As loathe as I am to admit it, jobs in finance look very sexy on paper. Managing a small business involves running to OfficeMax, the post office, or the bank – nothing that will grab one’s attention. There are no million dollar deals, or headlines in the newspaper announcing the bonus levels of other office managers. During a lunch break, I’ll come across a story about some new merger, or read those stories about the year-end bonuses that will exceed my salary by several degrees. Being a good capitalist, I understand the role that a vibrant financial sector plays in a modern market – allocating capital efficiently, allowing entrepreneurs a new source of investment funds, and rewarding investors who are taking risks with their money.
What I’ve always wondered though, is how prominent should finance be in a nation’s economic profile? You can even go down to the city level – how much role should Wall Street play in New York’s local economy? What role do the futures exchanges play in Chicago today, and what role will they play 20 years from now? For a developing nation like India, how prominent a role can financial firms play? Should the rules governing their behavior be different than in a developed country? This October 1 issue of Time has an article, Banking on India which reports how Goldman Sachs entered India in 2005, starting out by renting a Hilton hotel suite in Bombay, and two years later, had a hand in two of corporate India’s biggest deals – Vodaphone buying Hutchinson Essar, an Indian cellphone company, for $11 billion and helping ICICI bank do another IPO for $4 billion. The head of the office, L. Brooks Entwistle, exhibits an infectious enthusiasm about the opportunities in India. He has good reason to be. According to the article,
With an economy growing at about 8% a year and corporate earnings a robust 25%, India has become a must-see for multinational investment banks looking for big, bold corporate mergers, acquisitions and financing deals outside the U.S. The country’s total market cap reached $1 trillion earlier this year, up from just $280 billion five years ago. Companies in India’s technology and financial sector are booming, and the world’s investment bankers are paying court. Banks used to “come to India about once a decade, get spooked and pull out,” says industry analyst Janmejaya Sinha of Boston Consulting Group. This time around, “it’s going to take more than parachuting in.”
While there will be beneficial effects on other areas of Bombay’s economy, I can’t help wonder if there wouldn’t be a bigger bang for the buck if there was more attention given to more basic sectors – manufacturing and transport, for starters.
The September 15 issue of The Economist has a special report on financial centers. In developed cities like New York and London, there are already complaints that housing costs are increasingly out of reach, as wealthy finance types price teachers, cops, drivers out of the market. One of the articles notes
Growing prosperity, a bigger tax haul and the cosmopolitan lifestyle of young financial professionals have injected new vitality into places like London, New York and Hong Kong. Yet there is also growing inequality, a steep rise in the cost of living and increasing pressure on middle-class families who are having to live ever farther away from city centres. The income discrepancy between haves and have-nots in the world’s financial capitals has not been this great since America’s “gilded age†in the late 19th century, says Susan Fainstein, an expert on urban issues at Harvard. The trend began in the 1980s and has become stronger, despite temporary blips such as the dotcom bust in 2001. A report on wealth inequality in Britain in July found that the gap between rich and poor is now bigger than it has been for 40 years, with the proportion of middle-class households shrinking.
India already has a substantial disparity of wealth, and while there is always some in a market economy, shouldn’t public policy be geared towards lessening inequality? It would certainly make other reforms more palatable if voters can see that the benefits of reform are not going to a select few.
Of course, India’s politicians often do more harm than good, by not repealing counter-productive restrictions on how much land can be bought by one person or entity, and keeping in place labor restrictions that discourage companies from hiring. Like information technology, India’s financial sector seems to benefit from the fact that most Indian politicians don’t know how it works, so they’ve ignored it. But as India’s financial sector continues to grow, and profits increase, it is bound to attract attention. Hopefully, that attention will be to build on existing strengths, rather than simply redistributing the existing wealth – which wins elections, but does not create profits.
Somewhat connected to this, I read this morning in the WSJ
i could’ve swear that i heard the finance minister tell charlie rose that a foreign bank can own up to 74 percent of an Indian bank, but they only have 10 percent voting rights. i wonder how goldman sachs reached that level in under only two years in India.
What I’ve always wondered though, is how prominent should finance be in a nation’s economic profile? You can even go down to the city level – how much role should Wall Street play in New York’s local economy? What role do the futures exchanges play in Chicago today, and what role will they play 20 years from now?
to answer such questions you need to go upstream in terms of your axioms. people who marry and want to raise kids who meet in manhattan go elsewhere. the abnormal socioeconomic profile and cost of living, driven by the concentration in finance, is part of the reason for this. do we want our vibrant big cities to be transient centers for a melange of young professionals, the super rich, the and immigrant enclaves? but then again, transiency is relatively common in american urban areas in any case, rootedness is rarer than elsewhere…
I’m hardly an expert on the subject, but my guess is that inequality per se in Desh is not such a big deal–as long as everyone moves up–and there’s a lot of upside that should be easy in the short term. Take the Ireland example–poor for a very long time, then–boom–and, the pensioners, etc. weren’t demanding a lot of the upside–a bit more, and they were happy. So, ironically, Desh’s low starting point (in terms of wealth) should hold off the squabbling over “dividing the pie” for a while. Of course, I could be spectacularly wrong–but, the very size of Desh also means local areas that are more redistributionist (Bengal?) will just get passed over for areas more open to investment–the only thing that could put a wrench in growth would be national-level policies.
“how much role should Wall Street play in New York’s local economy?”
Clearly you’ve never heard of municipal bonds or understand how government projects are paid. Let me make this simple – taxes don’t pay for roads, taxes pay the interest on the money borrowed to pay for roads. Federal and state governments are in perpetual debt, mostly because people like low-taxes, but taxation levels are merely how quickly debts are repaid, it doesn’t magically reduce the size of debt – and the slower the debt is repaid, the more that’s being wasted as interest payment (e.g. 30-yr mortgage has lower annual payments than a 15-yr mortgage, but it’s more expensive in total). So sweet-talking politicians finance the budget with long-term bonds rather than either using short-term bonds or paying in cash without borrowing at all. In fact, nearly every federal or state project is financed through bonds. To make matters worse, general obligation bonds, one of the most popular forms of municipal bonds, use the tax base as collateral. What does that mean? Well, it means if the city defaults, the power to tax is seized by the creditors (bond owners), and the creditors can therefore alter the tax rate or dip into the tax stream without objections and this is enforced by the courts. The enforcement is key, because contracts are only valuable if they have teeth. Bonds cannot be issued without a legal opinion which finds the promises the debtor makes to be legal. E.g. I can’t issue bonds promising Anna’s soul if I default because I lack that legal right. After some debate (long ago), the courts agreed that any government (towns/cities, districts, states, or federal) can promise away its constitutional power to tax to entities which otherwise lack constitutional power to tax. What does all this have to do with Wallstreet? Everything. Bonds undergo an initial public offering just like stocks, and this means finding an underwriter and selling to a bunch of fellow institutions. The bonds eventually trickle down in the secondary market to mom and pop, but this process is irrelevant for the bond issuer.
That’s just wrong–higher interest payments for longer term debt isn’t “waste,” just the cost of $$, & sometimes worth paying–that’s econ 101 (or, 201).
not so obvious–see ,e.g., Orange County, California’s default & the deep ambiguity on this issue in Ch. 9 of the bankruptcy code.
“For a developing nation like India, how prominent a role can financial firms play? Should the rules governing their behavior be different than in a developed country?”
Well, the U.N. Development Programme has recommended that India adopt the approach of using municipal bonds. What is the title of this UN page? “World Alliance of Cities Against Poverty: Experiences in the Fight Against Poverty” The subtitle? “Financing Anti-Poverty Policies: Issuing Municipal Bonds and Borrowing from the International Credit Market”
While the Reserve Bank of India is sophisticated and follows standard monetary supply policies and raises capital through treasury notes and bonds, the state and city governments in India are woefully unsophisticated. Economists have long lamented the lack of financial sophistication at the state and city level in India. 1998 was a bit of a milestone when Ahmedabad raised Rs 1 bn ($25 million) through municipal bonds for a water supply and sewerage program,[1] the first time a city had ever done so (states and the federal govt. had earlier done so – Ahmedabad is a city in Gujarat for the clueless). This allows urban, educated cities to detach their umbilical cords to states run by rural hicks. Progressive cities urgently needing infrastructure can do so; and well-administered towns and villages can follow suit. As India’s overall dysmal state of infrastructure became more and more apparent, many have shouted for the Ahmedabad model to be replicated nationwide.[2]
Given the rapid growth potential in India (6-10% GDP growth), with many “outperformers” at the city and town level with growth rates at 15-30%, it absolutely makes sense to borrow money. When financial firms are willing to lend to Indian cities at 8-12% and these cities see returns of 12-15% at least, it should be obvious how prominent a role financial firms should play “for a developing nation like India.”
rob,
“That’s just wrong–higher interest payments for longer term debt isn’t “waste,” just the cost of $$, & sometimes worth paying”
It absolutely is waste – I’m talking in the context of U.S. municipal bonds. When the economy grows at a meager 1-2% and there’s ample cash to pay for projects, municipalities are wasting money paying out bond interest. Wouldn’t you call someone sitting on student loans at 9% while having cash in equal or greater amount growing at 4.5% a complete moron for wasting money like that? Loans make sense only when you don’t have money or the money you do have is growing at a faster rate.
“India already has a substantial disparity of wealth”
Supported by… your gut feeling? By poverty porn on National Geographic juxtaposed with a Forbes article about Mittal? Look up gini coefficient and see the wikipedia page for a list of countries by income equality. The U.S. and China are far worse than India. Gini coefficient (0 = perfectly equal, i.e. everyone has equal wealth; 1 = perfectly unequal, i.e. one person has all the wealth) for India, U.S., China, and Brazil are as follows: 32.5, 40.8, 44.7, 54.0
heh. this is how goldman entered London, cold-calling their way to the top. dialing for $$’s is the lifeblood of brokerage. when deals get done, it often seems like the brokers fees are too fat, but we never think of all the deals that never closed, and the hours spent by the broker. try going out to raise money or get a someone to buy you by yourself one day, and after a week, you’ll gladly pay the 6%.
i haven’t looked at any stats, but i’m pretty sure that the merchant bankers/VC’s/hedge funds have made bigger inroads into india than the ibanks, and since they put up their own $$ and generally invest in transformative technologies, i think this is a good sign for for India.
Many thoughts –
I’m not sure public policy in India is not supporting financial institutions, and devaluaing manufacturing. In fact, if you look at the Indian government’s focus has been on supporting manufacturing and encouraging the growth of basic industries and infrastructure, which, ironically, is undermined by the lack of infrastructure. I’m just not sure, except for broad macroeconomic regulations, the government should decide what role financial firms play or don’t play – leave that to the customers.
Equality is highly overrated when everybody is equally indigent. I am more interested in pulling up overall wealth, than making sure it is distributed equally.
Right now, merchant banking and principal businesses are much more developed than agency business (investment banking) in India. This is not a suprise, and is often the case in most emerging economies (including the U.S. in the 1920s)
Goldman is a fine firm and Brooks is a great guy but this is a classic case of the Goldman PR machine in India. Right now, Merrill and Morgan (and arguably HSBC, Deutsche and UBS) are much more developed than Goldman in India.
Yes, financial industry salaries are completely out of whack, particularly in the U.S. When, in a good year, a mid-level functionary at an investment bank or private equity fund can make more money than their CFO client (and multiples more than other professions that require more talent, dedication and education – and I can say this bluntly as I work in the industry), something is clearly wrong. I’m not sure what the corrective mechanism is. Felix Rohatyn was complaining about this in the 1980s, and the trend has only exacerbated since then.
Just to add to that though, India’s Gini coefficient in recent years has been rising i.e. disparity is increasing which I think is just as important especially because it’s not just the rich getting richer. Also, Gini itself has it’s problems though it is a starting point to figuring things out. From wiki –
Also, this may be interesting when talking about income inequalities in India.
The U.S. and China are far worse than India. Gini coefficient (0 = perfectly equal, i.e. everyone has equal wealth; 1 = perfectly unequal, i.e. one person has all the wealth) for India, U.S., China, and Brazil are as follows: 32.5, 40.8, 44.7, 54.0
Some people need to visit China. It will swiftly disabuse you of the idea that there is a “comparison” between the two countries. There is none. China is a solid thirty years – a generation – ahead of India. And I say that as an Indian-American patriot
Have you done business in China? I would strongly disagree, having done so. The command / control model can only take you so far, and China’s lack of investment in high-end human capital could stop its trajectory in its tracks.
Gujarat state’s public sector company “Sardar Sarovar Narmada Nigam Ltd” had issued bonds earlier in the 1980s when the government was fed up with World Bank loans that came with many strings attached. World Bank and IMF were dispised by the technical folks working on the Narmada dam. Gujarat government then created the aforementioned company and issued bonds. Obviously it was over subscribed and a huge success.
A mature capital market where money can be raised for development and other project may be the only edge India has over China. (No it is not English speaking babus)
Indian capital markets have already gone thru’ a couple of major scandals and as a result a bit more matured compared to China, where there has not been any scandals yet. This is scary for anyone invested in the Shanghai exchange, whose index has quadrupled in 3 years. Indian market is getting toppy too.
Great post KXB!!
Greater investment in high-end human capital
Greater willingness to engage the rest of the world
MUCH stronger corporate management
Don’t sell India short
Points 2 and 3 are result of the tradition of capital markerts. Bombay is the oldest stock market it Asia BTW. But point 1 is actually hurting India. There are few enclaves of excellence while vast majority of poplulation is woefully underseved in terms of education.
Infact education is the BIGGEST problem India has (lack of it). On the other hand Chinese far more likely to have access to education and this has been going on since decades creating in much MORE EDUCATED population in China. India will take atleast 10 years to get to the kind of education availability that chinese have.
And having a few IITs dont mean sh@!. I wonder if any meaningful groundbreaking research FOR INDIAN condition came out of IITs or is it just waste of tax payer money.
i’m ebarassed to ask this b/c i fear its basic. but i’ve heard this term “babus” a lot and i don’t know what it means.
Hari, I’ve acted as agent for an American business in China; I have never done so in India, so I won’t dispute what your saying re: the superiority of Indian markets and management. Re: Education. India has some notable achievements in higher education, but the fact that India’s (official) literacy rate is 64% vs a nearly 90% literacy rate in China tells me that the Chinese have gotten the basics right. India has a much better demographic profile than the rapidly aging China, but if nearly half the children under five are malnourished, much of that (admittedly huge) advantage is lost. These are correctable, I think, but time is a factor, and Indian and Indian-American elites tend to sound the trumpet of India’s arrival into the elect nations of the earth, rather than confronting the problems.
Manju: Babu — bureaucrat. http://en.wikipedia.org/wiki/
Hari: Re: High end capital
See: http://en.wikipedia.org/wiki/Higher_Education_in_China#Chinese_Higher_Education_Today
In addition to quantity, Chinese Colleges are ranked higher than Indian ones in every survey I have seen so far.
We have an edge in english oriented higher education, but based on what I learnt while working on a project supporting an leading english test, China is catching up rapidly.
Infact I did not mean to say Babu in my earlier comment. I wanted to say that the “English education” is actually hurting India by denying higher education to more than 75% of the population.
As far as the word “Babu” is concerned, It is a term used for government workers, but now can be applied to workers in general.
I would say ‘white collar workers’. The term began in describing the clerks and lower level administrative staff during the British empire, and quickly acquired a derogatory aspect – a supercilious person with a modest amount of power over you and who added little value in the general scheme of things.
On the larger point that this post is about, I agree with KXB that the wholesale transplantation of the ‘Wall Street culture’ into India is a cause for some concern. It was already bad in the ‘license-permit raj’ days when IIT engineers went to IIM, only to take jobs selling soap, tea or lozenges on graduating – but now the culture transplantation might lead them into similar ‘high prestige’ jobs in ‘finance’ instead, attracted by the cachet attached to ‘doing big deals’ and earning multimillion dollar bonuses. Of course, even in the old days, there were IIT engineers who became bank officers. It’s quite a waste of a technical education either way, and this time around, the distortionary consequences could be quite serious.
I has been happening for several years now. Why is it cause for concern? What I think is cause for concern are the subtle layers of prejudice in your statements.
First, what makes you think that activities like selling soap, tea or lozenges are not as economically useful as being some kind of an engineer? Secondly, what’s wrong with IIT engineers getting management degrees? IIT hones your ability to solve problems – not just how to write good code.
And what kind of distortionary consequences are you talking about? I would have thought that the fact that competent and smart professionals entering the Indian capital markets which were prone to crony-ism and fraud would be a good thing. Clearly you have no idea of how capital markets work.
bhateeja, I’m glad that you’ve found a way of making your point here in a friendly and non-accusatory fashion.
There is nothing inherently less valuable in selling soap or lozenges from a moral or ‘intrinsic worth’ point of view. Distortionary consequences arise, however, if the economic value generated in employing the engineer as a soap salesman (or bond salesman, for that matter) is less than the economic value that can be derived from him being employed in (say) engineering design or R&D. Normally, in a perfect economy, this is taken care of by the actual compensation given out to engineers and soap salesmen. But there is no perfect economy, so perceptions, cultural assumptions, and the relative strengths of the financial sector versus ‘real economy’ matters in the calculus.
Training an engineer in an IIT also costs much more than training an engineer elsewhere in India, and what is more, the cost is borne mostly by the Indian state. This is why the distortionary consequences must be considered, if not explicitly factored in. If, however, as is true in the US, the cost of the education is largely borne by the person concerned, then he or she should be able to do what he or she likes later. (Of course, even in the US, an engineering education is effectively subsidized by federal R&D grants and the overhead charged to them – by most engineering schools. But the level of effective subsidy is much smaller.)
The question is why someone with the motivation to go through IIT training as a mechanical engineer (say) eventually settles for being a bank officer or a soap salesman – this is partly a question of culture, of ‘prestige’, of ‘salary’, of ‘cachet’, of ‘the buzz from doing million dollar deals’. It’s also a question of alternative opportunities – or lack thereof. So perhaps it might have been tolerable when there were no other comparable opportunities for a technical career in India. But today, that is not true. Therefore, a wholesale transplantation of the Wall Street culture into India, without simultaneously removing the effective subsidy for an IIT education – distorts the career calculus of the graduating engineer.
And while I agree that until fairly recently Indian capital markets were rife with insider trading, cronyism, self-dealing etc – please don’t imply that this is unknown in Wall Street, or that the solution to this is for IIT engineers to go into finance. The solution, such as is possible under the circumstances – lies in the direction of greater enforcement, stronger vigilance, higher ethical standards and more effective regulatory mechanisms.
Thanks also for the gratuitous suggestion that I don’t know anything about capital markets – perhaps I don’t know as much as a bond salesman might – but certainly enough to comment intelligently on this issue.
And, btw, IIT does not merely hone your ability to solve problems in general, it trains you to do so in specific technical areas. (Also, I agree that if an IIT engineer is employed only in writing ‘code’, that could also be a waste, depending on specifics – for example, coding a GUI might be a waste while an aerodynamic simulation might not.)
As a blind ignoramus about the big picture — I’m assuming , for instance, that Goldman Sachs and similar will be getting into financing transportas well as other infrastructure development projects — I still think Goldman strong arming its way into Indian capital markets at all seems like bad news. Regulation of their activities and others with similar should definitely be legislated afresh in India, and not patterned on the American model. And there should be new legislation to protect consumers too– we don’t need a sub-prime lending crisis in urban India to mirror the farm foreclosures. Some sectors of consumer banking in America are amazingly corrupt and their practices way under regulated.
q: how prominent should finance be in a nation’s economic profile?
ans: It should be as prominent as it is in the US and Germany. The answer is that it is second only to the government in importance to a country’s economy.
the reason for India’s “developing country” status is a long history of misgovernance and bad investments. All in the hands of the sarkari babu. If you think about it, allocating a country’s budget efficiently is the biggest investment challenge of all and should be based on a sound financial principle, ie ROI – return on investment. The private banking industry does it better than politically motivated ministers.
24 Chachaji: “Distortionary consequences arise, however, if the economic value generated in employing the engineer as a soap salesman (or bond salesman, for that matter) is less than the economic value that can be derived from him being employed in (say) engineering design or R&D.”
Are we wishing for just a little bit of manipulative power over a market driven economy? Remember, Chachaji, one cannot be a little bit pregnant.
Knowing how diligently you apply yourself to issues, I am sincerely interested in your views about the economic value of advertising, essentially a free market industry that brings some very smart people together for a very specific purpose – sell more soap.
Actually, Floridian, the argument is that the introduction of the Wall Street culture without withdrawing the subsidy to the IIT education is like being a little bit pregnant. If the subsidy was withdrawn, while at the same time, a free market which demanded technical talent also arose, then this distortion should not arise. Some IIT engineers in this situation may go into finance, and that should even out, except if the financial sector, though the entry of Wall Street firms with deep pockets, became extraordinarily strong, and was able to pay above market salaries, etc. The distortion with the subsidy is not limited to “misunderutilizing” the IIT graduate, there a number of horizontal and downstream effects as well. This is the crux of the matter that KXB has raised. As you will agree, there is a real economy, which produces goods and consumables, and a financial economy, which ideally should intermediate between capital suppliers and capital demanders, pocketing an intermediary’s fee. However, in practice, the financial sector has a lot of power, and the question is whether it should be stronger, and by how much?
Thank you for the good words, and I do recognize the economic value of advertising, no disrespect was meant to that sector in general! 🙂
I am with Sic on this issue, I believe that a strong and visible financial services sector which will eventually lead to increased financing through munies will do all round good.
Also Chachji, what do you think of the subsidies to IIM education, I believe like IITs the fees are subsidized there as well. I personally feel the stronger the financial sector the better it is, although it may lead to excessive focus on earnings, I believe that a robust financial sector also increases competition, innovation and accountability all of which India can do with.
Yes, I agree, the IIM subsidies are a matter of serious concern as well. Starting salaries for IIM graduates have gone into the stratosphere – there was a report of someone getting a Rs. 1.1 crore offer ($250K p.a.) this year at Ahmedabad. Sure, that may be an outlier, but even if the average is a fifth of that, at a ‘reasonable-sounding’ $50K p.a., it’s a great return on the fees that are charged. I think, though (just my gut feeling) that there isn’t as much resistance to market-norming the cost of an IIM education, as in the IIT case.
Just a couple of side points – all the IITs have Departments of Management and Business – including BHU-IT and Roorkee and even the IISc at Bangalore, but perhaps excluding Guwahati (I don’t know). Some of them, such as IIT-Bombay and IIT-Kharagpur, also have fully branded Business Schools. The IIT engineering curriculum, in its core and electives, does include business courses, as well as Humanities, as well it should. No problem there.
As people well know, when engineers grow in mainline technical careers, they can branch off into sales engineering or technical management, which can call for some specialized training, and both of which add a lot of economic value. I fully support the idea of those tracks.
I hope this hasn’t gotten too far off topic. Thanks.
Chachaji,
Thank you for the detailed response, the kicker to IIM salaries is that most of the high paying positions are in London/HK and U.S
No probs, brown. But I think a $250K starting salary is fantastic anywhere in the world, including if you plan to live in Manhattan, SanFran, or London.
Actually, a lot of those kinds of salaries are laterals i.e. people who already have a significant amount of experience in corporate life before they come into b-school. Nonetheless, that is a serious chunk of change.
I find it comic that all Indian bloggers prattle on about “free markets” but have a pause when they hear about people earning more than themselves. Sir, you right well, but you dont have half the brains it takes to make a good banker. This kind of “anti-super-wealth” rubbish (while shameless worshipping film/political dynasties, corrupt politicians, and over compensated sports stars) is what is driving IIM graduates to NY, London, Hong Kong and Sydney.
Lets not be crabs in the barrel, and let smart people earn their pay.