It is quite appropriate that the Nobel Prize in Economics this year has been awarded to persons who have worked broadly in the field of governance, which is the talking point today. The winners have spoken on how to enforce rules where detailed contracts or legal frameworks do not exist. The recent financial crisis was a failure of governance where unbridled greed exposed the fallacies of Smith’s invisible hand. The two awardees do compel us to reflect over how their theories should be viewed in the context of what has transpired.
Elinor Ostrom’s work is significant because it talks of how community resources are best managed by users of the resource. At the most rudimentary level, when a housing society owns the premises, it best uses the resources that go along with it. There is no wastage of water or electricity as the society ensures that there is optimisation Forests, water, pastures etc, would ideally be best managed by users, provided property rights are transferred to them. This is the problem in India, where there is a difference between owners, managers and users, with all of them having their own motivations. The owners are typically the government or the private sector. Governments are inefficient as they have no interest in maximising benefits and often conduct business where there is no expertise. They manage an irrigation system because they have to, and are not concerned with leakages or wastage. Private sector is profit- motivated and would squeeze the maximum from the resource that does not optimise the welfare of society. Users do not value a service when the government provides it at a low cost. Farmers tend to waste water or over-graze cattle or over-exploit land for sowing when it is cheap. If the resource is provided by the private sector, then it is not affordable for them. This is the conundrum.
Therefore, ideally, resources should be owned by users. The formation of cooperatives was a step in this direction, where the cooperative works for enhancing value for the members. However, rarely has the natural resource been owned by the cooperative. This means that unless we have a combination of joint ownership by users, which means transfer of property rights to them at a cost, such resources will continue to be sub-optimally used as they are owned by the government or private enterprise.
Now, this ideal situation would confront the Oliver Williamson theory,which states that administrative decisions within a legal entity are more efficient than a market transaction. Williamson showed that complex transactions, involving investment decisions that are much more valuable within a relationship than to a third party, are best made within a firm. But he also showed that organising matters within companies had costs as it relied on internal authority—which could be abused—to get things done.
In light of the recent financial crisis, is it possible to put these two theories together? Firms should be classified as those that are owner-driven or professionally managed, where owners are several and dispersed. Owner-driven firms tend to be more efficient in taking decisions and tend to be more efficient than the markets, but they will not have public interest. Here, there is less likelihood of abuse of internal authority. But the financial crisis showed that it was organisations where the appointed chiefs were not the owners that delivered sub-optimal results, by over-leveraging and stretching their luck in the securitisation markets.
If we go back to the Ostrom case of user ownership, the possibility of abuse of internal authority is possible. Absence of professionals to run the organisation will have an inherent bias toward less efficient governance. While farmers may run their resource say an irrigation project well, the moment the scale changes, there would be need to bring in professionals who can improve functioning. As we move from micro-level resource to a larger setup, the downside risk of decision-taking internally could be a stumbling block.
Both theories are good at the micro-level in the ideal state, which rarely occurs. Ownership necessarily leads to the creation of structures, and managing the same cannot be divorced from the market. The price mechanism-based capitalist setup should ideally provide the best solutions, with government restricting itself to fiscal duties like taxation. Ostrom is an extreme case while Williamson’s will never always get it right. The Schumpeterian story of creative destruction would be a necessary corollary, just as natural calamites and wars are necessary to prove Malthus right.
Tuesday, October 20, 2009
Why don’t we get it about development: Financial Express:10th October
In the early 1980s it was quite common to see Rajiv Gandhi on TV, talking convincingly to a large gathering of presumably illiterate villagers about the great strides which the Congress party had taken in building the information technology highway and the different allocations for mega power projects in the Plan and so on. While the speech was in Hindi, these achievements would be uttered in English as the peasants nodded away in appreciation. He went on to win the elections and become PM. Things are not very different today where successive governments speak eloquently on how the Indian economy is one of the fastest growing nations, which has withstood the financial crisis and will be growing by 6%, or 7% or even 8% this year. The stock markets react buoyantly and there are several interviews with the PM, FM, Planning Commission etc, where these numbers are explained. The two situations are similar because in both the cases we are looking very narrowly at the economy and the performance of the government and probably feeling good about it without pausing to see if life around us has really improved. UNDP’s recently released Human Development Report is an eye-opener as it comes at a time when we are in this mode of self-praise, and brings us back to reality. Looking at growth numbers is passé today and the French President Mr Sarkozy has spoken of a happiness index to gauge the real success of an economy and Joseph Stiglitz is a part of the committee that will be looking at conceptualising these alternatives. Now, the HDI (Human Development Index) has been doing this for some time. The HDI basically looks at four parameters such as life expectancy, adult literacy, enrolment rate and per capita income and scores the nation out of 1. India has got a score of 0.612 and comes in the lower half of the medium range of human development countries and is ranked 134 out of a set of 184 countries. This is disappointing because it clearly shows that our performance is pathetic in the area of social development, which is missed when we talk of our growth story. The curious part is that while we are better than countries like Pakistan and Bangladesh, we are lower than Botswana and Bhutan. Clubbing India as part of the Bric group looks odd considering that Russia and Brazil are ranked 59 and.75 and come under the high human development group, while China is ranked in the upper half of the medium development group with a rank of 92 and a score of 0.772. It is not hard to guess that the countries which are ranked lower than India are generally located in Africa (over 35 of the remaining 48 nations). Quite clearly, there is a lot of housekeeping that needs to be focused on before we take our growth numbers seriously. In fact, the report also does a check on the rank of a country with respect to human development and the same in per capita income and the difference is presented. India has a negative number here. It is time that we did focus on the quality of development and not get carried away by purely growth indicators which camouflage the true picture. This report is significant as it comes a month or so after the World Bank and IFC brought out the Doing Business Report for 2010. This report talks of the basic environment provided by the government for industry to operate. It talks in some detail on the ranking of countries in terms of the ease of doing business and has ranked India 133 in a list of 183 countries. Once again we seem to be falling short of expectations and it indicates to an extent the difficulties that industry faces when doing business in India. Quite expectedly the African countries and certain Central and Latin American countries fare lower than India. Some of the sub-ranks that we have are 182 in enforcing contracts, 169 in taxation, 175 for construction permits and 138 for closing business. This means two things. The first is that even in terms of facilitating industrial growth, we have not done much and we make things difficult for industry to operate. The impediments are high, which means that despite the sounds made on economic reforms and liberalisation, life is still tough for those who operate within our boundaries. The second is that enterprise in India has to be lauded for doing this well despite tough operational conditions. We evidently can produce better numbers if we are able to bring about improvements in our mindsets. The two reports, hence, do expose considerable frailties in bringing about quality growth in the country and clearly show the distance between the developed and developing nations. More significantly,even within the developing nations our approach can be improved substantially to deliver superior results.
Friday, October 9, 2009
The message from gold & real estate: 30th September 2009 Financial Express
Two apparently unrelated attractive investment avenues are real estate and gold both of which have shown similar proclivities of late. Conventional wisdom suggests that their prices must go up in the long run for the simple reason that they can never come down over such a period. This is why even rural India considers both of them to be safe investments and this is ingrained in our psyche. They also help to buffer against inflation and bring in capital appreciation to levels comparable with those on the stock market. However, while the long-run direction is clear, inter-temporal variations affecting them are quite different even though demand is typically from the same segment of users. Gold has been quite volatile in the last few years and has offered commensurate returns. Further, gold is not correlated with stocks meaning that it is a good product diversifier. The price of gold is inversely related to the dollar and typically, the weakening of the dollar strengthens gold. The recent race past the $1000/ounce mark was a direct result of the weakening dollar which has inched towards the 1.50 level (vis-a-vis euro). However, while India is the largest consumer of gold (20% share) we still remain price takers and not price setters which should have been the case. Hence, while at the margin, prices domestically are affected by demand factors, there is not much deviation from the international price with the correlation remaining above 95%.
The physical balances do matter at times, especially on the supply side when there are larger quantities in the market. However, the main source for the same, i.e. releases by central banks, is more or less controlled to ensure that there are no serious distortions in the market. The rising price of gold, however, does not deter consumption as it is purchased essentially for its quality of store of value and for purposes such as marriage, social mores and egotistic wealth. Demand tends to be fairly inelastic most of the time and demand is almost a straight line. Conjecturing the price of gold really means knowing how the dollar will move. This is tricky today as the dollar is declining despite the US current account deficit improving. This is so because global sentiment is adverse on account of the high risk perception of US assets. Countries are holding fewer dollars and have switched to the euro. The revival measures have.further caused consternation over the future of the dollar. Hence, the interest in gold will always be there with global cues being the guiding factor, while physical demand will simply be reacting to the prices that are being set in global market, COMEX in particular. The other phenomenon is real estate where prices have steadied after declining for most of last year. Typically the cycles follow a set pattern. Prices are demand-led where higher demand creates the supply as builders get into the act of making available housing spaces. But, prices do not come down to the same extent when there is a downturn in business due to the holding power of builders. The semi-oligopolistic set up ensures that prices never come down sharply even during these times and a correction of not more than 20% takes place at the best of times. Demand is driven by two segments, households and investors. The former have started investing in houses on account of lower interest rates being offered (one is not sure if they read the fine print of the limited validity on these rates), and the expectations that property rates will move up in future. The emergence from the slowdown has added to the demand for housing in recent times. Besides, the continuous migration of population to the urban centres has added to the demand for housing at the lower end. Also the expansion of companies into the suburbs of cities would keep up the demand for commercial property except during recession times. There is hence a positive correlation between economic recovery and demand for property. The other group of demand comes from investors who typically operate in the stock market and would move funds across to property when the time is right. Here the link with the equity segment is distinct where a longer term view is taken when the markets are down. Funds move to property and provide support for prices as they buy low and wait to sell at a higher price when conditions improve. This segment is typically less active when the stock market is up. Hence, while real estate sector is in a way indirectly dependent on the stock markets for seeking direction, gold continues to be an independent investment avenue for individuals. It is not surprising that all the markets are up today.
The physical balances do matter at times, especially on the supply side when there are larger quantities in the market. However, the main source for the same, i.e. releases by central banks, is more or less controlled to ensure that there are no serious distortions in the market. The rising price of gold, however, does not deter consumption as it is purchased essentially for its quality of store of value and for purposes such as marriage, social mores and egotistic wealth. Demand tends to be fairly inelastic most of the time and demand is almost a straight line. Conjecturing the price of gold really means knowing how the dollar will move. This is tricky today as the dollar is declining despite the US current account deficit improving. This is so because global sentiment is adverse on account of the high risk perception of US assets. Countries are holding fewer dollars and have switched to the euro. The revival measures have.further caused consternation over the future of the dollar. Hence, the interest in gold will always be there with global cues being the guiding factor, while physical demand will simply be reacting to the prices that are being set in global market, COMEX in particular. The other phenomenon is real estate where prices have steadied after declining for most of last year. Typically the cycles follow a set pattern. Prices are demand-led where higher demand creates the supply as builders get into the act of making available housing spaces. But, prices do not come down to the same extent when there is a downturn in business due to the holding power of builders. The semi-oligopolistic set up ensures that prices never come down sharply even during these times and a correction of not more than 20% takes place at the best of times. Demand is driven by two segments, households and investors. The former have started investing in houses on account of lower interest rates being offered (one is not sure if they read the fine print of the limited validity on these rates), and the expectations that property rates will move up in future. The emergence from the slowdown has added to the demand for housing in recent times. Besides, the continuous migration of population to the urban centres has added to the demand for housing at the lower end. Also the expansion of companies into the suburbs of cities would keep up the demand for commercial property except during recession times. There is hence a positive correlation between economic recovery and demand for property. The other group of demand comes from investors who typically operate in the stock market and would move funds across to property when the time is right. Here the link with the equity segment is distinct where a longer term view is taken when the markets are down. Funds move to property and provide support for prices as they buy low and wait to sell at a higher price when conditions improve. This segment is typically less active when the stock market is up. Hence, while real estate sector is in a way indirectly dependent on the stock markets for seeking direction, gold continues to be an independent investment avenue for individuals. It is not surprising that all the markets are up today.
After the dollar, what? DNA 9th October 2009
There has always been the requirement for an anchor or reserve currency in the world, which started off with gold and then the pound, moved over to the SDR (special drawing rights) and then settled with the dollar.
The reserve currency is one which is accepted as being strong, safe and stable. While individuals can default, the country that owns the currency cannot and has to be seen as one which is well governed and has to be responsible because it does not have any limit on the quantity of currency that can be printed. In a way it has to be seen as one which writes cheques that will not be cashed.
It is not surprising that the dollar is the reserve currency and between 60 to 100 per cent of foreign exchange reserves of countries are indollars with an average of 64 per cent reserves being in dollars, while euros, yen, pound and SDR take up the rest. Further, 88 per cent of world trade is in dollars and USA has anchored the global economy -- its deficits and monetary policy pronouncements are tracked assiduously.
The question raised today is whether or not we can continue to depend on the dollar for support. Let us look at the reasons for dissatisfaction with the dollar. The US deficits, both current account and fiscal, are very high at 2.9 per cent and 13.5 per cent of GDP respectively.
The Americans are clearly spending more than they should be doing and the dollar has been depreciating sharply and is close to $1.48 per Euro. This gives the USA an unfair advantage in world trade, as its exports become more competitive.
Last year, this has been exacerbated by the bailout of the financial system which has already been valued at close to $5 trillion which is one-third of the GDP of the USA. The fiscal stimulus programme has been another factor driving down the dollar and the earnest talk by president Obama on Medicare means that the deficits will persist.
Under these circumstances, the issue raised is whether such a state is sustainable in the medium run. Would any other country have survived under such economic conditions?
Anecdotal evidence shows that around 80 per cent of currency failures follow a pattern: a large country borrows cheap (other countries invest in the US bonds) and loads up debt by importing much more than it produces.
The other (emerging) markets benefit to begin with until the borrowing country gets overburdened and trade retreats causing deflation which erases the wealth of creditors as less dollars are available externally. The amount of dollars available is dependent on the trade deficit and creates a problem for those countries trying to trade in dollar denominated assets. In fact, 2008 would have been catastrophic had the US Federal
Reserve not agreed bail out the system by inducting dollars in currency. Is the world satisfied with these developments? The answer is no, as can be seen by relentless noises being made by the oil producers, Russia and China. China is the largest subscriber to Fed treasuries (with forex reserves of over $ 2 trillion).
China has already flexed its muscle by setting up currency swaps with several countries like Argentina, Belarus and Indonesia and by letting institutions in Hong Kong issue bonds denominated in the Chinese currency, renminbi. Brazil and China are now working towards using their own currencies rather than the US dollar.
The oil-producing countries had even earlier justified the increase in oil prices in 2007 and 2008 to the shaky dollar as they are denominated in dollars. Further, there has been a tendency for foreign trade between nations to also be reckoned in alternative currencies like the Euro as it is seen as being more stable.
What then should be an alternative anchor currency? In the 1960s, an economist by the name of Triffin came up with the paradox that as the marginal supplier of the world's reserve currency, the US had no choice but to run persistent current account deficits.
Today, China could be a choice but its economy is opaque.The euro will be a good idea, but again it is based on the coordination between several members' nations -- some weak and others strong and cannot sustain the world economy.
As the emerging markets do have a fair say in the world economy, they would necessarily have a bigger role to play and we need to think of reinventing the SDR (a basket of four key currencies created by the International Monetary Fund in 1969) with the renminbi, euro, peso and so on, and maybe also the rupee, playing a role. The Stiglitz Committee under the auspices of the UN has suggested this route.
Will the dollar collapse? Not really as doomsayers predict but it will gradually lose its sheen as a currency that will be globally acceptable. The fact that nations are moving away to alternatives means that one is not overly dependent on the dollar. This by itself should induce more discipline in the way in which the US operates.
The reserve currency is one which is accepted as being strong, safe and stable. While individuals can default, the country that owns the currency cannot and has to be seen as one which is well governed and has to be responsible because it does not have any limit on the quantity of currency that can be printed. In a way it has to be seen as one which writes cheques that will not be cashed.
It is not surprising that the dollar is the reserve currency and between 60 to 100 per cent of foreign exchange reserves of countries are indollars with an average of 64 per cent reserves being in dollars, while euros, yen, pound and SDR take up the rest. Further, 88 per cent of world trade is in dollars and USA has anchored the global economy -- its deficits and monetary policy pronouncements are tracked assiduously.
The question raised today is whether or not we can continue to depend on the dollar for support. Let us look at the reasons for dissatisfaction with the dollar. The US deficits, both current account and fiscal, are very high at 2.9 per cent and 13.5 per cent of GDP respectively.
The Americans are clearly spending more than they should be doing and the dollar has been depreciating sharply and is close to $1.48 per Euro. This gives the USA an unfair advantage in world trade, as its exports become more competitive.
Last year, this has been exacerbated by the bailout of the financial system which has already been valued at close to $5 trillion which is one-third of the GDP of the USA. The fiscal stimulus programme has been another factor driving down the dollar and the earnest talk by president Obama on Medicare means that the deficits will persist.
Under these circumstances, the issue raised is whether such a state is sustainable in the medium run. Would any other country have survived under such economic conditions?
Anecdotal evidence shows that around 80 per cent of currency failures follow a pattern: a large country borrows cheap (other countries invest in the US bonds) and loads up debt by importing much more than it produces.
The other (emerging) markets benefit to begin with until the borrowing country gets overburdened and trade retreats causing deflation which erases the wealth of creditors as less dollars are available externally. The amount of dollars available is dependent on the trade deficit and creates a problem for those countries trying to trade in dollar denominated assets. In fact, 2008 would have been catastrophic had the US Federal
Reserve not agreed bail out the system by inducting dollars in currency. Is the world satisfied with these developments? The answer is no, as can be seen by relentless noises being made by the oil producers, Russia and China. China is the largest subscriber to Fed treasuries (with forex reserves of over $ 2 trillion).
China has already flexed its muscle by setting up currency swaps with several countries like Argentina, Belarus and Indonesia and by letting institutions in Hong Kong issue bonds denominated in the Chinese currency, renminbi. Brazil and China are now working towards using their own currencies rather than the US dollar.
The oil-producing countries had even earlier justified the increase in oil prices in 2007 and 2008 to the shaky dollar as they are denominated in dollars. Further, there has been a tendency for foreign trade between nations to also be reckoned in alternative currencies like the Euro as it is seen as being more stable.
What then should be an alternative anchor currency? In the 1960s, an economist by the name of Triffin came up with the paradox that as the marginal supplier of the world's reserve currency, the US had no choice but to run persistent current account deficits.
Today, China could be a choice but its economy is opaque.The euro will be a good idea, but again it is based on the coordination between several members' nations -- some weak and others strong and cannot sustain the world economy.
As the emerging markets do have a fair say in the world economy, they would necessarily have a bigger role to play and we need to think of reinventing the SDR (a basket of four key currencies created by the International Monetary Fund in 1969) with the renminbi, euro, peso and so on, and maybe also the rupee, playing a role. The Stiglitz Committee under the auspices of the UN has suggested this route.
Will the dollar collapse? Not really as doomsayers predict but it will gradually lose its sheen as a currency that will be globally acceptable. The fact that nations are moving away to alternatives means that one is not overly dependent on the dollar. This by itself should induce more discipline in the way in which the US operates.
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