Corruption

Economic Survey’s Spin on Demonetisation Doesn’t Quite Add Up

Arvind_Subrahmaniyam

The Economic Survey for 2016-2017 was released yesterday. The Survey has a chapter on demonetisation and makes some very interesting points which I want to discuss in today’s piece.

One of the reasons offered for the Modi government carrying out demonetisation is: “Across the globe there is a link between cash and nefarious : the higher the amount of cash in circulation, the greater the amount of corruption, as measured by Transparency International.”

The Survey further points out: “In this sense, attempts to reduce the cash in an economy could have important long-term benefits in terms of reducing levels of corruption. Yet India is “off the line”, meaning that its cash in circulation is relatively high for its level of corruption.”

Is this really true? Is there a link between the total cash in the economy and corruption? Let’s take a look at the currency to gross domestic product(GDP) ratio across countries for 2015.

cash-to-gdp

Source: The Curse of Cash, Kenneth Rogoff, http://scholar.harvard.edu/rogoff/curse_of_cash_data

As can be seen from the above table, India’s currency to GDP ratio is quite high at 12.51 per cent. But Japan’s is even higher at 18.61 per cent. What rank does Japan hold in the Transparency International’s corruption ranking? In 2015, Japan was the 18th least corrupt country in the world. Where did India stand? India was the 76th least corrupt country in the world.

Hence, Japan which has a higher currency to GDP ratio than India is significantly less corrupt than India is. This basically means that cash is a greater part of the Japanese economy than it is of the Indian economy, but still the Japanese are less corrupt than the Indians. This goes totally against the point made in the Economic Survey.

Also, Japan is not an outlying one-off example. Take the case of Brazil. The currency to GDP ratio in this case is 3.44 per cent. This is nearly one-fourth the Indian ratio of 12.51 per cent. This means that Brazil has largely moved away from cash or currency as a form of payment. Nevertheless, does that mean that Brazil is less corrupt? As per Transparency International data Brazil is also the 76th least corrupt country in the world, like India is.

There are other examples as well. At 1.45 per cent, the currency to GDP ratio is the lowest in Norway. At 1.53 per cent Nigeria comes in next. Norway is the fifth least corrupt country in the world. On the other hand, Nigeria is the 136th least corrupt country in the world.

Let me give you more examples. After Norway and Nigeria, come Sweden, Argentina, New Zealand and Denmark, when it comes to low currency to GDP ratio. Sweden is the third least corrupt country in the world. New Zealand is the fourth least and Denmark is the least corrupt country in the world. But Argentina comes in at 107th, much lower than even India, despite having a very low currency to GDP ratio.

Are we done yet? Colombia has a currency to GDP ratio of 6.79 per cent, which is significantly lower than that of India. But it is the 83rd least corrupt country in the world. Or take the case of Singapore, which has a reasonably high currency to GDP ratio of 8.46 per cent, but it is the eight least corrupt country in the world, as per Transparency International.

How about China? China’s currency to GDP ratio at 9.34 per cent is lower than that of India. But it is the 83rd least corrupt country in the world, a little below India at 76th position.

All these examples clearly show that there is no clear link between high cash in the economy and the prevailing corruption in the country. And even if there is a link, it is a very weak one. Given this, what do we say about the Economic Survey’s observation? To put it simply, the Economic Survey is published by the ministry of finance, which is a part of the government. Hence, not surprisingly, it is trying to bat for the government on the demonetisation front.

What else does the Economic Survey have to say on demonetisation? On page 55 it points out: “A cautionary word is in order. India’s demonetisation is unprecedented, representing a structural break from the past. This means that forecasting its impact is hazardous.”

This is a very interesting statement. What the Economic Survey is essentially saying here is that forecasting the impact of demonetisation can be hazardous. Why is that? This, for the simple reason that there is no past example of demonetisation in a country being carried out in a situation, like that of India.

As the Survey points out on Page 54: “India’s demonetisation is unprecedented in international economic history, in that it combined secrecy and suddenness amidst normal economic and political conditions. All other sudden demonetisations have occurred in the context of hyperinflation, wars, political upheavals, or other extreme circumstances.”

Given this unique context, it is risky and dangerous (other meanings of the world hazardous) to forecast the impact of demonetisation. If this is the case, it is worth asking on what basis did the government make the decision to demonetise high denomination notes, given that forecasting its impact is not easy at all. Or so the Economic Survey published by the Ministry of Finance tells us. Further, after warning the readers that forecasting the impact of demonetisation is hazardous, the Survey goes about making several forecasts (on pages 59-60).

Such silly blemishes that bat for the government, spoil what is otherwise a well-written Survey.

Real estate prices are not just about corruption; they are also about affordability


India-Real-Estate-Market

Last week, Suraj Parmar, a leading Thane builder committed suicide. In his suicide note Parmar talked about the corruption in the system. A report in The Indian Express quoted V V Laxminaryan, the joint commissioner of police of Thane, as saying: “The suicide note speaks of several problems that Parmar was facing, including difficulties in obtaining approvals and the stop-work notices issued to him. The note goes on to say that several people were repeatedly demanding bribes, that he had already paid them a lot in the past but that their demands were still continuing and it had become too much for him to deal with.”

Corruption in real estate at the government level has always been an issue. But now if builders are to be believed it has reached never before seen levels. As Niranjan Hiranandani, director of Hiranandani Group told NDTV.com, after Parmar’s suicide: “In the last couple of years, I think corruption is over but extortion has started. So, I think what was unbearable to the builder was the fact that there was no corruption in that sense of the term, but it had gone far beyond corruption levels that have ever happened.”

A June 2011 news-report in The Economic Times gets into the details of the issue. In Maharashtra, which happens to be the biggest real estate market in the country, a builder typically needs around 60 approvals to construct a property. Of this, 50 approvals need to be taken from the municipal corporation where the property is being built.

The Economic Times report then goes on to quote Pune builder Kumar Gera, as saying: “These clearances should not take more than three months…But in most states, it takes anywhere between one year and four years. And they add 20-30 % to a builder’s project cost.”

This is, in turn, passed on to consumers who want to buy homes. As a report in the Daily News and Analysis points out: “At every step, there is a price to be paid to obtain necessary clearances. The ‘Golden Gang’, a group of corporators and civic officials, calls the shots and builders are bound to cough up exorbitant sums to avoid harassment. This expenditure, so to speak, is then passed on to home buyers. That explains why real estate in Mumbai, Thane and Navi Mumbai is so prohibitively expensive.”

In fact, as a real estate consultant told The Economic Times: “Builders don’t just pass it on…They often add to it big time.” So builders add their own corruption premium to the price of homes they sell.

Most builders use corruption in government and increasing input costs to explain that the price of homes won’t fall anytime in the near future. Take the case of cement, a major input into building homes. As a recent newsreport in The Economic Times points out: “Cement prices have jumped 20-40 per cent over the past two months in top cities despite demand from the real estate industry, which is its largest buyer, being low.”

In this scenario the price of homes won’t fall, say builders. But this logic just takes into account the supply side of the equation. It only talks about the builders who supply homes and the costs they have to incur. What about the end consumers who want to buy these homes?

As John Kay writes in an essay titled Guess Who’s Come to Dinner which is a part of the book Everlasting Light Bulbs – How Economics Illuminates the World: “But surely people can’t spend an increasing proportion of their incomes on housing.” The affordability of homes also needs to be taken into account.

Also, owning a house is just not about putting up a down-payment, taking a home loan and paying the builder. There are other costs involved as well. Hence, as Kay puts it, it is important “to focus on the costs of house ownership rather than the cost of houses.”

Given this, affordability isn’t just being able to pay the price of the house. There is more to it than that. As Kay writes: “Mortgage repayments [home loan EMIs basically] are only a…part of the cost of buying a house: you have to pay for repairs and maintenance, heat and light, property taxes.” Then there is the cost of moving in, the cost of setting up the place, and so on.

In a scenario where home prices are anyway high all these costs make the entire cost of owning a home even more expensive. So, the point that builders make about their inability to cut prices doesn’t have any meaning. They can build homes and sell them at prices they think are right, but the question is will there be any takers at that price? And the answer is clearly no.

In any market there are always two sides – demand and supply. And that is a basic point that our builders need to remember. So, they can continue holding on to their prices, but at those prices there will be not much demand for homes. As Kay writes in another essay titled A Fetish for Manufacturing: “The rewards of different activities [are] detached from their position in the hierarchy of needs. You only [get] paid for producing goods that people [want].”

Kay makes another interesting point, which I would like to talk about here. As he writes: “In classic bubbles – from tulip mania to the dot.com frenzy – people bought things, not for their intrinsic worth, but to sell on to others at a higher price. That rarely happens with houses.”

This is not true in the Indian context. Homes in India have “not” always been bought “for their intrinsic worth” but they have also been bought “to sell on to others at a higher price”. And that clearly is not happening anymore. Over the last few years you would have been better off letting your money sit idle in a savings bank account rather than investing in real estate. Given this, the interest in owning real estate has come down. That is clearly visible from the huge number of unsold homes across cities as well as fall in the launch of new projects.

As Kay writes: “As in every asset market, short term price movements are driven by beliefs, not underlying realities.” The underlying reality is that at these prices it does not make any sense to invest in real estate. But the belief that real estate prices always go up is still reasonably strong. The question is for how long will the belief remain strong?

I think we are half way there.

The column originally appeared in The Daily Reckoning on October 15, 2015.

Corruption in bank lending starts at very beginning

rupee
“Anyone with any sense had already left town…” – Bob Dylan in Lily, Rosemary and the Jack of Hearts

In the Daily Reckoning newsletter dated September 9, 2015, I had extensively quoted a survey carried out by EY. In this survey 64% of respondents believed that the bad loans of banks resulted primarily because of lapses in the due-diligence carried out by the banks, before the loans were sanctioned.
As the report which came along with the survey pointed out: “Third party agencies such as surveyors, engineers, financial analysts, and other verification agencies, etc., play a critical role in assuring financial information, proposals, work completion status, application of funds, etc. Lenders rely significantly on the inputs issued by such third parties.”

And this system is being manipulated. “Reports are made as a routine, with little scrutiny. In some situations, the reports may be drafted under the influence of unscrupulous borrowers,” the EY report pointed out.

In response to the column someone with a detailed knowledge of the loan processing and disbursal process of banks got in touch with me. He gave me two examples of the loan disbursal system being manipulated. This ultimately led to several banks ending up with bad loans.

The first case was of an unlisted entity in the business of manufacturing luggage, borrowing from two big public sector banks. The promoter of the company offered his equity in the company, as well as land and the factory, as a collateral. This transaction took place in 2007. The valuation report by a third party agency put the combined value of all the assets at Rs 35 crore. Against these assets the banks gave a loan of around Rs 27 crore. The promoter took this loan. He also borrowed Rs 3 crore more from the banks.

Later another valuer was brought in to examine the value of the assets, and the value of the assets was put at a much lower Rs 19 crore. The old valuer was dismissed but by then the damage had already been done. The company had given out a loan of Rs 30 crore against assets which were worth only Rs 19 crore.

Ideally the situation should have exactly been the other way around.

The second case involves a listed company in the building materials space. The company came out with an initial public offering in 2008-2009. The company was listed at a three digit price. Currently, the price of the stock is in lower single digits.

The company took loans amounting to Rs 325 crore from two big public sector banks and one of the bigger new generation private sector banks. The promoter did not stop at this. He borrowed more using his other listed entities as well. In 2013, he defaulted on the loans citing slowdown in construction activity.

Now he owes banks around Rs 1000 crore to the banks. The book value of the assets that banks have as a collateral is around Rs 225 crore. The market value is expected to be in the region of Rs 325-350 crore. The rest of the money was lent by banks against shares, which are now quoting in single digits.

In both the cases, the banks ended up with losses. Both the companies that we talked about are not very big companies and they were able to do so much damage to banks so easily. Now imagine what must be happening when the banks deal with the bigger corporates.

The Reserve Bank of India (RBI) governor, Raghuram Rajan, summarised the situation accurately in a speech last year when he said: “The promoter enjoys riskless capitalism – even in these times of very slow growth, how many large promoters have lost their homes or have had to curb their lifestyles despite offering personal guarantees to lenders?” Almost none.

In fact, these defaults have pushed Indian banks into a difficult situation. As R Gandhi, one of the deputy governors of the RBI, said in a speech he made on September 15: “The amount of non-performing assets [have] witnessed [a] spurt and as on March 2015, it was at 4.62. per cent of the gross advances of the banks in comparison with 2.36 per cent of the gross advances as at March 2011.”

Further, non-performing assets or bad loans have grown at a much faster pace than the overall lending in the last few years. Along with the growth in bad loans, as I have often pointed out in the past, the restructured assets (where the tenure of the loan or the interest on the loan has been changed in favour of the borrower) have also grown.

As Gandhi pointed out: “The ratio of restructured standard assets to gross advances grew to 6.44 per cent as at the end of March 2015 from 5.87 per cent of gross advances as on March 2014. The total stressed assets (i.e., NPAs plus Restructured Assets) as on March 2015 were 11.06 per cent of gross advances.”

All this has had a severe impact on profitability of banks. “The sharp increase in stressed assets has adversely impacted the profitability of the banks. The annual return on assets has come down from 1.09 per cent during 2010-11 to 0.78 per cent during 2014- 15,” Gandhi said.

This has become a drag on the economy. The increase in bad loans and restructured assets also hurts those borrowers who have been repaying their loans without fail, as they end up paying higher interest rates. As Rajan said last year: “One consequence of skewed and unfair sharing is to make credit costlier and less available. The promoter who misuses the system ensures that banks then charge a premium for business loans.” Hence, the next time the businessmen want the RBI to cut interest rates, they should understand they are a major part of the problem.

Other than the fact, that the banks lent more money than they should have [i.e. due-diligence wasn’t proper], they also did not monitor the loans properly. In cases where money had been lent against shares, the falling share price should have led to some action from banks. But that doesn’t seem to have happened.

The RBI has since asked banks to follow a proper credit-risk management system. As Gandhi said during the course of his speech: “The guidelines entail involvement of top Management, including the Board of Directors of the bank in actively managing the credit risk of the banks. Banks are required to put in place proactive credit risk management practices like annual / half-yearly industry studies and individual obligor reviews, credit audit which entails periodic credit calls that are documented, periodic visits of plant and business site, and at least quarterly management reviews of troubled exposures / weak credits.”

While this will help banks in not making the same mistakes as they have in the past, it will do nothing about the mess that they already are in. For loans that have gone bad already or are in the process of going bad, all these steps are essentially too little and too late.

The column originally appeared on the Daily Reckoning on Sep 18, 2015

If Rahul is serious about corruption, then let law of the land investigate Vadra

rahul gandhi

Vivek Kaul
Some of the political pundits who operate between Gurgaon in Haryana on one side and Noida in Uttar Pradesh, on the other, have been very impressed with Rahul Gandhi’s big speech, which he made late last week.
But there are several reasons which clearly point out that Rahul’s big speech should be treated like just another speech and nothing more.
In his speech Rahul Gandhi talked about giving “the country anti-graft bills which will transform the country,” and which will lead to “punish[ing] the corrupt and protect[ing] the honest.” A very noble thought indeed.
But look at the way the Congress party government in Haryana is treating the IAS officer Ashok Khemka. The government has recommended a CBI probe against Khemka for awarding a contract worth Rs 8 crore to a Gujarat based company. Over and above this, news reports suggest that a second chargesheet will be filed against Khemka, by the Haryana government. Khema has been accused of incurring a loss of Rs 22 lakh to the Haryana Seed Development Corporation of which he was the managing director between October 15, 2012 and April 4, 2013. Yes, you read the right. A loss of Rs 22 lakh.
As is well known by now Khemka exposed how the Haryana government went out of its way to help Rahul’s brother-in-law, Robert Vadra, to acquire land at cheap rates. Vadra later sold the land to DLF to make massive profits. (You can read a detailed analysis on this here).
So does this mean that Rahul’s statement of “punish[ing] the corrupt and protect[ing] the honest,” applies to everyone else other than the Gandhi family? And those who dare to expose the shenanigans of the family, will be hounded like Khemka has been?
As Pratab Bhanu Mehta writes in The Indian Express “Gandhi’s fiery AICC speech also vested too much in speeches and less in action. An anti-corruption stance is not very convincing when your own government is hounding Ashok Khemka and blaming the CAG and CVC.”
Also, why has Rahul suddenly woken up to corruption, a few months before the next Lok Sabha elections are due? Where was he when the Commonwealth Games scam, the 2G scam and the Coalgate scam happened? Holidaying in Europe?
Further, what does Rahul have to say about the CBI plea to drop criminal prosecution against Ashok Chavan, the former chief minister of Maharashtra, in the Adarsh Housing Society scam? That CBI is an independent organisation, which operates on its own? A special court in Mumbai rejected this plea.
Or what does he have to say about the Maharasthra government first rejecting the report by the judicial commission on Adarsh Housing Scam and then only partially accepting it. The Judicial Commission’s report pointed out that the Adarsh Society enjoyed political patronage of former chief ministers, the late Vilasrao Deshmukh, Sushil Kumar Shinde (the current home minister of India) and Ashok Chavan.
As pointed out earlier, the Maharashtra government accepted the report in parts. While it accepted allegations against Ashok Chavan, it decided to give a clean chit to the late Vilasrao Deshmukh and the current home minister Sushil Kumar Shinde.
Rahul also talked about “people demand[ing] honest and efficient governance,” and the Congress party “respond[ed] by getting the Lokpal Act passed.” The Lokpal Act in its current form has been doing the rounds for the last few years. Can Rahul tell us why did it take the Congress party so long to get it passed? Are the recent election results, where the party suffered an electoral humiliation, the main reason for it?
Rahul also took potshots at his main rival Narendra Modi of the Bhartiya Janta Party and said “Democracy is not rule by dictate. It is not rule by one man. It is rule through empowered elected representatives.” Very good point indeed.
But if Rahul is so concerned about democracy then when was the last time the Congress party had elections for the post of the President and Vice President?
As Ashutosh Varshney writes in Battles Half Won – India’s Improbable Democracy “An interconnected problem is the lack of intra-party democracy. Inter-party competition is vigorous, but intra-party competition is not. Party officials are appointed by the leaders, not elected by party members. During 1920-1973, the Congress party used to have regular elections, a practice dropped since then.” A Gandhi family scion who has inherited the throne should be the last person talking about democracy.
All these reasons make it very clear that Rahul Gandhi and the Congress party being very serious about corruption, doesn’t cut much ice. The Gandhi family scion needs to realise that ultimately actions speak louder than words.
As MJ Akbar put it in The Times of India “Corruption is a slippery slope for anyone in power. Congress should have stuck to its familiar narrative of populism and stability, for such advertising can be backed by evidence.” So, if Rahul is serious about corruption, then he should let the law of the land investigate the land dealings of Robert Vadra for a start and ensure that the Congress governments do not hound honest bureaucrats like Ashok Khemka. Then there will be real evidence to back his words. Of course, that is easier said than done.
(Vivek Kaul is an author. He tweets @kaul_vivek) 

How exposing corruption in India is different from China

IMG_8757.JPGVivek Kaul

Does exposing corruption work all the time? “(In India) every media outlet seems to have a story about corruption. But in the context of this hyper-transparency, the moral outrage is lost. Additional information on corruption does little to move the needle. So, yes, transparency is a potent tool against corruption particularly when you’re dealing with low aggregate levels of transparency…In high aggregate levels of transparency, the next new story about corruption has to be followed up with real enforcement for it to be effective,” says Karthik Ramanna, Associate Professor of Business Administration at the Harvard Business School. Ramanna is also the faculty for the Leadership and Corporate Accountability-India (LCAI) programme being offered by Harvard Business School in India, later this month. In this interview he speaks to Firstpost about various online attempts around the world to tackle corruption. 
What impact does corruption have on economic growth in a country? Can you give us some numbers that research in economics has thrown up?
Corruption has emerged over the last five to ten years as a big issue both in the public discourse as well as among corporate managers, particularly in emerging markets. A 2012 World Economic Forum survey of corporate managers and senior leaders from China, Russia, and India identified corruption as one of the top five issues in each of these countries. However, it’s hard to directly measure , the impact of corruption because you can only observe corruption when it is surfaced in a legal context. But, of course, not all cases of corruption will be prosecuted to the extent that there are limits to legal resources and that prosecutors themselves or the judicial system itself is corrupt. So it’s hard to estimate this beyond surveys.
How much does corruption impact the amount of foreign direct investment and foreign portfolio investments coming into any country?
It is in the long-term interest of any free-market society to have an independent judiciary, an effective legal system, and strong democratic institutions that promote an accountable and trustworthy government. Corruption detracts from those long-term objectives and thus compromises the basis of a free-market system. Corruption might help a foreign investor seek short-term recourse to a problem, but, in the long-run, it destroys the foundation for capitalism and negatively impacts foreign investment. This has been shown in the context of several emerging-market nations.
You have written that “corruption is the top issue in emerging market economies — and transparency is the most potent tool available to combat corruption.” Could you explain that in some detail through some examples?
One of the things I’ve been exploring over the last two to three years is the role of transparency as an instrument of accountability against corruption in different emerging-market contexts. In Russia, where I’ve studied the work of Alexey Navalny and his web platform RosPil.info, transparency seems to have quite a large impact on instances of corruption. In part, I think this is because the aggregate level of transparency in this context is low. In Russia, you’re dealing with a mainstream media environment that generally does not report on public corruption and that is pro-government. In that context, even small amounts of information can have a profound impact. So when RosPil.info releases information about a potentially corrupt government tender, it seems to have an impact in how that tender is re-evaluated or reassessed.
What about a country like India?
Switching to a country like India, where you encounter a hyper-transparent environment, and you have, for all practical purposes, a vibrant, free press, in this context reporting on corruption has almost become a national sport. Every media outlet seems to have a story about corruption. But in the context of this hyper-transparency, the moral outrage is lost. Additional information on corruption does little to move the needle. So, yes, transparency is a potent tool against corruption particularly when you’re dealing with low aggregate levels of transparency. But there seems to be a nonlinearity associated with the way transparency is effective against corruption. In high aggregate levels of transparency, the next new story about corruption has to be followed up with real enforcement for it to be effective.
In a HBR article you wrote that “Private Citizens are also joining the fight against corruption. Some are making the effort via for-profit ventures.” Could you discuss this in some detail with global examples?
Caijing is an example of a for-profit venture that is fighting corruption in China. It is a magazine that is about 15 years old, and was established by a gentleman called Wang Boming who is a very central figure in the development of capital markets in China. Mr. Wang was asked by the State Council, which is one of the highest organs of the state in China, to develop a financial press in the country in the late 90s. And with that charge, he established Caijing. Mr. Wang was educated in the United States and has worked in the media environment in the West. He is committed to a long-term vision of a free and transparent press in China. That being said, he has built his magazine very much on the principle of working with the state rather than opposed to it. The strategy of an organization such as Caijing, which embeds itself as a long-term ally of the government, working to create conditions that make markets work, might be, in fact, the approach that works best.
Could you elaborate on that?
Over the last 15 years Caijing has built a reputation for breaking stories about corruption and corporate governance malfeasance in China, including those involving very senior officials in the country, but has done so in a very deliberate and measured way. It has earned international respect and recognition for its coverage, but at the same time doubts remain about how closely aligned it is with the state. Mr. Wang has in part pursued this strategy because he’s running a for-profit business, which is listed on the Hong Kong Stock Exchange. He very much needs to turn a profit and needs to survive to tell another story another day. This is not a one-shot game for him, this is a long-term game. And in part it’s that sustainability aspect that gets him to work with rather than opposed to state institutions.
That’s interesting…
One could argue that the long-term profit motive is what has built that sustainability into the organization. The interesting thing about this long-term approach is that Caijing has over time been able to push the limits of subjects that it can acceptably cover. Fifteen years ago when Boming started the magazine, it was hard even to touch local government officials or report on local government officials. Today he can report on corruption at the local government level without much concern about censorship. It’s only if he’s dealing with top national officials that there is some concern around those issues. Thus, there’s been a gradual evolution in a way which Boming would consider progress.
Are there any such examples in India where for profit ventures are fighting corruption?
IPaidABribe is a not-for-profit organization leveraging transparency and both the ubiquity and the anonymity of the internet to bring greater light to petty bribery or what is called “retail corruption.” This is the corruption necessary to turn on your water supply or to turn on your electric supply or to pay your property tax bill. In some ways retail corruption is more dangerous that “wholesale corruption,” the massive bribes paid for public licenses. Retail corruption corrodes not just a few; it corrodes the ethic of an entire nation. Then when in fact citizens do observe instances of wholesale corruption, they appear less egregious. Part of what the website ipaidabribe.com does is to leverage the anonymity of the internet to bring back some shame, if you must, to corruption or to the payment of bribes.
Could you tell us a little more about it?
The purpose of something like ipaidabribe.com is to restore a national consciousness to the idea that bribe-paying is unusual, it is ethically wrong, as opposed to something that is a common and necessary for day-to-day existence. The next challenge for reformers in this area is how to close the loop. What happens after you report your bribe? As I said earlier, when we are in the context of hyper transparency, if you’re dealing with an environment where reporting on corruption is widespread, it’s important to have institutions to close the loop around corruption. It’s important to be able to give people some sense of closure. It’s not simply about saying, “Yes, I paid a bribe,” it’s about how is justice in fact being meted out to the corrupt.
What do you think about the New Companies Bill? Is it fair for a government to mandate that businesses spend an ‘X’ amount of money on corporate social responsibility?
Milton Friedman famously said that the social responsibility of business is to increase its profits. I think that the general spirit of the New Companies Bill is the idea that companies have responsibilities beyond delivering on shareholder profits. This idea is broadly consistent with a lot of the research that has been done since Professor Friedman wrote that article in 1970. In particular, we’ve come to see that there are at times “negative externalities” associated with corporate profit-seeking activity, which is to say that there are costs imposed on labour, on customers, and on local communities from profit-seeing activity. This is especially true in the presence of what we recognize as “institutional voids,” that is when the institutional architecture of the market system is underdeveloped.
Can you give us an example on this? 
For example, in India, where courts are clogged and access to justice is notoriously slow, customers and employees often rely on corporate responsibility – rather than legal recourse – for their well being. In this context, unbridled profit-seeking activity could impose significant costs on society. So, it is in the long-term interests of corporations to take a more nuanced view of what their objective function should be. It is not viewed as a distraction or as a luxury, but as something very core to the business. As managers start taking a long-term view on their business, they recognize that incorporating corporate responsibility into corporate strategy is good business and good leadership.
Anything else you would like to add to that?
All this said, the idea of mandating a 2% of net profit expenditure on CSR, as the new law does, strikes me as aggressive in that it’s not clear that every company has tightly developed a way to integrate corporate responsibility into its strategy. It’s not clear that every company has the right ideas and the right vehicles to invest this money on behalf of their shareholders and society. I think about this Act as, on the one hand, recognizing a moral imperative for companies to take their social responsibility seriously, but, on the other hand, potentially opening the door to considerable value destruction by mandating such activity.
Do you think companies are seriously following this or will they find accounting tricks to get around it?
I wouldn’t be surprised if some companies found ways to circumvent this mandate, by pursuing activities that ostensibly seek to serve the public interest, but in practice only serve the interests of, say, family members of founders and managers. I could also see ways in which this sort of mandate could become an avenue to bribe politicians by, for example, contributing to the charities of powerful ministers. There are many ways in which this law could be misused. Again, I think we don’t want to lose sight of the ethical principle behind the law, but we must also recognize that mandating corporate expenditure to this effect might be stepping too far.
The interview originally appeared on www.firstpost.com on November 5, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek