Thoughts on corruption

"Corruption is the market mechanism for privileged access" - C K Prahalad.

I came across this quote/definition while reading a chapter extract from C K Prahalad's "Fortune At the Bottom of the Pyramid". It has been a long time since i have given corruption some serious thought and this statement made me think quite a bit. At the end of an intense thinking session I had number of perspectives and insights into the economic and ethical implications of corruption as we deal with it in our day to day lives.

While thinking of the economic implications of corruption I got the following insights into the nature of corruption:

• As long as there is a consumer surplus in a price regulated environment (most government services are price regulated so as to make them affordable to all strata of the society), there is always a scope for corruption. Those consumers that hold a higher surplus are more likely to seek a more privileged access (be it in the form of reduced processing time or a higher evaluation in a dispute like situation) and are more likely to encourage the practice of corruption. Even people who enjoy the slightest of a surplus may give in to corrupt practices. Any form of governmental price fixing or supply restrictions on privately provided goods and services can also lead to a market for "privileged access" (read corruption) in the private sector.
• According to C K Prahalad, the most important factor that aids corruption is the lack of transparency in government processes, which in turn makes the completion of a transaction with the government a highly time consuming experience. This in turn causes the people at the "bottom of the pyramid" to consider the time value of money and therefore forces them to add to their costs in two more dimensions, one the price paid to the broker or intermediary who is getting the work done, and two the bribe needed for the government official to perform his duty. I couldn't agree more with his analysis on this subject.
• As much as private enterprises could raise the the cost of essential goods and services, given the flexibility that they hold in differential pricing, they may turn out to be a better alternative than fixed price government services. Public perception is very forgiving towards the private enterprise in providing a differentiated service/good at differential prices. Effectively private enterprise in a slightly regulated market could possibly reduce the need for corruption in a society where there is a high differential between the haves and the have not s.

These are not observations that have no technical basis, these can be proven using various economic models of demand and supply and i am quite convinced of the truth in these arguments.

On a more philosophical note, i found quite a few ethical applications of the term corruption as taken in the context of "privileged access".

When we tip the security guard so that he sorts our mail more carefully than that of our neighbors, or we tip the waiter a little more so that we get the most prized "romantic" seats at the restaurant, or when we pay that extra tip to the gas delivery boy expecting a more prompt delivery of the gas cylinder, aren't we all giving in to our perceived need of a "privileged access"? In effect are we all being corrupt in these simple actions that we perform day to day without giving it a second thought!

There are a lot more personal and professional scenarios in which i could try to apply this definition of corruption, focusing mainly on the words "privileged access" and i find it fascinating that so many routine actions of mine fall into the bucket of "corruption".

Perhaps there is a different definition of corruption when it comes to ethical and moral actions that I need to seek out ... but for today my quest stops here ... more perhaps sometime later in the year ...

10 years of the internet

I got my first computer in May 1999. It was a smart looking Compaq Presario with a 333Mhz Celeron processor, 32 MB RAM, 4 MB VRAM, 128KB L2 Cache, 4GB Hard Disk, a state of the art machine which cost my father a fortune and most importantly came with an inbuilt 56Kbps modem!

The new machine came bundled with a Satyam internet starter pack that gave me a total of 25 hours access to the internet.

It was any 15 year olds dream come true, a gadget for games, music, movies and fun along with a chance to get online and have my own e-mail account!!!

As we entered 2010 i remembered the most crazy thing i did at the fag end of 1999 (or atleast i thought it was quite a crazy thing to do). It was the year of the Y2K bug, doomsday was predicted and i was expecting the worst ... It was the last day of the year, being in between my pre-final exams the only celebration was with the family and at precicely 11:00 p.m. everybody retired to bed to prepare for a long new years day. I remember my first real encounter with the internet was around 11:45 p.m. December 31st, 1999. Inspite of all warnings from my parents to stay away from the computer, i thought "wtf", what could go wrong? After all billions of dollars were spent on fixing the Y2K bug right? A thought struck me, i should be celebrating my entry into 2000 by getting into a chat room and seeing what could go wrong ... would planes really come crashing down all over the US, would Russian ICBMs be triggered off due to a faulty code patch or would the internet fall apart at the precise moment of 00:00:00 hours!

Those were the days when chat rooms were really chat rooms, untouched by bots, real people discussed real issues in a common window. I think i logged in to Rediff Chat and entered one of those general rooms. The mood was quite light and everybody was talking of what was happening ... there were folks from Japan, Singapore, HongKong where dawn had broken in the new year and things were going just fine ... and slowly as the clock inched to 00:00:00 IST there were wild jubilations around and there was nothing that seemed out of the ordinary!

I went to sleep at 12:45 a.m. after getting a confirmation that Pakistan too has survived the entry into Y2K ...

It has been 10 years of using the internet since then, from being a tool to keep in touch with friends, to a source of all those adolecent porn, to being a source of all my music and movies, and culiminating in being my indispensible companion in all my college projects, it has been a faithful comapnion and perhaps the most useful tool i have used in my life ...

Here's a toast to the greatest technological invention of all times that has served me well for the past 10 years!

Global Economic Recession - Lessons and Impacts

[This article was originally written as an essay by my friend, teacher and guide on all things related to economics – Devanshi Madan. A quick guide on the financial crisis of 2009 along with a unique view on the principal-agency problem makes this a very interesting article for the average person. I have added a few lines, deleted a few and modified a few more before reproducing it here, all the matter published here has been the original work of the above mentioned author …]

Recessions and business cycles

Recessions are the outcomes of business cycle fluctuations. Business cycle fluctuations are naturally occurring crests (positive growth) and troughs (negative growth) in the revenues and growth of a business. These fluctuations in the business cycle have been well documented. A progression from a crest to a trough leads to a slowdown in economic growth and in extreme cases, as it was in 2008; cause a deep economic recession with global repercussions. Whereas slowdowns and recessions have been around as a naturally occurring economic phenomenon, the global recession of 2008-2009 was exacerbated by the fact that the fundamentals of the financial markets were thrown to the wind in the face of uncontrolled greed.

The global recession of 2009

The origins

It all started with the housing loan crisis, more commonly called the “sub prime mortgage” crisis. American banks and agencies started indiscriminately issuing housing loans to people who did not meet the required eligibility criteria to secure such loans. They slashed interest rates on these housing loans and the demand for these loans shot up. Banks ignored the “credit worthiness” of the applicant and gave loans which were backed by the house bought as the underlying security. These loans were offered at 3% the same rate as the inter bank rate!

The modus operendi of the lending banks and agencies was to lure people by showing much lower variable interest rates on housing loans for a certain period. However hidden behind this promise, as per the fine print, by the time the loan reached its maturity, the total amount repaid would have been the same as the total amount that would have had to been repaid in the case of a high interest fixed rate loan.

This process of ensuring that total cash flows were large and yet it looked to be small in the initial period was done by the process of “negative amortization”. As opposed to normal amortization in negative amortization the principle balance and hence the interest keeps increasing every month. With the lure of lower EMI’s in the initial years, the banks managed to play with peoples psyche and lead them to believe that they were actually getting a very cheap loan. This in turn led to a dramatic increase in the demand for housing.

After a certain amount of time the housing bubble burst, people were unable to pay back these loans and abandoned their houses. As a result, the supply of houses far outstripped the demand for houses, this drove the real restate prices down. The mortgaged houses were redeemed by the banks, albeit as non performing assets. The house prices were much lower than the loan value plus the cost of maintaining the houses would have had to be incurred.

In such a scenario, banks were collapsing due to the large number of non performing assets being added in the form of foreclosure of housing loans. In order to save the banks from collapsing, they were bought out or taken over by other banks and the Federal Reserve. The government intervened later with bail out packages running into billions of dollars to save the banks from bankruptcy.

What are the key lessons to be learnt in analyzing the cause for such a financial catastrophe?

In my opinion it is the misperception and the mismanagement of risk, the low level of interest rates and the indiscriminate de-regulation of financial systems leading to a skew in the market demand that is biased towards a price increase which is artificial and unsustainable.

Today’s world is highly interdependent. Instability in one institution will cause instability in many others. It’s the case of the “ripple effect”. It’s the human psychology around risk perceptions. Individual actions, such as the decision to forward loans to non credit worthy individuals, cannot be viewed in isolation. A global perspective is required in assessing the potential long term impacts over the short term gains that are achieved.

Too greedy in the present - future repercussions

The primary cause for the authorization of risky short term financial decisions would be the greed of the management to show phenomenal revenues and expected future profits. I would call it a managerial greed and callousness. CEOs and other senior managerial personnel rely on compensation received from the companies in the form of salary and other perks. They do not hold any significant stake in their companies. The banking and insurance companies are joint stock companies which have the system of collective ownership.

The “Principal Agency theory”, where the management top teams are just the managers but not the owners, comes into play here. They are the decision makers but they do not bear the burden of the losses incurred by the company. The risk is borne by them and the shareholders, who are collectively the “owners” of the company. The management team earns a percentage of the profits/sales of the Company. Incorrect and greedy decisions made on the part of the management for personal “short term” gain without paying any heed to the long term implications of such decisions, has lead to the financial meltdown in the “developed” countries. There needs to be a principle change in the laws that govern the structure of business institutions at an international level. There is a need to redefine the laws of management and ownership.

Given these observations, it is imperative to have a balance in the principal-agency relationship. Short term profits should not be the sole driver to determine the compensation of the top management team. Shareholders need to be more vigilant and governments need to introduce more stern rules with regard to the regulation of management compensations when linked with the performance of the company.

Experienced Trade-offs !!!

Experience is the biggest asset a manager has on his side. As much as I learn the nuances of "business" and "management" at my MBA course (the PGSEM) at IIMB, nothing will ever be able to take the place and role that time learned experience would play in shaping the characteristics i would like to develop as a good manager (and leader).

I believe that making the right decisions in the face of available trade-offs will always be an art that will be the most visible source of differentiation between managers!

Simply put, trade-offs are choices that need to made between available alternatives in scenarios where the consequences of the choice that is made is not fully known. Decision trees have been used extensively in many of my classes to define evaluation of alternatives at decision points in a business flow. It all looks hunky-dory in a classroom scenario where the consequences at each decision point are well defined and the end result neatly mapped out by the professor on the whiteboard!In the real world, there is absolutely no way of knowing the consequences of each decision! Not only are the consequences not well defined, it is also impossible to really know the full breadth of alternatives that can be taken at a decision point.

As we move deeper into the information world, it is not the owner of the cache information who has the ultimate edge as a manager, rather the one who knows how best to derive results from that huge cache of information that holds to key to future managerial success.

My management education provides me the tools and frameworks that help in gathering the required knowledge and information along with the partial ability to derive some form of results from the information that is gathered. However it has to be experience that will enable me to take the right choice more often.

Given that experience is time bound, i am reminded of the classic dilemma that a fresh graduate faces. Every employer wants to recruit someone with a minimum threshold of experience for exciting roles that involves certain amount of responsibility. A fresh graduate wants an exciting job of responsibility, and is possibly capable of it, but has no way to satisfy the "experience" requirement of the potential employer.

If I were to draw parallels, as a manager, the ability to make the right decision choice (in a world of imperfect information) would rest largely on experience gained while having made a large number of decisions in the past. Failure is but a small price I will have to pay in order to gain the "experiential wisdom" that I require for the long run. I will have to take risky choices knowing that the consequences may or may not be favorable, and not be afraid while facing the consequence.

Gandhian Thoughts

I had a chance to attend the Gandhi Colloquium at IIM Bangalore. The theme of the colloquium was “Gandhi, Governance and the Corporation”. I was impressed by some of the thoughts that the eminent speakers (Prof Dwijendra Tripati, Prof N Balasubramanian, Prof Peter DeSouza, Prof Pratap Bhany Mehta) put forth as a part of the introductory session in the morning.

Key takeaways from the lectures:

- Gandhian philosophies have not had a widespread acceptance in the corporate world

- The philosophy of trusteeship is focal point for corporate embracement of Gandhian thought

- Trusteeship involves a sense of debt to society; an organization exists to serve the society and the context of the society in which it exists

- Gandhi believed that an individual or a corporation had to earn just as much as was “reasonably” required and any amount earned in excess of this was expected to be returned to the society, since it was “excess” wealth that was accumulated unduly and it belonged to the society and not the corporation or the individual (Contrast this with socialism, looks like Gandhi’s philosophy was geared towards voluntary actions for equitable distribution of wealth unlike the “socialist” thought of Government enabled distribution of wealth!)

- Gandhi was perhaps the only political figure who was aware of the communal tinderbox that India could evolve into at the time of independence

- Gandhi placed a great emphasis on the aspect of friendship, friendship across groups to which an individual belonged

I find myself resonating with a lot of the thoughts that were put forth. I believe that socialism, an excellent concept, can never be imposed. Voluntary socialism as espoused by the “trusteeship” philosophy is perhaps sustainable. It is perhaps necessary that this philosophy is inculcated as a way of life in Indian society. Is it going to be successful? Gandhi was convinced that it would succeed, yet today 50 years after his death there is still no clear answer. Even I am not fully convinced of the efficacy of “trusteeship”.

To get a wider perspective on trusteeship:

http://www.gandhi-manibhavan.org/gandhiphilosophy/philosophy_trusteeship.htm

Summed up in one paragraph:

“Supposing I have come by a fair amount of wealth—either by way of legacy, or by means of trade and industry—I must know that all that wealth does not belong to me; what belongs to me is the right to an honorable livelihood, no better than that enjoyed by millions of others. The rest of my wealth belongs to the community and must be used for the welfare of the community.”