remains disarmingly modest. “I’m not a guru, I’m not a prophet,” he told me.

If there were no great 'lessons' from Algorta's ordeal- at any rate, lessons that contributed to his business success- surely a three day mountain climb or cross-country trek is not going to produce the next Jack Welch.

Is global gloom overdone?

I have been saying for a while now the situation in the financial markets is not of catastrophic proportions. That would be the case only if there was the prospect of major bank failures- and there is little evidence of this so far. Yes, banks will face lower profit margins and bankers' bonuses will shrink but neither of this is such a big deal. I can't see the real economy being impacted to the extent that financial market pundits think. Of course, growth in the US will take a beating but the global economy should grow in line with rates seen before the recent boom- or so I have been saying.

I am gratified, therefore, by the comments of a manufacturing head in Europe. BASF CEO Jürgen Hambrecht is quoted in the FT as saying:

“I am glad to say that business in general does not show the panicking approach of the financial industry. The reality is better than the words [written about the scale of problems] and I am sleeping well at night. ...In the real economy – in much of manufacturing – many companies have a big order backlog and are extremely busy with meeting demand. In this context, why should there be a big, big crisis? I can’t see this happening."

The FT report adds:

European manufacturers remain optimistic that sales will increase in 2008 and their businesses will remain immune from deepening gloom over the US’s economy and in its companies.<>In a pan-European survey of expectations by the NTC Economics consultancy, 56 per cent of European manufacturers expected sales volumes to rise in the coming year compared with 12 per cent forecasting a decline

It makes me wonder.... How much of the panic in the financial markets is intended to be self-serving? You create a big hullabaloo so that the Fed keeps cutting rates and this helps shore up asset prices. Good for bankers and their bonuses but does the world economy need all this pessimism and the Fed response to it?

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.