April 1, 2009 — drsubrotoroy
“Summits” of global political leaders require competent “sherpas” to do the preparations. From what I gather about the London “G-20 summit” this has not happened adequately enough, so I expect only a lot of waffle to emerge. (If they suddenly start talking about Global Warming or AIDS in Africa or whatever, we will know the actual talks have failed badly.)
Reforming the IMF? Hmmm, let’s see, what happened to all that talk four years ago about reforming the Big Daddy of them all, the UN? Oh yes, I forget, India is now a permanent veto-wielding Security Council Member, NOT!
It has been said that academic syllabus reform at a university is like ‘”moving a graveyard”. Reforming the world monetary system and its major institutions would be like moving thousands of graveyards. And there is no one with the brains of a White or a Keynes to help things along. But we should not be surprised if there were pronouncements of this or that high-powered commission of pompous worthies who will make recommendations for reform some time in the future. In general, little more than waffle will emerge now — I cannot even see the UK Government following informal British advice to stand down from its founding role at the IMF.
There is no clear path to solving the great (alleged) economic and financial crisis because no one wants to admit its roots were the overvaluation (over decades) of American real-estate, and hence American assets in general.
India’s PM shall be seen at least up and about after several months out of action, indeed he will be up and about for the first time in months doing what he (like India’s nomenclatura in general) likes doing best, which is to travel outside India.
Subroto Roy, Kolkata
February 14, 2009 — drsubrotoroy
The wonders of the Internet continue to surprise (and yes Virginia, there was a world before SMS and before the Internet too). In early January, in context of India’s Satyam fraud (of a size of perhaps 1 or perhaps 2 billion dollars), I referred here to what seemed to me the likelihood of Satyam becoming a zombie company and I said “we in India have many such zombies walking around in the organised business sector”. I drew attention to Andrew Beattie’s astute definition of zombies and other such ghoulish phenomena in the financial world, and also referred to John Stepek’s excellent if brief November 2008 analysis “How zombie companies suck the life from an economy”. Today I find Ms Arianna Huffington has made reference to Mr Martin Wolf’s reference a couple of days ago to zombie companies and to his statement that President Obama needs to “Admit reality, restructure banks and, above all, slay zombie institutions at once.” Ms Huffington has agreed, though of course all this slaying may be easier said than done. (It is better that zombies not be created in the first place.)
Mr Wolf has pointedly asked a question that many around the world may have half-thought about but not articulated: “Has Barack Obama’s presidency already failed?” It would be a grave and appalling state of affairs if it has, within less than a month of entering office. I am grateful to find in Ms Huffington’s article a reference to an October 2008 Wall Stret Journal interview of Dr Anna Jacobson Schwartz, perhaps the most respected voice in monetary economics today. There have been numerous people claiming to have predicted America’s financial crisis but none may have as much credibility as Dr Schwartz. Six years ago, in a National Bureau of Economic Research study dated November 2002, “Asset Price Inflation and Monetary Policy”,Working Paper 9321 she had said with utmost clarity: “It is crucial that central banks and regulatory authorities be aware of effects of asset price inflation on the stability of the financial system. Lending activity based on asset collateral during the boom is hazardous to the health of lenders when the boom collapses. One way that authorities can curb the distortion of lenders’ portfolios during asset price booms is to have in place capital requirements that increase with the growth of credit extensions collateralized by assets whose prices have escalated. If financial institutions avoid this pitfall, their soundness will not be impaired when assets backing loans fall in value. Rather than trying to gauge the effects of asset prices on core inflation, central banks may be better advised to be alert to the weakening of financial balance sheets in the aftermath of a fall in value of asset collateral backing loans….”
Most poignantly too, Dr Schwartz was present when Ben Bernanke said in a 2002 speech honouring the late Milton Friedman “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” Dr Schwartz told the Wall Street Journal ‘”This was [his] claim to be worthy of running the Fed”. “He was ‘familiar with history. He knew what had been done.’ But perhaps this is actually Mr. Bernanke’s biggest problem. Today’s crisis isn’t a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. ‘I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.'”
President Obama’s economists need to urgently consult Anna J Schwartz.
Subroto Roy, Kolkata
Postscript: My own brief views on the subject are at “October 1929? Not!” dated September 18 2008, and “America’s divided economists” dated October 26 2008. The latter article suggested that playing the demographic card and inducing a wave of immigration into the United States may be the surest way to move the housing demand-curve firmly upwards.
January 8, 2009 — drsubrotoroy
Corporate Governance & the Principal-Agent Problem
by
Subroto Roy
for a conference on corporate governance
I am most grateful for this opportunity to speak at this distinguished gathering. I have to say I have had just a day to collect my thoughts on the subject of our discussion, so I may be less precise than I would wish to be. But I am delighted I have a mere 7 minutes to speak, and I will not plan to speak for a second more!
I would like to ask you to consider the following pairings:
PATIENT: DOCTOR
CLIENT: LAWYER
PUPIL: TEACHER
STUDENT: PROFESSOR
SHAREHOLDER: DIRECTORS & MANAGERS
CITIZEN: GOVERNMENT
You will recognize something in common to all of these pairings I am sure. A patient goes to a doctor with a problem, like a swelling or a stomach ache or a fever, and expects the doctor to do his/her best to treat it successfully. A client goes to a lawyer with a problem, of a contract or a tort or a criminal charge, and expects the lawyer to represent him to the best of his ability. A student attends a University or higher educational Institute, and expects the professors there to impart some necessary knowledge, to explain some difficult or complex natural or social phenomena, to share some well-defined expertise, so the student too may aspire to becoming an expert.
In each case, there is a Principal – namely the patient, the client, the student, — and there is an Agent, namely, the doctor, the lawyer, the professor. The Agent is not acting out of charity but is someone who receives payment from the Principal either directly through fees or indirectly through taxes.
The Agent is also someone who necessarily knows more than the Principal about the answer to the Principal’s problem. I.e. there is an asymmetry in the information between the two sides. The Agent has the relevant information or expertise — the Principal needs this information or expertise and wishes to purchase it from him one way or another.
A company’s Board of Directors and the management that reports to it, may be similarly assumed to have far greater specific knowledge than the company’s shareholders (and other stakeholders) about the state of a company’s operations, its finances, its organisation, its position in various input and output markets, its potential for growth in the industry it is a part of, and so on. Yet the shareholders are the Principal and the directors and managers are their Agents.
And indeed the Government of a country, i.e. its political leadership and the bureaucracy and military that are reporting to it, also have much more relevant decision-making information available to them than does the individual citizen as to the economic and political direction the country should be taking and why, and again the body of the ordinary citizenry of any country may have a reasonable expectation that politicians, bureaucrats and military generals are acting on their behalf.
In each of these cases, the Principal, having less information than the Agent, must necessarily trust that the Agent is going to be acting in good faith on the Principal’s behalf. There is a corporate governance problem in each case simply because the Agent can abuse this derived power that he acquires over the Principal, and breach the contract he has entered into with the Principal. Doctors or lawyers can practise improperly, professors can cheat their students of their money and teach them nothing or less than nothing, boards of directors and managers can cheat their shareholders and other “stakeholders” (including their workers who have expectations about the company) of value that should be rightfully theirs — and of course politicians, bureaucrats and military men are all too easily able to misuse the public purse in a way that the public will not even begin to know how to rectify.
In such situations, the only real checks against abuse can come from within the professions themselves. It is only doctors who can control medical malpractice, and only a doctor can certify that another doctor has behaved badly. It is only lawyers who can control legal malpractice, and testify that yes a client has been cheated of his money by some unscrupulous attorney. It is only good professors and good teachers who can do what they can to stand out as contrasting examples against corrupt professors or incompetent teachers.
In case of managerial malpractice, it is only fellow-managers who may be able to comprehend the scam that a particular CEO has been part of, in stealing money from his shareholders. And in case of political malpractice, similarly, it is only rival political parties and when even those fail, rival political institutions like the courts or the press and media, who can expose the shenanigans of a Government, and tell an electorate to throw the rascals out in the next election.
In other words, self-policing, and professional self-discipline are the only ultimate checks and balances that any society has. The ancient Greeks asked the question “Who guards the guardians”, and the answer has to be that the guardians themselves have to guard themselves. We ultimately must police ourselves . I think it was William Humboldt who said that a people get the government they deserve.
In India today, indeed in India in the last thirty or forty years, perhaps ever since 1966 after the passing away of Lal Bahadur Shastri, we may be facing a universal problem of the breach of good faith especially so perhaps in the Government and the organised corporate sector. Such breaches occur in other countries too, but when an American court sends the top management of Enron to jail for many years or a Korean court sends the top management of Daewoo to jail for many years, we know that there are processes in these countries which are at least making a show of trying to rectify the breaches of good faith that may have occurred there. That is regrettably not the situation in India. And the main responsibility for that rests with our Government simply because our Government is by far the largest organised entity in the country and dwarfs everyone else.
As an economist, I have been personally intrigued to realise that Government corruption is closely caused by the complete absence of serious accounting and audit norms being followed in Government organisations and institutions. Get control of as big a budget as you can, is the aim of every Government department, then spend as little of it as is absolutely necessary on the publicly declared social or national aim that the department is supposed to have, and instead spend as much as possible on the travel or personal lifestyles of those in charge, or better still transform as much as possible into the personal property of those in charge – for example, through kickbacks on equipment purchases or building contracts. For example, it is not unknown for the head of some or other government institution to receive an apartment off-site from a builder who may have been chosen for a major construction project on site. This kind of thing has unfortunately become the implicit goal of almost all departments of the Government of India as well as the Governments of our more than two dozen States. I have no doubt it is a state of affairs ultimately being caused by the macroeconomic processes of continuous deficit-financing and unlimited printing of paper-money over decades. For the first two decades or so after Independence, our institutions still had enough self-discipline, integrity, competence and optimism to correct for the natural human instincts of greed and domination. The next four decades — roughly, as I have said, from the death of Shastriji — there has been increasing social and political rot. I have to wonder if and when a monetary collapse will follow.
Independent Indian: Work & Life of Professor Subroto Roy 