Panel 4: Globalization and Effects on Labor and Financial Markets Tuesday November 15 (2:30-3:45)

1. 12th Symposium on Development and Social Transformation Panel 4: Globalization and Effects on Labor and Financial MarketsTuesday November 15 (2:30-3:45)

2. 12th Symposium on Development and Social Transformation Panel 4: Globalization and Effects on Labor and Financial Markets Regulation of Financial Conglomerates—An International PerspectiveBidisha Chaudhuri

3. What are financial conglomerates? • They are entities/financial institutions that offer a range of financial services – (i) traditional banking operations; (ii) selling insurance products; (iii) carrying out securities business etc. • Combining at least two of the above areas of financial services

4. Structure of Financial Conglomerates • Mainly three organizational ways of combining banking, securities business and insurance activities – - in-house ; i.e. different departments of a bank conducting different functions – they are fully integrated within the entity; - through a subsidiary of the bank controlled by the bank - through a subsidiary of the bank holding company

5. Growth of financial conglomerates • Deregulation initiatives in financial centres – e.g. (i) the LSE amended its rules to allow acquisition of its members firms by banks etc. (ii) US Congress passed the Gramm-Leach-Bliley Act in November 1999 • Improved information technology, financial innovations have reduced proportion of interest income as a proportion of financial earnings • Cost advantages of conglomeration arising from economies of scale and scope

6. Regulatory issues in case of financial conglomerates • Appropriate corporate structure and business relationship between the entities i.e. to what extent risk is to be segregated by separate capital requirements etc. • Extent to which supervisory regime should be institutional or functional oriented since this choice affect competition among entities which provide similar services • The institutional structure of financial regulation/ supervision and the degree to which the supervision be consolidated

7. What has been the policy response • Response of national authorities has been divergent • US has adopted a “functional” regulatory system for financial services ensuring regulatory oversight is imposed in each sector to the extent necessary • Corporate structure preferred for a conglomerate in the US is that of a holding company model with proper “firewalls” so that risk is segregated and conflicts of interests and contagion is reduced

8. What has been the policy response (contd.) • Along with functional supervision, conglomerates are also required to be regulated at the holding company level. The Fed is the umbrella supervisor for bank holding companies; the SEC has statutory authority over investment holding companies • Regulation at the holding company level is through consolidated capital requirements, reporting requirements, coordination among functional regulators etc.

9. What has been the policy response (contd.) • US regulators’ policies also takes into account the rules established by international agencies like BCBS and IOSCO • In many countries the policy response has been to consolidate regulatory structures e.g. in the UK, the FSA is the single statutory regulator which regulates most financial services’ intermediaries, firms etc. for securities business, deposit taking, insurance etc. • There have been efforts to harmonize supervision across national boundaries – EU’s Financial Conglomerates Directive

10. What is the position in India? • Emergence of conglomerates (entities engaged in at least two out of the three activities – banking, insurance, securities business) is recent in India • Like the US, India has a multiple regulatory structure, following “functional” supervision • As of now there are no requirement for consolidation of accounts of group entities under the accounting principles (other than banks)

11. Policy Implications for India • There is no settled model of regulating financial conglomerates, approaches have been varied and still evolving • Functional supervision to continue since basically each financial service has different characteristics • However, there is an appreciation of the limitations of the segmental approach to supervision in addressing potential risks associated with conglomeration

12. Policy Implications for India (Contd.) • Focused supervision of conglomerates within the sectoral regulatory framework through enhanced inter-regulatory coordination capturing intra-group transactions, exposures etc. • Formalising a mechanism for inter-regulatory exchange of information through consolidated capital requirements, reporting requirements etc.

13. 12th Symposium on Development and Social Transformation Panel 4: Globalization and Effects on Labor and Financial Markets Corporation Disclosure Policy – Its Impact on US Financial MarketsP. Pani Prasad

14. Collapse of Corporations • LTCM collapse in 1998 caused about $ 3 billion capital loss • Enron restates its earnings by $ 2 billion, goes bankrupt on Dec’02, 2001 • WorldCom restates revenues by $ 7 billion • Average American family lost - $ 3740 in the period of 5 years (1997 – 2002)* due to mutual Funds alone *Dodd. R (2004) Financial Policy Forum

15. Wash Trades – Enron Case Bank GAS SPE-2 SPE Sell GAS (forward) Fixed Maturity Payment Float Adjustment Pay for GAS (forward) Loan Enron Source: Keith, Northcut, Zmijewski (2002)

16. Other Types of Frauds • Financial Adventurism - LTCM • Too much reliance on price prediction models • High risk Strategy • Account Manipulations – WorldCom • Account Period Irregularities – Computer Associates • Swap Mergers – Many DOTCOM companies • Embezzlement – Tyco Corporation Source: Bailey (2003) Economics of Financial Markets

17. Eagerness to show Higher Profits Management Pay linked to Profits Voiceless Share holders Complacent Board, Auditors Accountability Issues of Management Underlying Reasons Principal Share holders Fin. Inst Proxy Board of Directors Agent Management Operations Company Source: Demirag (2003)

18. Evolving Policy • Civil Liabilities against frauds – 1933 • Shareholder resolutions – 1942 • Mandatory audit committees – 1978 • Drive for separation of Chairman & CEO posts – 1992 • Voluntary action by Stock Exchanges – Blue Ribbon Committee - 1999 • Sarbanes Oxley Act of Board overhaul – 2002 • Director’s Independence – 2003

19. Company Law Mandatory for CEO, CFO to certify the financial statements Independent directors majority Independence of Audit committees Clear disclosure procedures Formation of Internal Control Procedures Attorney supervision Sarbanes Oxley Act Institutions • Formation of Public company Accounting Oversight Board as monitoring agency for audit firms • Criminal penalties for misconduct / violations • Whistle blower Protection • Creation of Legal Board under SEC for evaluation

20. Blue Ribbon committee • NYSE, NASD sponsored committee for voluntary adoption of recommendations. • Consensus model of governance • All listed companies should • Audit committee formation and its independence • Adequacy of Committee’s Charter • Director Independence disclosure • Financial literacy for directors

21. Impact of Sarbanes Oxley Act • Initiation of Criminal Proceedings against erring people • Many companies, Audit firms have started complying to the norms • No. of cases of Earnings Restatement has reduced* * Cohen, Dey, Lys (2004)

22. Learning for India • 99.9% of Indian Private companies are family owned businesses • Insider Trading, Embezzlement are frequent • Necessity of Board Independence • Regulate Derivatives market against wash trades

23. 12th Symposium on Development and Social Transformation Panel 4: Globalization and Effects on Labor and Financial Markets Globalization and Its Impact on U.S. LaborRajat Subhra Biswas

24. Background • Globalization – a fiercely debated issue. • Unprecedented pace of USA’s increased global engagements in the last three decades. • Global experience - declining tariffs, trade and communication costs and rapid changes in technology.

25. American Experience • Widespread changes in economic environment. 1.Breakdown of mega conglomerates and vertically integrated production process. 2.Increased application of ICT. 3.Deregulation and rightsizing. 4.Changes in IPR and increased product and process innovation.

26. Contd…. • Secular growth in productivity and American standards of living till 2003. • Growth in productivity in majority of sectors. • 0.5% to 1.0% per year growth in American household’s (median) income. • Increasing inequality in income within and across categories of population.

27. Contd…. • Impact of globalization - difficult to measure. • Globalization simultaneously influences technological and organizational changes - all three forces reinforce each other. • Latest research consensus - globalization has disproportionately favored American labor with higher skills, education and mobility compared to their less endowed compatriots. • Modest rewards for those willing to engage globally. • More costs than benefits to relatively insular sections.

28. Findings of Lewis and Richardson (2001) • Globally engaged American firms, workers and communities enjoy significant advantages compared to their identical ‘twins’. • Differences in productivity, growth rates, wages and job stability as high as up to 30%. • Difference is not limited to manufacturing sector alone - much more diverse and multi-dimensional. • Benefits accruing out of global linkages through exports, investments, imports, outsourcing and technology flow hang together.

29. Some interestingstatistics • American exporting plants continuously grow .5% to 1.5% than their insular ‘twins’. • They seem to enjoy more than 1.5% lower annual plant closure rates. • Globally engaged services firms enjoy up to 2.0% faster growth rate per year. Even only importing firms enjoy the advantage. • Plants with equity link to American or foreign MNCs enjoy 2.0% to 4.0% faster productivity growth per year.

30. Contd… • Equity linked plants to American or foreign MNCs absorb 27% to 31% more technologies. • Worker wages are 10 % to 11% higher at plants that export, 2.5% to 7.0% higher at plants with equity links to MNCs compared to their insular ‘twins’. • In American services wages are 6.0% higher in globally linked enterprises. The same is even higher in high technology areas.

31. Therefore….. • Globally engaged plants and firms usually grow faster and fail less often than their comparable ‘twins’. • Over time, with better sustainability their market share in respective industry rises and impacts overall industry productivity. HOWEVER • Where technology is standardized, head-on competition from low wage countries is quite fatal for American industry.

32. Contd….. • Competitive burdens, however, get significantly reduced for those plants or firms that become capital intensive or upgrade their technology or product line or workers’ education and training-implying increased productivity. • Increased global linkages ensure global cross penetration of markets and reduces the residual demand for lower productivity firms forcing the least productive to exit the industry. • But some global linkages have been detrimental to the prospects of a large number of American workers

33. Contd…. • Labor productivity in America has increased considerably due to increased imports of intermediate goods. • Heuther and Richardson’s (2001) research on increasing imported input intensity relative to employment from 1989 to 2000 shows that a third of 20.55% growth of GDP per worker actually took place through import of intermediate goods.

34. Contd… • Direct head to head competition due to globalization has hit less productive manufacturing and services sectors. • Evidences of increased dislocation of low productive American work force is evident. • Modest gains for typical middle class Americans. • Lower middle class American workers have often suffered due to low skill and mobility. • Evidence of increasing popular backlash against further American global integration. • 50% or more voters oppose such initiatives.

35. Contd… • Americans with average skills, disproportionately women and blue-collar workers and insular communities have not gained. • Evidences of a globally-induced deunionization has been taking place in America – definitely not a good trend. • Unionists with relatively lower skills and education seem to have been left out in this great churning process.

36. Required Policy Initiatives • American policies should ideally empower the less endowed labor. It should ideally build capability and not just compensate the loss. • Worker empowerment should entail enhanced mobility ,adaptability and educational objectives(eg, literacy, ICT capability, job search facilitation, transportability of health and pension benefits, language and cultural training). • The policy support should be increasingly worker owned and portable i.e. less and less attached to a worker’s current employer, industry or a community.

37. Contd…. • Employers and unions in partnership with insurance firms and governments should develop and manage new insurance markets for worker opportunity and security. • Not-for-profit insurance firms, especially those organized in the principles of ‘mutual’ companies and cooperatives may supply new worker oriented insurance services. • Giving firms incentives (tax concessions or tax levies on payrolls reimbursed) to train their employees. • Voluntary supplement to conventional unemployment insurance as a public-private joint venture.

38. 12th Symposium on Development and Social Transformation Panel 4: Globalization and Effects on Labor and Financial Markets East Asian Financial Crisis: Issues and Policy Perspectives for IndiaRaman Kant Garg

39. India and East Asian Nations • East Asian crisis has important policy lessons for India as there are interesting parallels • East Asian Nations comprising Korea, Thailand, Malaysia and other ASEAN nations experienced strong economic growth for more than two decades before the crisis in 1997. • Consistent High Growth, low inflation, rising exports, high returns on capital • India is also experiencing strong economic growth since 1991 - growth rate of more than 6% - low inflation - comfortable foreign exchange reserves - stable exchange rate, rising exports

40. Onset of Crisis • In the presence of strong pull factors, these nations attracted huge capital inflows • These large flows had three negative effects on these economies -pressure on prices with bubble in real estate prices -currency appreciation affecting export competitiveness -large increase in domestic bank lending • Due to these negative perceptions, there was sudden outflow of funds from these countries plunging these nations into crisis leading to contraction of these economies along with sharp currency depreciation

41. Causes of Crisis • Different authors have emphasized different reasons for the crisis- -declining returns on investment, bad banking, Misguided macroeconomic management, Unsound fundaments, self fulfilling prophecies, financial under regulation and speculation • Overinvestment, financial liberalization, large foreign debt (especially in short-term liabilities), and the “herding” behavior in foreign capital and currency markets definitely played important role

42. Main Lessons • Financial liberalization only after achieving macroeconomic stability, trade liberalization and solid financial systems. • Domestic financial deregulation in a context of inadequate supervision and prudential regulation is a recipe for increased vulnerability • Financial opening before establishing a sound domestic financial system is prone to render large vulnerabilities • The policy aim to encourage long term flow of foreign funds and discourage short term, potentially reversible flows through appropriate policy intervention like some kind of Tobin Tax system or outright supervision.

43. Implication for India • These lessons have important policy implications for India • On the back of successful economic reforms, India has also been able to attract strong capital flows. • Portfolio and FDI flows have exceeded USD 30 billions during 2003-05

44. Indian Financial System • A good financial system since 1947 • Nationalization of Banks in 1969 • Concerted efforts to strengthen Indian banking system in 90’s as per Narsimham Committee recommendations- rationalization of SLR, CRR requirement, market determined Interest rates, risk based asset classification, capital adequacy norms • Roadmap for capital account convertibility as per Tarapore Committee- norms for Gross fiscal deficit, inflation, current account deficit, Gross NPAs of banks

45. Policy Issues • The agenda for domestic financial sector still incomplete -ownership of banks, merger of weak banks, efficiency of banking system • Even other conditions for full liberalization of capital flows far from satisfactory- high Gross Fiscal deficit, High NPAs, though inflation and current account comfortable • In spite of recognition of potential benefits from liberal capital flows, there is a strong case for cautious liberalization of capital flow

46. 12th Symposium on Development and Social Transformation Panel 4: Globalization and Effects on Labor and Financial Markets Tuesday, November 15 (2:30- 3:45)