More on the Reinhart- Rogoff paper

Martin Wolf, writing in the FT, has an interesting take on the public debt- growth thesis. He contends that high public debt is often the consequence of an explosion in private debt, He cites RR's book in support:

Indeed, in their masterpiece, This Time is Different, professors Reinhart and Rogoff explained how soaring private debt can lead to financial crises that generate deep recessions, weak recoveries and rising public debt. This work is seminal. Its conclusion is clearly that rising public debt is the consequence of the low growth, itself explained by the crisis. This is not to rule out two-way causality. But the impulse goes from private financial excesses to crisis, slow growth and high public debt, not the other way round. Just ask the Irish or Spanish about their experience. 

Wolf makes the point that what caused public debt to rise, in the first place, is important. Following a financial bust, a rise in public  debt is inevitable and necessary because otherwise the economy will plunge into a recession.

Wolf also points to an interesting historical fact. The UK had debt to GDP ratio of 240% in 1816.  The "economic disaster" that followed was the industrial revolution! Thereafter growth accelerated and the ratio declined to below 90% by 1860s. The colossal debt that UK had run was not even for productive activities, it was to finance a war! So much for the correlation between public debt and growth.

Database on graduate schools

I have received a link to a most useful database b-schools. It provides a wealth of information on MBA as well as Ph D programs. Here it is:

http://graduate-school.phds.org

Indian judiciary's finest hour

More than one newspaper has thought fit to recall, on its fortieth anniversary, the historic Kesavananda Bharati judgement delivered by the honourable Supreme Court. An article in the Hindu gives the background:

The Kesavananda Bharati case was the culmination of a serious conflict between the judiciary and the government, then headed by Mrs Indira Gandhi. In 1967, the Supreme Court took an extreme view, in the Golak Nath case, that Parliament could not amend or alter any fundamental right. Two years later, Indira Gandhi nationalised 14 major banks and the paltry compensation was made payable in bonds that matured after 10 years! This was struck down by the Supreme Court, although it upheld the right of Parliament to nationalise banks and other industries. A year later, in 1970, Mrs Gandhi abolished the Privy Purses. This was a constitutional betrayal of the solemn assurance given by Sardar Patel to all the erstwhile rulers. This was also struck down by the Supreme Court. Ironically, the abolition of the Privy Purses was challenged by the late Madhavrao Scindia, who later joined the Congress Party.

Smarting under three successive adverse rulings, which had all been argued by N.A. Palkhivala, Indira Gandhi was determined to cut the Supreme Court and the High Courts to size and she introduced a series of constitutional amendments that nullified the Golak Nath, Bank Nationalisation and Privy Purses judgments. In a nutshell, these amendments gave Parliament uncontrolled power to alter or even abolish any fundamental right.

The judgement in the Kesavananda Bharati case put the brakes on the amendment spree that parliament had embarked on . The Court ruled, by a narrow 7-5 verdict,  that parliament's amending power was limited by the "basic structure" the constitution. Different judges articulated what they meant by the "basic structure". However, in the very nature of things, this cannot be exhaustively defined. It is left to the Supreme Court to judge whether, in a given instance, the "basic structure" is disturbed.

As several legal experts have noted, there is, in the Constitution, no explicit bar on parliament's amending power: Article 368, which deals with parliaments' powers on this subject, does not impose any limitation. What, then, is the rationale for imposing a limitation? As I recall, the essence of the argument is that parliament itself is a creature of the Constitution and hence subordinate to it. Parliament cannot, therefore, act in ways that erode or undermine the "basic structure" of the Constitution.

Despite this judgement, the Supreme Court, during the emergency, did not strike down the suspension of the right to habeas corpus, which many would regard as fundamental to basic liberties of the citizen. It required a Constitutional amendment by parliament later to ensure that this right is not taken away during an emergency. One shudders to think of what might have been had the "basic structure" doctrine not been propounded by the Supreme Court. The author of the Hindu article is right in saying that this judgement saved Indian democracy.

Economists' fads and fashions

I had a post yesterday on the controversy over the Reinhart-Rogoff paper. Such controversies wouldn't be troubling if they remained strictly in the academic realm. The difficulty arises when some findings or prescriptions of economists are accepted and acted upon by policy-makers. These prescriptions, mind you, are often over-simplified versions of theory When the findings come to be questioned later, as has  happened with the RR paper, the costs of wrong policy fall on the hapless citizens of economies where these policies have been practised.

There is little doubt that austerity in the Eurozone has hurt millions badly. This would have been acceptable had there been light at the end of the tunnel. It does appear, however, that economic recovery is going to stretch out as austerity causes economies to contract. You can't blame RR alone for this.

The IMF, which has pushed for austerity in the bailout packages for Greece and others, disclosed last October that its estimate of the fiscal multiplier (of around 0.5) was an under-estimate. The multiplier may be higher than 1. This means that cuts in government spending will cause a reduction in gdp that is greater than the cut, so that debt to gdp rises, it doesn't fall! Now, who is going to pay for the IMF's turnabout? The people of the Eurozone, of course.

One can think of other prescriptions that have turned out to be dubious- capital account convertibility, opening up to foreign banks, privatisation, efficient markets and 'light-touch' regulation.... it's a long list. Policy makers must be careful not to fall for passing fads and fashion amongst economists. They must allow policy always to be mediated by the democratic process, so that they have a better understanding of how policy impacts on the lives and aspirations of people.

More in Hindu article, Beware the nostrums of economists.

Public debt and growth

Many readers will be aware of the first class controversy that is raging in the economist fraternity over a paper written by Reinhart and Rogoff  (RR)on the relationship between public debt and growth. In a nutshell, the paper purported to show that growth falls off a cliff once the public debt to gdp ration crosses 90%. Three economists at Massachussets, Amherst have shown that the calculations underlying the paper were flawed: the impact on growth at that level of debt is far less lethal than RR made it out to be.

FT has several interesting posts on the subject. Here is a sample: One, two and three

Students of economists should know, from first principles, that there was more than an element of exaggeration in the RR thesis. Think of why higher debt should hurt growth. As governments raise borrowings, there is crowding out of private investment through higher interest rates. But in an open economy where savings from outside the economy can be tapped, this effect will be far less severe than in a closed economy.

Secondly, much depends on what your borrow for. If higher government borrowing goes into infrastructure or even human capital, it could "crowd in " private investment.

Lastly, when the economy is way below full employment, government borrowing helps move output towards the equilibrium level; it is when an economy close to full employment that the deleterious effects of government borrowing are felt. When governments cut back on borrowings by cutting government spending at a time when economies are mired in recession, you get what we are seeing in the Eurozone today.

Women at work

How women can advance at the workplace is one of the recurrent themes in discussions on gender equality and management. Sheryl Sandberg, COO of Facebook, weighed into this debate with  a book that advised women to "lean in"- be more vocal and demanding at the workplace. The Economist reviews a clutch of three books that shed more light on this subject.

One point the review highlights is the differences in how men and women respond to situations at the workplace:

Women ask more questions, gather more people’s opinions and seek collaboration with co-workers more frequently than men. Men view these preferences as signs of weakness, and women, in turn, grow annoyed by how competitively men work, and how quickly and unilaterally they arrive at conclusions.

But this doesn't explain why women do not rise as much in the corporate world as men do. To put it all down to gender discrimination is a lazy explanation. Women opting out to look after children or opting for a certain career path in order to balance work and family are part of the explanation; it could also be that not enough women opt for professional degrees (such as engineering) that are required for rapid progression.

What we can say with a measure of confidence is that firms lose our when they do not have adequate gender diversity at various levels. And it may well be that to achieve a certain diversity along the line, you need to begin at the very top: representation for women on boards. European countries that have mandated minimum seats for women on boards seem to have got it right. The improvement in the lot of particular groups just does not happen in society unless there is a measure of affirmative action.

Modi's biographer on Narendra Modi

Nilanjan Mukopadhyay, author of a biography of Narendra Modi, interviewed by Rediff.com

Analytics and recruitment of employees

Analytics- or crunching of data on a large scale-is being widely used for a variety of purposes. The Economist has an interesting report on the use of analytics for hiring employees.

Some of the findings on employee performance, which helps in taking decisions on recruitment, are interesting:

• ....people who fill out online job applications using browsers that did not come with the computer (such as Microsoft’s Internet Explorer on a Windows PC) but had to be deliberately installed (like Firefox or Google’s Chrome) perform better and change jobs less often.
•  ....one of the best predictors that a customer-service employee will stick with a job is that he lives nearby and can get to work easily. These and other findings helped Xerox cut attrition by a fifth in a pilot programme that has since been extended. It also found that workers who had joined one or two social networks tended to stay in a job for longer. Those who belonged to four or more social networks did not.
• A study of 20,000 workers showed that more honest people tend to perform better and stay at the job longer. For some reason, however, they make less effective salespeople.

I don't suppose such findings can be a substitute for going through applications and interviewing candidates. But they can be an aid to good hiring, especially when backed by firm-specific data. 

And now China gets rating downgrade

China may be growing at 8% but that hasn't stopped Fitch from downgrading it from AA- to A+, FT reports.:

Fitch downgraded China’s long-term local currency rating from AA- to A+, citing a number of “underlying structural weaknesses” in the Chinese economy including low average incomes, lagging standards of governance, and a rapid expansion of credit. 

The agency also warned of the growing risks from the rise of shadow banking, and said that total credit in China may have reached 198 per cent of gross domestic product by the end of last year, up from 125 per cent in 2008. 

“Ultimately we think China’s debt problem is going to require sovereign resources to resolve and debt will migrate onto China’s sovereign balance sheet. We don’t yet know what form this will take – central bailouts of local governments or of banks, perhaps”, said Andrew Colquhoun, head of Asia sovereign ratings at Fitch.  

The downgrade does not come entirely a surprise. There has long been a perception that China's public debt is understated, partly because debt raised by provincial and other agencies are not included, but mainly because China uses state-owned banks to lend in a big way to state-owned enterprises and public projects. In effect, this buries public debt in banks' balance sheets. When balance sheets are growing rapidly, the NPA/ asset  ratio stays low, again disguising the underlying problem.

The rapid expansion in credit as a percentage of GDP, however, is unlikely to leave Chinese banks unsinged. As Fitch points out correctly, this will ultimately require sovereign bail-outs and an increase in public debt.

China's high leverage coincides with signs that the chances of growth slowing down sharply are rising. Martin Wolf quotes a Chinese agency as forecasting a slowing down of growth to 6.5% between 2018 and 2022, compared to growth of 10% from 2000 to 2010.This again points to a rise in NPAs in banks. The big question is whether the transition to slower growth will be smooth or disorderly.

British banks under fire

Two British banks have come under renewed fire this week. A UK parliamentary had a scathing report on HBOS and an independent report on Barclays Bank targeted the flawed culture at the bank.

HBOS, which went to ruin in the financial crisis, was a case of colossal mismanagement: bad lending, excessive dependence on short-term funds, poor controls. Just to give one statistic, the bank's loan to deposit ratio at one point was 198%- here in India, we get nervous even if the figure approaches 100%.

All this was made possible by poor regulatory oversight. It is hard to believe that a bank can be so badly managed right under the nose of regulators. To add insult to injury, its CEO sat for two years on the board of the Financial Services Authority.

The whole problem is that bankers can get away with their behaviour without any cost to themselves. One interesting recommendation is that, in future, bankers should face sanctions for the costs they impose on their firms and on society:

Margaret Thatcher and Chandraswami

The Hindu carries a fascinating piece by K Natwar Singh on an encounter between the late Margaret Thatcher, former British PM, and godman Chandra Swami.

Apparently, the Godman predicted that Thatcher would go on to become PM and that she might remain PM for 9, 11 or 13 years. The circumstances in which this forecast was made are interesting. At the first meeting that Singh set up between the two of them in London, the godman floored Thatcher with his extra-sensory powers:

He gave Mrs. Thatcher five strips of paper and requested her to write a question on each. She obliged, but with scarcely camouflaged irritation. Chandraswamy asked her to open the first paper ball. She did. He gave the text of the question in Hindi. I translated. Correct. I watched Mrs Thatcher. The irritation gave way to curiosity. Next question. Again bull’s eye. Curiosity replaced by interest. By the fourth question the future iron lady’s demeanour changed. She began to look at Chandraswamy not as a fraud, but as a holy man indeed. My body language too altered. Last question. No problem. I heaved a sigh of relief. Mrs Thatcher was now perched on the edge of the sofa. Like Oliver Twist, she asked for more. Chandraswamy was like a triumphant Guru. He took off his chappals and sat on the sofa in the lotus pose. I was appalled. Mrs Thatcher seemed to approve.

Mrs Thatcher then requested a second meeting with Swami at which he made his prophesies about her becoming PM. 

Cyprus solution is band-aid, not cure

Another crisis, another half-solution, another sigh of relief. When will the Eurozone stop rattling financial markets? Not in the near future, I guess.

In Cyprus, those concerned- the EU, the ECB, the IMF and the government of Cyprus- had the sense to rework a badly flawed proposal and come up with something that seemed to pass muster. But this does not mean the Eurozone problems have gone away. Indeed, the approach in Cyprus raises serious questions about what would happen if problems in Spain, Italy or Portugal reared their head again.

The total cost of the bail-out is € 17 bn. The absolute amount is so small that the EU could easily have underwritten all of this. But voters in Germany won't stand for it- they want to see citizens in the distressed economies suffer for their past sins. So, Cyprus had to bear some of the pain. The issue was what form it should take.

Mercifully, the insane proposal to penalise insured depositors- which mean a straight flouting of the EU-wide guarantee- was given up. Instead, Cyprus agreed that their share of the burden-
€ 5.8 bn- would fall on large deposits (those over € 100,000). In return, the EU would hand Cyprus 
€ 10bn. 

What are the implications? First, Cyprus has imposed capital controls, which goes against the principle of an economic union.  These controls are supposed to be "temporary" but we all know what that means. Secondly, and more importantly, the principle of bailing in creditors has been carried farther than in the case of Greece. In Greece, bond-holders suffered a hair-cut; here, uninsured depositors have been included. 

You might say this is fair: creditors should suffer in any bankruptcy (after shareholders), not tax payers. Not accepting this principle gives rise to moral hazard, which has been the bane of banking. But there are costs to this approach. First, Cyprus' banking system will shrink. Make no mistake, this means that GDP will shrink. What happens to the debt to GDP ratio then? How does the Cyprus solution solve the basic problem of sovereign indebtedness?

Secondly, how would depositors in other troubled economies, such as Italy and Spain, respond? Can we expect a flight of deposits to safer economies? What does this mean for recovery in Italy and Spain? Lastly, in the case of Greece, bond-holders were told that the losses they had to take were an exceptional case. It now turns out that this is to be the norm. What does this mean for the cost of raising subordinated debt for banks in Europe? Debt is going to become more expensive and this will translate into higher costs for borrowers. Also, at the first hint of trouble, bondholders will flee. Again, growth will be a casualty.

Granted, all stakeholders in banks will have to suffer the burden of adjustment in what is fundamentally a banking crisis. But the burden has to be distributed not just among bank shareholders, creditors, taxpayers and the citizens of distressed economies. Taxpayers elsewhere in Europe - and indeed the rest of the world- have to chip in if stability and recovery in the Eurozone are to be facilitated. Banks in Europe have to be recapitalised and the costs of recapitalisation must be universally shared, albeit in differing degrees. 

FT has a good article on the balance to be struck between moral hazard and systemic risk and resolving banks.  

Monetary policy: the case for an interest rate cut

Industry as well some members of the fraternity of economists are clamouring for a rate cut on the ground that it will stimulate growth. Those oppose to it say the RBI can't afford a rate cut when consumer inflation is in the double digits (and has risen lately) and the current account deficit is alarming. I think there is a case for a rate cut but not because it will stimulate growth. The case I would make is a different one.

Let me address the reasons given for not having a rate cut. Inflation is now driven by food inflation and demand management can't do much about that. As for the impact of a rate cut on the CAD, the RBI governor addressed the issue in his recent I G Patel memorial lecture at Oxford:

The risk of the CAD widening further because of the stimulus offered by the rate cut is much less than apprehended for a host of reasons. First, when growth is sluggish as is the case now, the rate cut is unlikely to translate into import demand. Second, the rate cut was a response to softening inflation. Lower inflation will improve the competitiveness of our exports. Third, the rate cut was effected during a phase of easing commodity prices - particularly of oil - which will reduce the pressure on the CAD. Finally, empirical evidence shows that in emerging economies such as India, import demand is less a function of lower interest rate than of increased income. In other words, the marginal propensity to import by borrowing money is small.

However, the case for a rate cut is not that it will stimulate growth by boosting investment. Real interest rates today are way below the real interest rate of 7.8% in the 2004-08 boom period, so high interest rates are not why growth is being held back. The villains are policy and regulatory uncertainty and a weak global environment. There is not a damned thing fiscal policy can do to stimulate growth because if the fiscal deficit is not brought down as promised, the rating agencies will downgrade us.

The finance minister has said his principal worry is the CAD. His budget was driven by his concern that any fiscal deterioration would cause a downgrade and result in a flight of FII flows. We need, as he said, $75 bn to finance our CAD. An interest rate cut  would improve corporate profits and valuations and hence keep FII interest in India alive. It would also help banks access capital needed to meet Basel 3 norms and ease credit constraints in growth which seem to have emerged. (Proof: SLR holdings are 30% instead of the mandatory 23%). A cut in interest rate, as the RBI governor points out in his lecture, might cause FII flows into debt to slow down but it would still have a positive effect on equities. Monetary policy would thus reinforce fiscal policy in sustaining the financing the our large CAD.

More in ET column, Will Mint Street and Dalal Street unit to sustain FII flows?

  

Infosys surge: another miss for analysts

Infosys surged past Rs 3000 yesterday and has fallen back a bit today. I have no expertise on the IT sector. However, having been in investment banking, I do note with interest- though not with surprise- that analysts completely missed the turnaround in the stock's fortunes.

The big shocker to the analyst community was the favourable revenue guidance given by the company during the last quarter results. That caused analysts, who were predicting a stock price of around Rs 2200 or below in the months ahead, to revise the stock price target upwards. Even then, the higher targets were only around Rs 2850. Some analysts insisted they would wait for another quarter to see if the improvement was sustainable. Then, there was a whole tribe of analysts and media commentators who were telling us that the problem lay with the wrong choice of CEO to succeed Kris Gopalakrishnan, that the exit of most of the founders had changed the company culture completely, etc. So, the stock surging past Rs 3000 is quite a miss for the analyst community.

Of course, in these situations, hindsight is always available. ET, quoting various experts, gives reasons for the stock's improved performance. But the question is worth asking: if analysts can't get it right with a company so visible and so closely tracked as Infosys, what are they there for?

Narendra Modi's bid for prime ministership

Speculation about Narendra Modi emerging as a contender for the PM's job has been rising and has reached fever pitch. Most of the analyses tend to be partisan. Those against say the nation will never allow it, given what happened in Godhra. Those for Modi say that the time has come for a leader in the mould of Indira Gandhi. Sheela Bhat provides a more insightful and detailed analysis in Rediff.

The key point she makes is that the BJP is unlikely to get more than 150-170 seats. How does Modi become PM in that situation? She argues that the regional parties will probably strike a suitable deal with Modi. The author is clear about one thing: the BJP cadres are all for Modi and there is support amongst voters not given to watching the talk shows on the English TV channels. She believes Modi's campaign will rest on the dynasty, corruption and inflation. But what if Chidambaram delivers and the economy turns around by 2014?

Management lessons from a spy

This might sound tiresome but it appears, from a book written by a spy (a lady), that there might be a lesson or two in management that spies -of all people- have to offer. Or so Lucy Kellaway suggests in her review in the FT. And, no, the lesson is not that you gun down bad guys using a silencer.

What can spy teach us? One thing seems obvious: observe people carefully. They have to do this for a living (and sometimes to save their own lives); most of us couldn't care less.

Ok, what else? Here a couple of points that Kellaway highlights that might be useful:

Less obvious but no less valuable is her tip for job candidates: get the interviewer to do most of the talking and then hang on their every word. As hard­ly anyone can resist talking about themselves to a rapt audience, a job offer is almost bound to follow.

To the public speaker and the salesman, Carleson has further good advice: never rely on a script and never learn what you are going to say off by heart. When you do this you use a different tone of voice, go on to autopilot and all trust is lost in an instant. Carleson is right. I have done this, but never again.

But the main lesson is the one mentioned at the outset, namely, watch people carefully to catch their weaknesses:

....and for this there are some common denominators: “ . . . ego, money, ego, ego . . . ego, ego, ego.”

UK's 'cash for access' affair

I had to pinch myself in disbelief when I read this. UK's fund managers pay brokers for getting access to the latter's CEO clients. The payment rate is as much as $20,000 an hour and total spending on this account in the sector runs into millions, FT reports.

Ed Harley, head of asset management supervision at the FSA, raised the prospect of multimillion-pound fines for fund managers found to be in breach of its rules......Mr Harley said analysis by the FSA of the use of client commissions by 15 asset managers found large payments that were “hard to justify”. The bulk of them covered payments for corporate access, alongside smaller sums for access to market data.

Why would fund managers pay for access to CEOs? Presumably, they glean information that is not otherwise available? There is public disclosure of information and CEOs take conference calls from analysts and fund managers after results are disclosed. So, what exactly is to be gained by meeting the CEOs in person? And if there is something to be gained, does not that not qualify as insider information?

Incidentally, ending cash payments for access may not solve the problem. There are so many other ways in which fund managers can take care of cooperative brokers and CEOs. 

IT sector: a case of successful government intervention

It's fashionable to say that India's IT sector has been a terrific success precisely because it doesn't need support from government- it was never subject to the licensing regime, for instance. We know this is not true because the sector has been supported through tax concessions and because it was state-subsidised education that made possible the initial supply of trained personnel.

In a thought-provoking article in EPW, Jyoti Saraswati elaborates on the theme of state intervention and shows how the sector's success is, in fact, a case study in successful intervention, contrary to the nonsense that is spouted by advocates of neo-liberalism or the leading figures in the sector.

The author mentions two big forms of support in the initial period. One, the 1972 Software Export Scheme which provided 100% loans for computers meant for export use. Secondly, investment in telecom infrastructure that made possible off-shore delivery of services. The state has continued to support the sector in the post-liberalisation phase as well- the Software Technology Parks of India was one such significant initiative. Another point worth noting is that India's IT firms were able to move up the value chain by gaining experience in the domestic market which, by then, had begun to find use for their services. (eg CMC's experience in computerising the Indian railways' ticketing system helped it win the London Underground contract).

The author's  conclusion is worth quoting:

The experience of the Indian software industry over the past 20 years supports the argument that the Indian state should not be seen as pro-market but be understood as pro-business (Kohli 2010), i e, it is able and willing to intervene in support of selected sectors and industries regardless of the neo-liberal rhetoric it may espouse and the international diktats it claims to adhere to. Indeed, the state can continue to play a significant supporting role for firms, industries and sectors.

The broader point I would add is that private entrepreneurship in most countries flourishes on the back of covert or overt government support. The idea that the state should back off  and 'leave it to the market' is a myth that is perpetuated by private sector interests when it suits them. 

Kumbh Mela managerial marvel

FT joins others (including a  team from Harvard) in marvelling at the managerial capabilities that underlie the successful organisation of the Kumbh Mela festival this year.

On the sandbanks of the river Ganges at Allahabad, bureaucrats and workers from Uttar Pradesh, India's most populous state and one of its poorest, took less than three months to build a tent city for 2m residents complete with hard roads, toilets, running water, electricity, food shops, garbage collection and well-manned police stations.....

.....Devesh Chaturvedi, a senior official who is divisional commissioner of Allahabad, is proud of the “huge task” that he and perhaps 100,000 workers have completed in organising this year’s festival.
He mentions 165km of roads on the sand made of steel plates, 18 pontoon bridges, 560km of water supply lines, 670km of electricity lines, 22,500 street lights and 200,000 electricity connections, as well as 275 food shops for essential supplies such as flour, rice, milk and cooking gas.

The obvious question that is being asked is if such a feat of organisation can be accomplished for this purpose, why not elsewhere? Why can't India's villages and towns be similarly transformed. Well, motivation apparently is everything: the people involved in the project think they are actuated by a sense of mission, given the religious significance of the event. In principle, however, India should be able to replicate it in other places: neither talent nor resources is the real constraint:

First, the authorities ensure that all those working on the project are accountable for their actions and the money they spend. Second, those involved are highly motivated.
“They feel it’s a real service to all these pilgrims who have come here, the sadhus [holy men] and the seers, so it’s a sort of mission which motivates them to work extra, despite difficult working conditions.” 

Good organisation and efficient infrastructure, in short, are no more impossible in India than anywhere else. “The lesson is, it can be done,” says Bhagawati Saraswati, a Californian-born Hindu devotee camped on the river bank with other members of an ashram based on the upper Ganges.

 

Capping bankers' bonuses

The European parliament has grasped the nettle when it comes to bankers' bonuses. They have passed a law that mandates a 1:1 limit on the salary to bonus ratio. This can be go up to 2:1 with shareholder approval. The move has raised a storm in London where bankers and politicians believe that the proposal will undermine the City's importance as a financial centre, perhaps by causing banks to move key personnel to locations where the caps would not apply. FT has a primer on the new regulations.

One obvious response on the part of banks would be to increase base pay so that the overall compensation is not affected. But this has its own problems: it raises a banks' fixed cost and leaves it vulnerable in times when revenues and profits shrink. The EU banks fear that the proposal would confer American banks, operating in the US, with an advantage. (Presumably, the rules would apply to American banks' subsidiaries in the EU). Andrew Hill has a critique in the FT, but I am not convinced by his arguments.

The cap on bonuses follows regulations that require banks to defer the vesting of stock options over a longish period. Increasing the requirement of bank capital, which will reduce returns to equity in banking, should also help address the issue of systemic risk posed by large bank bonuses.

Incidentally, we are seeing the first major attempt at clawing back bonuses. Barclays is clawing back 300 million pounds paid to its bankers. The claw back follows huge fines the bank has incurred for Libor rigging and mis-selling various products.

Where does all this leave banking? The outcome, one imagines, would be to reduce incentives for taking excessive risk. Will it curb innovation? Perhaps, but, then, there is the perception that much of the innovation we have seen in recent years is of dubious value. A certain imbalance has crept in between the financial sector and the real economy. There is such a thing as excessive 'f'inancialisation' of the economy. Tackling compensation in banking is one element in addressing the larger problem of systemic risk in banking.

At the mercy of the rating agencies

The FM has kept his pledge. He has contained the fiscal deficit for 2012-13 at 5.2%. All of us know that this is at the cost of a cut in Plan Expenditure of nearly Rs 90,000 crore. He pegs the deficit for the 2013-14 at 4.8%. Since he sees no choice but to appease the rating agencies, chances are he will stick to this target as well. The question is: how?

Many analysts have pointed out that the revenue estimates are optimistic even if we grant that growth revives to 6%- the figures non-tax revenues, including divestment proceeds, certainly are ambitious. Subsidies in the coming year are to decline by Rs 25,000 crore, which means fuel subsidies will be axed even further, which would be a tall order as elections approach. It is more likely that the FM will meet the fiscal deficit target the same way he did this year- by pruning Plan expenditure and capital expenditure. The increase in 29% in Plan expenditure is clearly iffy.

Growth has sagged in the current year because of an investment famine and cuts in government capital expenditure have clearly contributed. If the government resorts to the same in 2013-14, that is bound to tell on growth. The betting is that private investment will somehow revive strongly, helped by lower interest rates. As fuel subsidies are pruned, inflation will stay in the region of 7%, so there is little the RBI can do to help. More importantly, it is not at all clear that high interest rates are the deterrent to private investment- real interest rates today are way below they were doing the boom period of 2004-08.

Private investment will revive if investors see demand looking up. Either export demand must pick up with an improvement in the global situation. Or domestic demand must revive- and, in the present situation, this requires a strong push from the government. Think of the what the highways project did during the NDA regime. But, if the government is fixated on a fiscal deficit number, there is no way this can happen.

For me, the big puzzle is why rating agencies are so obsessed with the fiscal deficit number. India's total debt to GDP ratio of less than 70% looks good in the present environment; India is among the few countries to have seen the ratio declining post-crisis. States have got their acts together on the fiscal front. External borrowings are low. If only the rating agencies would allow elbow room in respect of the fiscal deficit, it will be easier to get into a virtuous cycle of higher growth, higher revenues, and lower fiscal deficit. Historical experience shows that nations grow their way out of a high debt situation. The G-20 is veering towards reducing austerity. But here the rating agencies won't allow it. And we can't annoy the agencies thanks to our yawning current deficit.

Just hope and pray that gold prices collapse. Then, the current account deficit will narrow. That will give us greater freedom in respect of fiscal policy. Also, pray that the global environment improves. t's hard to see how the present fiscal approach can lead to any early revival in growth.

Some related thoughts in my ET column, Budget must cheer the markets.

Sebi paper on corporate governance

Sebi has just come out with a consultative paper on corporate governance. I know most people can't help yawning- so much has been said about corporate governance and yet we have so little to show.

Still, I would recommend the Sebi paper because it not only gives the background to the situation in India but also documents some undramatic but useful initiatives Sebi has taken of later. The consultative paper itself contains some useful proposals, some of which I will mention:

• Giving minority shareholders in large companies the right to nominate at least one director: This is a useful step towards broad-basing the board, which today consists entirely of  nominees of  promoters.
• Requiring independent directors to give reasons when they resign: True, they can always cite "personal reasons" in order to avoid unpleasantness. But if things blow up later, they can't say they were aware of what was going and that is why they resigned; if they knew, they should have said so in their letter of resignation.
• A maximum tenure for independent directors: Two terms of five each. I am not sure I favour the same directors returning after a hiatus of three years. Surely, there is enough talent available in the country, notwithstanding claims to the contrary made by companies?
• Restricting the number of independent directorships: This should not be more than six or seven in my view. It is shameful that many people don't think it necessary to impose limits on their own when  they know you can't do justice otherwise.
• Performance evaluation of independent directors: This is to be done by peers, which could lead to back-scratching. But even a few adverse evaluations should have some effect,
• Making a whistle-blower mechanism compulsory: This is long overdue. It should be possible for employees to disclose wrong doing to a designated independent director. It should be mandatory for the said director to bring the matter to the board for discussion.
• Mandatory succession planning and disclosure of these plans to shareholders
• Mandatory e-voting

These are some of the more important proposals. The disappointment is that we are not seeing a wider participation of shareholders in the appointment of independent directors. I would like to see institutions nominate their directors who would be regarded as independent. Strangely, the Sebi paper thinks institutional nominees should not be regarded as independent presumably because they represent the interests of one groups. But institutional interests are also, in general, aligned with those of the broader shareholder body, aren't they?

You cannot have an effective board as long as management or promoters appoint independent directors and reward them lavishly. The appointment of independent directors should be done by different stakeholders, including minority shareholders. I believe not insisting on this is the big lacuna in an otherwise interesting paper put out by Sebi.

More in my column, Sebi dodges the central issue.

Corruption- India isn't unique

Spain's PM Mariano Rajoy has been implicated in a growing corruption scandal in Spain, which is already under pressure in the Eurozone crisis, FT reports:

Spain’s prime minister has become embroiled in a growing scandal over secret cash payments to ruling party politicians after a newspaper published that it claimed to be accounts showing payments reaching as high as Mariano Rajoy himself..... 

“The level of trust in politicians in Spain is very, very low, and corruption is one of the main problems,” said Antonio Argandoña, professor of Business Ethics and Economics at IESE business school. “Politicians must tackle this problem before any more damage is done.”

A recent poll for El País suggested that 96 per cent of Spaniards believed that political corruption was “very high”.

 

I know this is poor consolation but it helps to know that political corruption isn't unique to India.  It is alive and kicking in rich economies as well.

Big banks and operational risk

Big banks pose big risks. That has been clear enough in recurring banking crises. But the risks don't relate to credit or market risk alone. Bigness leads to problems with operational risk as well. This is the lesson from the huge finds that banks are paying out for the Libor scandal, money-laundering etc. The underlying reason is the same: lack of incentives to curb violations of law or regulations when you know criminal prosecution will not follow. Just pay out a big fine, which is still small in relation to profit, and move on.

More in my ET column, It's fine to be a big bank.

Cash transfers

There are indications that the government is having second thoughts on cash transfers- it is being restricted to fewer schemes in fewer places. This is appropriate. Without rigorous testing and feedback, the scheme can give rise to serious problems.

There are two issues here. One is the use of cash transfers for existing payments, some of which are made in cash and the rest by cheques. Another is the use of cash transfers in lieu of subsidies.

As for as the first is concerned, transferring directly to bank accounts should be fine in principle. Still, one must question whether such transfers need to be linked to Aadhar at all. Where pensions or loans are concerned, identities of individuals are not an issue. It is not clear why somebody, who has a bank account to which funds are to be transferred, should have an Aadhar identity as well, unless the idea is to give Aadhar itself wider currency. In the case of MNREGA, perhaps, Aadhar may help to avoid duplication of payments to individuals but this has to be clearly established through trials.

Cash transfers in lieu of subsidies built into prices of foodgrains are a different matter altogether. Paying cash may not ensure availability of food; and it is hard to find out what the market price for foodgrain is at a given point in time at a given place and, therefore, whether the cash transfer is adequate to enable purchase of the necessary quantities of foodgrain. Nor can cash transfers mean the dismantling of PDS. If the idea is to plug leakages in PDS, then it is important to take into account the fact that, in several states, leakages have been greatly reduced. These practices must be emulated elsewhere instead of opting for cash transfers to Aadhar accounts.

A letter signed by several economist and social activists in EPW says it all. It should be compulsory reading for those involved in making policy on cash transfers.

India's TV channels in crisis

India's TV channels are in the midst of a financial crisis which has serious implications for how report news, argues Sandeep Bhushan in a hard-hitting article in the Hindu. Bhushan points out that major industrial groups, such as Reliance, have acquired significant stakes in TV companies. (Even otherwise, one would think that intense competition for advertising revenues would tend to influence news coverage on TV networks). Bhushan spells out the impact:

The most far-reaching is the redefinition of the role of the editor. Increasingly his/her profile not merely entails leading the pack in the TRP race, but crucially acting as the “front” for the promoter in order to provide an appearance of both credibility and acceptability within the industry. The promoter’s line — his whims and fancies, idiosyncrasies and perhaps, most damagingly his political “preferences” — is increasingly the editorial line. It is not my case that this state of affairs uniformly prevails in all TV broadcast networks. But any “insider” will confirm that this is pretty much the picture by and large. 

This has resulted in growing centralisation of newsgathering operations. Editorial monitoring is closest with regard to “political” reportage because it is here that the government of the day can be really hit hard. In my experience of reporting “political” stories it was virtually impossible to generate a story in the field and hope that it got aired unless it coincided with the editorial “line.” “Political” stories invariably emerged from the “top.” Often a reporter may not even have a say in the particular “angle” of a story to which only he or she has privileged access. This has virtually taken the (political) reporter out of the scheme of things in broadcast journalism. 

It is not just the slant to political and corporate news coverage that is worrying. It is the lack of news coverage in the first place. If you want to know what happened in the country on a given day, you would be hard put to find it on any of the private TV channels. Instead, you get slanging matches performed in the studio, often with the same set of familiar faces. Going out and covering and reporting news is costly; it's much easier to get a bunch of talking heads into the studios.

Bhushan urges better protection of journalists, more professionalisation of management and anti-trust laws to counter the present trends. All this is easier said than done. Perhaps, a simpler way is to strengthen public broadcasting so that it emerges as a serious threat to popular channels. As I noted in my blog sometime ago, Doordarshan has improved in a big way and Lok Sabha and Rajya Sabha TV have some very interesting programmes to offer. This trend must be strengthened so that private TV channels and their owners find that better content is needed to retain and attract viewers and hence advertisers. 

 

Peer evaluation for IITs, IIMs

The IIT Council has said that all IITs will be subjected to evaluation by peers every five years, TOI reports. Apparently, the government intends a similar review for IIMs. I welcome the move- I had myself advocated external audit of the IIMs in my book on Ravi Matthai- IIMA, Brick by Red Brick, published in 2011.

An external audit is required for two reasons. One, we do not have sufficient competition for the IITs and IIMs and, therefore, it cannot be left to market forces to arrive at a judgement, reflected in applications for admissions. Given the acute scarcity of quality colleges in engineering and management in relation to demand, the market cannot be expected to deliver judgement. An alternative mechanism would be the Board of Governors of IITs/IIMs but this mechanism has simply not functioned. One reason is that those appointed to these boards have very little stakes in the institutions and cannot be expected to devote the attention necessary to keep management on its toes. Besides, for the Board itself to monitor effectively, an effective market for higher education needs to exist; as mentioned, it does not.

As a result of poor monitoring, the IITs and IIMs today are places where there are few checks and balances on the office of director. The scope for discretion is enormous and there is virtually no accountability. Whether a director performs or not performs, whether he abuses office or not has no bearing on his completing his term and even getting another term.

This is an unhealthy state of affairs. All public institutions should be accountable- in the case of the IITs/ IIMs, directors as well as faculty. And such accountability can be established only through an independent management audit. Indeed, the principle of independent audit needs to be applied to regulators and other public authorities, such as RBI, SEBI, the CAG, CEC, etc. No public institution should be beyond the pale of public scrutiny of their activities, decisions and performance.
 
The modalities of the independent audit are important. It appears the expert committee will be chosen by the minister of HRD from a panel of 10 names submitted by the Board of Governors of an IIT. This is not the most desirable state of affairs. The Boards cannot provide names for the audit panel because the boards themselves need to be audited. It would be better to create a collegium of distinguished academics (including NRIs) who would propose names to the ministry.

Secondly, the audit must not be based on meetings with top management of IITs/IIMs or on published documents alone. The audit panel must meet all stakeholders: faculty, students, staff, alumni, the corporate world. Not only the actual outcomes (placement, publications, number of doctorates, etc) need to be reviewed but the internal processes and important decisions. It should be open to any faculty member to submit written documents for consideration by the audit panel. It is only by shining the light on the internal processes and governance of these institutions that improvements can be brought about.

Lastly, the audit reports must be placed in the public domain. In today's world, we can expect the reports to be commented on not only in the mainstream media but also in the social media. Audit and disclosure are the keys to accountability at public institutions.

It is striking that the gurus of governance at the IIMs did not think of subjecting themselves to a peer review all these decades; it was left to their bete noire, the ministry, to initiate this proposal. 

Banking reform must focus on financial inclusion

One gets contradictory messages on banking reform these days. Some talk of consolidation as the need of the hour. This means fewer banks and less competition. Others say net interest margins are too high and we need to drive them down, which would require more competition. And yet others talk of the imperative of financial inclusion- one would imagine this is best done through keeping the existing set of public sector banks with their branch networks instead of opting for consolidation.

Neither consolidation nor lower margins is the need of the hour. India's banking system is not so fragmented as to be unviable and, besides, more concentration means greater systemic risk. If we want to pursue inclusion, we need banks to have reasonable surpluses, so they will need the margins they currently enjoy.

Financial inclusion is what we must focus on. The success of Indian banking in the post-reform period, it is not often realised, is the fruit of the substantial investment in inclusion during the nationalisation period. The branch network created in that period has created the low-cost deposits that form the backbone of Indian banking today and partly account for its financial success in the post-reform period. Inclusion on the asset side helped strengthen agriculture and SMEs and laid the foundation for industry doing well.

There is an opportunity to cash in on inclusion again, thanks partly to the direct cash transfer scheme. This will mean creating millions of new accounts with large cash floats. Whoever can make success of this will getting a hoard of low-cost funds and will also be creating potential borrowers and buyers of financial services a few years down the road.

The issue of licenses for new banks must be linked to financial inclusion targets. With industrial houses, the regulatory issue is not just interconnected lending. Interconnected borrowing is also an issue. A bank set up by an industrial house can easily acquire deposits and salary accounts from other business entities within the house and hence is saved the trouble of having to garner deposits through a large branch network. It is not enough to ask industrial houses to set up branches in under-banked centres. There must be clearly specified quantitative targets for inclusion for each branch. In other words, industrial houses can be allowed into the field, subject to their meeting the basic objective of financial inclusion.

More in my ET column, Banking reform needs focus.

Narayana Murthy on CEO pay

How do we determine CEO pay? Narayana Murthy, writing in ET, suggests that the ration of the  highest to the lowest pay in a company should be of the order of 20-25. This is rather more liberal than what Peter Drucker, the management guru, had proposed many years ago: 5: 1. But even NRN's prescription is way below what obtains in the corporate world today. In India, I would imagine the ratio is as high as 300: 1 or even 500:1 in many companies. If we factor in perquisites and stock options, the differential escalates even more. It is only in the much-derided public sector that NRN's prescription comes close to being true- and, that too, when you exclude the market value of perquisites such as housing provided by the company.

NRN's argument that companies are bound to benchmark pay with global practices is not persuasive for the simple reason that overseas companies do not have very clear norms for setting CEO pay. Nor is one persuaded by the point about independent directors setting pay- all of us know how independent these directors and how generous they can be when they are looked after well by the company.

The way CEO pay is set is just another manifestation of the fundamentally inequitous nature of modern society- those at the top will simply get away with doing whatever suits them. The best we can ask for more comprehensive disclosure not just of the total pay packages at the top but of the norms used for setting pay. The latter is seldom made available to shareholders or the general public.

More broadly, the answer to reining in private sector pay is to have a public sector alternative that offers a different lifestyle- more security, more job satisfaction, linked to more modest pay. When people have that sort of a choice and many spurn private sector salaries, however attractive, in favour of something that is inherently more satisfying, that might contribute to limiting pay in the private sector. 

Global economy more crucial to growth than reforms

India's growth prospects, it is generally agreed, should improve in the next year. That is because the global outlook has improved. One indication is the return of FII flows into India in a big way- net FII inflows this calendar year are over $20 bn, the same as in 2010. FII money fled India last year following the Eurozone crisis. The relatively stability in the Eurozone this year has prompted a return.

Note that FII flows did not return because of the burst of reforms. The bulk of the FII flows , $12 bn out of $20 bn, came into the country by August whereas the reform burst happened in September. This underlines an important point: what happens to the economy in the near future will be governed more by global conditions that any reform initiatives.

This proposition is borne out by the fact that India grew at 8-9% in 2004-08 without any serious reforms. Similarly, growth plummeted to 6.8% in 2008-09 at the peak of the global crisis. India's economy is far more integrated with the world economy than before through both trade and capital flows. Another reason the global economy matters is more is that private investment in infrastructure, which drove growth earlier, is hampered now by regulatory and legal issues and high leverage in infrastructure companies. We can't really expect domestic investment to drive growth in a big, given the difficulties in the big growth area, infrastructure.

As for reforms, the potential impact of these is constrained by two factors. One, the persistence of high inflation- this won't change in the next two to three years as domestic prices are gradually aligned with international prices. Two, the fiscal deficit will remain high upto 2014 if only for electoral reasons. Both these will mean a low rate of savings. High inflation will keep financial savings low as households prefer to park their savings in gold. A high fiscal deficit implies lower net savings. The fiscal deficit will decline substantially only when growth revives strongly on the back of a revival in global demand. It is unrealistic to expect that we can compress fiscal deficit to a level where interest rates fall, investment revives and growth accelerates.

Whichever way you look at it, the global outlook holds the key to India's return to the growth path of 8%. The Eurozone crisis will stretch out until at least 2014-15. That implies that India will have to wait at least until then before it gets to seeing growth of 8%.

More in my ET column, Slow return to 8% growth.

Reservation in promotions

The reservation in promotions for SC/STs Bill has been passed in the Rajya Sabha. Its passage in the Lok Sabha is awaited. Many of those who favour reservation for SC/STs at the point of entry are opposed to extending the principle to promotions. The merits of the Bill can be debated but the crucial thing to note is that the Bill will have to withstand any challenge in the  Supreme Court. The Hindu today carries an article that brings out the constitutional aspects very well.

There are two criteria of the Supreme Court that are relevant to any provision for reservation in promotions for SC/STs. One, such reservation must not come into conflict with requirements of efficiency. Two, the government must demonstrate lack of representation of the SC/STs by providing appropriate data. The article points that as part of the negotiation with the BJP, the UPA government agreed to drop an earlier provision in the Bill that would have allowed it to ignore concerns about efficiency. However, the present draft contends that the government need not demonstrate under-representation. The author writes:

The draft of the 117th Constitution Amendment Bill has a rather short-sighted response to the Supreme Court’s demand that the inadequacy of representation of the SCs/STs must be demonstrated on the basis of each cadre. In essence, the Supreme Court’s position is that if the state wants to provide quotas in promotions for clerks, it should demonstrate inadequate representation of the SCs/STs among clerks . The response of the 117th Constitution Amendment Bill is to remove any reference to the requirement of demonstrating inadequacy of representation. The Supreme Court’s demand that the cadre must be the basis for demonstrating inadequacy of representation is far from ideal. A cadre-based determination of inadequacy of representation of the SC/STs would not result in an accurate picture of representation of the SC/STs in public employment as a whole. The 117th Constitution Amendment Bill should have clarified that a cadre-based determination of inadequacy of representation was not required by the Constitution and that it would be sufficient for the State to demonstrate inadequacy of representation in public employment as a whole. Instead, the Bill that has been passed in the Rajya Sabha goes to the other extreme and no longer requires the state to demonstrate any sort of inadequacy of representation. 

I am not clear as to how quotas on promotions will work. Are we to suppose that there will be 22.5% reservation for SC/STs at each level- joint secretary, additional secretary, secretary- in the government? Or will governments settle for, say, representation in the office cadres as a whole? If SC/STs are adequately represented at the joint secretary and additional secretary level and in the services a whole but there are not enough of them at the secretary level, would this call for government intervention?

The implications of having 22.5% quota at every level should be evident. Promotion would become virtually independent of performance or any comparative evaluation of merit. However, if we don't have enough SC/STs at the senior levels, that could be construed as violative of the intent of the amendment proposed. A compromise would be settle for some rough indicators- at least 5-10% of SC/STs for all posts at senior levels in the aggregate. But, then, an argument could erupt about the numbers; some would say that anything short of 22.5% is discrimination.

I'm sympathetic to the idea of quotas in promotions but I'm afraid I can't see how quotas in promotions will operate or can be operated. Any suggestions?

Basel III complacency

Basel III is supposed to be a tough answer to Basel II- better quality capital and more capital for banks. Banks have resisted the higher requirements saying it they will affect loan growth. It is sobering to be reminded, therefore, that equity to total capital at banks, following Basel III, will be a mere 3%- that is, a leverage of 33! The reminder comes from the Vice Chairman of America's Federal Deposit Insurance Corporation:

Despite the promise of higher capital levels and better quality capital, Basel’s new minimum leverage ratio requirement is only 3 per cent, about the same as that of the largest US banks when the global crisis erupted. Basel III offers more complexity and, therefore, new opportunities to circumvent the system. But it does not offer any more certainty that banks will be well capitalised when the next crisis hits.

What is the answer? Go for a simple leverage ratio that is reasonably high:

We can establish a simple but stronger capital base by replacing the unmanageably complex Basel risk-weighted standards with a tangible equity capital ratio of around 10 per cent, and use a simplified risk-weighted measure as a check against excessive off-balance sheet assets or other factors that might influence banks’ safety. If the financial industry had had tangible equity capital approaching this level in 2008, we might still have had a crisis. But it would have been far less severe and far less costly to the public.

Interview on Narendra Modi

I found Rediff.com's interview with Gunvant Shah perceptive. The interview is about Modi- his strengths and weaknesses. Shah makes no bones about either. He condemns the Gujarat riots as a blot on the state but does not hold Modi personally responsible:

So you think he should not apologise.
Not at all! You are talking nonsense. When there is rioting and provocation of this dimension, do you think there won't be any reaction from the majority community? You conveniently forget that in 1984, Sikhs were killed by Hindu Congressmen. Not a single non-Sikh was killed. You can call it a pogrom. Here in Modi's Gujarat, 218 Hindus were killed in police firing... And do you know even Congressmen came to fight Muslims on that day?

It is good to see the media talking to people on the ground in  Gujarat. Rediff's coverage of the elections has been excellent.

Financial Times and Economist up for sale?

Well, there is certainly speculation on this account. FT is said to be losing money. The report does not say anything about the finances of the Economist. As somebody who is addicted to both periodicals, I sincerely hope that they don't lose their character if they are acquired. I wonder why Rupert Murdoch is not interested- could it be because of the troubles he has had to face in the UK? Whatever his failings, Murdoch will be gratefully remembered by journalists as the man who has helped preserve two of the greatest titles in journalism, The Times of London and the Wall Street Journal.

I have only one other thought. The FT and the Economist do not lack commentators who advise policy-makers and businessmen on how to get their policies and strategies right. FT has a whole section on Management. The redoubtable Schumpeter of Economist dissects corporate strategies all the time. Are we to believe that the pundits at these journals do not merit attention within their own publishing house? I do remember that some years back, the Economist flew Michael Porter in for a strategy session.  The cynical could say that that doesn't mean much: after all, Porter's own consulting firm, Monitor, is in the doldrums.

Economic growth can't be left to the market

After the financial crisis, the case for regulation of the financial sector has grown stronger; most people believe that leaving things too much to the market was part of the reason for the crisis. Still, not many would argue for a role of the state in promoting economic growth. The wider view is that the state should take care of law and order, infrastructure and efficient financial markets and leave the rest to entrepreneurs.

Chinese economist and former World Bank chief economist, Justin Lin argues otherwise in his recent book, The Quest for Prosperity. He makes the point that nations have seen sustained and strong growth all owe it to strong support from the state- very often, support for particular sectors. The proposition is not new. Robert Wade and others have pointed out that the East Asian miracle was pretty much state-led. But, the earlier thesis was that the state should generally support firms that were in competitive businesses, especially those that were trying to win in export markets. Lin goes further. He wants the state to target particular sectors and guide private investment into those areas.

This is really a strong form of what used to be called 'industrial policy'. Lin shows that this sort of thing is not unique to East Asia. It happened to all the advanced economies of the west earlier. What is more, the advanced economies practise this even today, although sometimes in not so obvious ways.

More in my ET column, How the state can boost growth.

J S Verma on SC judgement on Vodafone

I return to my blog after a fairly long time- preoccupied on many fronts in recent weeks.

I wanted to flag Justice JS Verma's comments on the Supreme Court verdict on Vodafone. There has been much criticism of the government's attempt at changing the tax law retrospectively in the Vodafone case. Many have differed, however, with the SC's views in this particular case and it is interesting that Justice Verma is one of them.

Justice Verma gives two reasons for his difference of opinion with the SC judgement. One, he believes that "the three-judge judgment in Vodafone bypasses a five-judge constitution bench judgment in the McDowell matter in 1985. The McDowell judgment in substance said that in this context what you have to see is the substance of the transaction to determine the tax liability and not merely the form of the transaction." Justice Verma points out that a three-judge bench cannot bypass the view of the larger five-judge bench in the McDowell case.

The bigger reason, according to Justice Verma, is as follows (all quotes here are from the report in the Indian Express):

Judges need to be committed to constitutional philosophy and not the philosophy of the ruling party. The constitutional philosophy in this case as laid out in Articles 38 and 39. The effect of benefiting a corporate is to cast a higher tax burden on the common man and when you uphold an illegal tax avoidance, then you cast a higher tax burden on the honest tax payer. According to me the Vodafone judgment has all these implications.

Justice Verma believes the Vodafone judgement is to be clubbed with two other SC judgements- those in the habeas corpus case during the emergency and the JMM bribery case as judgements “which are best forgotten or allowed to pass”. In the habeas corpus case, the SC had ruled that the right to habeas corpus stands suspended during an Emergency- this was subsequently changed by parliament through a constitutional amendment. In the JMM bribery case, the SC ruling was that the MPs who were accused of taking a bribe to vote in a particular way had committed no crime that the legal system could act on as they enjoyed immunity granted to members of parliament.