Competitive And Fair Markets Are Essential For Corporate Legitimacy

Montek Singh Ahluwalia

People look at the corporate sector with suspicion. We need to change this perception as the sector is set to expand in future.

Economic reforms are aimed at giving freer play to the private sector to respond to market signals, and this is expected to lead to greater efficiency and improved economic performance. The private sector in this context is not just the large corporate houses. It includes farmers, informal sector enterprises and small and medium scale enterprises. Liberalisation vis-a-vis smaller producers is almost universally welcomed, but when extended to the larger corporate sector it attracts suspicion.

Suspicion of business is not new. Adam Smith, the founder of modern market economics, famously said, “People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices”. Nor is such suspicion unique to India. The financial crisis of 2008 in the US produced a backlash against large financial corporations generating widespread anger against “Wall Street Greed”. Most recently, Pope Francis I said, “While the earnings of a minority are growing exponentially, so too is the gap separating the majority from the prosperity enjoyed by the happy few. This imbalance is the result of ideologies that defend the absolute autonomy of the market place and financial speculation.”

These developments suggest that market economics and large business houses face serious image problems. Since the scale and visibility of the corporate sector in India is set to expand in future, there is need to reflect on how its image as a “good citizen” in the economy can be improved.

I would list seven major areas where the corporate sector and the government need to act:

1. Observing Laws and Regulations

First, the public must be convinced that while economic reforms have given the corporate sector much greater freedom, this freedom is circumscribed by laws and regulations that promote and protect public welfare. Relevant laws include those governing worker safety and work conditions, those enforcing environment protection and pollution control and, of course, laws relating to taxation which ensure that some part of the income earned by the corporate sector flows to the exchequer to finance public services.

The mere existence of laws is obviously not enough. Much of the distrust which exists today derives from the widespread perception that large corporate entities are able to evade compliance. This problem can only be solved through effective enforcement. Unfortunately, it is also true that many of our laws involve excessive and often dysfunctional procedural requirements. This makes compliance difficult even for those wishing to comply, and it makes harassment and corruption easy for those so inclined. There is need for a major revamp.

Laws and regulations must be simplified and made transparent so they are easier to understand and procedures made much more transparent to minimise the scope for arbitrary decisions in the course of enforcement. Dispute resolution also needs to be made much faster. This may seem like an agenda for extending liberalisation and indeed it is: the laws need to be reformed in order to be effectively enforced.

2. Competitive Pressure

The social legitimacy of markets and large businesses would be greatly enhanced if markets are seen to be strongly competitive, creating an environment in which corporations can make profits only if they provide value to consumers. This is precisely what the economic reforms of 1991 sought to do. They eliminated detailed government control in areas such as the scale of investment of individual firms, the location of investment, the choice of technology and also the ability to use imported capital goods and inputs.

The earlier controls effectively prevented new entrants from challenging established incumbents and their removal was, therefore, not just a favour extended to the corporate sector. It was a strategic shift, subjecting it to much greater domestic competition. At the same time, external liberalisation increased the pressure of competition through imports and FDI. Those suspicious of markets should recognise that this part of the reforms has worked well. The combined effect of domestic and external competition has been to improve the quality and competitiveness of products available to the consumer.

However, as Raghuram Rajan pointed out in the Indian edition of his book Faultlines, the transformation was not complete. Natural resource sectors, such as spectrum, minerals and land remained subject to administrative direction. It is precisely in these areas that allegations of impropriety have surfaced. Fortunately, corrective steps have been taken for the future and both spectrum and minerals in future will be allocated by auction. Decisions taken earlier have been questioned and are under investigation. The law will take its course on these. But the decks have been cleared for future policy. Land is in the domain of the States and there is a strong case for State Governments evolving transparent methods of allocation of this scarce resource, including the basis on which change of land use is allowed.

3. Manipulating Markets

Large corporations are also suspect because of the perception that they can use market power to manipulate markets to their advantage. Mature market economies, therefore, have statutory regulators to guard against unfair competition. We have the Competition Commission, which was set up some years ago and is now fully operational. Regulation of competition is a technically complex area and the effectiveness of the new institution can only be determined over a period of time. However, its existence fills what would otherwise be an important gap in the architecture for a competitive economy. Those who perceive market manipulation and unfair trade practices in particular areas can now approach the Commission for redress, rather than clamour for government intervention to control private sector activity. The Commission has made a very good start by taking firm decisions in several important cases. As it gains experience, it will be seen as an important part of the architecture that ensures that markets are indeed fair.

4. Internal Corporate Governance

A fourth area where action can improve the image of the corporate sector relates to improvements in internal corporate governance, transparency in accounting practices, use of independent directors to exercise supervision over management and protection of minority shareholder rights. These issues become especially important as businesses grow from being family dominated private limited companies to listed corporations. Many of them remain dominated by promoter shareholders, who are in a strong position vis-à-vis other shareholders, and the rights of the latter need to be protected.

The need to expand access to equity capital will lead private limited companies to go public and ultimately to list on stock exchanges. Listing, in turn, forces greater transparency and subjects the company to SEBI guidelines, which include guidelines on independent directors. High quality financial audit is critical for ensuring any kind of transparency, both for shareholders and for lenders. In this respect, we will increasingly be under pressure to align our accounting standards with international standards. This process has already begun and should be accelerated.

5. Public Private Partnership

A fifth area where problems can arise relates to the role of the corporate sector in public private partnership (PPP) projects, which have become especially important for infrastructure development. India needs to invest a great deal more in infrastructure than has been done, if targets of high and inclusive growth are to be achieved. Infrastructure development has traditionally been the responsibility of the government, but the resources available with the public sector are limited and there are heavy demands on these resources from other priority sectors, such as health, education and various types of livelihood support in rural areas.

Recognising this problem, the government adopted a conscious policy of promoting infrastructure development through PPP. This involves private investment to develop infrastructure projects, many of which – roads, airports, power distribution companies, etc. – amount to a conferment of a limited monopoly on a private producer. The government effectively enters into a concession agreement with a private partner, which lays out the conditions under which the concession must operate. The government has to offer a possible capital subsidy for loss-making enterprises, or alternatively receive a revenue share, or other payment, when the venture is profitable. Both the subsidy and the revenue share should be determined by competitive bidding.

A large number of PPP projects have been started in areas such as roads, ports, power, airports etc., both by the Central government and the State governments. A recent World Bank report identified India as having the second-largest number of PPP projects in the world. However, as projects have proliferated, problems have also surfaced in implementation. These include delays in regulatory clearances, higher costs, lower than expected revenues, etc. Consumers have complained in some cases about the standards of service. There are demands from concessionaires in some cases for relaxation in the terms on which the projects were bid out. These problems clearly need to be addressed.

Complaints of consumers on service quality call for stricter monitoring of service standards and credible arrangements need to be set up for this purpose. Demands for post-award relaxation of terms to deal with unexpected problems pose special problems. Some relaxations may appear reasonable, as when clearances that should have been received much faster are delayed leading to higher costs, or when disputes are not resolved in time, or in circumstances of genuine force majeure.

However, relaxations relating to risks, which were clearly expected to be taken by the concessionaire, can be questioned. An unfavourable outcome compared to expectations does not automatically justify ‘post-award’ relaxation. It can easily invite allegations of undue favouritism or cronyism. It also raises the possibility of challenge by bidders who lost the bid, on the grounds that had they known such relaxations would be allowed they would have bid higher. The government is currently considering ways of resolving these problems in a transparent manner. The corporate sector should also contribute to building a consensus on this issue.

The important point made in the Plan document is that public private partnership must be seen as ways of putting private money into public projects, not public money into private projects. Unless the policy framework reflects this objective, suspicion will continue.

6. Financing New Entrants

For markets to be seen to be genuinely competitive, the system must facilitate new entry so that incumbents are constantly challenged by potential competitors. This depends critically on the quality of financial intermediation, including especially the availability of venture capital and the existence of private equity firms. This is an area where we have been lacking, but a good start has been made in recent years.

Financial sector reforms, with an emphasis on increasing access not just for the poor as in financial inclusion but much more broadly, is absolutely necessary if markets are truly to be seen as open to competition by new entrants.

Financial sector reforms are not the same thing as uncritical financial liberalisation. It is well known that the banking sector is characterised by asymmetries of information and moral hazard and, as a result, needs to be regulated. This was the accepted rule until relatively recently, when the United States embarked on extensive financial liberalisation, and a shift to “light touch regulation”. It was expected that this would lead to more efficient financial intermediation and, therefore, better economic performance. We know, it didn’t! Instead, it led to an inordinate amount of risk taking, which led to the financial crisis of 2008, which, in turn, imposed huge costs on many industrialised economies, including severe recession and loss of employment impacting very adversely on the lower income groups.

Critics of market economics were quick to project the 2008 financial crisis as a “terminal crisis” of capitalism. This was, of course, hyperbole. One is reminded of Mark Twain’s comment, “reports of my death are somewhat exaggerated!” Putting the problem in perspective, one must recognise that the post-2008 backlash in the US was not against the corporate sector generally, but only against the financial sector. Nevertheless, it is relevant to ask whether we should rethink or slow down our own pace of financial liberalisation? Personally, I do not share this view. The industrialised countries certainly liberalised excessively and are now reversing some of their ill-advised steps. We, on the other hand, have been at the other end of the spectrum. It can be said that we have not liberalised enough. We would therefore be right to continue the process of financial liberalisation, albeit, at a cautious and gradual pace.

7. Corporate Philanthropy

Finally, the corporate sector can improve its social standing by engaging in philanthropy as part of corporate social responsibility. This has now been given statutory recognition under the new Companies Act, which prescribes that corporations above a certain size should devote 2 per cent of their profits to corporate social responsibility activities. Corporate philanthropy is important, but it is only the icing on the cake of what needs to be done to give broader social legitimacy to the corporate sector. Tata Steel used to run a charming advertisement on the company’s philanthropic activity, which amusingly ended with the announcement, “We also produce steel”. But of course they knew very well that it is how well they produce steel, and how cheaply and how they comply with laws that will determine their social standing.

8. CONCLUSION

To summarise, in an atmosphere of distrust it is important to create an environment in which the corporate sector can claim social legitimacy. This requires credible progress in all the seven items listed above. Together they create an economic environment in which corporations can pursue their corporate objectives in terms of profit or market share, or some combination of the two, and yet serve a social purpose. More generally, the social legitimacy of the economic system will depend on whether the overall growth process is seen to bring a sufficiently wide spread of benefits to the population, especially the youth who are the most aspirational.

Any prolonged economic downturn or disappointment on inclusiveness, whether due to failures of the corporate sector or otherwise, will produce disillusionment and a search for someone to blame. If this happens, it should not surprise us that the corporate sector, which is rightly perceived as the privileged modern sector of the economy and also as being both powerful and influential, will come in for more than its fair share of criticism. On the other hand, success in achieving rapid and inclusive growth, together with progress in the seven specific areas listed above, will create an environment in which the corporate sector is much more likely to be accepted, and indeed even appreciated, for the critical role it must play in the economy.

Montek Singh Ahluwalia is Deputy Chairman, Planning Commission

(The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of INCLUSION. Comments are welcome at info@skoch.in)

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