Dealing with the Too-Big-to-Fail

Can we hope that, in dealing with the  crisis in financial markets, US government has dodged a bullet without inadvertently lighting the fuse to fire a canon ball?

Bear Stearns was judged to be too-big-to-fail because the hard-to-predict network effects of such a failure would have been potentially devastating to the US and possibly the global economy. Therefore, the government arranged a takeover of Bear Stearns by J.P. Morgan Chase and subsidized it with taxpayer money and guarantees.

Having swallowed Bear Stearns, J.P. Morgan has grown. If either of them was too-big-to-fail then, the consequences of letting the combined entity fail would be even less acceptable.

The wizards who run and oversee the financial system permitted creation and growth of, and risk taking by private financial institutions which they knew could fail, but could not be allowed to. Then, at the brink of failure, they combined them into larger institutions subject to the same risk and logic, only at a bigger scale. This is postponing the day of reckoning with compound interest.

After a year of crisis, the world financial system is rapidly consolidating into a handful of US, European and Asian giants such as Bank of America and J.P. Morgan Chase.  In what sense, and for how long will these firms and the economy remain private and capitalistic if they can walk away with their profits, and dump their bad bets  on taxpayers?

The financial private sector can be protected from progressive nationalization by placing limits on the size of firms. Too-big-to-fail, instead of absolute size, can serve as a natural bound on how far private financial institutions are allowed by regulators to grow through organic growth, mergers or acquisitions.

The traditional rationale for intervening in the size of firms has been antitrust "to limit power and promote competition in product markets to promote economic efficiency. Government bailouts of giant financial institutions in order to safeguard the domestic and the global economy suggest another new criterion for reviewing proposed mergers and acquisitions: Will a proposed merger or acquisition create an entity which the government (US Federal Reserve System, US Treasury, European Union, or national governments in Europe as the case may be) will feel compelled to save from failure for the fear of its domino effects? If the answer to this question is yes, the proposal should be disallowed to reduce the chances that the government may have to intervene at some time in the future to save the larger combined firm.

Under this arrangement, the Federal Reserve and Treasury will review all merger and acquisition proposals to certify that they will not result in an entity that is too big to fail.

Since firms could also grow organically, the legislature could require an annual certification from the Fed and Treasury that no firm in the financial sector (defined as banking, investment banking, insurance, mutual, hedge and pension funds, and brokerage) is too big to fail. If a firm is found to have crossed that threshold, it would be required to divest itself in the manner of antitrust enforcement.

Will this leave the European and Asian giants free to crush the American pygmies in the global market place? EU, Japan and China will have to decide for themselves if adopting a similar policy to save the private financial institutions, and reaping the benefits of their efficiency, is in their best interest.

Placing the responsibility of such reviews on the Fed and the Treasury will create an incentive compatible system for these regulators; they would not be able to rush to Congress and the public exchequer when a financial firm is about to go belly up. US Congress will soon consider legislation to commit public funds to save the financial sector. This is also the only time the legislation to limit the size of financial firms can possibly be passed as a part of a rescue package. Ones the public money hss been committed, pressures from the industry lobby will make it all but impossible to achieve this end.

The short-term solutions to the current financial crisis carry the risk of setting us up for even more severe problems later. The time for establishing a mechanism to limit on the size of financial firms to protect the financial system and the public exchequer is now.

Renovating India's Higher Education

Yash  Pal Committee Report on Higher Education in India: A Review

The Committee to Advise on Renovation and Rejuvenation of Higher Education (the Yash Pal Committee) has submitted its report to the Union Minister of Education on June 23, 2009. Given the wide-spread concerns about the current state and trends in India's higher education system, the report could not come at a better time when the new government may want to take major steps to improve higher education.

The Report, written by a panel of eminent educationists, identifies some major weaknesses of the current system that include disciplinary fragmentation and isolation, separation of instruction from exploration, proliferation of single-discipline institutes, erosion of autonomy and democratic spirit of freedom of thought, unattractiveness of careers in education to the talented youth, excessive commercialization, uneven accessibility, poor financing, governance and management, and excessive and inappropriate regulation of colleges and universities. Political pressures and control from the outside find internal resonance in the interested parties within these institutions, often generating resource and attention consuming litigation and many conflicts which are unrelated to their educational mission.

The Committee proposes a bold structural move in creation of a new constitutional body, National Commission for Higher Education and Research (NCHER), to takeover the responsibilities of the Universities Grants Commission, the All India Council for Technical Education, and all educational aspects of 13 professional regulatory bodies such as the Bar Council of India. The Commission will be directly responsible to the Parliament, along the lines of the National Election Commission, to protect it from political interference.

The Commission will serve as the apex regulatory body in the field of higher education in India and seek to redefine the higher education through (1) developing a vision of higher education as reflected in framework for curricula, university benchmarks, international comparisons, educational policies including costs and pricing; (2) advising the union and state governments, (3) creating norms, processes and structures for entry, accreditation, and exit of institutions and programs; (4) developing sources and mechanisms for funding; (5) promote effective and transparent governance; (6) creating a national database on higher education; (7) promoting an environment to attract talented youth to education and research; (8) creating processes for richer environment for learning and exploration through softer interaction among students and teachers; (9) finding ways of gradually freeing the universities from the administrative burdens of affiliated colleges; and (10) reporting annually to the Parliament on the state of higher education.

This three paragraph summary does not do justice to the grand vision of the future of India's higher education that motivates this 94-page document. Every system, no matter how inefficient and dysfunctional, has plenty of beneficiaries. Threatened by proposals for reform, they stand ready with their inside knowledge to rip the reform proposals apart by line, paragraph and chapter. Where is the evidence for this? Prove it first. But as Samuel Johnson said: Nothing will ever be attempted if all possible objections must first be removed.  The Government of India has a clear choice ahead "act now, or spend its five-year term dealing with the objections.

The Report can, however, be improved by strengthening some of its recommendations. It underplays the severity of shortage of talent in higher education and research and the weakness and consequences of the for-profit "investment" model of higher education for quality and innovation. It hardly mentions the responsibility of the business corporation in supporting higher education and does not adequately promote the benefits of regulatory competition in the vast Indian system. Let us consider each of these issues briefly.

Many of the ills of Indian higher education can be linked to the quality of talent in the field. A significant number of the best minds of each year's graduates will have to be attracted to instruction and research for the Committee's recommendations to have any chance of success. Perhaps the President of India could congratulate the top 1 percent of each year's undergraduate class through a letter, letting them know that as exceptional people, they are invited to pursue post-graduate studies with a government fellowship in any field at a university (in India or abroad) that admits them at any time during the five years following graduation. If even a small proportion of such talented graduates accept this offer of a Presidential Fellowship, we shall have significantly increased the flow of talent into education within a decade or so.

In addition to educating some 40 lakh new graduates, Indian colleges and universities also must also educate about 4 lakh new instructors each year. If undergraduate classroom is the wheat farm, the graduate program is its seed farm; whether we eat or starve tomorrow depends on the quality of grain saved as the seed. At present Indian universities grant some 17,000 PhD degrees annually across all fields and, in the judgment of many educators, of mixed quality. Graduate programs, like seed farms, are extremely expensive to run, and yield little revenue to motivate profit-making colleges. Profit-making companies do not invest in educating educators and exacerbate the problem in India. To create and sustain a good system of higher education, the Commission will have to have a "seed farm" division of its own to deal with the problem.

No university in the world has found a way of delivering quality higher education without government or charitable subsidy. Quality education is expensive, and anyone who can figure out a way of running a world class (or even average) university at profit deserves at least a Nobel Prize. Since none of the top 500 universities across the world is run without large subsidies, the source of widespread belief in India that investment by profit-seeking organizations "whether foreign or domestic "in higher education will help deliver quality education is a mystery. There is no such thing as commercially viable higher education beyond low-level vocational education.

While declining in relative importance, government employment is still important in India. Strict written definitions of qualifications for government jobs requiring specific subjects sustain the compartmentalization of education in universities. The Committee's recommendation on lowering the walls among the disciplines should be accompanied by greater flexibility in defining educational requirements for jobs and allowing greater role for judgment by the recruiting personnel for government.

The Committee's recognition of the diverse skills needed for management of various operations of universities calls for care in education, training and selection of administrators. Managing academic (programs, faculty recruitment and promotion, admissions, curriculum and budgeting), financial, facilities, personnel, government, community, governance, and fundraising operations of universities requires a diversity of skills. The NCHER would do well to help universities build such management capabilities and do appropriate succession planning. Improving the management of universities will help increase the chance of success in reaching the goal of university autonomy.

A great many institutions of secondary and higher education in India were created and are run well by charitable trusts. However, the same charitable trust has also become a veil for colleges run by operators who see them as little more than profit-making businesses. The Commission will have to make sure that the not-for-profit trusts are true to their legal charter and do not leak funds to their controlling parasites. Alumni of these institutions could be given a voice in helping the Commission evaluate the operations of colleges run by the trusts.

Finally, the proposed new structure of the Commission should have appropriate features to protect it from the conditions that led to failures of the structures is will replace. Monopoly regulatory power over higher education for a population of 1.15 billion presents a prima facie risk of getting mired again in inefficient procedures and rules. The Committee Report itself recognizes that one-size-fits-all regulation of higher education will not work. For this reason, the Government of India would be better advised to adopt a model of regulatory competition by creating not one but two, or perhaps three such commissions, each acting independently with jurisdiction over the entire country.  Absence of monopoly regulatory power will induce these commissions to compete, innovate by trying different models and ideas, allow experimentation, comparisons, imitation and rejection, and ultimately evolve a complex diverse matrix of institutions of higher education appropriate for a large fast developing country to support its ambitions to join countries of the first rank in the world.

Building Research Culture

The following article was published in the China Journal of Accounting Research, Vol 1. Issue 1, in December 2008.

Business school faculty and administrators in Asia often ask their foreign colleagues: Why won't your journals publish our research? What kind of research should we conduct in order to have the chance to have it published in international journals? This is no idle talk; these urgent and sincere questions arise in the face of impending promotion and tenure decisions under university or government rules calling for publication in international journals. Such external publications often are an important consideration in these decisions that are widely believed to make or break academic careers.

Rules requiring publication in international journals (and presentations at international conferences) as criteria for promotion have been promulgated by many universities and ministries of education in Asia. The intent is to introduce research cultures to old institutions which may not have such a tradition, or to build such a culture from the outset in new institutions. This is an admirable goal.

Trying to achieve this goal through international publication rules may serve the short term goal of selecting the qualified faculty, but not without paying a heavy price in the form of undermining the longer term goal of building an indigenous research culture to address the important problems of society.

In many emerging economies, there are few universities and even fewer business schools with a robust tradition of research. Some universities publish their in-house journals to disseminate the work of their own faculty without the benefit of independent evaluation of its quality. Sometimes, the evaluation processes that exist get closely entangled in interpersonal relationships. There may not be enough active scholars engaged in research in domestic universities who can be relied upon to conduct such evaluation.

Processes of international journals are hardly perfect, and there exist Asian journals that compete with the very best in the world. Still, on the whole, many more of the international journals have established themselves in their respective fields for decades. They are edited and refereed by renowned scholars, many of them pioneers in their fields. These editors and referees are unlikely to know most of the authors who live in other countries, and even if they did, their well- established processes can be relied upon to be reasonably free of favoritism and interpersonal conflicts. It is understandable that under such circumstances, educational administrators, eager to identify the research talent in their own faculties, would use publication in the better known international journals as a way to address the problem of objective evaluation of faculty research.

This strategy runs into several difficulties. First, the Asian countries are so large, with so many "and fast growing "universities and faculty that there is no way for the journals published in US or Europe to have enough space to publish more than a handful of papers originating in Asia. The strategy of outsourcing the task of assessing research conducted by thousands of Asian faculty to international journals is simply infeasible, especially for giants like China and India. They must bear the burden of devising their own solutions.

Second, even if space were not a constraint, international journals focus their attention on addressing the problems of the economies in which most of their readers reside. When a research article crosses an editor's desk, the first question the editor asks is if it is important and of interest to the journal's readers. Given that a considerable volume of business research is economy-specific, only a small fraction of articles from Asia are able to cross this importance-and-interesting hurdle at international journals. This perceived and real hurdle generates the questions mentioned at the outset.

Third, scholars faced at home with rules of promotion that call for international publications, and with the importance-interesting hurdle at the international journals, tend to turn away from addressing the research questions of their home economies toward the problems of societies in which their target journals are published. As much as they might try, most of Asian scholars have no comparative advantage in this task. What is worse, the scarce time and talent of these scholars get diverted away from addressing the important issues and pressing problems at home where their research might yield significant results and better policies. The policy of requiring international publications induces them to turn toward addressing unfamiliar problems of distant lands for the sole purpose of getting a publication or two so they can get promoted. This turns the very purpose of research on its head " instead of doing research in order to serve society, faculty start doing research so they can get it published, so they can get promoted and in turn be able to do more such research. One might reasonably ask: Why should a society, especially a developing one, pay for the time and resources spent on this activity?

Fourth, Asian universities' culture of research and innovation suffers under the heavy burden of hierarchy and rank. It is difficult to claim credit for better ideas if the older folks whose ideas are being improved upon hold the veto power and they are not reluctant to exercise it. Workshops in which people present their work, answer questions and face criticism are not quite as frank and open in Asia. The processes to add rigorous reasoning, innovation, and cross-disciplinary insights is weak. Independence of the editing and refereeing processes also shows gaps when compared with international standards. most important, separating interpersonal relationship from criticism of research is harder to do in Asia. developing research culture in Asia calls for working on these aspects of universities and their faculties by changing their shared expectations.

There is no better way of building research cultures in Asia than to develop healthy authorship, workshop, refereeing and editorial processes of the indigenous journals. Unfortunately, the international publication requirement undermines this fundamental goal. It not only diverts the best minds to try to publish abroad, it undercuts the attempts to develop good journals and research culture at home.

Educational administrators and policy makers in Asia have to address a basic policy dilemma. Should they continue to focus their attention on the immediate goal of making sure that the faculty who get promoted or appointed to senior positions have scholarly accomplishments comparable to elsewhere in the world? But pursuing this worthy short term goal too vigorously undermines the progress toward building an indigenous research culture through domestic processes and journals. If building domestic research culture is also an important goal, how can the two to be balanced?

While there are no fixed formulas for building a culture of any kind, much less of research, a few steps taken under judicious (not bureaucratic) supervision may help. de-emphasizing the power of hierarchy and rank over the creative younger faculty, especially when those in power are not themselves productive researchers, could be a first step. Innovation itself, as reflected in their work and activities, could be considered a plus in faculty assessment. Starting new kinds of journals with radical new ideas would be a kind of innovation that could receive special attention. Any steps that will increase the mobility of faculty across educational and research institutions would be helpful by creating an external market for research talent. Lowering the cost of transactions that involve moving from one institution will prevent faculty from getting trapped in institutions whose needs do not match their abilities and talents. Allowing greater discretion and subjectivity in promotion and tenure decisions may also help, although the immediate question of favoritism comes to mind. If the transactions cost of moving across institutions can be reduced, favoritism can be counterbalanced, and the mistakes made by the subjective processes of one institution can be checked " if not corrected by " the market place for talent. Overall, most systems of higher education in Asia treat faculty as just another civil service which can be managed through the standard bureaucratic procedures. Obviously they can be, and are, managed in this manner. But then they cannot be expected to produce radical innovation that a research culture calls for, and they don't.

In the recent half-a-century, many Asian economies have achieved rapid advancements in many fields that they themselves had earlier thought were beyond their ability due to presumed cultural barriers. The fact is that human beings are essentially the same everywhere; the differences in their achievements are rooted in what they believe about themselves, and expect from one another. In the recent decades, American and European scholars have made rapid advances in the level of scholarship in many fields. Asian research need not be an exception.