Showing posts with label bankruptcy. Show all posts
Showing posts with label bankruptcy. Show all posts
Tuesday 22 August 2023
Friday 17 June 2022
Friday 6 March 2015
Chapter 11 comes to India
Pritish Nandy in the Times of India
One of the best things in last week’s Union Budget, which has gone largely unnoticed, is the finance minister’s pledge to bring in a comprehensive Bankruptcy Code. Bankruptcy law reform is now a priority for improving the ease of doing business, said Arun Jaitley, thus telling us for the first time that the government has finally come to accept the fact that shit happens. And it’s time that we, as a nation, realized this and found ways and means to deal with it.
Till now, every failure was chased by a lynch mob hardwired to believe that failure is deliberate and must be punished. Not only countless lives and careers have been destroyed by this attitude but it has also fostered a business climate where people either stay away from taking the kind of crucial risks businessmen ought to take or, worse, it has brought risk taking and failure (which are at the heart of all serious entrepreneurship) into unnecessary disrepute. We, as a people, actually believe that every business that fails is a deliberate deep-rooted conspiracy, a plan to loot others. In this perverse worldview, we ignore the simple fact that most bankruptcies owe their origins to Black Swan events that have become increasingly commonplace. Not the greed and wickedness of businessmen.
History shows that the best businessmen go through many failures. They may not always talk about them but these failures teach them the lessons that eventually make them successful. The very failures we despise are the bedrock on which shining empires are built. Bankruptcy, or Chapter 11 as the Americans love to call it, is hardly a dirty word in today’s business scenario, where everything changes all the time, abruptly and without any notice. In fact, failure is a badge of honour that many successful entrepreneurs openly wear. For who will ever risk investing in a business where the promoter claims he has never known failure?
Hiding failure, in fact, is the worst thing one can do. It causes all round damage. Acknowledging it and then finding ways and means to mitigate it and move on is the way all civilised societies deal with failure. As Nassim Nicholas Taleb, my favourite economist recently said, failure is the only real asset of a nation and knowing how to fail is its biggest talent. Taleb also added that failure may be the best mantra for India’s success. For a nation that has not experienced failure and learnt from it is hugely handicapped in today’s world where everything changes at short notice, including the nature of risks. A nation that turns away from risk is not a nation yet ready for success.
He cites the examples of France and Japan. Their economies are doing poorly, Taleb argues, because the failure rate is so low. In the US, on the other hand, the highest fail rate is in California which also has the most inspiring success stories. Walt Disney is an example. He was fired by his editor because he “lacked imagination and had no good ideas”. He went bankrupt several times before he built Disneyland. In fact, even the proposal for Disneyland was rejected by the city of Anaheim on the ground that it would attract only riffraff. Henry Ford went bankrupt before he could steer Ford Motors to its huge success. So did HJ Heinz, founder of Heinz. And William Durant who created General Motors. And Milton Hershey, founder of Hershey Chocolates. The day Trump Towers was being announced with huge fanfare in Mumbai I read that Trump Taj Mahal in Atlantic City had gone belly up.
Business is not about not taking risks. It’s about riding the right risks to build institutions and create wealth. Sports, media, entertainment have had its share of bankrupts. From Larry King to Francis Ford Coppola to rapper MC Hammer to Stan Lee, founder of Marvel Comics, to blogger Perez Hilton to Mick Fleetwood, and Bob Guccione, founder of Penthouse, all have faced bankruptcy. Even famous US Presidents have. Abraham Lincoln, Ulysses S Grant, William McKinley, Thomas Jefferson. In recent years, Steve Jobs went almost bankrupt. So did Apple. Today it’s the world’s richest, strongest brand, seemingly indestructible.
Restaurants improve every time they fail. So do cars, trains, planes. They become safer because we always over-compensate after a disaster. Every shock strengthens us, readies us better for the future. Businesses too are like that and I am glad the Finance Minister has realised it and removed the stigma.
Have I ever gone bankrupt? No, but I have teetered on the edge often enough and never been embarrassed to admit it.
Funnily, as Taleb points out, the only business that never learns from failure is banks. When a bank crashes today, the probability of a bank crashing tomorrow actually increases. Banking is clearly not a business that learns from its mistakes. History proves that too.
Monday 26 November 2012
How could Greece and Argentina – the new 'debt colonies' – be set free?
Protesters wear chains in a protest against Greece's austerity measures. The burden of debt falls mostly on the weaker members of society. Photograph: Aris Messinis/AFP/Getty Images
Colonialism is back. Well, at least according to leading politicians of the two most famous debtor nations. Commenting on the EU's inability to deliver its end of the bargain despite the savage spending cuts Greece had delivered, Alexis Tsipras, the leader of the opposition Syriza party, said last week that his country was becoming a "debt colony". A couple of days later, Hernán Lorenzino, Argentina's economy minister, used the term "judicial colonialism" to denounce the US court ruling that his country has to pay in full a group of "vulture funds" that had held out from the debt restructuring that followed the country's 2002 default.
While their language was deliberately incendiary, these two politicians were making extremely important points. Tsipras was asking why most burdens of adjustment for bad loans have to fall on the debtor country and, within them, mostly on its weaker members. And he is right. As they say, it takes two to tango, so those who condemn Greece for imprudent borrowing should also condemn the imprudent lenders that made it possible.
Lorenzino was asking how we can let one court ruling in a foreign country in favour of one small group of creditors (who bought the debt in the secondary market) derail a painfully engineered process of national recovery. The absurdity of this situation becomes clear when we recall that, partly thanks to the default and subsequent debt restructuring,Argentina, expanding at close to 7% per year, has been the fastest growing Latin American economy between 2003 and 2011.
But there is far more at stake here than the national welfares of Greece and Argentina, important though they are. The Greek debt problem has dragged down not just Greece but the whole eurozone, and with it the world economy. Had the Greek debt been quickly reduced to a manageable level through restructuring, the eurozone would be in a much better shape today. In the Argentinian case, we are risking not just an end to Argentina's recovery but a fresh round of turmoil in the global financial market because of one questionable US court ruling.
Many people argue that, regrettable as they may be, such situations are unavoidable. However, when it comes to debt problems within our borders, we actually don't let the same situation develop. All national bankruptcy laws allow companies with too big a debt problem to declare themselves bankrupt. Once bankruptcy is declared, the debtor company and its creditors are forced to work together to reorganise the company's affairs, under clear rules.
First, a standstill is imposed on debt repayments – for as long as six months in the case of the debtor-friendly American bankruptcy law. Second, subject to the majority (or in some countries a super-majority of two thirds) of them agreeing, creditors are required to accept a debt reduction programme in return for a new company management strategy. This programme could involve outright reduction (or even cancellation) of debts, lowering of interest rates, and extension of the repayment period. Third, lawsuits by individual creditors are banned until there is an agreement, so that individual creditors cannot disrupt the restructuring process. Fourth, the claims of other stakeholders on the company are also taken into account, with wages being typically given "seniority" over debts.
Unfortunately, no mechanism like this exists for countries, which is what has made sovereign debt crises so difficult to manage. Because they don't have any legal protection from creditors in times of trouble, countries typically postpone the necessary restructuring of their economies by piling on more debts in the (usually unfulfilled) hope that the situation will somehow resolve itself. This makes the debt problem bigger than necessary.
What's more, because they cannot officially go bankrupt, countries face a stark choice. Either they default and risk exclusion in the international financial market (although countries can overcome it quickly, as Russia and Malaysia did in the late 1990s) or they have to opt for a de facto default, in which they pretend that they have not defaulted by making full repayments on their existing loans with money borrowed from public bodies, like the International Monetary Fund and the EU, while trying to negotiate debt restructuring.
The problem with this solution is that, in the absence of clear rules, the debt renegotiation process becomes lengthy, and can push the economy into a downward spiral. We have seen this in many Latin American countries in the 1980s, and we are seeing it today in Greece and other eurozone periphery economies.
Meanwhile, the absence of rules equivalent to the protection of wage claims in corporate bankruptcy law means that claims by weaker stakeholders – pensions, unemployment insurance, income supports – are the first to go. This creates social unrest, which then threatens recovery by discouraging investment.
It is not because people condoned defaulting per se that they came to introduce the corporate bankruptcy law. It was because they recognised that in the long run, creditors – and the broader economy, too – are likely to benefit more from reducing the debt burdens of companies in trouble, so that they can get a fresh start, than by letting them disintegrate in a disorderly way.
It is high time that we applied the same principles to countries and introduced a sovereign bankruptcy law.
Sunday 4 November 2012
Unlimited Liability for Speculative Bankers
Bankers must be made to bear the cost of their reckless risk-taking
Separating retail and investment banking is not enough. Speculative banking needs to have unlimited liability
Lehman Brothers
employees leaving the Canary Wharf building in London, carrying their
possessions in boxes, aftert the bank collapsed in 2008. Photograph:
Graeme Robertson
Hot on the heels of the Libor scandal and money-laundering at HSBC and Standard Chartered Bank comes the allegation that Barclays Bank attempted to manipulate the US energy markets to make profits.
Of course, Barclays has no direct interest in buying or selling oil,
gas or electricity. Its aim is to make profits by betting on the price
changes, a process that often drives up the price of the underlying
commodity and forces ordinary people to pay sky-high prices.
This speculative activity is facilitated by complex financial instruments known as derivatives, described by investment guru Warren Buffett as "financial weapons of mass destruction". Behind the technical jargon lies a giant gambling machine, which bets on anything that can be priced. The hard cash needed to settle the outcome of the bets is always highly uncertain until the contracts mature, which could be 10 to 15 years in the future. And, like other bets, derivatives don't always pay off – as the cases of Nick Leeson at Barings and more recently Jérôme Kerviel at Société Générale exemplify.
The UK government claims that speculation will be curbed by a separation of investment banking from the retail side. This, it is claimed, will protect savers and taxpayers from the toxic effects of risky positions adopted by bankers. This policy will not work. Even after separation, investment banks will continue to use funds from retail banks, pension funds and insurance companies for their speculative activities. The speculators will continue to shelter behind limited liability and dump losses on to innocent bystanders. Unless the benefit of limited liability is removed from investment banks, their losses and reckless risks will inevitably be transferred to other sectors. The separation between retail and speculative operations needs to be accompanied by unlimited liability for investment banking, ensuring that those who take excessive risks are 100% liable for their mistakes.
Derivatives are central to the current economic crisis. In 2008, Lehman Brothers collapsed with 1.2 million derivatives contracts, which had a face value of nearly $39 trillion, though the economic exposure was considerably less. For nearly six years before its demise, almost all of the pre-tax profits at Bear Stearns came from speculative activities. It could not continue to pick winners indefinitely, and collapsed in 2008. It had shareholder funds of $11.8bn, debts of $384bn and a derivatives portfolio with a face value of $13.4 trillion. The derivatives gambles also brought down American International Group (AIG) – the world's largest insurer – and Washington Mutual. Then in October 2011, MF Global, a US brokerage firm that specialised in delivering trading and hedging solutions, filed for bankruptcy. It had nearly 3 million derivatives contracts with a notional value of more than $100bn.
Despite these high-profile casualties, risk-hungry investment bankers remain undeterred. The face value of the global derivatives trade is about $1,200 trillion (£749 trillion). With a global GDP of $65-70 trillion, the world economy is not in a position to absorb even 0.1% ($1.2 trillion) of losses.
The UK's GDP is about £1.5 trillion. Just three UK banks – Barclays, HSBC and Royal Bank of Scotland (RBS) – alone have a derivatives portfolio, with a face value totalling nearly £100 trillion. Barclays leads the way with £43 trillion. It has recently reported a third-quarter loss of £47 million, but its balance sheet points to a more serious position. Barclays' last full-year accounts show assets of £1.56 trillion and capital of only £65bn, meaning that its gross leverage is nearly 24 times its capital base. A decline of just 4% in asset values would wipe out its entire capital. Barclays' balance sheet shows gross exposure to derivatives of £539bn, though the bank could argue that this is offset by hedges of £528bn, leaving a net exposure of £11bn. The difficulty is that the hedges, as Lehman Brothers, Bear Stearns and Northern Rock have learnt, do not necessarily work in the desired way and always depend on the position of the counter parties in a highly unpredictable environment.
Merely separating retail and investment banking will neither choke off nor contain the effects of toxic gambles, because speculative activities will affect other sectors of the economy. For any possibility of containing the crisis, speculative banking needs to have unlimited liability. Thus, if the bets go bad, bankers will personally need to bear the negative consequences. One of the tasks of the banking regulator should be to ensure that the size of the bets bears a reasonable relationship to the assets of the gamblers, so that cavalier bankers are not able to gamble more than they can lose. No retail bank, pension fund, insurance company or pension fund should be able to provide money to any investment bank without specific approval from its stakeholders.
The above reforms will help to reduce speculative activity and quarantine the negative effects of reckless gambling. They will also remind neoliberals that the freedom to speculate needs to be accompanied by responsibilities.
This speculative activity is facilitated by complex financial instruments known as derivatives, described by investment guru Warren Buffett as "financial weapons of mass destruction". Behind the technical jargon lies a giant gambling machine, which bets on anything that can be priced. The hard cash needed to settle the outcome of the bets is always highly uncertain until the contracts mature, which could be 10 to 15 years in the future. And, like other bets, derivatives don't always pay off – as the cases of Nick Leeson at Barings and more recently Jérôme Kerviel at Société Générale exemplify.
The UK government claims that speculation will be curbed by a separation of investment banking from the retail side. This, it is claimed, will protect savers and taxpayers from the toxic effects of risky positions adopted by bankers. This policy will not work. Even after separation, investment banks will continue to use funds from retail banks, pension funds and insurance companies for their speculative activities. The speculators will continue to shelter behind limited liability and dump losses on to innocent bystanders. Unless the benefit of limited liability is removed from investment banks, their losses and reckless risks will inevitably be transferred to other sectors. The separation between retail and speculative operations needs to be accompanied by unlimited liability for investment banking, ensuring that those who take excessive risks are 100% liable for their mistakes.
Derivatives are central to the current economic crisis. In 2008, Lehman Brothers collapsed with 1.2 million derivatives contracts, which had a face value of nearly $39 trillion, though the economic exposure was considerably less. For nearly six years before its demise, almost all of the pre-tax profits at Bear Stearns came from speculative activities. It could not continue to pick winners indefinitely, and collapsed in 2008. It had shareholder funds of $11.8bn, debts of $384bn and a derivatives portfolio with a face value of $13.4 trillion. The derivatives gambles also brought down American International Group (AIG) – the world's largest insurer – and Washington Mutual. Then in October 2011, MF Global, a US brokerage firm that specialised in delivering trading and hedging solutions, filed for bankruptcy. It had nearly 3 million derivatives contracts with a notional value of more than $100bn.
Despite these high-profile casualties, risk-hungry investment bankers remain undeterred. The face value of the global derivatives trade is about $1,200 trillion (£749 trillion). With a global GDP of $65-70 trillion, the world economy is not in a position to absorb even 0.1% ($1.2 trillion) of losses.
The UK's GDP is about £1.5 trillion. Just three UK banks – Barclays, HSBC and Royal Bank of Scotland (RBS) – alone have a derivatives portfolio, with a face value totalling nearly £100 trillion. Barclays leads the way with £43 trillion. It has recently reported a third-quarter loss of £47 million, but its balance sheet points to a more serious position. Barclays' last full-year accounts show assets of £1.56 trillion and capital of only £65bn, meaning that its gross leverage is nearly 24 times its capital base. A decline of just 4% in asset values would wipe out its entire capital. Barclays' balance sheet shows gross exposure to derivatives of £539bn, though the bank could argue that this is offset by hedges of £528bn, leaving a net exposure of £11bn. The difficulty is that the hedges, as Lehman Brothers, Bear Stearns and Northern Rock have learnt, do not necessarily work in the desired way and always depend on the position of the counter parties in a highly unpredictable environment.
Merely separating retail and investment banking will neither choke off nor contain the effects of toxic gambles, because speculative activities will affect other sectors of the economy. For any possibility of containing the crisis, speculative banking needs to have unlimited liability. Thus, if the bets go bad, bankers will personally need to bear the negative consequences. One of the tasks of the banking regulator should be to ensure that the size of the bets bears a reasonable relationship to the assets of the gamblers, so that cavalier bankers are not able to gamble more than they can lose. No retail bank, pension fund, insurance company or pension fund should be able to provide money to any investment bank without specific approval from its stakeholders.
The above reforms will help to reduce speculative activity and quarantine the negative effects of reckless gambling. They will also remind neoliberals that the freedom to speculate needs to be accompanied by responsibilities.
Monday 16 April 2012
Civil Aviation in India
India mulls over 49% overseas share in airlinesBy Raja Murthy
MUMBAI - The Indian government on April 12 postponed to this week an eagerly awaited decision to allow foreign airlines own up to 49% stake in Indian carriers. But overseas funding alone is unlikely to rescue India’s struggling US$12 billion civil aviation industry.
It's more a case of mismanaged potential that has caused five out of the six Indian carriers, except Indigo, to have accumulated losses of nearly $2 billion in the past two years. India, the world's ninth largest civil aviation market, had passenger traffic doubling
India aims to be among the world's top three aviation markets within a decade. In between are mountains to climb and some strange oddities to correct - such as building multi-billion dollar luxury airports in an industry dominated by low-cost airlines.
The foreign direct investment (FDI) move, if it materializes as part of the mountain climbing process, could give desperately needed survival cash and breathing time to nearly dead flying companies like Kingfisher Airlines. The Vijay Mallya-promoted carrier is drowning in a debt of $1.3 billion, with no new loans forthcoming, with over 60% of its aircraft fleet grounded and its employees receiving salaries for December 2011 only on April 9.
The state-owned carrier Air India has similar mismanagement woes, but continues to receive public money to bankroll it. On April 12, the government approved 300 billion rupees (US$5.7 billion) as bailout and part of a revival plan for Air India across the next eight years. This after Civil Aviation minister Ajit Singh informed parliament that Air India incurs losses of $1.9 million every day, or over $700 million annually.
Whether Air India would fare better without government ownership is as moot a question as whether more funding, including FDI, could only be more investment down the drain. Waiting to be surgically treated are roots of the problem such as unviable operating costs for airlines.
Unfairly high taxes on aviation fuel have long been a major complaint for India's airline industry. Aviation Turbine Fuel (ATF) continues to be over 50% costlier in India than in Singapore and Malaysia. Fuel costs contribute about 45% of the operational costs of India's airlines.
Yet India's state-owned oil companies sell jet fuel cheaper to international airlines than for domestic flights in Indian airports. Indian Oil, for instance, sells jet fuel at $1,010 per kilo liter for international airlines in Mumbai (March 1, 2012 prices), while domestic airlines pay a pre-tax cost of $1,316.77. International airlines are free from sales tax on aviation fuel, while domestic airlines pay an additional 26% sales tax that local state governments levy.
Instead of the obvious step of reducing aviation fuel taxes to reasonable levels - or to only at least 25% above international levels - the Indian government earlier this year allowed domestic airlines to directly import aviation fuel. That seems as bizarre as asking an impoverished dying patient to go overseas to buy medicine available down the street.
Even more peculiar is that India exports nearly half its production of aviation fuel. According to Ministry of Petroleum data, India exported 4.478 million tonnes of aviation fuel in 2010-2011, out of total aviation fuel production of 9.570 million tonnes,
Fuel costs are only part of the problem. Aviation infrastructure growth appears heading in a direction different from requirements for industry growth. Privatization of metropolitan airports, for instance, resulted in multi-billion dollar upgrades for the Mumbai and Delhi airports, and new airports for Bangalore and Hyderabad. The impressive new airports though are driving up operational costs for a budget airline industry that critically needs low-cost infrastructure.
The spectacular new Terminal 3 of New Delhi's is itself both solution and problem. Built and operated by the Delhi International Airport (P) Ltd (DIAL) - a joint venture consortium of global infrastructure company GMR Group, Airports Authority of India, Fraport and Malaysia Airports Holdings Berhad - Terminal 3 makes Indira Gandhi International Airport (IGI) one of Asia's largest public buildings and the world's second-largest integrated airport, after Beijing Capital International Airport.
The $6 billion Terminal 3, spread along 4 kilometers and with a roof area of 45 acres (18.2 hectares), serves as future investment for Delhi having the world's fastest growing airport passenger traffic. According to the Montreal-based Airport Councils International, Delhi registered passenger traffic growth of 21.77%, faster than Jakarta's 19.2% and Bangkok's 12% growth. This compares impressively to the 1.8% air passenger traffic growth in North America.
But India's airlines and passengers are being asked to pay more airport fees and taxes to recover the multi-billion dollar costs for the new airports. Both Air India and Kingfisher Airlines alone owe the Delhi airport $100.4 million in airport fees. So airport employees are also suffering salary delays.
International carriers are too feeling the pinch. Malaysia's Air Asia, the continent's leading budget airline, announced termination of its flights out of the Delhi and Mumbai airports from March 24 this year, citing excessively high airport and handling fees and aviation fuel costs at these airports. Air Asia continues to fly from five other cities in South India.
The Airports Economic Regulatory Authority has proposed a 280% increase in landing and parking charges at Delhi airport, while the airport operator DIAL wants a 700% increase. Not just low-cost airlines, but Lufthansa, Air France, KLM and British Airways have announced putting on hold expansion plans in India due to the huge hike in operational fees at IGI Terminal 3.
Such headaches were not quite anticipated when an Air Deccan 48-seater ATR turbo-prop aircraft took off from Hyderabad to Vijayawada on September 26, 2003, to unofficially launch low-cost airlines in India. Since then, a heavily loss-making Air Deccan was bought by Kingfisher in 2007, and now a heavily loss-making Kingfisher is looking to sell itself to a foreign carrier.
The pending 49% FDI decision on the governmental anvil is actually a throwback to over six decades ago. In 1951, the government bought a 49% stake in Air India, founded and owned by the Tata Group. The government retained an option to buy another 2% stake and became owner. It did so under the Air Corporations Act of 25 August 1953 that nationalized all private airlines.
Air travel was booming in India in the 1950s, with cheaply available World War II surplus aircraft and India having bountiful skilled air pilots and maintenance crews after the war. The 26-page "Official Airline Guide" of July 1952, published by the Air Transport Association of India, lists schedules for about nine domestic airlines: Air India Ltd (also called The Tata Airline), the Air Services of India (also called the Scindia Airline), Airways (India) Ltd, Bharat Airways (also called the Birla Airline), Deccan Airways, Himalayan Aviation, the Indian National Airways, Kalinga Airlines and Air India International.
In 1953, India had over 20 private airlines, with unstructured growth without proper infrastructure creating market problems similar to the current woes of some domestic airlines. JRD Tata (1904-1993), called the father of civil aviation in the subcontinent, predicated an industry disaster. One of the reasons why the government nationalized the entire airline industry in 1953 was apparently to ward off many private airlines going bankrupt.
Now with Air India saved from bankruptcy with a $5.7 billion gift of public money, the government may as well consider re-privatizing Air India, and selling 49% of the stock back to its original owners the Tata Group.
The $5.7 billion bailout and the 49% FDI decision for overseas investors have better chances of working only if the government ensures there being low-cost operational costs to support low-cost air travel.
(Copyright 2012 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)
Sunday 8 April 2012
Post Soviet Privatisation - A policy of mass destruction
http://www.cam.ac.uk/research/news/a-policy-of-mass-destruction/
A new analysis showing how the radical policies advocated by western economists helped to bankrupt Russia and other former Soviet countries after the Cold War has been released by researchers.
The study, led by academics at the University of Cambridge, is the first to trace a direct link between the mass privatisation programmes adopted by several former Soviet states, and the economic failure and corruption that followed.
Devised principally by western economists, mass privatisation was a radical policy to privatise rapidly large parts of the economies of countries such as Russia during the early 1990s. the policy was pushed heavily by the International Monetary Fund, the World Bank and the European Bank for Reconstruction and Development (EBRD). Its aim was to guarantee a swift transition to capitalism, before Soviet sympathisers could seize back the reins of power.
Instead of the predicted economic boom, what followed in many ex-Communist countries was a severe recession, on a par with the Great Depression of the United States and Europe in the 1930s. The reasons for economic collapse and skyrocketing poverty in Eastern Europe, however, have never been fully understood. Nor have researchers been able to explain why this happened in some countries, like Russia, but not in others, such as Estonia.
Some economists argue that mass privatisation would have worked if it had been implemented even more rapidly and extensively. Conversely, others argue that although mass privatisation was the right policy, the initial conditions were not met to make it work well. Further still, some scholars suggest that the real problem had more to do with political reform.
Writing in the new, April issue of the American Sociological Review, Lawrence King and David Stuckler from the University of Cambridge and Patrick Hamm, from Harvard University, test for the first time the idea that implementing mass privatisation was linked to worsening economic outcomes, both for individual firms, and entire economies. The more faithfully countries adopted the policy, the more they endured economic crime, corruption and economic failure. This happened, the study argues, because the policy itself undermined the state’s functioning and exposed swathes of the economy to corruption.
The report also carries a warning for the modern age: “Rapid and extensive privatisation is being promoted by some economists to resolve the current debt crises in the West and to help achieve reform in Middle Eastern and North African economies,” said King. “This paper shows that the most radical privatisation programme in history failed the countries it was meant to help. The lessons of unintended consequences in Russia suggest we should proceed with great caution when implementing untested economic reforms.”
Mass privatisation was adopted in about half of former Communist countries after the Soviet Union’s collapse. Sometimes known as “coupon privatisation”, it involved distributing vouchers to ordinary citizens which could then be redeemed as shares in national enterprises. In practice, few people understood the policy and most were desperately poor, so they sold their vouchers as quickly as possible. In countries like Russia, this enabled profiteers to buy up shares and take over large parts of the new private sector.
The researchers argue that mass privatization failed for two main reasons. First, it undermined the state by removing its revenue base – the profits from state-owned enterprises that had existed under Soviet rule – and its ability to regulate the emerging market economy. Second, mass privatization created enterprises devoid of strategic ownership and guidance by opening them up to corrupt owners who stripped assets and failed to develop their firms. “The result was a vicious cycle of a failing state and economy,” King said.
To test this hypothesis, King, Stuckler and Hamm compared the fortunes between 1990 and 2000 of 25 former Communist countries, among them states that mass-privatised and others that did not. World Bank survey data of managers from more than 3,500 firms in 24 post-communist countries was also examined.
The results show a direct and consistent link between mass privatisation, declining state fiscal revenues, and worse economic growth. Between 1990 and 2000, government spending was about 20% lower in mass privatising countries than in those which underwent a steadier form of change. This was the case even after the researchers adjusted for political reforms, other economic reforms, the presence of oil, and other initial transition conditions.
Similarly, mass privatising states experienced an average dip in GDP per capita more than 16% above that of non mass-privatising countries after the programme was implemented.
The analysis of individual firms revealed that among mass-privatising countries, firms privatised to domestic owners had greater risks of economic corruption. Private domestic companies in these countries were 78% more likely than state-owned companies to resort to barter rather than monetary transactions. This was revealed to be the case after the researchers had corrected the data for firm, market and sector characteristics, as well as the possibility that the worst performing firms were the ones privatised.
The study also revealed that such privatised firms were less likely to pay taxes – a critical factor in ensuring the failure of the policy, which western economists predicted would generate private wealth that could be taxed and ploughed back into the state. However, firms that were privatised to foreign owners were much less likely to engage in barter and accumulate tax arrears.
“Our analysis suggests that when designing economic reforms, especially aiming to develop the private sector, safeguarding government revenues and state capacity should be a priority,” the authors add. “Counting on a future burst of productivity from a restructured, private economy to compensate for declining revenues is a risky proposition.”
A new study reveals how a radical economic policy devised by western economists put former Soviet states on a road to bankruptcy and corruption.
A new analysis showing how the radical policies advocated by western economists helped to bankrupt Russia and other former Soviet countries after the Cold War has been released by researchers.
The study, led by academics at the University of Cambridge, is the first to trace a direct link between the mass privatisation programmes adopted by several former Soviet states, and the economic failure and corruption that followed.
Devised principally by western economists, mass privatisation was a radical policy to privatise rapidly large parts of the economies of countries such as Russia during the early 1990s. the policy was pushed heavily by the International Monetary Fund, the World Bank and the European Bank for Reconstruction and Development (EBRD). Its aim was to guarantee a swift transition to capitalism, before Soviet sympathisers could seize back the reins of power.
Instead of the predicted economic boom, what followed in many ex-Communist countries was a severe recession, on a par with the Great Depression of the United States and Europe in the 1930s. The reasons for economic collapse and skyrocketing poverty in Eastern Europe, however, have never been fully understood. Nor have researchers been able to explain why this happened in some countries, like Russia, but not in others, such as Estonia.
Some economists argue that mass privatisation would have worked if it had been implemented even more rapidly and extensively. Conversely, others argue that although mass privatisation was the right policy, the initial conditions were not met to make it work well. Further still, some scholars suggest that the real problem had more to do with political reform.
Writing in the new, April issue of the American Sociological Review, Lawrence King and David Stuckler from the University of Cambridge and Patrick Hamm, from Harvard University, test for the first time the idea that implementing mass privatisation was linked to worsening economic outcomes, both for individual firms, and entire economies. The more faithfully countries adopted the policy, the more they endured economic crime, corruption and economic failure. This happened, the study argues, because the policy itself undermined the state’s functioning and exposed swathes of the economy to corruption.
The report also carries a warning for the modern age: “Rapid and extensive privatisation is being promoted by some economists to resolve the current debt crises in the West and to help achieve reform in Middle Eastern and North African economies,” said King. “This paper shows that the most radical privatisation programme in history failed the countries it was meant to help. The lessons of unintended consequences in Russia suggest we should proceed with great caution when implementing untested economic reforms.”
Mass privatisation was adopted in about half of former Communist countries after the Soviet Union’s collapse. Sometimes known as “coupon privatisation”, it involved distributing vouchers to ordinary citizens which could then be redeemed as shares in national enterprises. In practice, few people understood the policy and most were desperately poor, so they sold their vouchers as quickly as possible. In countries like Russia, this enabled profiteers to buy up shares and take over large parts of the new private sector.
The researchers argue that mass privatization failed for two main reasons. First, it undermined the state by removing its revenue base – the profits from state-owned enterprises that had existed under Soviet rule – and its ability to regulate the emerging market economy. Second, mass privatization created enterprises devoid of strategic ownership and guidance by opening them up to corrupt owners who stripped assets and failed to develop their firms. “The result was a vicious cycle of a failing state and economy,” King said.
To test this hypothesis, King, Stuckler and Hamm compared the fortunes between 1990 and 2000 of 25 former Communist countries, among them states that mass-privatised and others that did not. World Bank survey data of managers from more than 3,500 firms in 24 post-communist countries was also examined.
The results show a direct and consistent link between mass privatisation, declining state fiscal revenues, and worse economic growth. Between 1990 and 2000, government spending was about 20% lower in mass privatising countries than in those which underwent a steadier form of change. This was the case even after the researchers adjusted for political reforms, other economic reforms, the presence of oil, and other initial transition conditions.
Similarly, mass privatising states experienced an average dip in GDP per capita more than 16% above that of non mass-privatising countries after the programme was implemented.
The analysis of individual firms revealed that among mass-privatising countries, firms privatised to domestic owners had greater risks of economic corruption. Private domestic companies in these countries were 78% more likely than state-owned companies to resort to barter rather than monetary transactions. This was revealed to be the case after the researchers had corrected the data for firm, market and sector characteristics, as well as the possibility that the worst performing firms were the ones privatised.
The study also revealed that such privatised firms were less likely to pay taxes – a critical factor in ensuring the failure of the policy, which western economists predicted would generate private wealth that could be taxed and ploughed back into the state. However, firms that were privatised to foreign owners were much less likely to engage in barter and accumulate tax arrears.
“Our analysis suggests that when designing economic reforms, especially aiming to develop the private sector, safeguarding government revenues and state capacity should be a priority,” the authors add. “Counting on a future burst of productivity from a restructured, private economy to compensate for declining revenues is a risky proposition.”
Wednesday 16 November 2011
Pigeonholing protesters as anti capitalist will only allow those who are against reform to avoid the issue
In Singapore 'a staggering 22% of
national output is produced by state-owned enterprises'. Photograph:
Luis Enrique Ascui/Reuters
The Occupy London movement is marking its first month this week. It is routinely described as anti-capitalist, but this label is highly misleading. As I found out when I gave a lecture at its Tent City University last weekend, many of its participants are not against capitalism. They just want it better regulated so that it benefits the greatest possible majority.
But even accepting that the label accurately describes some participants in the movement, what does being anti-capitalist actually mean?
Many Americans, for example, consider countries like France and Sweden to be socialist or anti-capitalist – yet, were their 19th-century ancestors able to time-travel to today, they would almost certainly have called today's US socialist. They would have been shocked to find that their beloved country had decided to punish industry and enterprise with a progressive income tax. To their horror, they would also see that children had been deprived of the freedom to work and adults "the liberty of working as long as [they] wished", as the US supreme court put it in 1905 when ruling unconstitutional a New York state act limiting the working hours of bakers to 10 hours a day. What is capitalist, and thus anti-capitalist, it seems, depends on who you are.
Many institutions that most of us regard as the foundation stones of capitalism were not introduced until the mid-19th century, because they had been seen as undermining capitalism. Adam Smith opposed limited liability companies and Herbert Spencer objected to the central bank, both on the grounds that these institutions dulled market incentives by putting upper limits to investment risk. The same argument was made against the bankruptcy law.
Since the mid-19th century, many measures that were widely regarded as anti-capitalist when first introduced – such as the progressive income tax, the welfare state, child labour regulation and the eight-hour day – have become integral parts of capitalism today.
Capitalism has also evolved in very different ways across countries. They may all be capitalist in that they are predominantly run on the basis of private property and profit motives, but beyond that they are organised very differently.
In Japan interlocking share ownership among friendly enterprises, which once accounted for over 50% of all listed shares and still accounts for around 30%, makes hostile takeover very difficult. This has enabled Japanese companies to invest with a much longer time horizon than their British or American counterparts.
Japanese companies provide lifetime employment for their core workers (accounting for about a third of the workforce), thereby creating strong worker loyalty. They also give the workers a relatively large say in the management of the production process, thus tapping their creative powers. There are heavy regulations in the agricultural and retail sectors against large firms, which complement the weak welfare state by preserving small shops and farms.
German capitalism is as different from the American or British version as Japanese capitalism, but in other ways. Like Japan, Germany gives a relatively big input to workers in the running of a company, but in a collectivist way through the co-determination system, in which worker representation on the supervisory board allows them to have a say in key corporate matters (such as plant closure and takeovers), rather than giving a greater stake in the company to workers as individuals, as in the Japanese system.
Thus, while Japanese companies are protected from hostile takeovers by friendly companies (through interlocking shareholding), German companies are protected by their workers (through co-determination).
Even supposedly similar varieties of capitalism, for example Swedish and German, have important differences. German workers are represented through the co-determination system and through industry-level trade unions, while Swedish workers are represented by a centralised trade union (the Swedish Trade Union Confederation), which engages in centralised wage bargaining with the centralised employers' association (the Confederation of Swedish Enterprise).
Unlike in Germany, where concentrated corporate ownership has been deliberately destroyed, Sweden has arguably the most concentrated corporate ownership in the world. One family – the Wallenbergs – possesses controlling stakes (usually defined as over 20% of voting shares) in most of the key companies in the Swedish economy, including ABB, Ericsson, Electrolux, Saab, SEB and SKF. Some estimate that the Wallenberg companies produce a third of Swedish national output. Despite this, Sweden has built one of the most egalitarian societies in the world because of its large, and largely effective, welfare state.
And then there are hybrids that defy definition: China, with its large socialist legacy, is an obvious case, but Singapore is another, even more interesting, example. Singapore is usually touted as the model student of free-market capitalism, given its free-trade policy and welcoming attitude towards multinational companies. Yet in other ways it is a very socialist country. All land is owned by the government, 85% of housing is supplied by the government-owned housing corporation, and a staggering 22% of national output is produced by state-owned enterprises. (The international average is around 10%.) Would you say that Singapore is capitalist or socialist?
When it is so diverse, criticising capitalism is not very meaningful. What you have to change to improve the Swedish or the Japanese capitalist systems is very different from what you should do for the British one.
In Britain, as already physically identified by the Occupy movement, it is clear the key reforms should be made in the City of London. The fact that the Occupy movement does not have an agreed list of reforms should not be used as an excuse not to engage with it. I'm told there is an economics committee working on it and, more importantly, there are already many financial reform proposals floating around, often supported by very "establishment" figures like Adair Turner, the Financial Services Authority chairman, George Soros, the Open Society Foundations chairman, and Andy Haldane, the Bank of England's executive director for financial stability.
By labelling the Occupy movement "anti-capitalist", those who do not want reforms have been able to avoid the real debate. This has to stop. It is time we use the Occupy movement as the catalyst for a serious debate on alternative institutional arrangements that will make British (or for that matter, any other) capitalism better for the majority of people.
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