Column : Phony capitalism

Written by Bibek Debroy | Updated: Jan 13 2009, 04:01am hrs
The novelist William Makepeace Thackeray was born in Calcutta and his father worked for British East India Company. Should we read something into this The word capitalism was first used by Thackeray, though not in the sense of a production system. That usage is due to Werner Sombart and notwithstanding critiques of capitalism (not just from Left), its the most efficient system for resource allocation. Alternatives are worse, reminiscent of what Churchill said about democracy. It has been said that democracy is the worst form of government except all the others that have been tried. What is a textbook definition of capitalism Means of production are privately owned. Production, consumption and distribution decisions are taken by market through price signals and there is minimal intervention by government. In establishing superiority of the market, one invokes perfect competition, with stringent assumptions rarely satisfied. Is there really free entry or exit Does everyone have access to complete and perfect information Dont unfair and restrictive business practices exist When has one actually seen a world with a large number of undifferentiated and homogenous producers Isnt the world one of monopolies and oligopolies What happens if there are increasing returns to scale

Theory requires approximations and indeed, theoretically, capitalism is the best system possible. However, stringent assumptions required to establish this do smack of fiction. (In all fairness, Economics Nobel Prizes have been awarded to those who established this superiority and also to those who highlighted warts and blemishes) As taught, theory describes what historians would call merchant capitalism, though after the 1929 Wall Street crash and after World War II, there has been plenty of research into the modern corporation. Together with double-entry book-keeping, the concept of limited liability has probably done the most towards development of modern capitalism and one is therefore playing around with someone elses capital, not ones own. Fancy words like corporate governance arent needed to understand there might be conflicts of interest between the chief executive officer, board of directors, management and share-holders, with additional conflicts between institutional investors (pension funds, hedge funds, mutual funds, insurance companies, banks, brokers) and small investors. It wasnt that many years ago that Enron was described as Americas most innovative company or one of the best to work for. Arthur Andersen was a respectable accounting and consultancy firm. True, Kenneth Lay would have been imprisoned had he not died of a heart attack. And true, the Enron accounting fraud was eventually uncovered.

But it went on undetected for several years and Enron isnt the only one. One can add Worldcom, Adelphia Communications Corporation, Global Crossing, Tyco,

Peregrine Systems, Fannie Mae and Freddie Mac to the list, not to forget Bernard Madoff. CEO excesses (perks, stock options, size of golden handshakes) in the US receive a lot of attention. However, countervailing pressures in the US are also greater. First, there are instances (IBM, Kodak, Honeywell) of CEO-removal because of shareholder intervention. Second, some institutional investors (California Public Employees Retirement System or CalPERS is the most obvious) have succeeded in improving corporate governance. Third, there has been legislative response, such as through the Sarbanes-Oxley Act of 2002, incorporating establishment of a Public Company Accounting Oversight Board. Given our own home-grown Satyam, thats indeed the point. Globalisation is also about greater and freer cross-border flow of ideas. Therefore, innovative worst-practices in accounting fraud are also easily learnt. Can regulatory system adjust as fast If one is making the point that one shouldnt tar all Indian companies with the Satyam brush, thats a valid and limited point. But as with Enron, will it lead to greater regulatory oversight, especially on accounting and auditing

There is an additional point too. There have been straws in the wind earlier. In 2006, World Bank informed the US Justice Department that Satyam might have been involved in bribery and in 2008, suspended Satyam from bidding in future contracts. And even earlier, in a dispute going back to 1997-98, a UK Appeals Court found Satyam guilty of fraud, forgery and intellectual property right violations. Corporate integrity isnt an issue limited to accounting fraud alone. Why wasnt this information disseminated widely To paraphrase from Ramalinga Rajus letter, the tiger was being ridden for a long time, without attempting to get off, for fear of being eaten. None of the board members, past or present, had any knowledge of the situation in which the company is placed.

The expression crony capitalism is used for nexuses between government and business. This isnt crony capitalism, but phony capitalism, with complete external and internal regulatory collapse. The board doesnt know. External auditors dont know. Internal auditors dont know. Had there not been an acquisition deal with Maytas, when would we have known For small investors, there is therefore a credibility issue about the system and future liberalisation. Heart attacks apart, the

US does punish mis-governance.

Do we

The author is a noted economist