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

Panel 4: Globalization and Effects on Labor and Financial Markets

Tuesday November 15 (2:30-3:45)

12th Symposium onDevelopment and Social Transformation

Regulation of Financial Conglomerates—An International Perspective

Bidisha Chaudhuri



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

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

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

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

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

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.

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

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)

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

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.

Corporation Disclosure Policy – Its Impact on US Financial Markets

P. Pani Prasad



*Dodd. R (2004) Financial Policy Forum

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

Source: Keith, Northcut, Zmijewski (2002)

Wash Trades – Enron Case

Enron

Bank

SPESPE-2

Pay

for G

AS

(for

war

d)

Sel

l GA

S (f

orw

ard)

Loan

GA

S

Floa

t Adj

ustm

ent

Fixe

d M

atur

ity P

aym

ent

Source: Bailey (2003) Economics of Financial Markets

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: Demirag (2003)

Underlying Reasons Eagerness to show

Higher Profits Management Pay

linked to Profits Voiceless Share

holders Complacent Board,

Auditors Accountability Issues

of Management

Share holders

Fin. Inst

Board of Directors

Management

Company

Principal

Proxy

Agent

Operations

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

Sarbanes Oxley ActInstitutions

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

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

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

* Cohen, Dey, Lys (2004)

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*

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

Globalization and Its Impact on U.S. Labor

Rajat Subhra Biswas



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.

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.

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.

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.

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.

Some interesting statistics 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.

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.

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.

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

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.

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.

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.

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.

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.

East Asian Financial Crisis: Issues and Policy Perspectives for India

Raman Kant Garg



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

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

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

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.

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

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

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


Tuesday, November 15 (2:30- 3:45)

Bidisha Chaudhuri Regulation of Financial Conglomerates

P. Pani Prasad Corporation Disclosure Policy

Rajat Subhra Biswas Globalization and Its Impact on U.S. Labor

Raman Kant Garg East Asian Financial Crisis


Documents

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