POLITICAL ECONOMY OF

GLOBAL
FINANCIAL CRISIS

Dr. Vijay R. Thite

Published by Numero Uno Management Consulting Pvt Ltd

Registered Office, No. 9, Revankar Complex, Near Court,
Hubli – 580029. Karnataka, India

1
 Foreword

The world economic system recently faced a biggest jolt

when a few of the biggest investment bankers faced
bankruptcy and many banks and insurance companies
followed the suit with one of the biggest bailout plans of
recent times being put in place by United States followed by
similar acts by many other European countries. This sudden
downturn in the booming world economy has sent shiver
down to many leaving them puzzled and confused. Though,
there is no effect without a cause and every puzzle is solved
when the cause and effect relationships are understood until
such time the confusion persists.

There have been several precedents such as ASEAN

currency crisis, subprime crisis at United States which
deserved a careful study to find out the future trends but the
world is too busy with many other success stories and there
are not takers for failures. It is well said ‘Nothing succeeds
like success and nothing fails like a failure.’ Success has
many fathers and failure has none. The world financial
system needs to be investigated and understood. Though,
every one in general has a clue here and there, very few have
a complete story. It is here that there was an opportunity for
a shrewd researcher to put the pieces together and weave a
complete story which everyone can understand.

Vijay Thite who has completed his doctoral work from

Kousali Institute of Management Studies on ‘Privatization of

2
public enterprises an Indo British Comparative Study’ has
tremendous appetite for serious research in spite of the fact
that he is well known Chartered Accountant much sought
after.

I have had occasions to go through the contents of the book

and I find that a careful delineation of the problem has been
done leading to step by step analysis. The work done by Dr.
Vijay Thite deserves to be commended for its relevance and
timeliness. I congratulate him on the same. This book can
make very good reading for business executives.
academicians, chartered accountants, students and above all
the common man for whom we have a responsibility to
inform.

Dr. A.H. Chachadi

Dean & Director
Kausali Institute of Management
Studies,
Karnataka University,
Dharwad Karnataka

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For Forms of Government let fools contest;
What is best administered is best.

POPE

4
 Contents

Preface

1. Political Economy

Political Economy of Global Financial Crisis:

2. Made in USA

3. Europe

4. China

5. India

6. Roll Forward and Roll Backward

Lessons from Privatisation in Britain

7. Socio Economic Cost and Political Fallout

8. Economic Patriotism

References

Acknowledgements

Index

Preface

5
A tea vendor or a ‘chaiwala’ to remind you of Slumdog
Millionaire asked me in Belur Industrial Estate, a remote
place in India, “Sir, tell me why my tea sales has come down
all of a sudden? I stopped sipping the chai for a second and
started thinking how to explain him the effect of global
financial crisis. His issue was simple, the tea stall is next to a
steel factory which was doing brisk business before October,
2008, but due to slowdown, the employees were removed
and there were no takers for the ‘garam chai’ or hot tea.
This crisis has effected construction workers to big builders,
simple technicians to software giants, a small town beauty
parlor to Bollywood. Of course, I need not mention the fate
of investors, bankers and stock brokers. Even the doctors are
affected by this trauma. Psychologists are making more
money but the surgeons are loosing. When I was making a
presentation of GFC (Global Financial Crisis) to medical
students, one student asked me the difference between
‘global financial crisis’ and ‘global economic crisis’. I was
surprised to know that the medical students are also
becoming ‘Economics savvy’. Similarly the engineers and
engineering students, advocates and law students,
management consultants and management students were
curious to know the details of this crisis whenever I made a
presentation.

An interesting but most apt comment was passed by a senior

surgeon. When Iceland banks became bankrupt, he told me,
“See doc, now-a-days not only the banks, but the countries
are becoming bankrupt”. What an observation from a
medical professional! I remember, even Mr. Gordan Brown,
the Prime Minister of UK had said, the banking system in
Iceland was bigger than the country. Couple of days back,
Cox & Kings travel agent asked me “Do you think power
equation gets shifted to China? “What happens to our
money, if dollar looses its value?”

FAQ’s
The frequently asked questions are
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  What is a melt down?
 Why it happened?
 How it happened?
 Who is responsible?
 Which countries will be affected?
 How it affects India and China?
 Whose job it is to improve?

In the 20th century, state intervention in the economic

development of a country had been accepted as a pre -
requisite by developed, developing and communist countries
alike. In developed countries of Europe, till today the state
has a major stake in many industries. In case of developing
countries, like India, the state has become an inseparable part
of the economy. Even though in many communist countries
(i.e., centralised economies) the role of the state is
substantially reduced, but till today these countries depend
on the state for active participation in the development of its
shattered economy. Hence the subject of the state
intervention is a global phenomenon.

Since 17th century the role of the state in economic

development has been a debatable issue. In 17 th century,
Adam Smith advocated a limited role for the state. He did
not suggest any state intervention in the economic
development. The role was that of maintaining law and
order. This role remained stagnant till 1930s. In 1930s,
Keynes actively advocated for the state intervention due to
economic depression and market failures. This argument
became more pronounced after the second world war. The
shattered economy of many countries cried for state
intervention for economic development. Hence
nationalization became well accepted economic policy in
many developed countries and developing countries alike.
During the same period a few countries like Russia, East
Germany, China and others followed the pattern of central
economy which was influenced by the thinking of Karl
Marx, Lenin and others. In case of developing countries

7
which were facing problems of inadequacy of capital, lack of
market competition, low technical expertise, huge population
and poverty, lack of basic infrastructure like drinking water,
roads, education etc were forced to accept the state
intervention as the only way out. Hence the state enterprises
went on to occupy ‘commanding heights’ and the state
enterprises became ‘temples of economy’.

By the turn of the century, sweeping changes had occurred in

various fields all over the world which necessitated a re-
look at the state intervention in the economic development.
Geographically, USSR and East Germany do not exist;
centrally controlled economies failed to deliver the goods;
cold war is in cold storage. Technological development has
made the world a global village. Liberalization, privatization
and globalization (LPG) is the order of the day. ‘Hand
holding’ by State Government has become a ‘hand binding’
in the economic development. Public sector units have
become a burden to the exchequer. Governments can no
more bear the losses out of public money and it has to
discharge many other important obligations to the down-
trodden. Very often it is said that ‘Government has no
business to do business.’

Privatization has become the buzzword in the economic and

political world for the last three decades. The pace of
privatization in Britain created international waves of
privatization. Rolling back the frontiers of the state is the
policy of many governments around the world.

Developments in 2008 and Global Financial Crisis

The recent developments in the global financial markets like
USA and Europe specially after Sept 2008 meltdown has
again brought back this subject to limelight. The crash of the
financial markets across the globe has rekindled the idea of
government intervention in the economy.
Capitalistic economy of USA has simply crashed and lead to
a ripple effect throughout the world. Now people have gone

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to the extent of asking ‘whether capitalism is dead?’ United
States of America totally believed in brand capitalism. Free
market was its mantra. When the controlled economy of
USSR crashed and splintered USSR into a shattered nation,
everybody thought communist ideology is dead and Marxist
theory is not sustainable. But the evil face of capitalism is
more cruel than that of its counterpart.

In Europe, not only banks but countries are getting bankrupt.

People have lost their houses, jobs, pension funds and are on
streets due to the crash of the Wall Street. The liquidity in
the market is totally dried up. The stock markets have
reached their lowest level. Share certificates have become
waste paper. Banks have ended up with huge bad loans.
Investment bankers have vanished into thin air.

All this is the product of unregulated free market economy. It

is a well known commandment in free market that the
Regulatory Authorities are the anchors of the economy.
Their responsibility is unparalleled in free economy. Free
economy is not free-for-all economy. The controls have to be
in place. But just like human nature, nobody likes controls.
Everybody wants wild abandonment of restrictions.
Uncontrolled human being is worse than a beast. This
Greedy man – the wildest and cruelest is the creation of the
free economy. The investment banker’s greed to make
millions and billions of fat earnings, the banker’s reckless
lending, creation of fantastic financial instruments,
Government’s deficit budgets without proper fiscal
discipline, monetary authorities without any monetary policy
except providing cheap funds to keep the economy burning,
huge borrowings to finance deficit budgets, individuals
without personal savings, credit crazy citizens, wasteful
living styles, leaders more occupied with international
politics when the home front is burning, created this global
crash. The US crash had an immediate effect in Europe
because they are like the twin brothers with the same
characteristics.

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The World economy having become a global economy, the
impact of this is throughout the globe. Unlike the depression
of 1920s, this is going to suck all the countries in this
financial vacuum. All the share markets have crashed, the
economies are slowing down, liquidity has evaporated,
people around the globe are losing their jobs, every body is
running for shelter.

First time the leaders of the free economy are strongly

advocating government intervention in the economy through
bailout packages and even nationalisation. US debated in the
Congress for days together and came out with a package of $
700 billion dollar plan. In fact it is questionable how this
figure was arrived at. The Bush Government with already
one foot outside White House was debating how to
implement the bailout plan. Either to buy bad loans or infuse
funds in to banking system. G-20 meeting was called by
president Bush to discuss the global crisis. The countries
around the globe have already announced their bail-out
plans. In certain countries, banks have been already taken
over by the government. Role of the Government in the
economy is increasing.

All governments have to take an active role because of the

simple reason that, this crisis of international scale will
create upheavals in the country in the form of rise in
unemployment, fall in income, meltdown of wealth, loss of
savings, bankruptcy of companies, huge shrinkage for
demand of goods and services and liquidity crisis. Which
may lead to change in government, social unrest and
bloodbath. This has happened many times in history. It
happened in Russia, Indonesia and before that, in other parts
of the world.

The conclusion one can arrive at is whether it is free

economy or controlled economy or socialistic economy, the
Government has a great role to play. Politics and economics

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are inseparable. Hence the name of the game is POLITICAL
ECONOMY.

To understand this global financial crisis, one has to know

about the political and economic system prevailing in the
country. Causes, effects and solutions are embedded in this
system. Each country has different solutions depending on
the political and economic system prevailing. The solutions
that are arrived at have to be politically desirable, politically
feasible and politically credible. Politically, countries have
Westminster system of Democracy and Presidential system.
There are communist countries with various ideologies.
Economically the countries have capitalistic, socialistic and
mixed economy models. All these countries are also in
different stages of economic development. The economic
inter-dependencies with other countries is different for
different countries. In the present world trade scenario,
economically all countries are coupled. Forces of coupling is
strong in some countries like USA, China, UK and Germany.
In case of others coupling may not be so strong. To
understand this crisis, knowledge of political and economic
system along with the stage of economic development is
fundamental.

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 Political Economy

ADAM SMITH

The famous eighteenth century political economist and father

of modern economics Adam Smith in his treatise “Wealth of
Nations” published in 1776 stated that, “The duties of the
state should consist of the provisions of defense, justice and
some expenditure for economic and social ends”. Which
means that, the state has no business to do business.
Another most visible theory of Adam Smith was the theory
of “Invisible hand”. According to him, this invisible hand
controls demand and supply and thereby the price
mechanism. The production of goods and services takes
place in order to satisfy the wants of the consumers
expressed by the prices they are willing to pay. If these
prices are bound to be profitable, the continued production of
the commodity or services is assured. On the other hand, if
the prices, which the consumers are willing to pay are
insufficient to make further production worth while, the
commodity or service will no longer be supplied. In the
private sector, profitability is the motive force operating

12
through price mechanism. Each purchase is a vote in favour
of continued production of the commodity.
This theory of ‘invisible hands’ has been criticized on
various counts. In certain cases, the criticism has been
considered serious enough to warrant a transfer of a
particular section of activity from the private sector to the
public sector. A few of the important criticisms are:
1. Certain goods and services would not be supplied
under pricing system. They are collective goods,
which must be provided for the community as a
whole. People who do not pay towards this provision
can’t be excluded from their benefit. For e.g.,
defense.
2. The monopolies form another bases of criticism of
the private sector because they provide the
opportunity for restrictive practices.

3. The private enterprise left to itself, the resulting

distribution of income and wealth will be inequitable
and since the goods and services depend on effective
demand (demand backed by money) rather on needs,
there will be social injustice.

An often-quoted passage from The Wealth of Nations is:

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“It is not from the benevolence of the butcher, the brewer, or
the baker that we expect our dinner, but from their regard to
their own interest. We address ourselves, not to their
humanity but to their self-love, and never talk to them of our
own necessities but of their advantages.”

Case for Private Ownership

The case for private ownership and market allocation has
been based on three well known theories.
1. Tragedy of commons.
2. Dispersed Knowledge.
3. Residual Claimant Theory.
According the neo classical property rights school, which
suggests that, communal ownership (The lack of private
property rights) will lead to dissipation i.e., the ‘tragedy of
commons’.
Hayek’s views of ‘Dispersed knowledge’ assumes:
knowledge is widely dispersed in every society and efficient
acquisition and utilisation of such knowledge can only be
achieved through price signals provided to the markets.
Alchians and Demsetz’s ‘Residual claimant theory’ suggests
much in line with property rights school that private
capitalist ownership of firms is predicated upon the need for
residual claimant of income generating assets. In the absence
of which, members of a coalition, for example a firm, would

14
tend to free ride, thus leading to inefficient utilisation of
resources.
Among other factors which tend to ensure that private sector
‘agents’ (managers) behave in conformity with the wishes of
the ‘principals’ (shareholders), by maximizing profits in
private firms, are, for example the concentration of shares in
the hands of financial institutions; the emergence of M-form
of organisation which tends to ensure that ‘divisions’ operate
as profit centres; the possibility of ‘contestable markets’ that
is markets where competitive forces operate through
potential entry by new competitors, given free entry and cost
less exit conditions. It is assumed public sector enterprises
are not subject to such forces, not to the same degree
anyway, which implies the possibility that managerial
incentives for efficient use of resources and profit
maximisation may be less present in public sector firms.
Many of the above factors are linked to the concept of
competition and competitive forces, where again the claim is
that public sector enterprises may be more insulated from
such forces and are less likely to pursue efficiency and profit
maximization. The latter will also be true if public sector
enterprises simply do not aim at such policies for example,
because they are used as redistribution vehicles by the
government and/or other non economic reasons such as the
need for electoral support and/or because they aim at
correcting structural market failures (for example, the high
15
prices of private sector monopolies). All these factors tend to
establish the economic theoretical rationale for the efficiency
of private firms and therefore for privatisation (Vickers and
Yarrow – Kay et al offer extended discussion on the assumed
superiority of the private versus state firms).

Capitalism:

Capitalism is an economic system in which wealth, and the

means of producing wealth, are privately owned and
controlled rather than publicly or state-owned and controlled.
In capitalism, the land, labor, and capital are owned,
operated and traded by private individuals or corporations,
and where investments, distribution, income, production,
pricing and supply of goods, commodities and services are
primarily determined by private decision in a market
economy largely free of government intervention. A
distinguishing feature of capitalism is that each person owns
his or her own labor and therefore is allowed to sell the use
of it to employers. In capitalism, private rights and property
relations are protected by the rule of law of a limited
regulatory framework. In the modern capitalist state,
legislative action is confined to defining and enforcing the
basic rules of the market, though the state may provide some
public goods and infrastructure.

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Some consider laissez-faire to be "pure capitalism." Laissez-
faire (French, "let it be"), signifies a policy of only minimal
intervention by the state in the economy, with the state
confined mostly to protecting property rights rather than
exercising control over the means of production. This has
never existed. Another approach, anarcho-capitalism, would
eliminate the state and replace it entirely by market processes
and private enterprise. However, because all large economies
today have a mixture of private and public ownership and
control, some feel that the term "mixed economies" more
precisely describes most contemporary economies. In the
"capitalist mixed economy", the state intervenes in market
activity and provides many services.

During the last century capitalism has often been contrasted

with centrally planned economies. The central axiom of
Capitalism is that the best allocation of resources is achieved
through consumers having free choice, and producers
responding accordingly to meet collective consumer demand.
This contrasts with planned economies in which the state
directs what shall be produced. A consequence is the belief
that privatization of previously state-provided services will
tend to achieve a more efficient delivery thereof. Further
implications are usually in favor of free trade, and abolition
of subsidies. Although individuals and groups must act
rationally in any society for their own good, the

17
consequences of both rational and irrational actions are said
to be more readily apparent in a capitalist society.

J.M.KEYNES
J.M. Keynes was a British economist whose ideas, called
Keynesian economics have had a major impact on modern
economic and political theory as well as on many
governments' fiscal policies. He advocated interventionist
government policy, by which the government would use
fiscal and monetary measures to mitigate the adverse effects
of economic recessions, depressions and booms. He is one of
the fathers of modern theoretical macroeconomics and
considered among the most influential economists of the
20th century.
In his book, “The General Theory of Employment, interest
and Money” published in 1936 drew attention to the
probable causes of the “trade cycle” and pointed ways to
possible remedies. Private enterprise economies are subject
to periodic booms and slumps in trade. During the
depression phase of cycle there is considerable waste of both
human and non-human resources. During the boom phase,
inflation produces problems of different kind followed
eventually by the collapse of the prices which accompanies
the movement of the economy in the direction of slump.
Various kinds of activity in the public sector are necessary to

18
stabilize the economy on a steady course of expansion at full
employment.
His main contribution can be seen in establishing an
approach to macroeconomics that maintains its relationship
to the underlying microeconomic behaviors, but assumes a
form qualitatively different from microeconomic models.

In his Theory of Money, Keynes said that savings and

investment were independently determined. The amount
saved had little to do with variations in interest rates which
in turn had little to do with how much was invested. Keynes
thought that changes in saving depended on the changes in
the predisposition to consume which resulted from marginal,
incremental changes to income. Therefore, investment was
determined by the relationship between expected rates of
return on investment and the rate of interest.

The failures of the market and need for state

intervention:
In main stream economic theory, the first fundamental theory
of welfare economics shows that, market can allocate
resources efficiently without state intervention, provided that
market failures do not exist. Such failures, however, are
widely observed, famous instances being the existence of
externalities (interdependence not conveyed through prices);
public goods (goods which are jointly consumed and not

19
excludable); and monopolies which tend to increase the
prices above the competitive norm.

Warning From Adam Smith

Our merchants and master-manufacturers complain much of

the bad effects of high wages in raising the price, and
thereby lessening the sale of their goods both at home and
abroad. They say nothing concerning the bad effects of high
profits. They are silent with regard to the pernicious effects
of their own gains. They complain only of those of other
people.

Merchants and master manufacturers are the two classes of

people who commonly employ the largest capitals, and who
by their wealth draw to themselves the greatest share of the
public consideration. As during their whole lives they are
engaged in plans and projects, they have frequently more
acuteness of understanding than the greater part of country
gentlemen. As their thoughts, however, are commonly
exercised rather about the interest of their own particular
branch of business, than about that of the society, their
judgment, even when given with the greatest candor (which
it has not been upon every occasion) is much more to be
depended upon with regard to the former of those two
objects than with regard to the latter.

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Their superiority over the country gentleman is not so much
in their knowledge of the public interest, as in their having a
better knowledge of their own interest than he has of his.

It is by this superior knowledge of their own interest that

they have frequently imposed upon his generosity, and
persuaded him to give up both his own interest and that of
the public, from a very simple but honest conviction that
their interest, and not his, was the interest of the public.

The interest of the dealers, however, in any particular branch

of trade or manufactures, is always in some respects different
from, and even opposite to, that of the public. To widen the
market and to narrow the competition, is always the interest
of the dealers.

To widen the market may frequently be agreeable enough to

the interest of the public; but to narrow the competition must
always be against it, and can serve only to enable the dealers,
by raising their profits above what they naturally would be,
to levy, for their own benefit, an absurd tax upon the rest of
their fellow-citizens.

The proposal of any new law or regulation of commerce

which comes from this order ought always to be listened to
with great precaution, and ought never to be adopted till after
having been long and carefully examined, not only with the

21
most scrupulous, but with the most suspicious attention. It
comes from an order of men whose interest is never exactly
the same with that of the public, who have generally an
interest to deceive and even to oppress the public, and who
accordingly have, upon many occasions, both deceived and
oppressed it.

Communism:

Communism is a socioeconomic structure and political

ideology that promotes the establishment of an egalitarian,
classless, stateless society based on common ownership and
control of the means of production and property in general.
Karl Marx posited that communism would be the final stage
in human society, which would be achieved through a
proletarian revolution. "Pure communism" in the Marxian
sense refers to a classless, stateless and oppression-free
society where decisions on what to produce and what
policies to pursue are made democratically, allowing every
member of society to participate in the decision-making
process in both the political and economic spheres of life.

As a political ideology, Communism is usually considered to

be a branch of socialism; a broad group of economic and
political philosophies that draw on the various political and
intellectual movements with origins in the work of theorists
of the Industrial Revolution and the French Revolution.

22
Communism attempts to offer an alternative to the problems
with the capitalist market economy and the legacy of
imperialism and nationalism. Marx states that the only way
to solve these problems is for the working class (proletariat),
who according to Marx are the main producers of wealth in
society and are exploited by the Capitalist-class
(bourgeoisie), to replace the bourgeoisie as the ruling class in
order to establish a free society, without class or racial
divisions. The dominant forms of communism, such as
Leninism, Stalinism, Maoism and Trotskyism are based on
Marxism, but non-Marxist versions of communism (such as
Christian communism and anarcho-communism) also exist.

Karl Marx never provided a detailed description as to how

communism would function as an economic system, but it is
understood that a communist economy would consist of
common ownership of the means of production, and
eventually the negation of the concept of private ownership
(which is not to be confused with personal possessions).
Unlike socialism, which is compatible with a market
economy, a communist economy consists of local or
communal democratic planning.

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Marxism-Leninism

Marxism-Leninism is a version of socialism adopted by the

Soviet Union and most Communist Parties across the world
today. It shaped the Soviet Union and influenced Communist
Parties worldwide. It was heralded as a possibility of
building communism via a massive program of
industrialization and collectivization. Historically, under the
ideology of Marxism-Leninism the rapid development of
industry, and above all the victory of the Soviet Union in the
Second World War occurred alongside a third of the world
being lead by Marxist-Leninist inspired parties. Despite the
fall of the Soviet Union and Eastern Bloc countries, many
communist Parties of the world today still lay claim to
uphold the Marxist-Leninist banner. Marxism-Leninism
expands on Marxists thoughts by bringing the theories to
what Lenin and other Communists considered, the age of
capitalist imperialism, and a renewed focus on party
building, the development of a socialist state, and democratic
centralism as an organizational principle.

24
 2

Political Economy of Global Financial Crisis

Made in USA

The great civilization is not conquered from without until

it has destroyed itself from within.
W. Durani

United States of America is brand capitalism. It is looked

upon as the model of free market mechanism. A land of
limited regulations and unlimited opportunities. The roaring
1920s, unfettered capitalism lead to Great Depression. This
Great Depression is again looked upon as the model of free
market failure. It is frequently quoted around the globe as the
worst depression faced ever.

A central feature of the U.S. economy is the economic

freedom afforded to the private sector by allowing the
private sector to make the majority of economic decisions in
determining the direction and scale of what the U.S.

25
economy produces. This is enhanced by relatively low levels
of regulation and government involvement, as well as a court
system that generally protects property rights and enforces
contracts.

In the United States, the corporation has emerged as an

association of owners, known as stockholders, who form a
business enterprise governed by a complex set of rules and
customs. Brought on by the process of mass production,
corporations, such as General Electric, have been
instrumental in shaping the United States. Through the stock
market, American banks and investors have grown their
economy by investing and withdrawing capital from
profitable corporations. Today in the era of globalization
American investors and corporations have influence all over
the world. The American government has also been
instrumental in investing in the economy, in areas such as
providing cheap electricity (such as from the Hoover Dam),
and military contracts in times of war.

The number of unemployed workers and, more importantly,

their productivity help determine the health of the U.S.
economy. Throughout its history, the United States has
experienced steady growth in the labor force, a phenomenon
both cause and effect of almost constant economic
expansion. Until shortly after World War I, most workers

26
were immigrants from Europe, their immediate descendants,
or African Americans who were mostly slaves taken from
Africa, or slave descendants. Beginning in the early 20th
century, many Latin Americans immigrated; followed by
large numbers of Asians following removal of nation-origin
based immigration quotas. The promise of high wages brings
many highly skilled workers from around the world to the
United States.

While consumers and producers make most decisions that

mould the economy, government has a powerful effect on
the U.S. economy in at least four areas. Strong government
regulation in the U.S. economy started in the early 1900s
with the rise of the Progressive Movement; prior to this the
government promoted economic growth through protective
tariffs and subsidies to industry, built infrastructure, and
established banking policies, including the gold standard, to
encourage savings and investment in productive enterprises..

27
Government intervention
Regulation and control

The U.S. federal government regulates private enterprise in

numerous ways. Regulation falls into two general categories.

Economic regulation

Some efforts seek, either directly or indirectly, to control

prices. Traditionally, the government has sought to prevent
monopolies such as electric utilities from raising prices
beyond the level that would ensure them extremely large
profits. At times, the government has extended economic
control to other kinds of industries as well. In the years
following the Great Depression, it devised a complex system
to stabilize prices for agricultural goods, which tend to
fluctuate wildly in response to rapidly changing supply and
demand. A number of other industries—trucking and, later,
airlines—successfully sought regulation themselves to limit
what they considered as harmful price cutting.

Another form of economic regulation, antitrust law, seeks to

strengthen market forces so that direct regulation is
unnecessary. The government—and, sometimes, private
parties—have used antitrust law to prohibit practices or
mergers that would unduly limit competition.

28
Bank regulation in the United States is highly fragmented
compared to other G10 countries where most countries have
only one bank regulator. In the U.S., banking is regulated at
both the federal and state level. The U.S also has one of the
most highly regulated banking environments in the world;
however, many of the regulations are not safety and
soundness related, but are instead focused on privacy,
disclosure, fraud prevention, anti-money laundering, anti-
terrorism, anti-usury lending, and promoting lending to
lower-income segments.

Monetary Policy

The federal government attempts to use both monetary

policy (control of the money supply through mechanisms
such as changes in interest rates) and fiscal policy (taxes and
spending) to maintain low inflation, high economic growth,
and low unemployment. A relatively independent central
bank, known as the Federal Reserve, was formed in 1913 to
provide a stable currency and monetary policy. The U.S.
dollar has been regarded as one of the most stable currencies
in the world and many nations back their own currency with
U.S. dollar reserves. During the last few years, the U.S.
dollar has gradually depreciated in value and its reserve
currency status is no longer as high as previously.

29
The dollar used gold standard and/or silver standard from
1785 until 1975, when it became a fiat currency.

Public finances

Public $10.63 trillion (January 2009) 74% of GDP

Debt

Revenues $2.523 trillion (2008)

Expenses $3.150 trillion (2008)

Source : Wikipedia

The economy of the United States is the largest national

economy in the world Its gross domestic product (GDP) was
estimated as $14.3 trillion in 2008. The U.S. economy
maintains a high level of output per person (GDP per capita,
$46,800 in 2008, ranked at around number ten in the world).
The U.S. economy has maintained a stable overall GDP
growth rate, a low unemployment rate, and high levels of
research and capital investment funded by both national and,
because of decreasing saving rates, increasingly by foreign
investors. In 2008, seventy-two percent of the economic
activity in the U.S. came from consumers.

Major economic concerns in the U.S. include international

debt, entitlement liabilities for retiring baby boomers who

30
have already begun withdrawing from their Social Security
accounts, corporate debt, mortgage debt, a low savings rate,
falling house prices, and a large current account deficit. As
of June 2008, the gross U.S. external debt was over $13
trillion, the most external debt of any country in the world.
The 2008 estimate of the United States public debt was 73%
of GDP. In January 2009, the total U.S. federal debt
exceeded $10.6 trillion, about $34,700 per capita. As of
October, 2008 the bailout package that is “The Emergency
Economic Stabilization Act of 2008” raises the current debt
ceiling to US $11.3 trillion.

Statistics

GDP (PPP) $14.28 trillion (2008)

GDP growth 1.3% (2008) / -3.8% (Q4 2008)

GDP per capita $46,800 (2008) (10th)

GDP by sector agriculture (0.9%), industry (20.6%),

services (78.5%)

Inflation (CPI) 0.1% (Dec 2007 to Dec 2008

Population 12.5% (2007)

below poverty line

Labor force 154.5 million (includes unemployed)

31
 (May 2008)

Labor force managerial and professional (35.5%),

by occupation technical, sales and administrative
support (24.8%), services (16.5%),
manufacturing, mining, transportation,
and crafts (24%), farming, forestry, and
fishing (0.6%) (excludes unemployed)
(2007)

Unemployment 7.2% (December 2008)

Main industries petroleum, steel, motor vehicles,

aerospace, telecommunications,
chemicals, culture, electronics, food
processing, consumer goods, lumber,
mining, defense

Source : Wikipedia

Imports and Exports

The United States is the most significant nation in the world

when it comes to international trade. For decades, it has led
the world in imports while simultaneously remaining as one
of the top three exporters of the world.

32
As the major epicenter of world trade, the United States
enjoys leverage that many other nations do not. For one,
since it is the world's leading consumer, it is the number one
customer of companies all around the world. Many
businesses compete for a share of the United States market.
In addition, the United States occasionally uses its economic
leverage to impose economic sanctions in different regions
of the world. USA is the top export market for almost 60
trading nations worldwide.

Since it is the world's leading importer, there are many U.S.

dollars in circulation all around the planet. The stable U.S.
economy and fairly sound monetary policy has led to faith in
the U.S. dollar as the world's most stable currency.

In order to fund the national debt (also known as public

debt), the United States relies on selling U.S. treasury bonds
to people both inside and outside the country, and in recent
times the latter have become increasingly important. Much
of the money generated for the treasury bonds came from
U.S. dollars which were used to purchase imports in the
United States.

External

Exports $1.149 trillion f.o.b. (2007 est.)

33
 Export goods Production machinery and equipment, 31.4%;
industrial supplies, 27.5%; non-auto consumer goods,
12.7%; motor vehicles and parts, 10.5%; aircraft and
parts, 7.6%; food, feed and beverages, 7.3%; other,
3.0%. (2007)

Main export Canada, 21.4%; Mexico, 11.7%; China, 5.6%; Japan,

partners 5.4%; Germany, 4.3%; United Kingdom, 4.2%.

Imports $1.968 trillion c.i.f. (2007 est.)

Import goods non-auto consumer goods 24.3%; production

machinery and equipment, 20.7%; fuels, 19.0%; non-
fuel industrial supplies, 13.5%; motor vehicles and
parts, 13.2%; food, feed and beverages, 4.1%; aircraft
and parts, 1.9%; other 3.3%. (2007)

Main import China, 16.9%; Canada, 15.7%; Mexico, 10.6%; Japan,

partners 7.4%; Germany, 4.8%.

Gross $13.77 trillion (30 June 2008)

External Debt
Source : Wikipedia
US trade by nation

US trade of goods by nation in 2004 (services not included)

Exports Imports

34
 Cumul Cumul
Million Millions
Percen ative Percen ative
Nation s of Nation of
tage Percen tage Percen
dollars dollars
tage tage

Canada 189,101 23.12% 23.12% Canada 255,928 17.41% 17.41%

Mexico 110,775 13.54% 36.66% China 196,699 13.38% 30.80%

Japan 54,400 6.65% 43.31% Mexico 155,843 10.60% 41.40%

United
35,960 4.40% 47.71% Japan 129,595 8.82% 50.22%
Kingdom

China 34,721 4.24% 51.95% Germany 77,236 5.26% 55.48%

United
Germany 31,381 3.84% 55.79% 46,402 3.16% 58.63%
Kingdom

South South
26,333 3.22% 59.01% 46,163 3.14% 61.77%
Korea Korea

Netherlan 24,286 2.97% 61.98% 34,617 2.36% 64.13%

Taiwan,
ds

35
 ROC

Taiwan 21,731 2.66% 64.64% France 31,814 2.16% 66.29%

France 21,240 2.60% 67.23% Malaysia 28,185 1.92% 68.21%

Singapor
19,601 2.40% 69.63% Italy 28,089 1.91% 70.12%
e

Belgium 16,877 2.06% 71.69% Ireland 27,442 1.87% 71.99%

Hong
15,809 1.93% 73.63% Venezuela 24,962 1.70% 73.69%
Kong

14,271 1.74% 75.37% 21,157 1.44% 75.13%

Australia Brazil

13,863 1.69% 77.07% Saudi 20,924 1.42% 76.55%

Brazil
Arabia

10,897 1.33% 78.40% 17,577 1.20% 77.75%

Malaysia Thailand

10,711 1.31% 79.71% 16,246 1.11% 78.85%

Italy Nigeria

9,268 1.13% 80.84% 15,562 1.06% 79.91%

Switzerla India

36
nd

9,198 1.12% 81.96% 15,306 1.04% 80.95%

Israel Singapore

8,166 1.00% 82.96% 14,527 0.99% 81.94%

Ireland Israel

Philippin 7,072 0.86% 83.83% 12,687 0.86% 82.81%

Sweden
es

6,641 0.81% 84.64% 12,605 0.86% 83.66%

Spain Netherlands

6,363 0.78% 85.42% 12,448 0.85% 84.51%

Thailand Belgium

12,095 1.55% 86.16% 11,847 0.81% 85.32%

India Russia

Saudi 5,245 0.64% 86.80% 11,643 0.79% 86.11%

Switzerland
Arabia

Venezuel 4,782 0.58% 87.39% 10,811 0.74% 86.84%

Indonesia
a

4,504 0.55% 87.94% 9,314 0.63% 87.48%

Colombia Hong Kong

Dominica
4,343 0.53% 88.47% 9,144 0.62% 88.10%
n Philippines
Republic

37
United
4,064 0.50% 88.97% 8,514 0.58% 88.68%
Arab Iraq
Emirates

3,625 0.44% 89.41% 7,544 0.51% 89.19%

Chile Australia

3,386 0.41% 89.82% 7,476 0.51% 89.70%

Argentina Spain

3,361 0.41% 90.24% 7,409 0.50% 90.21%

Turkey Algeria

Costa 3,304 0.40% 90.64% 7,290 0.50% 90.70%

Colombia
Rica

3,265 0.40% 91.04%

Sweden

South 3,172 0.39% 91.43%

Africa

3,105 0.38% 91.81%

Egypt

100.00 100.00
Others 67,023 8.19% Others 136,661 9.30%
% %

Total Total
817,939 1,469,667
Exports Imports

Source : Wikipedia

38
The effect of military expenditure

Most economic models have shown that military spending

by the United States Government has diverted resources
from productive uses such as consumption and investment,
which has ultimately slowed growth and reduced
employment. Estimates project that by 2017 the Iraq War
and War in Afghanistan will have cost the U.S. budget
between $1.7 trillion and $2.7 trillion. Interest on money
borrowed to pay those costs could alone add a further $816
billion to that bottom line. Nobel Prize-winning economist
Joseph E. Stiglitz even says that estimating all economic and
social costs might push the U.S. war bill up toward $5
trillion by 2017. This figure includes the cost to the U.S.
economy of global oil prices that have quadrupled since
2003, an increase blamed partly on the Iraq war.

The Great Depression

The Great Depression was an economic slump in North

America, Europe, and other industrialized areas of the world
that began in 1929 and lasted until about 1939. It was the
longest and most severe depression ever experienced by the
industrialized Western world.

Though the U.S. economy had gone into depression six

months earlier, the Great Depression may be said to have
39
begun with a catastrophic collapse of stock-market prices on
the New York Stock Exchange in October 1929. During the
next three years stock prices in the United States continued
to fall, until by late 1932 they had dropped to only about 20
percent of their value in 1929. Besides ruining many
thousands of individual investors, this precipitous decline in
the value of assets greatly strained banks and other financial
institutions, particularly those holding stocks in their
portfolios. Many banks were consequently forced into
insolvency; by 1933, 11,000 of the United States' 25,000
banks had failed. The failure of so many banks, combined
with a general and nationwide loss of confidence in the
economy, led to much-reduced levels of spending and
demand and hence of production, thus aggravating the
downward spiral. The result was drastically falling output
and drastically rising unemployment; by 1932, U.S.
manufacturing output had fallen to 54 percent of its 1929
level, and unemployment had risen to between 12 and 15
million workers, or 25-30 percent of the work force.

The Great Depression began in the United States but quickly

turned into a worldwide economic slump owing to the
special and intimate relationships that had been forged
between the United States and European economies after
World War I. The United States had emerged from the war
as the major creditor and financier of postwar Europe, whose

40
national economies had been greatly weakened by the war
itself, by war debts, and, in the case of Germany and other
defeated nations, by the need to pay war reparations. So once
the American economy slumped and the flow of American
investment credits to Europe dried up, prosperity tended to
collapse there as well. The Depression hit hardest those
nations that were most deeply indebted to the United States,
i.e., Germany and Great Britain. In Germany, unemployment
rose sharply beginning in late 1929, and by early 1932 it had
reached 6 million workers, or 25 percent of the work force.
Britain was less severely affected, but its industrial and
export sectors remained seriously depressed until World War
II. Many other countries had been affected by the slump by
1931.

Almost all nations sought to protect their domestic

production by imposing tariffs, raising existing ones, and
setting quotas on foreign imports. The effect of these
restrictive measures was to greatly reduce the volume of
international trade: by 1932 the total value of world trade
had fallen by more than half as country after country took
measures against the import of foreign goods.

The Great Depression had important consequences in the

political sphere. In the United States, economic distress led
to the election of the Democrat Franklin D. Roosevelt to the

41
presidency in late 1932. Roosevelt introduced a number of
major changes in the structure of the American economy,
using increased government regulation and massive public-
works projects to promote a recovery. But despite this active
intervention, mass unemployment and economic stagnation
continued, though on a somewhat reduced scale, with about
15 percent of the work force still unemployed in 1939 at the
outbreak of World War II. After that, unemployment
dropped rapidly as American factories were flooded with
orders from overseas for armaments and ammunitions. The
depression ended completely soon after the United States'
entry into World War II in 1941. In Europe, the Great
Depression strengthened extremist forces and lowered the
prestige of liberal democracy. In Germany, economic
distress directly contributed to Adolf Hitler's rise to power in
1933. The Nazis' public-works projects and their rapid
expansion of munitions production ended the Depression
there by in 1936.

At least in part, the Great Depression was caused by

underlying weaknesses and imbalances within the U.S.
economy that had been obscured by the boom psychology
and speculative euphoria of the 1920s. The Depression
exposed those weaknesses, as it did the inability of the
nation's political and financial institutions to cope with the
vicious downward economic cycle that had set in by 1930.

42
Prior to the Great Depression, governments traditionally took
little or no action in times of business downturn, relying
instead on impersonal market forces to achieve the necessary
economic correction. But market forces alone proved unable
to achieve the desired recovery in the early years of the Great
Depression, and this painful discovery eventually inspired
some fundamental changes in the United States' economic
structure. After the Great Depression, government action,
whether in the form of taxation, industrial regulation, public
works, social insurance, social-welfare services, or deficit
spending, came to assume a principle role in ensuring
economic stability in most industrial nations with market
economies.

Roosevelt and the New Deal

In 1933 the new president, Franklin Roosevelt, brought an

air of confidence and optimism that quickly rallied the
people to the banner of his program, known as the New Deal.
"The only thing we have to fear is fear itself," the president
declared in his inaugural address to the nation.

In a certain sense, it is fair to say that the New Deal merely

introduced types of social and economic reform familiar to
many Europeans for more than a generation. Moreover, the

43
New Deal represented the culmination of a long-range trend
toward abandonment of "laissez-faire" capitalism, going
back to the regulation of the railroads in the 1880s, and the
flood of state and national reform legislation introduced in
the Progressive era of Theodore Roosevelt and Woodrow
Wilson.

What was truly novel about the New Deal, however, was the
speed with which it accomplished what previously had taken
generations. In fact, many of the reforms were hastily drawn
and weakly administered; some actually contradicted others.
And during the entire New Deal era, public criticism and
debate were never interrupted or suspended; in fact, the New
Deal brought to the individual citizen a sharp revival of
interest in government.

When Roosevelt took the presidential oath, the banking and

credit system of the nation was in a state of paralysis. With
astonishing rapidity the nation's banks were first closed and
then reopened only if they were solvent. The administration
adopted a policy of moderate currency inflation to start an
upward movement in commodity prices and to afford some
relief to debtors. New governmental agencies brought
generous credit facilities to industry and agriculture. The
Federal Deposit Insurance Corporation (FDIC) insured
savings-bank deposits up to $5,000, and severe regulations

44
were imposed upon the sale of securities on the stock
exchange.

Unemployment

An early step for the unemployed came in the form of the

Civilian Conservation Corps (CCC), a program enacted by
Congress to bring relief to young men between 18 and 25
years of age. Run in semi-military style, the CCC enrolled
jobless young men in work camps across the country for
about $30 per month. About 2 million young men took part
during the decade. They participated in a variety of
conservation projects: planting trees to combat soil erosion
and maintain national forests; eliminating stream pollution;
creating fish, game and bird sanctuaries; and conserving
coal, petroleum, shale, gas, sodium and helium deposits.

Agriculture

The New Deal years were characterized by a belief that

greater regulation would solve many of the country's
problems. In 1933, for example, Congress passed the
Agricultural Adjustment Act (AAA) to provide economic
relief to farmers. The AAA had at its core a plan to raise
crop prices by paying farmers a subsidy to compensate for
voluntary cutbacks in production. Funds for the payments

45
would be generated by a tax levied on industries that
processed crops.

Industry and Labour

The National Recovery Administration (NRA), established

in 1933 with the National Industrial Recovery Act (NIRA),
attempted to end cut-throat competition by setting codes of
fair competitive practice to generate more jobs and thus more
buying. Although the NRA was welcomed initially,
businesses complained bitterly of over-regulation as
recovery began to take hold. The NRA was declared
unconstitutional in 1935.

US President Franklin D. Roosevelt introduced regulation in

the financial system as well as the social security system. He
enacted Glass-Steagull Act 1933.

Glass – Steagull Act, 1933

Two separate United States laws are known as the Glass-
Steagull Act. The Acts (Glass & Steagull) were both
reactions of the US government to cope with the collapse of
a large portion of the American Commercial Banking
System in early 1933, which came three and half years later,
was only partially the result of the stock market collapse in
October, 1929.
Congressional Research Service summary stated that :
46
In the nineteenth and early twentieth centuries, bankers and
brokers were sometimes indistinguishable. Then, in the Great
Depression after 1929 Congress examined the mixing of the
“commercial” and “investment” banking industries that
occurred in the 1920s. Hearings revealed conflicts of interest
and fraud in some banking institutions securities activities.
A formidable barrier to the mixing of these activities was
then set up by the Glass Steagull Act. Glass Steagull Act
passed on 16 June 1933, and officially named the Banking
Act of 1933, introduced the separation of bank types
according to their business (commercial and investment
banking) and it founded the Federal Deposit Insurance
Company for insuring bank deposits.

The argument for preserving Glass-Steagall (as written

in 1987):

1. Conflicts of interest characterize the granting of credit –

lending – and the use of credit – investing – by the same
entity, which led to abuses that originally produced the Act

2. Depository institutions possess enormous financial power,

by virtue of their control of other people’s money; its extent

47
must be limited to ensure soundness and competition in the
market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous

losses. Such losses could threaten the integrity of deposits. In
turn, the Government insures deposits and could be required
to pay large sums if depository institutions were to collapse
as the result of securities losses.

4. Depository institutions are supposed to be managed to

limit risk. Their managers thus may not be conditioned to
operate prudently in more speculative securities businesses.
An example is the crash of real estate investment trusts
sponsored by bank holding companies (in the 1970s and
1980s).

Political Economy of Bretton Woods : Birth of US

Supremacy

To understand the political economy of the world economy it

is most important to understand the Bretton Woods
Agreements. It is these agreements which made US an
economic superpower. The world almost became unipolar
and was dictated by US. Why the fall of US economy is such
a serious matter? Why this fall has global scale? To know the

48
answers for these questions, one should understand the
political economy of Bretton Woods Agreements.

The political basis for the Bretton Woods System was in the
confluence of several key conditions : the shared experience
of the Great Depression, the concentration of power in a
small number of states and the presence of a dominant power
willing and able to assume a leadership role in global
monetary affairs.
According to Hull, United States Secretary of State from
1933 to 1944, fundamental causes of the two world wars lay
in economic discrimination and trade warfare. Specifically,
he had in mind the trade and exchange controls (bilateral
arrangements) of Nazi Germany and imperial preference
system practiced by Britain (by which members or former
members of the British Empire were accorded special trade
status)
Capitalism And Bretton Woods
A high level agreement among powerful on the goals and
means of international economic management facilitated the
decisions reached by the Bretton Woods conference. The
foundation of that agreement was a shared belief in
capitalism. Although the developed countries’ governments
differed somewhat in the type of capitalism they preferred
for their national economies (France, for example, preferred
greater planning and state intervention, whereas the United
49
States favoured relatively limited state intervention), all
relied primarily on market mechanisms and on private
ownership.
Planners at Bretton woods all favoured a regulated system,
one that believed in a regulated market with tight controls on
the value of currencies. Although they disagreed on the
specific implementation of this system, all agreed on the
need for tight control.
The principal architect of the Bretton Woods system Harry
Dexter White put it:
“The absence of a high degree of economic collaboration
among the leading nations will …. inevitably result in
economic warfare that will be but the prelude and instigator
of military warfare on an even vaster scale”.
US allies – economically exhausted by the war accepted the
leadership of US. They needed U.S. assistance to rebuild
their domestic production and to finance their international
trade; indeed, they needed it to survive.
Before the war, the French and the British were realizing that
they could no longer compete with US industry in an open
market place. During the 1930s, British had created their
own economic bloc to shutout the US goods. Churchill did
not believe that he could surrender that protection after the
war, so he watered down the Atlantic Charter’s “free access”
clause before agreeing to it.

50
Yet, the US officials were determined to open their access to
the British Empire. The combined value of British and US
trade was well over half of all the world’s trade in goods. In
order for the US to open global markets, it first had to split
the British (trade) empire. While Britain had economically
dominated the 19th century, the US officials intended the
second half of the 20th to be under US hegemony.
According to one commentator, “one of the reasons Bretton
Woods worked was that the US was clearly the most
powerful country at the table and so ultimately was able to
impose its will on others, including an often-dismayed
Britain. At the time, one senior official at the Bank of
England described the deal reached at Bretton Woods as “the
greatest blow to Britain next to the war” Largely because it
underlined the way in which financial power had moved
from the UK to the US”.

US Dollar as Reserve Currency

In the 19th and early 20th Centuries gold played a key role in
international monetary transactions. The gold standard was
used to back currencies; the international value of currency
was determined by its fixed relationship to gold; gold was
used to settle international accounts. The gold standard
maintained fixed exchange rates that were seen as desirable
because they reduced the risk of trading with other countries.
51
Supplementing the use of gold in this period was the British
Pound. Based on the dominant British economy, the pound
became a reserve, transaction, and intervention currency. But
the pound was not up to the challenge of serving as the
primary world currency, given the weakness of the British
economy after the second World War.
The architects of Bretton Woods had conceived of a system
where in exchange rate stability was a prime goal. Gold
production was not even sufficient to meet demands of
growing international trade and investment. And a sizeable
share of the Worlds known gold reserves were located in the
Saviet Union, which would later emerge as a cold war rival
to the United States and Western Europe.
The only currency strong enough to meet the rising demands
for international liquidity was the US dollar. The strength of
the US economy, the fixed relationship of the dollar to gold
($ 35 an ounce), and the commitment of the US government
to convert dollars in to gold at that price made the dollar as
good as gold. In fact, the dollar was even better than gold : it
earned interest and it was more flexible than gold.

In practice, however, since the principal "Reserve currency"

would be the U.S. dollar, this meant that other countries
would peg their currencies to the U.S. dollar, and—once
convertibility was restored—would buy and sell U.S. dollars
to keep market exchange rates within plus or minus 1% of

52
parity. Thus, the U.S. dollar took over the role that gold had
played under the gold standard in the international financial
system.

Meanwhile, in order to bolster faith in the dollar, the U.S.

agreed separately to link the dollar to gold at the rate of $35
per ounce of gold. At this rate, foreign governments and
central banks were able to exchange dollars for gold. Bretton
Woods established a system of payments based on the dollar,
in which all currencies were defined in relation to the dollar,
itself convertible into gold, and above all, "as good as gold".
The U.S. currency was now effectively the world currency,
the standard to which every other currency was pegged. As
the world's key currency, most international transactions
were denominated in dollars.

The U.S. dollar was the currency with the most purchasing
power and it was the only currency that was backed by gold.
Additionally, all European nations that had been involved in
World War II were highly in debt and transferred large
amounts of gold into the United States, a fact that
contributed to the supremacy of the United States. Thus, the
U.S. dollar was strongly appreciated in the rest of the world
and therefore became the key currency of the Bretton Woods
system.

Establishment of IMF & IBRD (Now World Bank)

53
John Maynard Keynes emphasized “the importance of rule-
based regimes to stabilize business expectations” something
he accepted in the Bretton Woods system of fixed exchange
rates.

The International Monetary Fund

Established on December 27, 1945 when the 29 participating

countries at the conference of Bretton Woods signed its
Articles of Agreement, the IMF was to be the keeper of the
rules and the main instrument of public international
management. The fund commenced its finance operations on
March, 1947. IMF approval was necessary for any change in
exchange rates in excess of 10% it advised countries on
policies affecting the monetary system.
Even though there was difference in the British Plan (more
concerned as a debtor country) and US plan (more concerned
as a creditor country), the compromise was reached on some
points. Participants at Bretton Woods largely agreed on US
plan because of the overwhelming economic and military
power of the United States.
Voting rights among governments are not on one-to-one
basis, but rather proportionate to quotas. Quotas are decided
on the basis of contribution of member countries. Since the
United States was contributing most, US leadership was the
key. Under the system of weighted voting, the United States
54
exerted a pre-ponderant influence on the IMF. The United
States held one third of all IMF quotas at the outset, enough
on its own to veto all changes to the IMF Charter. In
addition, the IMF was based in Washington, D.C. and staffed
mainly by US economists. It regularly exchanged personnel
with the US Treasury.

International Bank For Reconstruction And

Development

To promote the growth of world trade and to finance the

postwar reconstruction of Europe, the planners at Bretton
Woods created another institution IBRD. Now the most
important agency of the World Bank Group. Only the United
States contribution of $ 570 million was actually available
for IBRD lending.

The modest credit facilities of the IMF were clearly

insufficient to deal with Western Europe's huge balance of
payments deficits. The problem was further aggravated by
the reaffirmation by the IMF Board of Governors in the
provision in the Bretton Woods Articles of Agreement that
the IMF could make loans only for current account deficits
and not for capital and reconstruction purposes. Only the
United States contribution of $570 million was actually
available for IBRD lending. In addition, because the only

55
available market for IBRD bonds was the conservative Wall
Street banking market, the IBRD was forced to adopt a
conservative lending policy, granting loans only when
repayment was assured. Given these problems, by 1947 the
IMF and the IBRD themselves were admitting that they
could not deal with the international monetary system's
economic problems.

Thus, the much looser Marshall Plan—the European

Recovery Program—was set up to provide U.S. finance to
rebuild Europe largely through grants rather than loans. The
Marshall Plan was the program of massive economic aid
given by the United States to favored countries in Western
Europe for the rebuilding of capitalism. In a speech at
Harvard University on June 5, 1946, U.S. Secretary of State
George Marshall stated:

“ The breakdown of the business structure of Europe ”

during the war was complete. …Europe's
requirements for the next three or four years of
foreign food and other essential products…
principally from the United States… are so much
greater than her present ability to pay that she must
have substantial help or face economic, social and

56
 political deterioration of a very grave character.

From 1947 until 1958, the U.S. deliberately encouraged an

outflow of dollars, and, from 1950 on, the United States ran
a balance of payments deficit with the intent of providing
liquidity for the international economy. Dollars flowed out
through various U.S. aid programs: the Truman Doctrine
entailing aid to the pro-U.S. Greek and Turkish regimes,
which were struggling to suppress socialist revolution, aid to
various pro-U.S. regimes in the Third World, and most
important, the Marshall Plan. From 1948 to 1954 the United
States gave 16 Western European countries $17 billion in
grants.

To encourage long-term adjustment, the United States

promoted European and Japanese trade competitiveness.
Policies for economic controls on the defeated former Axis
countries were scrapped. Aid to Europe and Japan was
designed to rebuild productivity and export capacity. In the
long run it was expected that such European and Japanese
recovery would benefit the United States by widening
markets for U.S. exports, and providing locations for U.S.
capital expansion.

Bretton Woods created a system of triangular trade : the

United States would use the convertible financial system to

57
trade at a tremendous profit with developing nations,
expanding industry and acquiring raw materials. It would use
this surplus to send dollar to Europe, which would then be
used to rebuild their economies, and make the United States
market for their products. This would allow the other
industrialized nations to purchase products from the Third
World, which reinforced the American role as the guarantor
of stability.
John Vandele said (Democracy comes to world institutions
slowly, inter press service, October, 27, 2008) “The most
powerful international institutions tend to have the worst
democratic credentials : The power distribution among
countries is more unequal, and the transparency, and hence
democratic control, is worse”.

Golden Era Of Capitalism

Milton Friedman
One of the great influencing economist of the US Capitalism
was Milton Friedman. The Economist hailed him as ‘The
most influential economist of the second half of the 20 th
Century .…possibly of all of it’. He argued that a steady
expansion of the money supply was the only wise policy, and
58
warned against efforts by the treasury or central bank to do
otherwise.

Influenced by his close friend George Stigler, Friedman

opposed government regulation of all sorts. He once stated
that his role in eliminating U.S. conscription was his
proudest accomplishment, and his support for school choice
led him to found The Friedman Foundation for Educational
Choice. Friedman's political philosophy, which he
considered classically liberal and libertarian, stressed the
advantages of the marketplace and the disadvantages of
government intervention and regulation, strongly influencing
the outlook of American conservatives and libertarians. In
his 1962 book Capitalism and Freedom, Friedman advocated
policies such as a volunteer military, freely floating
exchange rates, abolition of licensing of doctors, a negative
income tax, and education vouchers. His books and essays
were widely read and even circulated underground behind
the Iron Curtain.

Friedman's methodological innovations were widely

accepted by economists, but his policy prescriptions were
highly controversial. Most economists in the 1960s rejected
them, but since then they have had a growing international
influence (especially in the US and Britain), and in the 21st
century have gained wide acceptance among many

59
economists. He thus lived to see some of his laissez-faire
ideas embraced by the mainstream, especially during the
1980s. His views of monetary policy, taxation, privatization
and deregulation informed the policy of governments around
the globe, especially the administrations of Augusto Pinochet
in Chile, Margaret Thatcher in Britain, Ronald Reagan in the
US, Brian Mulroney in Canada, Roger Douglas in New
Zealand, and (after 1989) in many Eastern European
countries.

Krugman

The Princeton University economist and Nobel laureate Paul

Krugman, while regarding Freidman as a "great economist
and a great man," criticized him in 2007 by writing:

In the aftermath of the Great Depression, there were many

people saying that markets can never work. Friedman had
the intellectual courage to say that markets can work too, and
his showman's flair combined with his ability to marshal
evidence made him the best spokesman for the virtues of free
markets since Adam Smith. But he slipped all too easily into
claiming both that markets always work and that only
markets work. It's extremely hard to find cases in which
Friedman acknowledged the possibility that markets could
go wrong, or that government intervention could serve a
useful purpose.
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Anglo-Saxon capitalism

An Anglo-Saxon economy or Anglo-Saxon capitalism (so

called because it is supposedly practiced in English-speaking
countries such as the United Kingdom, the United States,
Canada, New Zealand, Australia and the Republic of Ireland)
is a capitalist macroeconomic model in which levels of
regulation and taxes are low, and government provides
relatively fewer services.

The laissez-faire economic philosophy

Laissez-faire (French, “let it be”) activists support little or no

state intervention on economic issues, which implies free
markets, minimal taxes, minimal regulations and private
ownership of property. They support certain kinds of
negative liberty as opposed to positive liberties, such as
wealth redistribution, given by the state. However, some
laissez-faire proponents, like progressive libertarians prefer
negative income tax as a replacement to the existing welfare
system, arguing that it is simpler and has fewer of the
"perverse incentives" of "government handouts".

Supporters of laissez-faire favor a state that is neutral

between the various competing interest groups that vie for
privileges and political power in a country. They are critical
of mixed economies on the grounds that it leads to an

61
interest-group politics where each group is seeking to benefit
itself at the expense of another and the consumer. They
oppose government funding or regulation of schools,
hospitals, industry, agriculture, and social welfare programs.

According to them, any government intervention such as

regulation, protectionism, creating legal monopolies,
competition laws, or taxes, interfere with this judgment
being reflected accurately in the price and the maximization
of economic utility. Their opposition of competition law and
the U.S. Food and Drug Administration, stating that they are
corrupt and benefits the corporations instead of the
consumer.

REAGANISM

In an article in Newsweek, Francis Fukuyama explained the

raise and fall of Reaganism. According to him, many
commentators have noted that the Wall Street meltdown
marks the end of the Reagan era. Big ideas are born in the
context of a particular historical era. Few survive when the
context changes dramatically, which is why politics tends to

62
shift from left to right and back again in generation-long
cycles.
Reaganism (or, in its British form, Thatcherism) was right
for its time. Since Franklin Roosevelt’s New Deal in the
1930s, governments all over the world had only grown
bigger and bigger. By the 1970s large welfare states and
economies choked by red tape were proving highly
dysfunctional. Back then, telephones were expensive and
hard to get, air travel was a luxury of the rich, and most
people put their savings in bank accounts paying low,
regulated rates of interest. Programs like Aid to Families
with Dependent Children created disincentives for poor
families to work and stay married, and families broke down.
The Reagan-Thatcher revolution made it easier to hire and
fire workers, causing a huge amount of pain as traditional
industries shrank or shut down. But it also laid the
groundwork for nearly three decades of growth and the
emergence of new sectors like information technology and
biotech.
Internationally, the Reagan revolution translated into the
“Washington Consensus,” under which Washington-and
institutions under its influence, like the International
Monetary Fund and the World Bank – pushed developing
countries to open up their economies.
Like all transformative movements, the Reagan revolution
lost its way because for many followers it became an
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unimpeachable ideology, not a pragmatic response to the
excesses of the welfare state. Two concepts were sacrosanct:
first, that tax cuts would be self-financing, and second, that
financial markets could be self-regulating.
Prior to the 1980s, conservatives were fiscally conservative
that is, they were unwilling to spend more than they took in
taxes. But Reaganomics introduced the idea that virtually
any tax cut would so stimulate growth that the government
would end up taking in more revenue in the end (the so-
called Laffer curve). In fact, the traditional view was correct:
if you cut taxes without cutting spending, you end up with a
damaging deficit. Thus the Reagan tax cuts of the 1980s
produced a big deficit; the Clinton tax increases of the 1990s
produced a surplus; and the Bush tax cuts of the early 21 st
century produced an even larger deficit. The fact that the
American economy grew just as fast in the Clinton years as
in the Reagan ones some how didn’t shake the conservative
faith in tax cuts as the surefire key to growth.
More important, globalization masked the flaws in this
reasoning for several decades. Foreigners seemed endlessly
willing to hold American dollars, which allowed the US
government to run deficits while still enjoying high growth,
something that no developing country could get away with.
That’s why Vice President Dick Cheney reportedly told
President Bush early on that the lesson of the 1980s was that
“deficits don’t matter”.
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The second Reagan – era article of faith-financial
deregulation – was pushed by an unholy alliance of true
believers and Wall Street firms, and by the 1990s had been
accepted as gospel by the Democrats as well. They argued
that long-standing regulations like the Depression-era Glass-
Steagall Act (which split up commercial and investment
banking) were stifling innovation and undermining the
competitiveness of US financial institutions. They were
right-only, deregulation produced a flood of innovative new
products like collateralized debt obligations, which are at the
core of the current crisis. Some Republicans still haven’t
come to grips with this, as evidenced by their proposed
alternative to the bailout bill, which involved yet bigger tax
cuts for hedge funds.

The problem is that Wall Street is very different from, say,

Silicon Valley, where a light regulatory hand is genuinely
beneficial. Financial institutions are based on trust, which
can only flourish if governments ensure they are transparent
and constrained in the risks they can take with other people’s
money. The sector is also different because the collapse of a
financial institutions harms not just its shareholders and
employees, but a host of innocent bystanders as well (what
economists soberly call “negative externalities”).
Signs that the Reagan revolution had drifted dangerously
have been clear over the past decade. An early warning was
65
the Asian financial crisis of 1997-98. Countries like Thailand
and South Korea, following American advice and pressure,
liberalized their capital markets in the early 1990s. A lot of
hot money started flowing into their economies, creating a
speculative bubble, and then rushed out again at the first sign
of trouble. Sounds familiar? Meanwhile, countries like China
and Malaysia that didn’t follow American advice and kept
their financial markets closed or strictly regulated found
themselves much less vulnerable.
A second warning sign lay in America’s accumulating
structural deficits. China and a number of other countries
began buying US dollars after 1997 as part of a deliberate
strategy to undervalue their currencies, keep their factories
humming and protect themselves from financial shocks. This
suited a post – 9/11 America just fine ; it meant that we
could cut taxes, finance a consumption binge, pay for two
expensive wars and run a fiscal deficit at the same time. The
staggering and mounting trade deficits this produced - $ 700
billion a year by 2007 – were clearly unsustainable; sooner
or later the foreigners would decide that America wasn’t
such a great place to bank their money. The falling US dollar
indicates that we have arrived at that point.

66
 Causes of Financial Crisis

During this period of Lassize - faire, three commandments

were born. Total belief in these commandments without
understanding their limitations lead to the crisis.

 Markets
 What is
Street.
 Too big

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Legal Changes

Those who cannot remember the past are condemned to

repeat it.
George Santayana

Repeal of Glass Steagull Act and enactment of Gramm-

Leach-Bliley Act or Financial Services Modernization Act.
Enacted on 12th November, 1999 is an act of United States
Congress which repealed the part of the Glass-Steagull Act,
1933, opening up competition among banks, securities
companies and insurance companies.

The argument for not retaining Glass–Steagull (as written in

1987) by the Congressional Research Service was as follows.

The argument against preserving the Act:

1. Depository institutions will now operate in “deregulated”

financial markets in which distinctions between loans,
securities, and deposits are not well drawn. They are losing
market shares to securities firms that are not so strictly
regulated, and to foreign financial institutions operating
without much restriction from the Act.

68
2. Conflicts of interest can be prevented by enforcing
legislation against them, and by separating the lending and
credit functions through forming distinctly separate
subsidiaries of financial firms.

3. The securities activities that depository institutions are

seeking are both low-risk by their very nature, and would
reduce the total risk of organizations offering them – by
diversification.

4. In much of the rest of the world, depository institutions

operate simultaneously and successfully in both banking and
securities markets. Lessons learned from their experience can
be applied to our national financial structure and regulation.

Prior to the passage of GLB Act, there were many

relaxations to the Glass-Steagull Act. For example a few
years earlier, Commercial Banks were allowed to get into
investment banking, and before that banks were also allowed
to get into stock and insurance brokerage. Insurance
underwriting was the only main operations they weren’t
allowed to do, something rarely done by banks even after the
passage of the Act.

In 1998, Travelers, a financial services company with

everything but a retail/commercial bank, bought out Citi
Bank, creating the largest and the most profitable company
69
in the world. The move was technically illegal and provided
impetus for the passage of the Gramm-Leach-Bliley Act.

Section 108 of the Gramm-Leach-Bliley Act, titled “Use of

subordinated debt to protect the financial system and deposit
funds from ‘Too Big to Fail Institutions’ was one of the
important section. For the first time in US history, the law
was designating certain institutions as ‘too big to fail’,
implicitly promising government support in the face of any
mistakes.

Unregulated Regulators:

Apart from these legal changes, the Regulatory Authorities

like Federal Reserve Bank and Security Exchange Control
started having faith in minimal regulation and easy money
supply. In 1990, the Federal Reserve Bank allowed JP
Morgan (a bank) to underwrite securities, something once
the preserve of Investment Banks. The move snowballed in
1995, then US Treasury Secretary Robert Rubin testified
before congress saying “the banking industry is different
from what it was two decades ago, let alone 1933”. Pension
funds were allowed to invest in stock. In 1996, the Federal
70
Bank allowed commercial bank affiliates to have 25 percent
of their business in investment banking type operations.
Federal Reserve Bank believed in easy supply of money and
lowered its interest rates. It was cut to 1% in 2003.

Securities Exchange Control bartered away the traditional 12

to 1 cap on leverage allowing banks to take bets as big as
they liked. SEC regulators no longer had clear-cut capital
guidelines to review when judging the solvency of the banks.

Joseph Stiglitz argues that, “Failures in financial markets

have come about because of poorly designed incentive
structures, inadequate competition, and inadequate
transparency. Part of this is because larger institutions have
been resistant to changes that would actually create more
healthy competition, something Adam Smith had long noted
in his Wealth of Nations, often regarded as the Bible of
capitalism. Better regulation is required to reign in the
financial markets and bring back trust in the system.” In a
short but very powerful article he concludes, “Part of the
problem has been our regulatory structures. If government
appoints as regulators those who do not believe in regulation,
one is not likely to get strong enforcement. We have to
design robust regulatory systems, where gaps in enforcement
are transparent. Relatively simple regulatory systems may be

71
easier to implement and more robust, and more resistant to
regulatory capture.

Well-designed regulations may protect us in the short run

and encourage real innovation in the long. Much of our
financial market’s creativity was directed to circumventing
regulations and taxes. Accounting was so creative that no
one, not even the banks, knew their financial position.
Meanwhile, the financial system [has] resisted many of the
innovations that would have increased the efficiency of our
economy. By reducing the scope for these socially
unproductive innovations, we can divert creative activity in
more productive directions.

The agenda for regulatory reform is large. It will not be

completed overnight. But we will not begin to restore
confidence in our financial markets until and unless we begin
serious reform.”

Technological Developments

Technology has played a great role in hastening the speed of

the fall. Internet and mobile phones have been used
extensively. Internet has been hailed as the great
democratizer of information. Information is the heart of any
market. It allows the buyer and seller to access the
information available to take a rational decision. Internet has
72
done many important and useful things for the world
financial system. On line trading has revolutionalized trading
in stock exchange. Every ordinary investor has access to
information and freedom to trade at his will by press of a
button. All analyses of data of performance of companies or
industry hitherto available to investment analyst is available
to common man. In brief information is democratized.
Internet banking has further added the comfort of banking
and money transfer at the press of a button. Plastic money
through credit cards has made currency totally redundant.
Availability of credit through credit cards has made
availability of easy money without personal interaction with
the banker. ATM is spreading like mushroom everywhere,
made 24X7 banking a reality. Regulation over-sight of these
transaction and know-your-customer personally to judge the
credit worthiness have become irrelevant. It is highly
impersonal trading, banking and commerce.
Mobile phones have played an important role. Many
unregulated financial transactions are carried out through
instant messaging. Trading in high-stakes has become a
video gaming without any documentation. Overlapping of
trade has become common. Without the internet, many of
the credit innovations would never have been launched.
Huge data and high frequency data with all imaginary key
relations was a misguiding factor.

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Investment Bankers

This is a new breed of bankers. Bankers uncontrolled by any

regulatory mechanism. Bankers who look for double digit
return. The cigar smoking, suspender wearing, croestan
archetypes immortalized in many American movies. Millions
in salaries and stock options are their staple food. The Wall
Street wallas who strongly believe and swear that, “What is
good for Wall Street is also good for Main Street”. They are
the blue eyed boys of Federal Reserve because 25% of the
corporate profits in US were earned by the Investment
Banks. They have all the ears to listen at the right places.
Investment banks attract the best talent in Management,
Maths, Science from all the leading institutions in the world
and they are the highest pay masters. Left over talent is for
other corporates. They are the financial engineers and they
are great inventors of exotic financial products.

Quoting Stiglitz again, he captures the sentiments of a

number of people: “We had become accustomed to the
hypocrisy. The banks reject any suggestion they should face
regulation, rebuff any move towards anti-trust measures —
yet when trouble strikes, all of a sudden they demand state
intervention: they must be bailed out; they are too big, too
important to be allowed to fail…….

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America’s financial system failed in its two crucial
responsibilities: managing risk and allocating capital. The
industry as a whole has not been doing what it should be
doing … and it must now face change in its regulatory
structures. Regrettably, many of the worst elements of the
US financial system … were exported to the rest of the
world”.

Lehman Brother CEO Richard Fuld who filed for $ 600

billion bankruptcy was enjoying haf-billion-dollar
compensation and baronial life style: a $ 21 million Park
Avenue Penthouse, a $ 25 million estate in Greenwich,
Connecticut, and an estimated $ 200 million in art collection.

The CEOs of three auto majors came to Washington in their

private corporate jets to beg for $ 25 billion bailout. They
came without any concrete plan to submit. When CEO of
Ford, Allan Mullally was asked if he would consider
slashing his compensation to a symbolic dollar ( 2007
compensation $ 21.7 million) responded saying “No, I think
I am okay where I am”.

Exotic Financial Products

The investment bankers, nay, the financial engineers have

invented many exotic financial products. Many of these

75
products are beyond the control and even comprehension of
the Federal Reserve Bank, Security Exchange Control,
Credit Rating Agencies and Accounting Standards.
Joseph Stiglitz (the guardian, September 26, 2008) said, “It
was all in the name of innovation and any regulatory
initiative was fought away with claims that it would suppress
that innovation. They were innovating, all right, but not in
ways that made the economy stronger. Some of America’s
best and brightest were devoting their talents to getting
around standards and regulations designed to ensure the
efficiency of the economy and the safety of the banking
system. Unfortunately, they were far too successful and we
are all – homeowners, workers, investors, tax payers paying
the price”.
Credit Default Swap (CDS)

By mid 1990s JP Morgan’s book were loaded with tons of

billions of dollars in loans to corporations and foreign
governments. As per Federal Law, bank has to keep huge
amount of capital in reserve in case any of them went bad.
What if JP Morgan could create a device that would protect
it if those loans are defaulted and free up the capital? Then
they hit upon the idea of insurance policy. A third party
would assume the risk of the debt going sour, and in
exchange would receive regular payment from the bank,
similar to insurance premium. JP Morgan then gets to
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remove the risk from its books and free up the reserves. This
is similar to what bankers were hedging against risk of
fluctuations in interest rates and commodity prices. JP
Morgan was the first to hit on this idea in mid 1990s and
hired young maths and science grads from schools like MIT
and Cambridge to create a market for complex instruments.
They were designed to shift the risk of default to a third
party as this shifted risk did not count against their
regulatory capital requirements. In essence the swaps were
created as a regulatory loophole. It is said buying credit
derivative from bank was like buying insurance for the
Titanic from the people who were on the Titanic.

The Growth of CDS

1994-1997 First CDS deals done by JP Morgan,

Swiss Bank Corp and Bankers Trust.
1999 Commercial banks and insurance
companies are now able to trade CDS
contracts.
2003 First derivative index is created,
standardizing a major aspect of the
market.

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2004-2008 CDS deals default on $ 14 billion CDS
policies.

Total outstanding CDS derivatives are in the region of $ 55

trillion.

Mortgage Backed Securities

Mortgages backed together, cut into pieces and resold.
Investors brought them as a low risk way to earn returns
higher than treasuries.

Derivatives

Derivatives are financial contracts, or financial instruments,

whose values are derived from the value of something else
(known as the underlying). The underlying on which a
derivative is based can be an asset (e.g., commodities,
equities (stocks), residential mortgages, commercial real
estate, loans, bonds), an index (e.g., interest rates, exchange
rates, stock market indices, consumer price index (CPI) —
see inflation derivatives), or other items (e.g., weather

78
conditions, or other derivatives). Credit derivatives are based
on loans, bonds or other forms of credit.

The main types of derivatives are: forwards (which if traded

on an exchange are known as futures); options; and swaps.

Derivatives can be used to mitigate the risk of economic loss

arising from changes in the value of the underlying. This
activity is known as hedging. Alternatively, derivatives can
be used by investors to increase the profit arising if the value
of the underlying moves in the direction they expect. This
activity is known as speculation.

Because the value of a derivative is contingent on the value

of the underlying, the notional value of derivatives is
recorded off the balance sheet of an institution, although the
market value of derivatives is recorded on the balance sheet.

Growth of Derivatives : Over the counter trades ($ Trillion)

04 07 Growth
in %
Total Contracts 258 596 131
Foreign exchange contracts 29 56 92
Interest rate contracts 191 393 106
Equity linked contracts 4 9 94
Commodity Contracts 1 9 523

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Credit Default Swap 6 58 805
Unallocated 26 71 175

Trading value in derivatives markets

$ trillion $ trillion
2000 109 2004 304
2001 135 2005 355
2002 166 2006 485
2003 234 2007 677
Trouble Brewing 98 97
Trade Value ($ tn) 80 596
Mkt Value ($ tn) 3 14.5
Actual value as % of traded 4 2
value
Source : Quarterly report, Sept 2008:
Bank of International Settlements, Basel
A breakdown of the trading activity shows the investments
favoured by investors and brokers. Between 2004 and 2007,
the years of the most frenetic activity, investments in credit
default swaps zoomed up by 800%, while those in
commodity futures shot up by over 500%. More
conventional derivatives like equity index and forex trades
increased by only about 94% in these years.
These are two other features that define the bubble, its
location and its creators. The BIS report shows that almost

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50% of the trading was taking place in North America. Over
46% of the money invested in major derivatives came from
“other financial institutions”, which are investment banks,
hedge funds, private equity funds, etc. So now we know why
it is the US-based investment banks like Lehman and Merrill
Lynch that have gone under – because such banks were
exposed to the tune of trillions of dollars to the fickle
derivative market.

Super Leveraging
Unofficial tripartite deal between deep pocketed client,
broker and NBFC. It allows client to buy more shares by
putting reduced margin. The rest is financed by broker
affiliated NBFC. In falling market, brokers offload the shares
to protect their money.

Subprime Lending

Subprime lending (near-prime, non-prime, or second chance

lending) is a financial term that was popularized by the
media during the "credit crunch" of 2007 and involves
financial institutions providing credit to borrowers who do
not meet prime underwriting guidelines. Subprime borrowers
have a heightened perceived risk of default, such as those

81
who have a history of loan delinquency or default, those with
a recorded bankruptcy, or those with limited debt experience.

Although there is no standardized definition, in the US

subprime loans are usually classified as those where the
borrower has a FICO score below 680. Subprime lending
encompasses a variety of credit types, including mortgages,
auto loans, and credit cards.

Subprime lending evolved with the realization of a demand

in the marketplace for loans to high-risk borrowers with
imperfect credit. The first subprime was initiated in 1993.

Statistically, approximately 25% of the population of the

United States falls into this category. In 1998, the Federal
Trade Commission estimated that 10% of new-car financing
in the U.S. was provided by subprime loans, and that $125
billion of $859 billion total mortgage dollars were subprime.

In the third quarter of 2007, subprime ARMs only

represented 6.8% of the mortgages outstanding in the US, yet
they represented 43.0% of the foreclosures started. Subprime
fixed mortgages represented 6.3% of outstanding loans and
12.0% of the foreclosures started in the same period.

Subprime loans can offer an opportunity for borrowers with

a less-than-ideal credit record to become a home owner.

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Borrowers may use this credit to purchase homes, or in the
case of a cash-out refinance, finance other forms of spending
such as purchasing a car, paying for living expenses,
remodeling a home, or even paying down on a high-interest
credit card. However, due to the risk profile of the subprime
borrower, this access to credit comes at the price of higher
interest rates, increased fees and other increased costs.
Subprime lending (and mortgages in particular) provides a
method of "credit repair"; if borrowers maintain a good
payment record, they should be able to refinance into
mainstream rates after two to three years. In the United
Kingdom, most subprime mortgages have a two or three-year
tie-in, and borrowers may face additional charges for
replacing their mortgages before the tie-in has expired.

Subprime Mortgages :

Like other subprime loans, subprime mortgages are defined

by the financial and credit profile of the consumers to which
they are marketed. According to the U.S. Department of
Treasury guidelines issued in 2001, "Subprime borrowers
typically have weakened credit histories that include
payment delinquencies, and possibly more severe problems

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such as charge-offs, judgments, and bankruptcies. They may
also display reduced repayment capacity as measured by
credit scores, debt-to-income ratios, or other criteria that may
encompass borrowers with incomplete credit histories."

Unlike other nations, the US Tax Code allows 100% tax

deductibility of all interest payments and part of principal
payments on loans for housing. This means a tax break of
30% to 50%, not only of the real interest but also of the
inflation part of nominal interest rates. This tax break is what
fuelled second and third mortgages, used to buy cars and
other consumer goods. Interest rates on car purchases are not
deductible, but second mortgages are. This tax give away is
what makes America become the most personally indebted
nation in the world. Countries like Brazil that do not use
nominal interest rates in housing loans, and do not give such
tax breaks do not have a prime nor a sub-prime housing
problem.

Subprime mortgage loans are riskier loans in that they are

made to borrowers unable to qualify under traditional, more
stringent criteria due to a limited or blemished credit history.
Subprime borrowers are generally defined as individuals
with limited income or having FICO credit scores below 620
on a scale that ranges from 300 to 850. Subprime mortgage
loans have a much higher rate of default than prime

84
mortgage loans and are priced based on the risk assumed by
the lender.

Although most home loans do not fall into this category,

subprime mortgages proliferated in the early part of the 21st
Century. About 21 percent of all mortgage originations from
2004 through 2006 were subprime, up from 9 percent from
1996 through 2004, says John Lonski. Subprime mortgages
totalled $600 billion in 2006, accounting for about one-fifth
of the U.S. home loan market.]

As with other types of mortgage, various special loan

features are available with subprime mortgages, including:

 interest-only payments, which allow borrowers to pay

only interest for a period of time (typically 5–10
years);
 "pay option" loans, usually with adjustable rates, for
which borrowers choose their monthly payment (full
payment, interest only, or a minimum payment which
may be lower than the payment required to reduce the
balance of the loan);
 and so-called "hybrid" mortgages with initial fixed
rates that sooner or later convert to adjustable rates.

This last class of mortgages has grown particularly popular

among subprime lenders since the 1990s. Common subprime

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hybrids include the "2-28 loan", which offers a low initial
interest rate that stays fixed for two years after which the
loan resets to a higher adjustable rate for the remaining life
of the loan, in this case 28 years. The new interest rate is
typically set at some margin over an index, for example, 5%
over a 12-month LIBOR. Variations on the "2-28" include
the "3-27" and the "5-25".

Subprime credit cards

Credit card companies in the United States began offering

subprime credit cards to borrowers with low credit scores
and a history of defaults or bankruptcy in the 1990s when
usury laws were relaxed. These cards usually begin with low
credit limits and invariably carry extremely high fees and
interest rates as high as 30% or more. In 2002, as economic
growth in the United States slowed, the default rates for
subprime credit card holders increased dramatically, and
many subprime credit card issuers were forced to scale back
or cease operations.

In 2007, many new subprime credit cards began to sprout

forth in the market. As more vendors emerged, the market
became more competitive, forcing issuers to make the cards
more attractive to consumers. Interest rates on subprime
cards now start at 9.9% but in some cases still range up to
24% APR.
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In some situations, subprime credit cards may help a
consumer improve poor credit scores. Most subprime cards
report to major credit reporting agencies such as TransUnion
and Equifax, but in the case of "secured" cards, credit
scoring often reflects the nature of the card being reported
and may or may not consider it. Issuers of these cards claim
that consumers who pay their bills on time should see
positive reporting to these agencies within 90 days.

U.S. subprime mortgage crisis

Beginning in late 2006, the U.S. subprime mortgage industry

entered what many observers have begun to refer to as a
meltdown. A steep rise in the rate of subprime mortgage
defaults and foreclosures has caused more than 100 subprime
mortgage lenders to fail or file for bankruptcy, most
prominently New Century Financial Corporation, previously
the nation's second biggest subprime lender. The failure of
these companies has caused prices in the $6.5 trillion
mortgage backed securities market to collapse, threatening
broader impacts on the U.S. housing market and economy as
a whole. The crisis is ongoing and has received considerable
attention from the U.S. media and from lawmakers during
the first half of 2007.

However, the crisis has had far-reaching consequences

across the world. Tranches of sub-prime debts were
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repackaged by banks and trading houses into attractive-
looking investment vehicles and securities that were snapped
up by banks, traders and hedge funds on the US, European
and Asian markets. Thus when the crisis hit the subprime
mortgage industry, those who bought into the market
suddenly found their investments near-valueless - or
impossible to accurately value. Being unable to accurately
assess the value of an asset leads to uncertainty, which is
never healthy in an investment climate. With market
paranoia setting in, banks reined in their lending to each
other and to business, leading to rising interest rates and
difficulty in maintaining credit lines. As a result, ordinary,
run-of-the-mill and healthy businesses across the world with
no direct connection whatsoever to US sub-prime suddenly
started facing difficulties or even folding due to the banks'
unwillingness to budge on credit lines.

Observers of the meltdown have cast blame widely. Some

have highlighted the practices of subprime lenders and the
lack of effective government oversight. Others have charged
mortgage brokers with steering borrowers to unaffordable
loans, appraisers with inflating housing values, and Wall
Street investors with backing subprime mortgage securities
without verifying the strength of the underlying loans.

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Borrowers have also been criticized for entering into loan
agreements they could not meet.

Many accounts of the crisis also highlight the role of falling

home prices since 2005. As housing prices rose from 2000 to
2005, borrowers having difficulty meeting their payments
were still building equity, thus making it easier for them to
refinance or sell their homes. But as home prices have
weakened in many parts of the country, these strategies have
become less available to subprime borrowers.

Credit Rating Agencies

Credit rating agencies which were paid by the bankers gave
the sinking banks high ratings, which mislead the investors.

Consumerism and Credit Culture – Heart of US

Economy

There is a saying in Sanskrit, one of India’s most ancient

language, ‘Yatha Raja Tatha Praja’. Which means ‘As is
the king so is the common man’. The US Government
strongly believed in spending more by having huge deficit

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budget. For the fiscal year 2009, the deficit may cross $ 1
trillion. In terms of rupees it is equal to Rs. 50,000/- crores
assuming exchange rate of Rs. 50 per dollar. Trade deficit
for the year 2007 was little over $ 700 billion. For years, the
US has been funding its imports from China and other parts
of Asia through a massive current account deficit. There
have been fears that unwinding of the current account deficit
could cause further crisis. The emerging markets continue to
fund the US deficit by investing in Treasuries that is
Treasury bonds issued by Federal Reserve. For decades the
United States has attracted massive amounts of capital – 80%
of the surplus savings of the world – which has allowed it to
live beyond its means. The total public debt of US is $ 11.3
trillion. It is estimated that 10% of this is held by China.
Thereby China has become its biggest creditor and literally
its banker. The US treasury has issued $ 4.4 trillion dollars
worth US Treasury bonds (IOUs issued by American Federal
Bank). More than 25% of this is held by foreign countries;
China alone accounting for $ 414 billion.
China’s foreign exchange reserves are $ 2 trillion. Whereas
US reserve are just $ 73 billion. To come out of the crisis,
US needs China’s support and co-operation. US is a
consumer; China is a supplier (to sustain its growth atleast)
US spends; China saves. US borrows money and China
finances it. To some extent they need each other but still
China can survive without US but it is not true the other way
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round. To quote the Noble Laureate in Economics Joseph
Stiglitz, “People often say that China and America are
equally dependent on each other. But that is no longer true.
China has two ways to keep its economy growing. One way
is to finance the American consumer. But another way is to
finance its own citizens, who are increasingly able to
consume in large enough quantities to stimulate economic
growth in China. They have options, we don’t. There is not
really any other country that could finance the American
deficit”.

Similarly the culture of deficit financing and credit culture is

in built in to the life style of common man. Super size life
style of US citizens is well known. US citizens prefer to have
gas guzzling cars and sprawling houses. US citizens have the
fastest cars and the thinnest TVs. US is having world’s 5%
population, consumes world’s 24% energy. Average
American consumes energy as much as 13 Chinese, 31
Indians, 128 Bangladeshis and 370 Ethiopians. America’s
total calories intake is 815 billion calories a day. Which
according to nutritionists is some 200 billion in excess of the
requirement. This is sufficient to feed 80 million people.
Each day American throws away 2,00,000 tons edible food.
If developing countries wanted to live like this, four earth
sized planets would have to be created to provide necessary
resources.
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Documentary film ‘Super Size Me’ produced by Morgan
Spurlock in the year 2004 show the consequences of the
gluttony. The title of the film refers to the American practice
of supersizing fast food items by adopting a pricing policy
which induces customers to opt for larger portions at lesser
price. Spurlock subsisted on a diet of 3 Mac Donald’s meals
a day for a period of 30 days. The result was spurlock had
put on 11.1 kg, developed high BP psychological disorders
and liver problems. It took 14 months of rigorous
detoxification to come back to normal.

‘Greed is good’ was the mantra for all these days. Easily
available credit almost at zero interest fuelled the
imagination of the people. They thought that they deserve
whatever they imagine. To illustrate this, multimillionaire
Michael Hirtenstein used to say “I collect homes because I
enjoy it”. His properties included a $ 27 million apartment
on 76th floor of Manhattan’s Time Warner Centre. He had a
desire, as he told New York Post that, he will have a house
of $ 35 million glass enclosed duplex in Manhattan’s Tribeca
neighborhood, replete with suede-covered walls, 3 living
rooms and heated pool with built in underwater video screen.
With the financial crisis of 2008, his dreams ended up in
smoke. In February 2007 Schwarzman of private-equity firm

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Blackstone Group spent $3 million for celebrating his 60 th
birthday which he regretted in October, 2008.

Vicious Circle
The US economy believes in consuming more and more so
that there is demand for goods and services. As the demand
increases huge investment is attracted in creating capital
assets. Between 1990s to 2000 US attracted 22% of all
global inbound FDI which has come down to 13% in 2006.
This in turn increased employment opportunities. Bigger and
better salaries, bonus and stock options. Thereby the
purchasing power is increased to consume more and more.
This consumption is hugely supported by credit. Credit for
buying big houses and big cars (with almost negligible down
payment), tution fees on loans, food, gasoline and all other
purchases on credit cards fueled the economy. US citizens
carry on an average 13 credit cards and 40% of them carry
balances. US citizens’ savings are almost zero. Hospital
expenses are covered by health insurance, otherwise, they do
not have money to pay their huge hospital bills. Unless they
are covered by social security system, they have no fall back
whatsoever. Credit is cheap (US Federal Reserve announced
almost zero percent interest in December 2008) and
consumer goods are cheaper. Household debt increased from
680 billion dollars in 1974 to 14 trillion dollars in 2008. US
consumers were spending 800 billion dollars more than they
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earned every year. Now due to subprime loans in housing,
credit default swaps, super leverage deals, huge collapse in
share value on Wall Street, this great US show has come to a
grinding halt. Consumerism and credit which fueled the US
economy is no more a sustainable model. The policy makers
went on fueling consumerism since they were aware any fall
in demand will affect the supply side. Any fall in supply side
will collapse the whole economy. That is why credit was
pumped in to the system without realizing to what extent it
can sustain. Whatever crisis that US is facing is built over a
period of time. The attempts that are being made are pure
knee jerk reactions. Nobody has seriously studied the depth.
Everyday few trillions are added. Tons of advice is given to
Obama from all parts of the globe. Obama is not looking in
to the eye of the storm. He is more concerned about
convincing the senators to pass the bill whether it is $ 700
billion or $ 800 billion. Nobody wants to know the depth
since it is scary. Every body is looking for a quick fix. It is a
bottomless pit.

The Global Fall Out

The United Nation’s conference on Trade and Development

in its Trade and Development Report 2008 as summarized by
the Third World Network says that: “The global economy is
teetering on the brink of recession. The downturn after four
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years of relatively fast growth is due to a number of factors:
the global fallout from the financial crisis in the United
States, the bursting of the housing bubbles in the US and in
other large economies, soaring commodity prices,
increasingly restrictive monetary policies in a number of
countries, and stock volatility.
….. the fallout from the collapse of the US mortgage market
and the reversal of the housing boom in various important
countries has turned out to be more profound and persistent
than expected in 2007 and beginning of 2008. As more and
more evidence is gathered and as the lag effects are showing
up, we are seeing more and more countries around the world
being affected by this rather profound and persistent negative
effects from the reversal of housing booms in various
countries.
…. Uncertainty and instability in international financial,
currency and commodity markets, coupled with doubts about
the direction of monetary policy in some major developed
countries are contributing to a gloomy outlook for the world
economy and could present considerable risks for the
developing world.
Commodity dependent economies are exposed to
considerable external shocks stemming from price booms
and busts in international commodity markets.

Why the Crisis is Global ?

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Financial crisis recur frequently. Even US has faced it few
times after Great Depression. But why this ‘made in USA’
crisis is feared as a global crisis? Many reasons can be
attributed. US being a most important player in the market,
anything going wrong with US economy will create a black
hole/vaccum in which other countries will be sucked in.
1) Now the world has become a global village due to
technological developments like internet, mobile
phones, ATMs, Credit Cards, online banking and
online trading.
2) World trade has increased substantially compared
to earlier years and WTO has become a champion
of free trade strongly advocating for world trade.
Now-a-days world trade does not only trade in
goods as per GATT (General Agreement on
Tariffs and Trade) but also includes services in
banking, insurance, consultancy etc as per GATS
(General Agreement on Trade in Services)
3) Many countries prefer to export their goods to US
because of stronger dollar and dollar being a
reserve currency in the world trade. US economy
accounts for nearly two-thirds of the world’s
gross domestic product (GDP).

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4) Multinational companies of US and their
financial institutions have invested heavily in
other countries.
5) Most of these multinational companies of US
have huge global network in the field of banking,
software, business process outsourcing, real estate
investment, trade and manufacturing.
6) Foreign debt of US in the form of US treasury
bonds has bulged in to trillions of dollars and
according to an estimate China is holding 10
percent of all US public debt and has become
Washington’s largest creditor. It has become
America’s banker.
7) Total foreign investment in US is also substantial.
Right through the 1990s and up to 2000, the US
accounted for 22 percent of all global inbound
FDI. Over the years, this share has fallen to 13
percent in 2006, according to the latest World
Investment Report 2007 published by the United
Nations Conference on Trade and Development.
8) Many foreign companies have listed their
companies on US stock exchange.
9) The commodity trading and crude oil pricing
have become important economic inputs in
controlling the economy of many countries.

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 10) The global economy is highly intertwined and
coupled.

Political Economy of Bailout Packages and takeovers:

As the name suggests bailout packages are the financial

packages to pull out the country or company or an institution
from the economic or the financial crisis. These bailout
packages are announced by the government because, the
government thinks that if the situation is allowed to continue,
it may affect the larger population or it may create a chain
reaction affecting other economic entities and thereby
bringing down the economy or the company and in turn the
government itself.
As mentioned earlier, Adam Smith’s most visible theory was
the theory of “invisible hand”. According to him, this
“invisible hand” controls demand and supply thereby the
price mechanism. Milton Friedman advocated least
government control. He stressed the advantages of the
market place and the disadvantages of government
intervention and regulation. Reagan-Thatcher period
believed in unfettered capitalism. In a capitalistic
environment the companies should enjoy profits and suffer
losses. Government is only a regulator. The belief that,
‘Markets were supposed to know best’, ‘What is good for
Wall Street is good for Main Street’ and ‘Too big to fail’
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have all failed. ‘Too big to fail’ logic has lead to ‘Too big to
be allowed to fail’ because of the economic fallout of loosing
jobs, write off of huge loans, disruption of whole industry
and the chain reaction on the whole economy. Fall of Citi
Group or General Motors or Ford or AIG is unthinkable.
Now the champions of capitalism desire that their losses be
socialized and profit be privatized. US Government strongly
supported capitalism even by going out of the way like
having incompetent regulators, repeal to Glass Steagull Act,
creating the culture of living on debts and encouraging
consumption beyond means. Now all its iconic companies
like Lehman Brothers, Meryll Lynch, Citi Group, AIG
Insurance, General Motors, Ford, Diamler Crysler and many
more are down under. If allowed to sink without bailout they
will take many more along with them. Recession is in and
depression is expected. The faith in dollar is badly affected.
The super power status of US is badly dented. It looses its
status as a dream merchant of the world. Its position in IMF
and World Bank is hard hit. Which will ultimately bring
down its position as a military super power.
The French President Sarkozy is planning a world forum to
“rethink capitalism” declaring, “The legitimacy of public
power to intervene in the functioning of the financial system
is no longer in question”.

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Germany’s Angela Markel remarked, “A few years ago, it
was fashionable to say that governments would be ever
weaker in a globalized world. I never shared that view”.
Germany’s Finance Minister Steinbruck said the crisis will
lead to “The end of America as a financial superpower”. He
also said that “Unrestrained capitalism like the kind we’re
experiencing right now with all its greed will in end devour
it-self”.
Putin in Russia is blaming American Contagion for this
financial crisis.
The Chinese have come to conclusion that, “Something is
wrong with the teacher”.
Ecudaor’s Rafael Correa Said, “The US economic model is
terminally ill”.
The philanthropist and investor George Soros is of the
opinion that “At fundamental level, the model of
globalization and deregulation has blown up, and that is what
caused the current crisis”.
The Noble laureate Joseph stiglitz said “By allowing even
commercial banks into this riskier territory, and encouraging
stock options as pay, you had an increasingly short-sighted
focus on immediate profits. It created a culture of gambling”.
Warren Buffett of Berkshire Hathway had called the exotic
financial products as “Financial weapons of mass
destruction.”

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Princeton University economist and Nobel laureate Paul
Krugman, while regarding Milton Friedman as a great
economist and a great man, has criticized him by writing :
“In the aftermath of the Great Depression, there were many
people saying that markets can never work. Friedman had
the intellectual courage to say that markets can too work, and
his showman’s flair combined with his ability to marshal
evidence made him the best spokesman for the virtues of free
markets since Adam Smith. But he slipped all too easily into
claiming both that markets always work and that only
markets work. It’s extremely hard to find cases in which
Friedman acknowledged the possibility that markets could
go wrong, or that government intervention could serve a
useful purpose”.
Alan Greenspan who believed in easy money supply and
“market know best” was chairman of Federal Bank for an
unreasonably long period of 18 and half years. In testimony
prepared for the House Government Oversight and Reform
Committee, he voiced shock over the present turn of events
and called conditions deplorable. He said that he and others
who believed lending institution would do a good job of
protecting their shareholders are in a “state of shock and
disbelief”. And Greenspan also blamed the problems on
heavy demand for securities backed by sub-prime mortgages
by investors who did not worry that the doom in home price
might come to crashing a halt. Greenspan said, “Given the
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financial damage to date, I can’t see how we can avoid a
significant rise in lay-offs and unemployment”. He also said
“Fearful American households are attempting to adjust as
best as they can, to rapid contraction in credit availability,
threats to retirement funds and increased job insecurity. The
present global financial crisis is a “once in a century credit
tsunami” according to Greenspan.
Greenspan’s critics charge that he left the interest rates too
low in the early part of the decade 2000-2008, spurring an
unsustainable housing boom, while also refusing to exercise
the Fed’s powers to impose greater regulations on the
issuance of new type of mortgage, including sub-prime
loans. It was the collapse of these mortgages and raise of
default in the year 2007 that triggered the current crisis.

Government Intervention :
Bill Clinton claimed in 1996 State of the Union address that
“The era of big government is over”. Thatcher also believed
in rolling back the state’s role in the economy. Reagan
believed in “less government”. During this period economy
was booming – whatever may be the reason for that. Every
politician on both sides of the Atlantic believed in total
capitalism with less government intervention. Economists
like Milton Friedman believed in this kind of governance.

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The bubble of capitalism burst in 2008. Within a week’s
time, all the governments around the globe swung in to
action to save their banking system. They went on a spree of
nationalization, takeovers, bailouts and planned to spend
hundreds of billions to save the economy. From US to China
irrespective of the “isms” they preach or practice every
country swung in to action to protect the economy. US
government may have to spend in trillions of dollars. The
country which exported the idea of capitalism and free
market to various countries around the globe came out with a
huge government support for its ‘Too big to fail’
multinational corporations. When Mexico suffered the crisis
few years back it was advised by the US treasury that
Mexico should cut government spending, raise the interest
rates and allow the loss making corporations to die. But now
the US Government is doing exactly the opposite. It is
spending in trillions, has reduced the interest to zero percent
and is bailing out the corporations instead of allowing them
to die. All big Corporations in and around the world
privatized profits in good times. Now they want the
governments to socialize their losses. It only goes to prove
that, it is the government intervention which is the anchor in
this sea of financial tsunami.
Government role essential to ease crisis: Bush

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Bush had said that extensive federal intervention in financial
markets was both warranted and essential to hold the worst
financial crisis in decades and that the risk of not acting
would be far higher.
“America’s economy is facing unprecented challenges. We
are responding with unprecedented measure”. When he said
this at the White House Rose Garden on 19th September
2008, he was accompanied by Treasury Secretary Henry
Paulson, Federal Reserve Chairman Ben Bernanke and
Christopher Cox, Chairman of Securities and Exchange
Commission.
Bush had said, “This is a pivotal moment for America’s
economy”. He said that a financial contagion that began with
low quality home mortgages had spread throughout over
financial system. This has lead to an erosion of confidence
that has frozen many financial transactions including loans to
consumers and to businesses seeking to expand and create
jobs. As a result we must act now to protect over nation’s
economic health from serious risk. There will be ample
opportunity to debate the origins of this problem. Now is the
time solve it”. He also said “These measures will require us
to put a significant amount of tax payer dollar on the line.
This action does not entail risk, but we expect this money
will eventually be paid back. The risk of not acting would be
far higher. Further stress on our financial markets would
cause massive job losses, devastate retirement accounts and
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further erode housing values, as well as dry up loans for new
homes and cars and college tuitions. These are risks that
America cann’t afford to take”.

US Bailout Packages

$ 700 billion package: Emergency Economic Stabilization

Act of 2008
The US law makers after prolonged debate signed off a deal
to create $ 700 billion in troubled assets from financial firms
in an attempt to free their balance sheet of bad debts. The
money will be disbursed in parts. An initial $ 250 billion will
be released to get the rescue effort under way, followed by
another $ 100 billion after a report by the then President
Bush to Congress. Bush could then request for the rest $ 350
billion.

$ 800 Billion Package:

Under the new mortgage programme, the fed will buy up to

$ 100 billion of debt issued by government sponsored
mortgage enterprises Fannie Mae, Freddie Mac and Federal
Home Loans Banks. It will also buy up to $ 500 billion
mortgages securities backed by Fannie Mae, Freddie Mac
and Ginnie Mac. The Central bank also launched a $ 200
billion facility to support consumer finance, including
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student, auto and credit card loans backed by the Federal
shall business administration.

$787 Billion Stimulus Plan:

US President Barack Obama has signed economic stimulus

plan of $ 787 billion package. The plan is aimed at saving or
creating 3.5 million job and boosting consumer spending and
rebuilding infrastructure. The approved version of the plan is
split in to 36% for tax cuts and 64% percent in spending and
money for social programs. The bill also includes a
controversial “Buy American” provision. The approved plan
stipulates that public works and building projects funded by
the stimulus use only US made goods, including iron and
steel.

$ 326 Billion Package for Citi Group :

Citi has received government guarantees of $ 306 billion – a

cover that will help it sell the sticky assets and irrecoverable
mortgages on its books. Another $ 20 billion cash infusion
from US Treasury, which is over and above the $ 25 billion
it had received earlier.

Citi Splits

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  Citi group to be restructured in to citi group and city
Holding.
 Citi group will have core assets of around $1.1
trillion.
 Core assets include corporate and investment bank.
 City Holding to own troubled businesses including
Citi Financial, brokerage and asset management,
local consumer finance and the special asset pool.
 Citi Financial India has over 2000 employees.
 Citi has assets of $ 7.77 billion in its consumer
finance business, including credit cards and consumer
banking.

$ 85 Billion Package for AIG.

AIG could not settle $ 14billion claims and approached the

Government for funding US Government granted bailout
immediately to avoid the catastrophic effect.

$ 25 Billion Subsidized Loans

Automakers gained $ 25 billion in tax payer subsidized loans

costing tax payers $ 7.5 billion to subsidize the retooling of
plants and development of technologies to help US car
markers to build cleaner more fuel efficient cars.

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$17.4 billion Bailout for Automakers

The US Auto giants General Motors, Ford, Chrysler were

demanding bailout packages. Central to their campaign is the
theory of ‘too big to be allowed to fail’ Bankruptcy filing by
GM or any of these automakers would trigger domino effect,
potentially crippling the nation’s industrial base. Now $ 17.4
billion federal rescue package for the car makers includes
massive cuts in labor costs, a two-third reduction in debt that
involves convincing creditors to swap debt for equity and
possible shareholder losses.

Federal Reserve Take-over.

Federal Reserve has taken over Fannie Mac with asset write
down of $ 87.1 billion over three quarters and Freddie Mac
with asset write down $ 4 billion over three quarters.

Other Take-overs :
Bear Sterns with asset write down of $ 3.2 billion was taken
cover by JP Morgan.
Merrill Lynch was taken over by Bank of America.

$ 20 billion bailout for BOA

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Bank of America was rescued by the US Government in
January, 2008 through $ 20 billion bailout and guarantee for
almost $ 100 billion of potential losses of toxic assets to
cushion the blow from a deteriorating balance sheet at
Merrill Lynch.
According to Barry Ritholtz, author of forthcoming book
“Bailout Nation”, the bailout reaches as high as $ 8 trillion, a
figure that represents more than half of US GDP and is more
than the sum of every major US Federal project in the past
century, including the invasion of Iraq, the new deal and
Marshall Plan to save Europe after the war. It is more than
the total the United States spent on World War II - $ 3.6
trillion in today’s dollars.
So far, banks have written off nearly a trillion dollars in
losses, but estimates of the bad loans still on their books run
about $ 1.7 trillion. As mentioned by Jeffery Garten in
Newsweek.
The Governments have intervened in this global crisis by
infusing capital, by nationalizing, by guaranteeing the loans.
They are also applying fiscal and monetary policies to come
out of this crisis. Unfettered capitalism has become crony
capitalism. In effect few of these countries ended up in
‘socializing losses and privatizing profits’. It is the ultimate
responsibility of the government in saving the country from
going bankrupt. In the name of capitalism, no government
can shirk its responsibility.
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Are Bailouts Successful ?

These bailout plans are knee jerk reaction to the crisis. These
countries have announced the package in a hurry to restore
the confidence in the public. But none of them have studied
the total impact since the depth of the impact has not yet
reached the bottom. It is also not known whether these
bailout packages really succeed. They have not even planned
how it should be implemented. Initially Paulson, Secretary of
Finance said, that the money will be used for buying bad
loans thereafter he said they will not buy loans but infuse
funds in to banks so that they can lend. How it is going to be
infused? By buying shares of the banks? What will be
percentage of holding? A monitory stake or a majority stake?
A majority stake leads to nationalization. Many other
governments in Europe are already taking over the banks.
The government in Iceland has nationalized three of its
biggest banks.
Business World, October 2008 said that here is a troubling
number: while only 11 banks have failed since the beginning
of the crisis, the number on the Federal Deposit Insurance
Corporation’s watch list has grown to 117. And by all
accounts, it could get worse.
Two International Monetary Fund economists, Luc Laeven
and Fabian Valencia, studied a new dataset of 124 banking
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crisis. Their paper, Systematic Banking Crisis: A New
Database, reviews some of the features of the current crisis
and the global policy response by government agencies in
light of crisis history.
According to the study, in 71 per cent of the cases, liquidity
support has been used; as events unfold, the likelihood of
new ways of providing liquidity may actually increase. For
instance, on 29 September 2008, the US Federal Reserve
extended dollar swap lines with other central banks.
Another method used in crises is regulatory forbearance. For
instance, in 67 per cent of the cases, banks were allowed to
overstate their capital. In the Savings and Loans Crisis, for
instance, some banks, though technically insolvent, were not
subject to intervention. But that is unlikely in the present
circumstances, says Alex Patelis, economist at Merrill
Lynch. In 73 percent of the cases, prudential regulation has
been suspended or not implemented fully. Some of that is
evident in the current episode too, and there may be more on
a case by cases.
The authors point out that such measures may not necessarily
accelerate the economic recovery. Besides, they can also
prove to be fiscally costly. Even without the $700 billion
bailout package, US government debt has crossed $10
trillion. And if some people are to be believed, the worst is
yet to come.

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However, as former Nobel prize winner for Economics,
former Chief Economist of the World Bank and university
professor at Columbia University, Joseph Stiglitz, argued,
the plan “remains a very bad bill:”

“I think it remains a very bad bill. It is a disappointment, but

not a surprise, that the administration came up with a bill that
is again based on trickle-down economics. You throw
enough money at Wall Street, and some of it will trickle
down to the rest of the economy. It’s like a patient suffering
from giving a massive blood transfusion while there’s
internal bleeding; it doesn’t do anything about the basic
source of the hemorrhaging, the foreclosure problem. But
that having been said, it is better than doing nothing, and
hopefully after the election, we can repair the very many
mistakes in it”.

Joseph Stglitz (Guardian Oct, 1, 2008), said that “the very

assumption that the rescue plan has to help is suspect.
Afterall, the IMF and US Treasury bail-out for Wall Street
10 years ago in Korea, Thailand, Indonesia, Brazil, Russia
and Argentina did not work for those countries all though it
did enable Wall Street to get back most of its money. The tax
payers in these other poor countries picked up the tab for the
financial market mistakes.

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Themes from Bailouts

From the many bailouts over the course of the 20th century,
certain principles and lessons have emerged that are
consistent:

 Central banks provide loans to help the system cope

with liquidity concerns, where banks are unable or
unwilling to provide loans to businesses or
individuals.
 Let insolvent institutions (i.e., those with insufficient
funds to pay their short-term obligations) fail in an
orderly way.
 Banks that are deemed healthy enough (or important
enough) to survive require recapitalization, which
involves the government providing funds to the bank
in exchange for preferred stock, which receives a
cash dividend over time.
 If taking over an institution due to insolvency, take
effective control through the board or new
management, cancel the common stock equity (i.e.,
existing shareholders lose their investment), but
protect the debt holders and suppliers.
 Government should take an ownership (equity or
stock) interest to the extent taxpayer assistance is
provided, so that taxpayers can benefit later. In other

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 words, the government becomes the owner and can
later obtain funds by issuing new common stock
shares to the public when the nationalized institution
is later privatized.
 A special government entity is created to administer
the program, such as the Resolution Trust
Corporation.
 Prohibit dividend payments, to ensure taxpayer
dollars are used for loans and strengthening the bank,
rather than payments to investors.
 Interest rate cuts, to lower lending rates and stimulate
the economy.
 Strong oversight.

Reasons against Bailouts

 Signals lower business standards for giant companies
by incentivizing risk
 Creates moral hazard through the assurance of safety
nets
 Promotes centralized bureaucracy by allowing
government powers to choose the terms of the bailout
 Instills a socialistic style of government in which
government creates and maintains control over
businesses.

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  Instills a corporatist style of government in which
businesses use the state's power to forcibly extract
money from taxpayers.

On November 24, 2008, libertarian Congressman Ron Paul

(R-TX) wrote, "In bailing out failing companies, they are
confiscating money from productive members of the
economy and giving it to failing ones. By sustaining
companies with obsolete or unsustainable business models,
the government prevents their resources from being
liquidated and made available to other companies that can
put them to better, more productive use. An essential element
of a healthy free market, is that both success and failure must
be permitted to happen when they are earned. But instead
with a bailout, the rewards are reversed – the proceeds from
successful entities are given to failing ones. How this is
supposed to be good for our economy is beyond me.... It
won’t work. It can’t work... It is obvious to most Americans
that we need to reject corporate cronyism, and allow the
natural regulations and incentives of the free market to pick
the winners and losers in our economy, not the whims of
bureaucrats and politicians.”

Bailout Costs

In 2002, World Bank reported that country bailouts cost an

average of 14% of GDP.
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Capitalism To Nationalism

Now the disastrous failure of capital markets, banks and

automakers has forced the US Government and other
Governments to intervene. The cost of that intervention will
be substantial running in to trillions of dollars and it is
taxpayers money. Hence governments are responsible for its
proper utilization and answerable to tax payers. All these
governments in US and Europe are initiating bailout
packages and nationalization. In US Fannie Mae and Freddie
Mac have been taken over by Federal Reserve. In European
countries many banks have been taken over by governments.
US announced various bailout packages to increase the
confidence of stock market as knee jerk reaction. But the
execution and the accountability part will be the toughest.
Seriousness of these bailout packages is being understood
when the US automakers approached the government
without proper planning and held the government for a
ransom (i.e., bailout package) on the grounds of job losses,
breakdown of network of suppliers and dealers, pensioners
suffering and so on. By this time the government had come
out of the shock of financial crisis and started seriously
thinking. Hence the government is getting in to business. The
popular slogan “the government has no business to do
business” is taking a back stage. Evidence of this is when the

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White House and the Democrats who control the US
Congress were at odds on the ‘issue of viability.’
US president George Bush said, that “the definition of
viability is open to discussion. Viability means that all
aspects of the companies need to be re-examined to make
sure that they can survive in the long term. It includes an
analysis of business plans, dealerships, product lines and
labour contracts as well as the internal dealings of the
company”. This amounts to government doing business by
sitting in driver’s seat.

President Obama described the long-term bailout that would

be conditioned federal oversight. It could mean that the
government would mandate, or atleast heavily influence,
what kind of car companies make, what mileage and
environmental standards they must meet and what large
investments they are permitted to make to recreate an
industry that actually works, that actually functions.
Jeffrey Garten, a professor at the Yale School of
Management, who was Under Secretary of Commerce in the
1990s was stunned by the scope of intervention that
Washington was now considering. He said “I don’t know
that we have seen anything like this since government told
the automakers what kind of tanks to make during World
War II”.

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Political Economy of Reforms:

Politics and economics are always coupled. Whether it is

developed or developing economy, politics plays an
important role.
World bank in its study on the “politics of reforming, state
owned enterprises” (Bureaucrats in Business) came out with
certain findings. Key findings is that “Reform can’t succeed
unless countries fulfill each of the three conditions of
readiness”. According to World Bank there are three
conditions of readiness. They are political desirability,
political feasibility and political credibility.

These findings are fully applicable to present situation of

US. US is seeking reforms in all facets of economy. Obama
Government has to satisfy these conditions if the reforms are
to succeed.

Condition I : Political Desirability:

Reform must be politically desirable to the leadership and its

constituencies. Reform becomes desirable to the leadership
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and its supporters when the political benefits out weigh the
political costs.

Condition II: Political Feasibility

Leaders must have the means to implement change and

withstand opposition to reform. Reform is politically feasible
when the leadership can secure the approval and support of
other government entities whose cooperation is critical to
success. These include legislature, bureaucracies and the
state government that are responsible for formulating policy
or carrying out the reform. In addition the leadership must be
able to withstand the opposition to reform potential losers;
these may be employees, especially when such groups are
organized, numerous and ready to engage in demonstrations,
work stoppages in strategic industries etc.

Condition III- Political Credibility:

Investor must believe that the government will not reverse

the decisions. Employees and others, who fear that they may
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loose out in reform must believe that the government will
deliver on any promise of future.
First, credible governments have a reputation for keeping
promises, Second they face domestic restraints on policy
reversal by legislation or by wide ownership of shares that
create large, pro reform constituency. Third they submit to
international restraints, such trade treaties or loan covenants,
which make it costly to reverse the reform.

Free Market Fundamentals:

The fundamentals of free market are brought out effectively

in a study conducted by Kay and Thompson. Infact, the title
of the study was ‘Privatization: a policy in search of
rationale’
Even though the context of the study was different, the
rationale is totally applicable to test the privatized economy
or capitalistic economy. If the answer for the questions is
positive, then it is healthy capitalistic economy. Otherwise
improve the situation by taking corrective action.

1) Can firm go bankrupt?

2) Can firm be taken over?
3) Are there initiative to allocative efficiency?
4) Are there initiatives to productive efficiency?
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Let us apply this rationale to present context of US. Federal
Reserve has taken over Fannie Mae and Freddie Mac. City
Bank and AIG were bailed out with government intervention
and were not allowed to go bankrupt. Auto majors were
given a $ 17.4 billion bailout package. The government is
not willing to allow these ‘Too big to fail’ corporations to
fail. Huge bailout packages are still expected.
These firms are not going to be taken over by others due to
their huge size and the unviability in the present market
condition.
The allocative efficiency and productive efficiency of these
corporations are being questioned. All answers for the four
questions are negative, indicating that the US is not having
healthy free market environment.

Market Critical Factors:

Coopers and Lybrand in association with Business Today

had evolved a criteria for assessing the readiness of a sector
wise privatization. The four critical factors considered were

1) Market Structure
Are there any barriers to entry? Are prices state
controlled?
2) Ownership.
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 What is the level of private ownership in public
sector?
3) Management
What is the level of freedom the managers of
PSU enjoy?
4) Finance
What is the level of freedom the PSU has in terms
of raising funds?
These are the same factors on which one can decide the
maturity profile for government intervention in US.

Market Structure:
Even though there are no barriers to entry, there are barriers
to exit. ‘Too big to fail’ have been converted into ‘Too big
not to be allowed to fail’. Bailout packages at the cost of tax
payers money has created a unhealthy market. In a healthy
market structure, entry as well as exist should be
unrestricted.

Management Issues
Ownership:
The level of ownership in US corporations before the
financial crisis was hundred percent private ownership.
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Government ownership did not exist. US was a brand
capitalism. But now after the crisis, the Federal Reserve has
taken over banks Fennie Mae and Freddie Mac. Many more
may follow. The way in which divestment (instead of
privatization) is a politically palalatabe term in India, in US
it is bailout (instead of nationalization). Government
ownership or active intervention almost akin to
nationalization may take place. The statements made by
Bush and Obama clearly indicate that the government desires
to be in drivers’ seat or may do backseat driving.

Management:
It is assumed that, higher the level of freedom for managers
the public sector is more adaptable to privatization. In case
of US, it is the excessive managerial freedom that spoiled the
party. The investment banker or any multinational
corporations or auto majors had total freedom in managerial
decisions. They were paid millions of dollars in the form of
remuneration, bonus and stock options. It was totally
unchecked, unquestioned managerial freedom. Excessive
freedom lead to different kind of allocative efficiency.
Managers allocated benefits to themselves at the cost of the
shareholders and other stakeholders. It is proved in case of
British privatization, that the managerial remuneration of top
management increased disproportionately after privatization
(the details of the study is mentioned in British Experience
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of Privatization). Freedom for managers and manager using
that freedom for the benefit of stakeholders is a utopian
concept which the capitalistic model exploits. When the
going is good – even at the cost of manipulation by managers
– every body enjoys the so called benefits of efficient
management and argue for privatizing profit. When the
going is bad, the managers cry for socializing the loss.

Finance:
The level of freedom in raising finance from the market is
another criteria for privatizing. In US, company has total
freedom to raise finance from the market. US stock markets
were booming before the collapse. This unrestricted access
to market works wonders when the companies are making
profits, declaring high dividends for the shareholders and
when the future is rosy. The moment this situation changes,
stock markets dry up and these so called successful
companies end up with hugely reduced market caps. The
share value of the top 10 blue chip companies in US during
financial crisis were being quoted below $ 10 each. Even
though they have freedom to raise finance, the market is
totally dried up. Now this freedom to market has turned into
freedom to access government for huge bailout. So it is the
responsibility of the government in this capitalistic economy
to bailout these companies. Captains of capitalism have lost
faith in market mechanism.
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Regulatory Authorities:
Regulatory Authorities are the pillars of the capitalistic
economy of free market. They are the eyes and ears. They
are the anchors of this free market ship. The government and
the investors and even citizens believe that regulators are
working. If they sleep on the steering wheel, it is a disaster.
Exactly this is what happened in USA. Federal Reserve and
SEC slept on the wheel. They believed that market knows
best. They had faith in least government intervention. They
failed the US capitalism. Instead of becoming the saviours of
free market mechanism, they become puppets. Role of
regulators are well established in various cases of British
experience of privatization.

Stock Markets
The stock markets are the barometers of the economy in free
market. In US more than 50% of US citizens have invested
in stock markets. Investment bankers are the major players.
Manipulations in share markets have become order of the
day. Management is more concerned about its hourly report
of its share prices but not the hourly report of production and
sales. SEC has lost all its controls over the stock markets.
Rating Agencies are not controlled by SEC or any other
regulator effectively. They have created ‘make believe’
world. When the market was booming every body played in
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the hands of the market. No body stood up and applied the
break. The losers in the stock markets are small investors.
The big players fish even in the muddy water of collapsed
market. Latest Fraud of $ 50 billion Ponzi schemes
committed by Madoff is the biggest fraud in the world. Fraud
of this size does not happen overnight. This has grown over a
period of few years. Why the regulatory authorities did not
question Berni Madoff? Being a past chairman of NASDAQ,
he was aware of all manipulation skills.

Corporate Governance:

In the 20th century in the immediate aftermath of the Wall

Street crash in 1929, legal scholars such as Adolf Angustus
Berle, Edwin Dodd and Gardiner Means pondered on the
changing role of the modern corporation in society. Berle
and Means monograph ‘The modern corporation and private
property’ continued to have a profound influence on the
conception of corporate governance.
Since the 1970s, the corporate governance has been the
subject of significant debate in US. It is said the positive
effect of good corporate governance on different
stakeholders ultimately is to strengthen economy and hence
good corporate governance is a tool for socio economic
development.

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These ‘Too big to fail’ corporations seems never practiced
this well known management practice called Corporate
Governance. US being the land of this well known
management practice, its corporations failed in implementing
corporate governance which ended up in huge socio
economic loss to US and other countries.

Risk Assessment

This is one more important tool in the hands of quality

management. Risk assessment is regularly done by the Board
on a continuous basis of the threats in the external and
internal environment. The banks and other corporations
seems never did any serious assessment of risk. The sudden
collapse of these ‘too big to fail’ shows total negligence of
this managerial tool.
Institute of International Finance has prepared report
detailing best practices in the wake of financial crisis.
Accordingly developing a corporate culture of risk
awareness, integrating analysis of difficult sorts of risks
instead of keeping them in silos and basing compensation on
risk adjusted performance and long term, firm-wide
profitability are few of the risk assessment measures.
It is said risk gets forgotten in all bubbles. Ed Hida partner
of Deloitte & Touche told that the psychology during boom

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make it very difficult to come with large stress scenarios and
get management to consider them to be creditable.

Compliance Mechanism:
Corporate governance, risk assessment and compliance are
the well known GRC triad. Compliance with rules and
regulations of the regulatory bodies is a mandatory
requirement in the interest of the stakeholders at large. The
investment bankers invented ways to go around the
compliance requirement thereby failing this important
mechanism of safety. The regulators like Federal Reserve
and SEC were watching this as if they were helpless.

Fraud-is-a-fraud-is-a-fraud:

It is irony that, the top economists, well known investors,

corporate leaders of US are saying that, investment bankers
invented new financial products or invented ways to go
around the compliance mechanism. Instead, they should
admit all these financial engineering was a fraud.
Irrespective of their inventions of going round the word
‘fraud’, fraud-is-a-fraud-is-a-fraud. Action should be
initiated by Federal Agencies and Regulatory Authorities
against these ‘priests of high finance’. Nobody wants to put
them behind the bars. They were left scot-free. Small

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investors and tax payers will pay the price for the fraud not
committed by them.

Federal Governance:

The Government should be held responsible for all the

omissions and commissions in its governance. There has to
be Federal Governance mechanism working similar to
corporate governance. Accountability should be in built in to
the system. Alan Greenspan held the position as Fed Chief
for 18 and half years. Unusually long period. It is a known
fact or to put it bluntly it is common sense that, no head of an
Institution be allowed to continue for such a long period. He
or she will push the errors of judgment under the carpet if
allowed to occupy the position unusually for a long time.
After the collapse, Alan Greenspan has put the blame on the
bankers and investors. Similarly SEC not acting on Ponzi
schemes or any double digit profit schemes lead to this
exposure.
The government without fiscal or monetary discipline,
having huge budget deficits and huge public debts should be
made accountable. Quality in Federal Governance is the
order of the day. Of course it is too late. As usual it is the
common man, man on the street but not Wall Street is going
to pay heavy price for this uncontrolled freedom enjoyed by
the politicians, bureaucrats and corporate chiefs.
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Top B Schools of US: The mute Spectators

US has the best B schools in the world. It caters to the huge

management pool of the globe. US has the most renowned
‘Management Gurus’ to whom the world listens. It is a
tragedy that none of these schools or gurus could save US
from this collapse.

Biggest pool of Economists:

US has the maximum number of Noble laureates in the field

of Economics and many more experts in various disciplines
of Economics. When the whole country was burning with
economic indiscipline (fiscal as well as monetary) of a global
scale, why the government including Federal Reserve and
SEC were not brought to senses by these experts? Why they
became mute spectators? Many such trillion dollar questions
are an unanswered.

IMF and World Bank

IMF and World Bank situated in US keep a close watch on
the economy of other countries. Advise these countries on
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various measures they should adopt to improve their
economic conditions. But why these institutions failed in
advising US government? The failure of capitalism in US is
not just the failure of the government; it is the failure of all
these institutions, B schools and the pool of economists.
They failed the spirit of capitalism and there by brought the
country to this miserable state. Now it is the common man
who is going to pay the price.
All these institutions and experts including regulators are
pointing their finger to the common man saying it is the
consumption gluttony supported by credit caused this
collapse. Again the trillion dollar question is who pushed
them in to high consumption and credit mode? It is these
institutions and experts.

Job Loss in USA

As reported in Economic Times, job reduction in January,

2009 is estimated to be higher than 6, 00,000 or 7, 00,000.
Employers are slashing payrolls and turning to other ways to
cut costs – including trimming working hours, freezing
wages or cutting pay.

An avalanche of layoffs is slamming the nation from a wide

swathe of employers. Caterpillar, Pfizer, Microsoft, Estee
Lander, Time Warner Cable and Sprint Nextel are among
the companies slicing payrolls. Manufacturers – especially
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car makers – construction companies and retailers have been
particularly hard hit by recession.
Talbots, Liz Claiborne, Macy’s and Home Depot are all
cutting jobs. So are Detroit’s General Motors and Ford
Motor.
Many economists predict that the first quarter of 2009-in
terms of lost economic growth – will be the worst of the
recession. With fallout from the housing, credit and financial
crisis – the worst since 1930s – ripping through the
economy, analysts predict up to 3 million jobs will vanish
this year.

The American Problem

Recently in an article in Time (The Great Fall, February, 16,

2009) Michael Elliott and Peter Gumbel said that, “Trouble
is, Obama may have no alternative but to disappoint.
International leaders are about to rediscover a central fact
about the US., one that they tend to forget in good economic
times when they ask little of Americans. The US has an
unusually open and fragmented political system, with real
power centers outside the White House. The Senate has a
constitutional role in approving treaties; the House of
Representatives’ Committee on Ways and Means has always
been key to passing trade legislation. Both houses of
Congress, and the executive branch it-self, are constantly
besieged by the most sophisticated lobbyists in the world,
132
able to whip up campaigns in the media for or against this or
that aspect of international economic cooperation.”

133
 Political Economy of
Global Financial Crisis and Europe

Robin Hahnel and Michael Albert identify five economic

models within the rubric of socialist economics:

 Public Enterprise Centrally Planned Economy in

which all property is owned by the State and all key
economic decisions are made centrally by the State,
e.g. the former Soviet Union.
 Public Enterprise State-Managed Market
Economy, one form of market socialism which
attempts to use the price mechanism to increase
economic efficiency, while all decisive productive
assets remain in the ownership of the state, e.g.
socialist market economy in China after reform.
 A mixed economy, where public and private
ownership are mixed, and where industrial planning
is ultimately subordinate to market allocation, the
model generally adopted by social democrats e.g. in
twentieth century Sweden.
 Public Enterprise Employee Managed Market
Economies, another form of market socialism in
which publicly owned, employee-managed

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 production units engage in free market exchange of
goods and services with one another as well as with
final consumers, e.g. mid twentieth century
Yugoslavia, Two more theoretical models are Prabhat
Ranjan Sarkar's Progressive Utilization Theory and
Economic democracy.
 Public Enterprise Participatory Planning, an
economy featuring social ownership of the means of
production with allocation based on an integration of
decentralized democratic planning. An incipient
historical forebear is that of Catalonia during the
Spanish revolution. More developed theoretical
models include those of Karl Polanyi, Participatory
Economics and the negotiated coordination model of
Pat Devine.

Western Europe

Many of the industrialized, open countries of Western

Europe experimented with one form of socialist development
or another during the 20th century. They can be regarded as
social democratic experiments, because they universally
retained a wage-based economy and private ownership and
control of the decisive means of production.

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Nevertheless, many Western European countries tried to
restructure their economies away from a pure capitalist
model. Elements of these efforts persist throughout Europe,
even if they have repealed some aspects of public control and
ownership.

They are typically characterized by:

 Nationalization of key industries, such as coal, steel,

power, and transportation. A common model was for
a sector to be taken over by the state and then one or
more publicly-owned corporations set up for its day-
to-day running. Advantages of nationalization are:
o The ability of the state to direct investment in
key industries
o The distribution of state profits from
nationalized industries for the overall national
good
o The ability to direct producers to social rather
than market goals
o Greater control of the industries by and for
the workers.
o Benefits and burdens of publicly funded
research and development are extended to the
wider populace.

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  Redistribution of wealth, typically by progressive
taxation of high earners.
 Minimum wages, employment protection, and trade
union recognition rights for the benefit of workers.
There were a number of different models of
protection and trade union protection which evolved.
Germany, for instance, appointed union
representatives at high levels in all corporations and
had much less industrial strife than the UK, whose
laws encouraged strikes rather than negotiation. The
objectives of these policies were to redistribute and to
help produce full employment.
 National planning or state capitalism for industrial
development.
 Demand management in a Keynesian fashion to help
ensure economic growth and employment.

United Kingdom (UK)

Global Financial Centres and their role in Global

Financial Crisis:

It’s a great coincidence that an article on the global financial

centres was published exactly one year before the financial
crisis of September, 2008 in The Economist under the title
“Magnets for Money.” According to that article, unlike the
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walled medieval city-states, today’s financial centres are
increasingly dependent on their connections to one another.
Technology, the mobility of capital and the spread of
deregulation around the globe have created a vibrant and
growing network. When one city is asleep, another is wide
awake, so trading goes on round the clock. The number of
transactions between financial centres has surged recently as
investors have diversified across regions and asset types.
Although financial hubs have proliferated, few of them can
claim to be truly global. Many members of the financial
community feel that only New York City and London
deserve this title. Both are one-stop shops for a full range of
financial services. Any big financial organization has to be
represented there. From investment banking to insurance,
stocks to derivatives, everything can be found in the world’s
two pre-eminent financial hubs.
What do they have that others don’t? They score well on a
package of key criteria that global financial firms are looking
for : plenty of skilled people, ready access to capital, good
infrastructure, attractive regulatory and tax environments and
low levels of corruption. Location and the use of English, the
language of global finance, are also important. Based on
those measures, a survey by z/Yen, a consultancy, picks
London, New York and Hong Kong as the world’s top three
financial centres.

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Although New York and London are pre-eminent, other big
cities play important international roles of their own. Some
have prospered as the financial capitals of big national
markets (Tokyo and Sydney) or the gateways to emerging
regions (Hong Kong, Singapore and Dubai). Others have
found success in niches. These include Geneva (private
banking), Zurich and Bermuda (insurance and reinsurance),
Chicago (futures and options), Qatar (infrastructure finance)
and Bahrain (Islamic finance). Yet many of these too are
trying to diversify.
Governments are paying more attention than ever to wooing
and keeping financial firms because of the benefits they
bring with them, such as highly paid jobs, large tax revenues
and international connections. In New York and Hong Kong
the financial sector accounts for more than one-third of total
city tax revenues. In smaller centres it often makes up a large
chunk of total employment.
Aside from the political and economic gains to the host
countries, economists and investment banker point to two
wider benefits from having a range of financial centres
around the world. One is the increase in overall liquidity as
new countries and regions become integrated into the global
financial system. The second is increased efficiency as
competition between centres drives down the cost of trading
and other financial transactions. New and developing
financial centres are knocking down protectionist barriers
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and emulating the regulatory practices of the more
established hubs.

Two-way traffic
The rivalry between New York and London is merely the
most tangible sign of a booming transatlantic business in
financial services. Both centres benefit from their
interconnection with each other, as well as with the rest of
the global financial network. Financial flows between
America and Europe have surged in recent years, propelled
by forces such as mergers and acquisitions and alternative
investments. America’s big pension funds and other
institutional investors are still some of the biggest investors
in Europe’s hedge-fund and private-equity markets. Many
financial transactions in London are denominated in dollars.
And as American exchanges have increased their business in
Europe, their European counterparts-first Deutsche Borse’s
derivatives arm, Eurex, and more recently Euronext’s LIFFE
exchange-have been trying to grab a bigger share of
American securities trading.
The 2001 attacks also helped to change the way America
thought about regulation. Coupled with financial scandals
such as that over Enron, the events increased political
pressure for acting on potential abuses by executives and
greater scrutiny by investors. At the same time Eliot Spitzer,
then New York’s attorney-general (and now its governor),
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embarked on a mission to hunt down financial wrongdoing
in corporate and financial markets. His zeal won over many
consumers in New York, but it did not go down well in
international capital markets.
A string of reports released earlier this year-by groups
ranging from McKinsey, a consultancy (at the behest of Mr.
Bloomberg and Senator Charles Schumer) to the pro-
business US Chamber of Commerce has pointed to problems
in America’s capital markets ranging from regulatory
scrutiny to accounting standards and obstacles to
immigration. The worry is that rival hubs, notably London,
are attracting some of the financial business that New York
would like for itself. “Facts are facts,” says Mr. Doctoroff of
the reports, which involved extensive interviews with chief
executives of big financial firms. “Few people are disputing
the analysis we’ve done.” But many of the changes
suggested by the reports will need to come from
Washington, DC, where America’s regulators sit.
Three things that changed the system
John Thain, head of the New York Stock Exchange, notes
three key trends in the evolution of modern exchange,
demutulisation, diversification and globalization. These are
already having a profound effect on the global financial
system -and are linking financial centres more closely
together than ever before.

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Demutualisation is an industry term for the end of market
ownership by a small, privileged group of “seat owner”. Seat
ownership typically confers not only the right to trade but
also a say over the way an exchange is governed.
The second trend, diversification, means the exchanges are
trading a broader range of products. For most of their
history, stock markets traded companies’ shares in the
countries of regions where they were based. Derivatives
exchanges grew up offering contracts for the future delivery
of commodities that were often produced, imported or
widely traded nearby. These days exchanges trading
derivatives are highly imaginative in creating new products.
They have expanded well beyond commodities to offer
contracts tied to anything from foreign currencies to the
weather.
The third trend, globalization, is really another sort of
diversification. This can involve the listing of foreign shares
or depository receipts, alliances to exchange information or
technology, or cross-border mergers. By reaching across
national boundaries, exchanges are offering their customers a
new mix of products as well as reducing costs and increasing
profits. However, as in any cross-border merger they run the
risk of over-complexity and integration difficulties. They
also expose themselves to issuers who may not be governed
by the robust accounting standards of the world’s leading
financial centres.
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Whereas financial markets have undergone huge changes,
regulation has often lagged behind.
Financial innovation has proceeded at a head-spinning rate in
recent years. Hedge funds have ballooned to account for
more than $ 1.3 trillion in assets worldwide. They also bear
some responsibility for the growing volatility of global
financial markets and pose difficult questions for regulators.
Complex new products that are created in one financial
centre involve assets in another and are sold to investors in a
third, so who is supposed to keep an eye on them?
“It’s almost a virtual system,” says one regulator in a leading
financial centre. Increasingly capital markets are racing
ahead of the regulators, which remain rooted in their national
systems, thus creating problems for financial firms straddling
borders. Technology may have made electronic transactions
faster and cheaper than ever, notes an international banker,
but it is also making regulatory barriers less visible to clients.
That lack of visibility raises worriers over risk, too. Many
argue that risk is now dispersed more widely than ever
before, across geographical areas, financial institutions and
investors. This dispersion, the argument goes, allows the
financial system to absorb the stresses of a rapidly growing
system.
Others are less certain. It is hard to know exactly where the
risks are when they have been divided up, repackaged and
sold off. This may seem a concern only for financial
143
institutions and large investors. But with a growing number
of individuals exposed to capital markets from Americans
through their mutual funds and retirement accounts to small
investors in Shanghai taking out loans to buy shares-
governments cannot afford to ignore those risks.
It is up to regulators, who are generally appointed by and
report to government, to sort out the balance, but the
complexities of rapid trading, particularly across multiple
borders and asset classes, are stretching the capacity of even
the most sophisticated regulators.

Politics gets in the way

It is politics that finally drives regulatory reform. Real
change in Washington, DC, ultimately depends on Congress.
But insiders on Capitol Hill doubt that much will get done
before the 2008 presidential election. Mr. Cox, who himself
spent 17 years in Congress, takes the same view, noting that
the legislative branch moves to its own rhythm. Besides,
reform of financial markets is seen as important to only a
select few states, such as New York, Connecticut (home to
numerous hedge funds) and Illinois, all of which have big
financial sectors.
Financial firms, for their part, complain that drawn-out
debates over regulation are too complex, too philosophical
and too political. “We want to write a contract very quickly,”
a Citibank official explained at a recent financial-services
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conference. But the shifting regulatory sands make it hard to
achieve such simple aims.

The new wealth of nations

Not all this urban gentrification can be laid at the door of
financial services, but the new rich in the world’s top cities
are more likely to be hedge-fund managers than
industrialists. Research recently by Mr. Kaplan and Mr.
Rauh of the University of Chicago showed that in 2004 nine
times as many Wall Street executives earned over $ 100
million as did chief executives of public companies. The top
25 hedge-fund managers earned more than the Chief
executives of all the companies in the Standard and Poor’s
500 combined.

The UK was the first country in world history to industrialise

in the 18th and 19th centuries, and for much of the 19th
century possessed a predominant role in the global economy.
However, by the late 19th century, the Second Industrial
Revolution in the United States meant the USA had begun to
challenge Britain's role as the leader of the global economy.
The extensive war efforts of both World Wars in the 20th
century also weakened the UK economy in global terms, and
by that time Britain had been superseded by the United
States as the chief player in the global economy. At the start
of the 21st century however, the UK still possesses a

145
significant role in the global economy, given its large Gross
Domestic Product and the financial importance that its
capital, London, possesses in the world.

Economics of United Kingdom

The United Kingdom has a capitalist mixed economy that is

the 6th largest in the world in terms of market exchange rates
and the fifth largest by purchasing power parity (PPP). It is
considered the third largest economy in Europe after
Germany's and France's. Its GDP PPP per capita in 2007 is
the 22nd highest in the world.

Statistics

GDP (PPP) $2.772 trillion (2007 est.)

GDP growth -1.5% (Q4 2008)

GDP per capita $45,575 (2007 est. nom.) (12th)

GDP by sector agriculture (1%), industry (26%), services

(73%)

Inflation (CPI) 4.1% (2008 November RPI)

Population 14% (2006 est.)

below poverty
line

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 Labour force 31 million (includes unemployed) (2007 est.)

Labour force Services (81%), industry (18%) and agriculture

by occupation (1%) (excludes unemployed) (2007)

Unemployment 5.8% (Q3 2008)

Main industries machine tools, industrial equipment, scientific

equipment, shipbuilding, aircraft, motor vehicles
and parts, electronic machinery, computers,
processed metals, chemical products, coal
mining, oil production, paper, food processing,
textiles, clothing and other consumer goods.

External

Exports $442.2 billion (2007 est.)

Main export USA 15%, Germany 11%, France 10%, Ireland

partners 7%, Netherlands 6%, Belgium 6%, Spain 5%,
Italy 4% (2007)

Imports $621.4 billion (2007 est.)

Main import Germany 14.2%, US 8.6%, China 7.3%,

partners Netherlands 7.3%, France 6.9%, Belgium 4.7%,
Norway 4.7%, Italy 4.2% (2007)

Public finances

Public Debt $864 billion (2007)

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 Revenues $0.97 trillion (2007)

Expenses $1.04 trillion (2007)

Source : Wikipedia

FRANCE :

Dirigisme and decline of dirigisme

Following the Second World War, Fifth Republic, France

embarked on an ambitious and very successful program of
modernisation, under state impulse and coordination. This
program of dirigisme, mostly implemented by right-wing
governments, involved the state control of certain industries,
such as transportation, energy and telecommunication
infrastructures, as well as various incentives for private
corporations to merge or engage in certain projects.

However, dirigisme came to be highly contested after 1982

when newly elected socialist president François Mitterrand
called for increased governmental control in the economy,
nationalising many industries and private banks. By 1983
with the initial bad economic results the government decided
to renounce dirigisme and start the era of rigueur ("rigour")
or corporatization. As a result the government largely
retreated from economic intervention; dirigisme has now
essentially receded though some of its traits remain.

148
Despite significant liberalisation over the past 15 years, the
government continues to play a significant role in the
economy: government spending, at 53% of GDP in 2001, is
the highest in the G-7. Labour conditions and wages are
highly regulated. The government continues to own shares in
corporations in a range of sectors, including banking, energy
production and distribution, automobiles, transportation, and
telecommunications which differs from countries like the
U.S or U.K where most of these companies are privatised.

France is the fifth largest economy in the world, by

measurement of GDP (nominal), behind the United States,
Japan, China and Germany.

International Monetary Fund data rank the French economy

eighth largest by purchasing power parity (PPP) in 2007 at
US$2,046,899 million.

Statistics

GDP (PPP) $12,371,868

GDP growth -0.3% (Q2 2008)

GDP per capita $33,200 (2007)

GDP by sector agriculture (2.7%), industry (24.4%),

services (72.9%) (2004)

Inflation (CPI) 1.5% (2007)

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 Population 6.2% (2004)
below poverty
line

Labour force 27.88 million (2006)

Labour force services (71.5%), industry (24.4%),

by occupation agriculture (4.1%) (1999)

Unemployment 8%

Main industries machinery, chemicals, automobiles,

metallurgy, aircraft, electronics; textiles,
food processing; tourism

External

Exports $490 billion (2006)

Export goods machinery and transportation

equipment, aircraft, plastics, chemicals,
pharmaceutical products, iron and steel,
beverages

Main export Germany 14.7%, Spain 9.6%, Italy

partners 8.7%, United Kingdom 8.3%, United
States 7.2%, Belgium 7.1% (2005)

Imports $529.1 billion (2006)

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 Import goods machinery and equipment, vehicles,
crude oil, aircraft, plastics, chemicals

Main import Germany 18.9%, Belgium 10.7%, Italy

partners 8.2%, Spain 7%, Netherlands 6.5%,
United Kingdom 5.9%, United States
5.1% (2005)

Public finances

Public Debt $1.210 trillion (64.7% of the GDP)

(2006)

Revenues $1.150 trillion (2006)

Expenses $1.211 trillion (2006)

Source : Wikipedia

GERMANY:

Germany is the world's fourth largest economy in USD

exchange-rate terms, the fifth largest by purchasing power
parity (PPP), and the largest economy in Europe.

The German economy is heavily export-oriented; as of 2008,

Germany is the world's leading exporter of merchandise, and
exports account for more than one-third of national output.
As a result, exports traditionally have been a key element in

151
German macroeconomic expansion. Germany is a strong
advocate of closer European economic and political
integration, and its economic and commercial policies are
increasingly determined by agreements among European
Union (EU) members and EU single market legislation.
Germany uses the common European currency, the Euro,
and its monetary policy is set by the European Central Bank
in Frankfurt, Germany.

Most foreign and German experts agree that there are/were

domestic structural problems to be addressed. Beginning in
2003, the government gradually deregulated the labour
market to tackle formerly high unemployment, and
employment levels have been increasing. As of October
2008, the overall unemployment rate, as measured by the
German authorities, was 7.2 percent (6.0 percent in West
Germany, and 11.8 percent in East Germany). As of
September 2008, as measured by ILO standards the German
unemployment rate was 6.2 percent (compared with 7.4
percent as measured by German standards). Further issues,
which are being addressed by governmental policies, are
high non-wage labour costs and bureaucratic regulations that
burden businesses and the process of starting new
businesses.

152
Financial Services

By tradition, Germany’s financial system is bank-oriented

rather than stock market-oriented. The process of
disintermediation, whereby businesses and individuals
arrange financing by directly accessing the financial markets
versus seeking loans from banks acting as intermediaries, has
not fully taken hold in Germany. One of the reasons that
banks are so important in German finance is that they have
never been subject to a legal separation of commercial and
investment banking. Instead, under a system known as
universal banking, banks have offered a wide range of
services from lending to securities trading to insurance.
Another reason for the strong influence of banks is that there
is no prohibition of interlocking ownership between banks
and their client companies. However, in January 2002 the
government moved to discourage this practice and promote
more rational capital allocation by eliminating the capital
gains tax on the sale of corporate holdings from one
company to another.

At the end of 2000, 2,713 out of 2,931 German financial

institutions (92.6%) were universal banks, including 354
commercial banks, 1,798 credit cooperatives, and 561
savings banks. The non-universal banks specialized in such
activities as mortgage banking and investments. The list of
the six largest German banks illustrates the diversity of bank
153
structure and ownership. Of the top six banks, ranked by
total assets as of year-end 2002, four are private, but the fifth
largest is public, and the sixth largest is a cooperative.

Despite the central role of banks in finance, stock markets

are competing for influence. The Deutsche Börse (German
stock exchange), a private corporation, is responsible for
managing Germany’s eight stock markets, by far the largest
of which is the Frankfurt Stock Exchange, which handles
90% of all securities trading in Germany. The leading stock
index on the Frankfurt exchange is the DAX, which, like the
New York Stock Exchange’s Dow Jones Industrial Average,
is composed of 30 blue-chip companies. The other German
stock exchanges are located in Berlin, Bremen, Düsseldorf,
Hamburg, Hanover, Munich, and Stuttgart. Xetra is
Germany’s electronic trading platform. As of the end of
2004, the total market capitalization of the German stock
markets was nearly US$1.1 trillion, representing about 45%
of gross domestic product (GDP). The shares of some 684
companies trade on the exchanges.

Statistics

GDP (PPP) $2.585 trillion (2006 est.)

GDP growth 2.7% (2006)

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GDP per capita $31,400 (2006 est.)

GDP by sector agriculture (0.9%), industry (29.1%),

services (70%) (2006)

Inflation (CPI) 1.7% (2006)

Population 11% (2001)

below poverty
line

Labour force 43.66 million (2006 est.)

Labour force services (63.8%), industry (33.4%),

by occupation agriculture (2.8%) (2006)

Unemployment 7.3%

Main industries iron, steel, coal, cement, chemicals,

machinery, vehicles, machine tools,
electronics, food and beverages,
shipbuilding, textiles

External

Exports $1.354 trillion f.o.b. (2007 est.)

Export goods machinery, vehicles, chemicals, metals

and manufactures, foodstuffs, textiles

Main export France 9.7%, U.S. 7.5%, UK 7.3%, Italy

partners 6.7%, Netherlands 6.4%, Austria 5.4%,

155
 Belgium 5.3%, Spain 5% (2007)

Imports $1.075 trillion FOB (2007 est.)

Import goods machinery, vehicles, chemicals,

foodstuffs, textiles, metals

Main import Netherlands 12%, France 8.6%,

partners Belgium 7.8%, China 6.2%, Italy 5.8%,
UK 5.6%, the United States 4.5%,
Austria 4.4% (2007)

Public finances

Public Debt $1.93 trillion (66.8% of $2.89 trillion,

nominal GDP) (2006)

Revenues $1.277 trillion (2006)

Expenses $1.344 trillion; including capital

expenditures of $NA (2006 est.)
Source : Wikipedia

156
 Global Financial Crisis: Impact on Europe

The financial crisis in US has crippled the European

Economy. The whole banking system has collapsed. Thanks
to US, it exported the exotic financial products, consumption
and credit culture and bad banking practices to European
countries. The German economy has already entered into
recession. Thousands of jobs have been lost, financial
institutions have disappeared overnight/ Ireland has been
among the hardest hit. An economy that boomed by moving
hundreds of American companies with low corporate taxes is
now on the brink of recession.
Spain, whose buoyant economy was once Europe’s envy,
also is facing the financial turmoil. Following the collapse of
the construction boom that drive a decade of economic
growth, Spain is saddled with stagnant growth, 10.7%.
Unemployment and inflation at nearly 5%.

157
Germans are frightened by global financial turbulence are
turning to therapists, running to their banks. The hyper
inflation of the 1920s Weimar Republic that wiped away
their assets and paved the way for Adolf Hilter’s rise is
deeply embedded in the hearts and minds of Germans as is
the loss of wealth from World War II and Post War currency
reform.

2008 Recession

In November 2008, the economy contracted more than

expected by economists in the 3rd quarter, confirming entry
to its worst technical recession in at least 12 years. Gross
domestic product fell 0.5% from the 2nd quarter, when it
dropped a revised 0.4%, the first decline since late 2004,
according to the Wiesbaden Federal Statistics Office: "A
negative effect on gross domestic product came from foreign
trade, with a strong increase in imports and weakening
exports." German industrial output dropped to 3.6% in
September vis-à-vis August. Sebastian Wanke at Dekabank
predicted: "There won't be an improvement in the fourth
quarter. The situation will only get worse." Carsten Brzeski
at ING Financial Markets said: "Anecdotal evidence and
leading indicators are scary."

The UK has entered into recession. The UK Treasury seized

Bradford and Bingley, Britain’s biggest lender to landlords.
158
While governments in Belgium, the Netherlands and
Luxembourg threw an 11.2 billion – Euro ($ 16.3 billion)
lifeline to Fortis. Germany guaranteed loan to Hypo. Shares
of Dexia SA, a lender based in both Brussels and Paris, fell
as much as 33% in Brussels trading. Iceland agreed to buy
75% in Glitnir Bank HF, the island nation’s third largest
bank by market value, for 60 million Euros.
Tightening credit is casting a pall over the European
economy with UK growth the weakest since early 1920s and
the 15 nation Euro-area on the edge of the first recession.
The risk is special in which the credit crisis and the economy
begin to feed off each other, resulting in costlier borrowing
and weaker expansion.
According to Marco Annunziata, Chief economist at
Unicredit MIB, “The extreme dislocations in European
money markets are both a symptoms and a source of serious
stress in the financial sector, exacerbated by the rapidly
deteriorating growth environment.
Europe’s problems are more complicated than US. In Euro
zone, the European Monetary Authority on independent
institution decides the monetary policies. The resume
package are announced by the national governments Co-
ordination between these two is difficult. For eg. Surkozy
proposed a joint European financial rescue pool which was
opposed by Germany. Whereas in US, Federal Reserve and
Government can work together
159
Daniel Gros and Stefano Micosi wrote in The Financial
Times that some European banks are big to be saved, since
their liabilities far exceed than the GNP of their
Governments. The ratio of bank loans/assets to GDP proves
this point.

European Banks too Big To Be Saved. The Bank loans Assets

to GDP ratio shows that these banks have become too big for the country
to save them.

Country Bank Bank Loans Assets to

GDP
Iceland Kaupthing 623

Switzerland UBS 484

Iceland Landsbanki 374

Switzerland Credit Suisse 290

Netherlands ING 290

Belgium/Lux Fortis 254

Cyprus Bank of Cyprus 253

Belgium/Lux Dexia 173

Spain Santander 132
UK RBS 126
Netherlands Rabobank 121

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 France BNP Paribas 104
Ireland Bank of Ireland 102
Belgium KBC 102
Ireland Allied Irish 99
UK HSBC 98
Source : financialtimes.com

Banking in Crisis – Select Club of Survivors:

The list of the select club of survivors even in this financial

crisis is as follows:

HSBC, JP Morgan, Nomuro and Mitsubishi, Banco

Santander, BNP Paribas, Bank of America, Intesa San Paola.

Why they survived?

They did right things which their competitors did not. They
did conservative, ‘boring business’ (traditional banking)
during the decade of financial engineering frenzy.

Banco Santander:

 Always considered itself as a retail banker focusing

on consumers and small to midsize business. 84% of
its earnings are generated by retail banking at its

161
 13,500 branches – the world’s biggest international
retail network.
 No exposure to investment banking and funds itself
with predictable long term bonds.
 Sold its real estate property before Spain’s bust.

HSBC

 In the boom years, HSBC was managing a rate of

only about 5% while others hit 3 times.
 It has always been ultra conservative. Conservative
inertia saved these banks.
 Sale of its sky scraper during boom period for
massive $ 1.1 billion – highest ever price paid for a
British property.
 HSBC wrote off $ 17.2 billion losses on risky
advance well before the crisis.
 It is highly appreciated for admitting they had a
problem and never hiding anything i.e. transparency.

Advise from Emilio Botin, CEO, Banko Santander to the

young bankers

 “If you don’t understand an instrument don’t buy it.”

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  “If you do not know your customers very well don’t
lend them any money”
 “If you do these things, you will be a better banker,
my son”.

Political Economy of
Global Financial Crisis and China

‘Let China Sleep, for when she awakens she will shake
the world’
Napoleon Bonaparte.

China has woken up. In a short span of nearly 30 years of its

liberalization policy, it has stirred the World. According to
Goldman Sachs Report, (2003) Dreaming with BRICs : The
path to 2050, China is projected to take over UK, Germany
and Japan 2015 and US by 2040. With the unexpected turn
of event like once in a century financial tsunami of 2008,

163
probably this may happen faster. The European economies
and US are facing recession and may slip in to depression.

Maoism

Maoism is the Marxist-Leninist trend of Communism

associated with Mao Zedong and was mostly practiced
within the People's Republic of China. Khrushchev's reforms
heightened ideological differences between the People's
Republic of China and the Soviet Union, which became
increasingly apparent in the 1960s. As the Sino-Soviet Split
in the international Communist movement turned toward
open hostility, China portrayed itself as a leader of the
underdeveloped world against the two superpowers, the
United States and the Soviet Union.

Parties and groups that supported the Communist Party of

China (CPC) in their criticism against the new Soviet
leadership proclaimed themselves as 'anti-revisionist' and
denounced the CPSU and the parties aligned with it as
revisionist "capitalist-roaders." The Sino-Soviet Split
resulted in divisions amongst communist parties around the
world. Notably, the Party of Labour of Albania sided with
the People's Republic of China. Effectively, the CPC under
Mao's leadership became the rallying forces of a parallel
international Communist tendency. The ideology of CPC,
Marxism-Leninism-Mao Zedong Thought (generally referred

164
to as 'Maoism'), was adopted by many of these groups. After
Mao's death and his replacement by Deng Xiaoping, the
international Maoist movement diverged. One sector
accepted the new leadership in China; a second renounced
the new leadership and reaffirmed their commitment to
Mao's legacy; and a third renounced Maoism altogether and
aligned with Albania.

Socialistic Market Economy

Deng Xiaoping, the architect of Socialistic Market Economy

said that, “What is socialism and what is Marxism? We were
not quite clear about this in the past. Marxism attaches
utmost importance to developing the productive force. We
have said that socialism is the primary stage of communism
and that at the advanced stage of the “Principle” of each
according to his ability and to each according to his needs
will be applied. This calls for highly developed productive
forces and an overwhelming abundance of material wealth.
Therefore, the fundamental task for the socialist stage is to
develop the productive forces. The superiority of the socialist
system is demonstrated, in the final analysis, by faster and
greater development of those forces than under the capitalist
system. As they develop, the people’s material and cultural
life will constantly improve. One of four shortcomings after
the founding of the People’s Republic was that we didn’t pay
enough attention to developing the productive forces.
165
Socialism means elimination poverty. Pauperism is not
socialism, still less communism”

Since the late 1970s and early 1980s, the economic reforms
initially began with the shift of farming work to a system of
household responsibility to start the phase out of
collectivized agriculture, and later expanded to include the
gradual liberalization of prices; fiscal decentralization;
increased autonomy for state enterprises that increased the
authority of local government officials and plant managers in
industry thereby permitting a wide variety of private
enterprise in services and light manufacturing; the
foundation of a diversified banking system but with
overwhelming domination by state banks; the development
of stock market; the rapid growth of the non-state sector, and
the opening of the economy to increased foreign trade and
foreign investment. China has generally implemented
reforms in a gradualist fashion, although there is increasing
evidence that state control was increased in the 1990s, the
sale of equity in China's largest state banks to foreign
investors and refinements in foreign exchange and bond
markets in mid-2000s. As its role in world trade has steadily
grown, its importance to the international economy has also
increased apace. China's foreign trade has grown faster than
its GDP for the past 25 years. China's growth comes both
from huge state investment in infrastructure and heavy

166
industry and from private sector expansion in light industry
instead of just exports, whose role in the economy appears to
have been significantly overestimated. The smaller but
highly concentrated public sector, dominated by 159 large
SOEs, provided key inputs from utilities, heavy industries,
and energy resources that facilitated private sector growth
and drove investment, the foundation of national growth. In
2008 thousands of private companies closed down and the
government announced plans to expand the public sector to
take up the slack caused by the global financial crisis in the
capitalist world.

The government's decision to permit China to be used by

multinational corporations as an export platform has made
the country a major competitor to other Asian export-led
economies, such as South Korea, Singapore, and Malaysia.

A decision was made in 1978 to permit foreign direct

investment in several small "special economic zones" along
the coast. The country lacked the legal infrastructure and
knowledge of international practices to make this prospect
attractive for many foreign businesses, however. In the early
1980s steps were taken to expand the number of areas that
could accept foreign investment with a minimum of red tape,
and related efforts were made to develop the legal and other
infrastructures necessary to make this work well. This

167
additional effort resulted in making 14 coastal cities and
three coastal regions "open areas" for foreign investment. All
of these places provide favored tax treatment and other
advantages for foreign investment. Laws on contracts,
patents, and other matters of concern to foreign businesses
were also passed in an effort to attract international capital to
spur China's development. The largely bureaucratic nature of
China's economy, however, posed a number of inherent
problems for foreign firms that wanted to operate in the
Chinese environment, and China gradually had to add more
incentives to attract foreign capital.

During 1993, output and prices were accelerating,

investment outside the state budget was soaring, and
economic expansion was fueled by the introduction of more
than 2,000 special economic zones (SEZs) and the influx of
foreign capital that the SEZs facilitated. The government
approved additional long-term reforms aimed at giving still
more play to market-oriented institutions and at
strengthening central control over the financial system; state
enterprises would continue to dominate many key industries
in what was now termed a "socialist market economy".

Following the Chinese Communist Party's Third Plenum,

held in October 2003, Chinese legislators unveiled several
proposed amendments to the state constitution. One of the

168
most significant was a proposal to provide protection for
private property rights.

Planning and Execution Process

The whole policy-making process involves extensive

consultation and negotiation. Economic policies and
decisions adopted by the National People's Congress and the
State Council are to be passed on to the economic
organizations under the State Council, which incorporates
them into the plans for the various sectors of the economy.
Economic plans and policies are implemented by a variety of
direct and indirect control mechanisms. Direct control is
exercised by designating specific physical output quotas and
supply allocations for some goods and services. Indirect
instruments—also called "economic levers"—operate by
affecting market incentives. These included levying taxes,
setting prices for products and supplies, allocating
investment funds, monitoring and controlling financial
transactions by the banking system, and controlling the
169
allocation of key resources, such as skilled labor, electric
power, transportation, steel, and chemicals (including
fertilizers). The main advantage of including a project in an
annual plan is that the raw materials, labor, financial
resources, and markets are guaranteed by directives that have
the weight of the law behind them. In reality, however, a
great deal of economic activity goes on outside the scope of
the detailed plan, and the tendency has been for the plan to
become narrower rather than broader in scope. A major
objective of the reform program was to reduce the use of
direct controls and to increase the role of indirect economic
levers. Major state-owned enterprises still receive detailed
plans specifying physical quantities of key inputs and
products from their ministries. These corporations, however,
have been increasingly affected by prices and allocations that
were determined through market interaction and only
indirectly influenced by the central plan.

Total economic enterprise in China is apportioned along

lines of directive planning (mandatory), indicative planning
(indirect implementation of central directives), and those left
to market forces.

Regulatory environment

Though China's economy has expanded rapidly, its

regulatory environment has not kept pace. Since Deng
170
Xiaoping's open market reforms, the growth of new
businesses has outpaced the government's ability to regulate
them. This has created a situation where businesses, faced
with mounting competition and poor oversight, will be
willing to take drastic measures to increase profit margins,
often at the expense of consumer safety. This issue acquired
more prominence in 2007, with a number of restrictions
being placed on problematic Chinese exports by the United
States. The Chinese Government recognizes the severity of
the problem, recently concluding that up to 20% of the
country's products are substandard or tainted. The recent
milk powder scam and toxic toys export to USA are the
latest examples of poor quality.

Financial and banking system

Most of China's financial institutions are state owned and

governed. 98% of banking assets are state owned. The chief
instruments of financial and fiscal control are the People's
Bank of China (PBC) and the Ministry of Finance, both
under the authority of the State Council. The People's Bank
of China replaced the Central Bank of China in 1950 and
gradually took over private banks. It fulfills many of the
functions of other central and commercial banks. It issues the
currency, controls circulation, and plays an important role in
disbursing budgetary expenditures. Additionally, it

171
administers the accounts, payments, and receipts of
government organizations and other bodies, which enables it
to exert thorough supervision over their financial and general
performances in consideration to the government's economic
plans. The PBC is also responsible for international trade and
other overseas transactions. Remittances by overseas
Chinese are managed by the Bank of China (BOC), which
has a number of branch offices in several countries.

Other financial institutions that are crucial, include the China

Development Bank (CDB), which funds economic
development and directs foreign investment; the Agricultural
Bank of China (ABC), which provides for the agricultural
sector; the China Construction Bank (CCB), which is
responsible for capitalizing a portion of overall investment
and for providing capital funds for certain industrial and
construction enterprises; and the Industrial and Commercial
Bank of China (ICBC), which conducts ordinary commercial
transactions and acts as a savings bank for the public.

75% of State Bank loans to go State Owned Enterprises

(SOEs).

With two stock exchanges (Shanghai Stock Exchange and

Shenzhen Stock Exchange), mainland China's stock market
had a market value of $1 trillion by January 2007, which
became the third largest stock market in Asia, after Japan
172
and Hong Kong. It is estimated to be the world's third largest
by 2016.

External Trade

China's global trade exceeded $2.4 trillion at the end of 2008. It first
broke the $100 billion mark in 1988, $200 billion in 1994, $500 billion in
2001 and $1 trillion mark ($1.15 trillion) in 2004. The table below shows
the average annual growth (in nominal US dollar terms) of China’s
foreign trade during the reform era.

Period Two-way trade Exports Imports

1981–85 +12.8% +8.6% +16.1%

1986–90 +10.6% +17.8% +4.8%

1991–95 +19.5% +19.1% +19.9%

1996–2000 +11.0% +10.9% +11.3%

2000–05 +24.6% +25.0% +24.0%

2006 +27.2% +19.9% +23.8%

173
2007 +25.6% +20.8% +23.4%

Source : Wikipedia

The vast majority of China's imports consists of industrial

supplies and capital goods, notably machinery and high-
technology equipment, the majority of which comes from the
developed countries, primarily Japan and the United States.
Regionally, almost half of China's imports come from East
and Southeast Asia, and about one-fourth of China's exports
go to the same destinations. About 80 percent of China's
exports consist of manufactured goods, most of which are
textiles and electronic equipment, with agricultural products
and chemicals constituting the remainder. Out of the five
busiest ports in the world, three are in China.

The U.S. trade deficit with China reached $232.5 billion in

2006, as imports grew 18%. China's share of total U.S.
imports has grown from 7% to 15% since 1996. At the same
time, the share of many other Asian countries' imports to the
United States fell, from 39% in 1996 to 21.1% in 2005.

The U.S. trade deficit with China reached $232.5 billion in

2006, as imports grew 18%. China's share of total U.S.
imports has grown from 7% to 15% since 1996. At the same

174
time, the share of many other Asian countries' imports to the
United States fell, from 39% in 1996 to 21.1% in 2005.

Foreign investment

China's investment climate has changed dramatically with

more than two decades of reform. In the early 1980s, China
restricted foreign investments to export-oriented operations
and required foreign investors to form joint-venture
partnerships with Chinese firms. The Encouraged Industry
Catalogue sets out the degree of foreign involvement
allowed in various industry sectors. From the beginning of
the reforms legalizing foreign investment, capital inflows
expanded every year until 1999. Foreign-invested enterprises
account for 58–60% of China’s imports and exports.

Since the early 1990s, the government has allowed foreign

investors to manufacture and sell a wide range of goods on
the domestic market, eliminated time restrictions on the
establishment of joint ventures, provided some assurances
against nationalization, allowed foreign partners to become
chairs of joint venture boards, and authorized the
establishment of wholly foreign-owned enterprises, now the
preferred form of FDI. In 1991, China granted more
preferential tax treatment for Wholly Foreign Owned
Enterprises and contractual ventures and for foreign
companies, which invested in selected economic zones or in
175
projects encouraged by the state, such as energy,
communications and transportation.

China also authorized some foreign banks to open branches

in Shanghai and allowed foreign investors to purchase
special "B" shares of stock in selected companies listed on
the Shanghai and Shenzhen Securities Exchanges. These "B"
shares sold to foreigners carried no ownership rights in a
company. In 1997, China approved 21,046 foreign
investment projects and received over $45 billion in foreign
direct investment. China revised significantly its laws on
Wholly Foreign-Owned Enterprises and China Foreign
Equity Joint Ventures in 2000 and 2001, easing export
performance and domestic content requirements.

Foreign investment remains a strong element in China's rapid

expansion in world trade and has been an important factor in
the growth of urban jobs. In 1998, foreign-invested
enterprises produced about 40% of China's exports, and
foreign exchange reserves totalled about $145 billion.
Foreign-invested enterprises today produce about half of
China's exports (note that the majority of China's foreign
investment come from Hong Kong, Macau and Taiwan), and
China continues to attract large investment inflows.
However, the Chinese government's emphasis on guiding
FDI into manufacturing has led to market saturation in some

176
industries, while leaving China's services sectors
underdeveloped. From 1993 to 2001, China was the world's
second-largest recipient of foreign direct investment after the
United States. China received $39 billion FDI in 1999 and
$41 billion FDI in 2000. China is now one of the leading FDI
recipients in the world, receiving almost $80 billion in 2005
according to World Bank statistics. In 2006, China received
$69.47 billion in foreign direct investment.

Foreign exchange reserves totaled $155 billion in 1999 and

$165 billion in 2000. Foreign exchange reserves exceeded
$800 billion in 2005, more than doubling from 2003. Foreign
exchange reserves were $819 billion at the end of 2005,
$1.066 trillion at the end of 2006, $1.9 trillion by June 2008.
In addition, by the end of September 2008 China replaced
Japan for the first time as the largest foreign holder of US
treasury securities with a total of $585 billion, vs Japan $573
billion. China has now surpassed those of Japan, making
China's foreign exchange reserves the largest in the world.

Statistics

GDP (Nominal) (2007) $3.42 trillion (ranked 3rd)

(2008) $4.42 trillion (official data)

177
GDP (PPP) $7.099 trillion (ranked 2nd)
(2007)

GDP per capita $2,660 (ranked 104th)

(Nominal)
(2007)

GDP per capita $5,300 (ranked 105th)

(PPP) (2007)

GDP growth 9.0% (official data)

rate (2008)

GDP by sector agriculture (primary) (11.1%)

(2007) industry (secondary) (48.5%)
services (tertiary) (40.4%)
note: industry includes construction
(5.5%)

GDP by Private consumption (36.4)

components, % Government consumption (13.7)
(2006) Gross fixed investment (40.9)
Exports of goods/services (39.7)
Imports of goods/services (-31.9)

Domestic 9.3%
demand growth
(2002-06 av)

Interest rates One-year benchmark deposit rate:

178
(2007-12-20) 4.14%
One-year lending rate: 7.47%

Inflation rate 4.9%[1] (CPI: 8.7%,[2] Feb 07 - Feb 08)

(CPI) 4.5% (2007 av)
1.7% (2006 av)

Household lowest 10%: 1.6%, highest 10%: 34.9%

income or
consumption by
percentage
share (2004)

Population 10%
below poverty
line (2004)

Labor force 795.3 million

(2006)

Labor force by Agriculture (43%), industry (25%),

occupation services (32%)
(2006)

Unemployment 4.3% (official); 17% (unofficial)

rate (2006)

Industrial 22.9%
production
growth rate

179
(2006)

Main industries mining and ore processing, iron, steel,

aluminum, and other metals, coal;
machine building; armaments; textiles
and apparel; petroleum; cement;
chemicals; fertilizers; consumer
products, including footwear, toys, and
electronics; food processing;
transportation equipment, including
automobiles, rail cars and locomotives,
ships, and aircraft; telecommunications
equipment, commercial space launch
vehicles, satellites

Investment 40.9% of GDP

(gross fixed)
(2006)

Foreign direct 3.1% of GDP

investment
(FDI) inflows
(2006)

Stock of direct $699.5 billion

foreign
investment - at
home (2006)

Stock of direct $67.4 billion

foreign
investment -

180
abroad (2006)

Market value of $2.426 trillion

publicly traded
shares (2006)

Commercial 6.7%
bank prime rate
(%; year-end)
(2007)

Trade

Current $262.2 billion (9% of GDP)

account balance (ranked 1st)
(2007)

Exports (2007) $1.22 trillion f.o.b.

Principal Office machines & data processing

exports (US $ equipment (134.5),
bn) (2006) Telecommunications equipment
(123.6), Electrical machinery (101.7),
Apparel & clothing (95.4),
Miscellaneous manufactures (55.5)

Main US 19.1%, Hong Kong 15.1%, Japan

destinations of 8.4%, South Korea 4.6%, Germany 4%
exports (2007)

181
Imports (2007) $904.6 billion f.o.b.

Principal Electrical machinery (174.8),

imports (US $ Petroleum & related products (84.1),
bn) (2006) Professional & scientific instruments
(48.6), Metalliferous ores and scrap
(44.0), Office machines & data
processing equipment (40.7)

Main origins of Japan 14%, South Korea 10.9%,

imports (2007) Taiwan 10.5%, US 7.3%, Germany
4.7%

Public finances

Public debt 22.1% of GDP

(2006)

External debt $315 billion

(2006)

Foreign $1.905 trillion

exchange
reserves (2008)

Revenues (2006) $482.2 billion

182
 Expenditures $515.8 billion; including capital
(2006) expenditures of $NA

Budget balance -7.0% of GDP (deficit)

(2006)

Corporate 33% (official)

income tax rate
(2006)

Source : Wikipedia

Business Environment:
 Number of days to start business: 48 days.
 Enforcing debt contract: 241 days.
 To register the property: 32 days.
 According for funds : 40 days
 Resolving insolvency: 2.4 years.
 Investment rate is 45% for 9.5% GDP growth.
 Cost of capital i.e., interest rate is 4.5%.
 Power cost just Rs. 2 per unit.
 In engineering China’s productivity is 1:6 times that
of India. China enjoys 20-40% cost advantage over
India.

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  In IT and ITEs labour cost is 19% of US hourly
labour cost. Whereas it is 12% in case of India.
 Extremely good physical infrastructure.
 Highly investor friendly environment.

US Trade and Investment with China.

The trade between these two countries have increased from $
33 billion in 1992 to over $ 285.3 billion in 2005. Presently
United States is China’s second longest partner in the field of
trading. US imports from China grew to 18% in 2005 bring
the US trade deficit with China to more than $ 200 billion.

Direct investment made by the United State in China

particularly cover the areas such as manufacturing, hotel
projects, restaurants and petro chemicals. Nearly 100 US
based multinationals have project second largest partner in
the field of trading. US imports from China grew to 18% in
2005 bring the US trade deficit with China to more than $
200 billion.

Direct investment made by the United State in China

particularly cover the areas such as manufacturing, hotel
projects, restaurants and petro chemicals. Nearly 100 US
based multinationals have projects in China. The cumulative
investment in China has crossed $ 54 billions.

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China : Biggest Creditor of US

In September, 2008 China became largest creditor of USA. It

is estimated that, 10 percent of U.S. Public debt is held by
china and there by it has almost become banker to USA.
USA’s public debt is estimated in the range of $ 11.3 billion.
Out of $ 4.4 trillion US treasury bonds, $ 440 billion is held
by China. In comparison with China’s foreign reserves of $
2 trillion, America’s reserve is just $ 73 billion.

China and American Meltdown:

China and USA are highly coupled economies of the world.

USA is a consumer, China is producer. USA is a borrower
and China is its financier. US citizen spends whereas
Chinese citizen saves. American meltdown has affected
China badly. In second quarter of 2008, China GDP had
clocked a growth percentage of 9.9 percent. But in the third
quarter it has come down to 9 percent. According to some
analysts it may go down to 7 percent. If the exports to US
come down drastically, it will affect the export growth and
GDP which will inturn raise unemployment and bad debts of
the banks.
185
China’s Problems:

1) Balancing two extreme situations: for China it is

a difficult act to balance highly centralized
political system with an increasingly
decentralized economic system.
2) The great divide between urban rich and rural
poor. This gap is increasing as the economy is
growing.
3) The fragile banking system. It is estimated that
the non performing loans are $ 133 billion. But
the report of Earnest and Young placed it at $ 91
billion. This account firm withdrew the report
which was objected by China’s central bank.
4) China is investment and export oriented
economy. During crisis this strength becomes its
great weakness.
5) Socio economic cost of unemployment and its
consequences will be unbearable.
6) China remains country of low consumption. The
nations consumption to Gross Domestic
Production was 50% between 1996 and 2004
against world average of 80%. It has fallen to
35%. In a period of recession low consumption is
a big drawback to sustain the growth. In China
186
 total house hold consumption is 5 percent of
America by value, the challenge is to sustain an
economy that is largely investment and export
driven which means finding ways to perpetuate
industrial over production.

The stimulus package

The Chinese government announced a stimulus package of 4

trillion Yuan or $ 585 billion to tackle the challenges posed
to its economy by global slowdown. It is said this will be
used to improve the livelihood of people living in rural areas
and houses of low income earners.

It is said about 280 Yuan of package will be used for housing

projects of low income earners. For rural infrastructural
projects around $ 370 billion Yuan will be allocated and 40
billion Yuan would be spent on health care, cultural projects
and education.
187
 5

Political Economy of
Global Financial Crisis and India

Mixed Economy – Indian Model

The economy of India is the fourth-largest economy in the

world, with a GDP of $3 trillion (2007) when measured on a
purchasing power parity (PPP) basis. Since 1991, continuing
economic liberalization has moved India towards a market

188
economy and transformed it into a fast-growing economy
with a growth rate of 9% in 2007.

India remains one of the poorest countries in the world. Although the Indian economy has grown steadily

over the last two decades; its growth has been uneven when comparing different social groups, economic

groups, geographic regions, and rural and urban areas. Unemployment rate is 7.2% (2007 estimate). The

percentage of people living below the new international poverty line $1.25 a day (PPP, in nominal terms

Rs 21.6 a day in urban areas and Rs 14.3 in rural areas in 2005) decreased from 60% in 1981 to 42% in

2005.. 85.7% of the population was living on less than $2.50 (PPP) a day in 2005, compared with 80.5%

for Sub-Saharan Africa. Even though the arrival of Green Revolution brought end to famines in India,

half of children are underweight, one of the highest rates in the world and nearly double the rate of Sub-

Saharan Africa.

Statistics

GDP (PPP) $3.305 trillion (2008 est.)

GDP growth 9% (2007)

GDP per capita $2,600 (PPP)

GDP by sector agriculture: 17.8%, industry: 29.4%, services:

52.8% (2007 est.)

Inflation (CPI) 6.4% (CPI) (2007 est)

Population 27.5% (2008 est.)

below poverty line

Labour force 516.4 million (2007 est.)

189
Labour force agriculture: 60%, industry: 12%, services: 28%
by occupation (2003)

Unemployment 7.2% (2007 est.)

Main industries textiles, chemicals, food processing, steel,

transportation equipment, cement, mining,
petroleum, machinery, software, services

External

Exports $163 billion (Financial Year 2007-2008)

Export goods petroleum products, textile goods, gems and

jewelry, engineering goods, chemicals, leather
manufactures

Main export US 15%, the People's Republic of China 8.7%,

partners UAE 8.7%, UK 4.4% (2007)

Imports $230.5 billion f.o.b. (2007 est.)

Import goods crude oil, machinery, gems, fertilizer, chemicals

Main import the People's Republic of China 10.6%, US 7.8%,

partners Germany 4.4%, Singapore 4.4%

Public finances

Public Debt $149.2 billion (2007)

Revenues $141.2 billion (2007 est.)

190
 Expenses $172.6 billion (2007 est.)
Source : Wikipedia
Demography
INDIA CHINA
Population 1110 mn 1312 mn
Middle Class 50 mn 150 mn
Illiteracy 35.2% 24% (2003)
(2004)
Unemployment 9.9% (2005) 4.2% (2000)
Life expectancy 65 Years 71 Years
Pool of young university 14 million 9 million
grads
Active population engaged in 58% (2007) 47% (2007)
Agriculture
Daily News Paper (Per 1000) 60 59
Television (Per 1000) 320 890
Telephone (Per 1000) 45 269
Mobile Phones (Per 1000) 82 302
Personal Computers (Per 16 41
1000)
Internet users (Per 1000) 55 85
Business Environment INDIA CHINA
To start business 71 days 48 days
Registering Property 67 days 32 days
Arranging for funds 90 days 40 days

191
Resolving insolvency 10 years 2.4 years
Entering debt contract 425 days 241 days
Investment rate 29% (to 45% (to
achieve 8% achieve 9.5%
GDP) GDP)
Sources : Outlook Business

Public Sector Undertakings:

The Central Public Sector Enterprises (CPSEs) comprise
enterprises established by the Government of India (GOI) as
Government companies under Section 617 of the Companies
Act, and wherein the equity holding of the GOI is more than
50 per cent. It also includes statutory corporations
constituted under specific statues of the Parliament. The
CPSEs do not, however, include departmental undertakings,
banking institutions and enterprises where equity holding of
the GOI is 50% or less.

India has an investment of Rs. 3,93,057 crores in 245 Central

Government undertaking as on 31st March, 2006 excluding
railways, Banks, Insurance and posts. Out of 245
undertakings, only 10 top enterprises (out of which 5 are in
power sector) have investment of Rs.2,08,197 crores. Apart
from this, there are many public sector enterprises in State
Government having investment of Rs. 2,59,180 crores as on

192
31.3.2005. Majority of this investment is in power and
transport sector. The total investment in public sector
undertakings (department and non department ) at the centre,
state and local level is Rs. 7,52,240 crores. In a developing
country like India this huge investment naturally attracts
attention because this money belongs to the public. Hence
optimum utilisation should be made or otherwise it can be
put to better use for providing basic necessities, upliftment of
the poor and other areas where the public is really benefited.
So, it casts an onerous duty on the Government to act swiftly
to stop further wastage of public money at the cost of human
and social development
Government having realised this made many attempts to
improve the performance of public sector in the last 10 years
but has miserably failed. In 1990, the investment in central
undertakings was Rs. 99,330 crores. But shockingly within
12 years i.e., by 2002 it was Rs. 3,24,614 crores.

Highlights of CPSE Performance in 2005-2006

 The share of CPSEs in GDP at market prices stood at
11.12 per cent in 2005-06 and 11.68 per cent in 2004-
05.
 The cumulative investment of all CPSEs at end –
March, 2006 was Rs. 3,93,057 crore. The share of
manufacturing CPSEs in such investment was the

193
 highest at 51 percent followed by service CPSEs at
40 percent, mining CPSEs at 7 per cent.
 The overall growth in turnover of CPSEs was 11.86
percent. The growth in the turnover of heavy
engineering and construction services’ group was the
highest at 39 per cent during the year.
 In terms of capacity utilization, 51 percent of all
CPSEs operated at 75 percent or higher; 16 percent at
50-75 percent and the residual 33 per cent at less than
50per cent.
 CPSEs had a near monopoly in the production of coal
(85.52 per cent), crude oil (85.87 per cent) and
petroleum refining (74.51 per cent). The aggregate
reserves and surpluses of all CPSEs went up to Rs.
3,59,077 crore.
 The long term loans of CPSEs went up to Rs.
3,61,714 crore.
 The accumulated losses of all CPSEs declined by
Rs.10,578 crore from Rs.83,725 crore in 2004-05 to
Rs.73,147 crore.
 While the petroleum producing CPSEs ranked among
the top ten profit-making CPSEs were generally the
loss-making ones.
 44 CPSEs are listed on the domestic stock exchanges.
While the shares of MTNL (ADR) are listed on the

194
 New York Stock Exchange, the shares of GAIL and
SAIL are listed on the London Stock Exchange.
 In net value addition of CPSEs at market prices, the
shares of ‘taxes and duties’ was the highest at 45 per
cent, followed by ‘net profit’ (26 per cent), ‘Salaries
and Wages’ (19 per cent) and ‘interest (9 per cent).
 At end-March, 2006, the 239 CPSEs employed over
16.49 lakh people excluding casual workers. The
comparable figures in the previous four years were
19.92 lakh, 18.66 lakh, 17.00 respectively.
Source: Department of Public Sector Enterprises.
INDIA’S TOP 10 PRIVATE SECTOR COMPANIES
BY VALUE
Rank Company Value in Rs.
Crores
1 RIL 3,07,207
2 Bharati Airtel 1,48,728
3 Infosys 94,931
4 REL Communication 88,940
5 DLF 79,307
6 TCS 78,780
7 L&T 73,241
8 ICICI Bank 73,213
9 ITC 71,946
10 RPL 70,911

195
Based on market cap between April and Oct. 2008.
Source : Business World, November 30, 2008

Top 10 Net Exporters

Company Rs. In Crores
TCS 9,968
Infosys 7,565
Wipro 7,241
HCL 2,663
Sesa Goa 2,511
Hindustan Zinc 1,821
Satyam 1,761
Bajaj Auto 1,721
Tech Mahindra 1,705
Ranbaxy Lab 1,542
Source : Business World, November 30, 2008

TOP 20 PUBLIC SECTOR UNDERTAKINGS:

(Rs. In Crores)
Company Market Cap Sales 07-08 Profit
Apr-Oct 08 07-08

Oil & Natural Gas 200,762.7 67,262.5 16,701.7

Corpn.
NTPC 1,40,895.0 40,676.1 7,414.8
NMDC 1,21,376.1 6,387.7 3,251.0
MMTC 1,10,767.0 26,831.4 200.5

196
State Bank of India 89,816.6 58,437.4 6,729.1
Bharat Heavy 76,935.8 23,463.5 2,859.3
Electricals
Steel Authority of 58,478.5 47,454.8 7,536.8
India
Indian Oil Ocrpn. 47,046.4 2,74659.6 6,961.7
Power Grid Corpn. 37,962.4 5,197.0 1,429.2
GAIL (India) 32,360.7 19,189.6 2,601.5
National Aluminium 25,607.8 6,053.0 1,631.5
Co.
Neyveli Lignite Corpn 18,150.8 3,743.4 1,098.9
Hindustan Copper 17,258.2 1,950.1 246.5
Punjab National Bank 14,847.6 16,291.5 2,048.8
Power Finance Corpn. 14,621.2 5,056.9 1,206.8
Bank of India 14,499.5 14,472.1 2,009.4
IDFC 13,503.5 2,588.0 669.2
Bharat Petroleum 11,445.7 1,23,250.3 1,580.5
Corpn.
Mangalore Refinery & 11,115.2 37,725.0 1,272.2
Petrochemicals
Container Corpn. Of 10,618.3 3,514.2 752.2
Ind
Source : Business World, November 30, 2008

197
STRENGTHS OF PRIVATE SECTOR
(i) Profit motive is the greatest strength.
(ii) Thrives in competition
(iii) Responds to market changes immediately. Fast
decision making.
(iv) Better productivity & cost controls.
(v) Efficient work culture and team spirit.
(vi) Free hand in dealing with employees.
(vii) Rewards efficiency and punishes inefficiency.

WEAKNESSES OF PRIVATE SECTOR.

(i) Profiteering is the greatest weakness.
(ii) Highly self-centered. Survival at any cost is the
strategy.
(iii) Absence of good corporate governance.
(iv) Lack of transparency and accountability to investors
(v) Lack of credibility of management.
(vi) Lack of adequate capital for large scale projects
(vii) Exploitation of constituents like workers and
consumers.
(viii) Disregard for environment protection.
(ix) Poor in discharging social obligations.
(x) Not a good corporate citizen.
198
A. Role of the Government in the economy of the
country:
I. Government intervention in market regulation is
acceptable if there is market failure not otherwise.
II. Government’s role as investor and entrepreneur is
expected in case of developing countries, which are
lacking funds to initiate industrial activity, lacking
entrepreneurial talent and technical know-how.
Government should withdraw in phased manner once
the private sector is developed and competition in the
market is enhanced.
III. Government has a greater role to play in providing
basic necessities like drinking water, food, shelter,
basic education, roads and transport, power to
villages for light and irrigation, reducing
unemployment, alleviating poverty and providing
social security particularly in developing countries.
Government should involve fully in this because, this
is an area where private sector has little role to play.
As the Government withdraws from industrial and
commercial fields of activity, it should invest the
proceeds in vital areas of human development.

199
IV. The role of regulator is the most important one in the
privatisation process and privatised sectors. The
government should act as regulator by creating
independent regulatory authorities.
V. The experience of 20th century from Adam Smith to
J.M. Keynes to Margaret Thatcher proves that the
role of government in the economic development is
changing. In the first phase the role is that of creator,
initiator for the development. In second phase it is
the role of competitor with private sector. In the third
phase it is the complementary role or supportive role
to private sector. This can be compared to Hindu
Mythology i.e., role of lord Brahma, Vishnu,
Maheshwara. Lord Brahma is the creator, Lord
Vishnu is the protector and Lord Maheshwara is the
destroyer. In the first phase the government should
create a strong role for public sector (dominant role
in comparison with private sector i.e. “commanding
heights”) in the second phase as protector it should
develop and nurture private sector to take over and in
the third phase, reduce the role of the public sector
and play the role of regulator.

B. Privatisation: Purpose And Process.

I. The main objective of privatisation has been
improvement in the efficiency of the privatised
200
 undertaking and increase in the competition. Hence
privatisation should achieve these twin objectives.
II. Privatisation is not a panacea. Privatisation is not a
prescription to cure all the ills of the public sector.
Privatisation is one of the many measures to be
undertaken to improve the efficiency of the
organsation. There are many more measures to be
undertaken by the government, pre and post
privatisation. If privatisation has to succeed, all these
measures should be given due importance and must
be undertaken with all the earnestness and
commitment.
III. Privatisation policy should be preceded by economic
liberalisation measures like deregulation (i.e., entry
and exit in to a sector is not regulated), removal of
operational barriers, simplification of labour laws
with the power to hire and fire, import liberalisation,
removal of price control and subsidisation;
liberalisation of foreign direct investment, corporate
law reforms (i.e. Companies Act, Securities Act,
MRTP, FEMA, Labour laws); and financial sector
reforms.
IV. Privatisation without satisfying certain preconditions
like political feasibility, desirability and credibility
will not succeed in the long run. The Government
should have statement of objectives of privatisation,
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 decide all the policy matters related to privatisation in
advance and should have serious commitment from
the top.
V. Privatisation measures should be preceded by
improvement in the stock exchange operation,
deepening and widening of capital markets, measures
for protection of small investors, legislation for
transparency in corporate affairs.
VI. Privatisation without the change in the internal
environment i.e., management restructuring,
marketing strategies, commercialisation, cutting the
deadwood, inflow of new talent, technological
upgradation, will not yield any positive results in the
performance of the privatised undertaking.
VII. Global perspective of privatisation makes it very
clear that, different countries have followed different
routes to privatisation. Purpose and methods of
privatisation suitable to country situation should be
adopted.
VIII. British privatisation model is not a emulative model
for India in toto but British privatisation has many
lessons for India to learn. Few of them are: high
degree of political commitment, clarity of objectives,
well defined policies and methods of privatisation,
creation of political and corporate mind set for
privatisation. India can benefit from knowledge of
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 the problems of creating privatised monopolies
without inducing competition, exploitation of
consumers in the absence of regulators,
disproportionate benefits enjoyed by the management
at the cost of workers, losses suffered due to sale of
shares of public sector undertaking in a hurry to push
through privatisation at any cost, increase in the
foreign holdings of privatised PSUs, relationship
between ownership and performance, problems of
privatising natural monopolies and the concept of
holding golden share in privatised company.

C. India – A Case Study:

The following conclusions have been a arrived at taking
India as a case study for privatisation.

Public Sector:
1) India being a developing country, Government has an
important role to play in the economy.
2) Public sector in India has served the purpose for which it
was initiated through Industrial Policy Resolutions.
3) Indian public sector lost its purpose and focus when it
entered in to the area of manufacturing consumer goods
and service sector like hotels.

203
4) Public sector has become a political tool in the hands of
politicians. It has lost economic sense due to excessive
political interference.
5) Bureaucratisation has robbed the public sector
undertakings of its managerial talent, created sycophants,
rule ridden setup, non-responsive approach to consumers
and competition.
6) Public sector in India is in a state of coma due to lack of:
commercialisation, incentives for efficiency,
disincentives for inefficiency, technological upgradation,
funds to invest in expansion and upgradation and
political will to take economic decisions in the interest of
the undertaking as well as the country as a whole.

Private Sector:
1. Indian private sector has grown substantially compared
to its size and spectrum five decades back.
2. The licensing raj, draconian laws, lack of level playing
ground between public and private sector, lack of
availability of funds through capital markets were the
main reasons for the slow growth of private sector.
3. Family controlled industrial houses on one hand and fund
starved small-scale sector on the other dominate private
sector in India.

204
4. Family controlled industrial houses have not nurtured
managerial talent to occupy the top positions. The
decisions are often personal and whimsical to suit the
dominating family members. Family disputes have
affected the growth very badly.
5. Even though the small scale industries have contributed
substantially for employment and exports, they have
remained low tech due to lack of funds, scale of
operations make them unviable in the long run. Sufficient
managerial talent is not available with SSI and many
large industrial houses exploited these units for their
growth.
6. Sickness in private sector (large and small scale sector) is
alarming. Huge funds of public sector banks and public
is locked up in these sick units.
7. Private sector in India except in few cases is not known
for honesty, integrity and fair play in dealing with
consumers, employees, investors, government, bankers
and creditors.
8. Regulatory agencies have not discharged their duties
without fear or favour.

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 Global Financial Crisis – Impact on India

India is one of the strong emerging economy in the world. It

is growing at an average annual rate of 8% a year for the last
3 years to log a GDP of $ 700 billion in 2005-06. India and
China constitute around 6% of the GDP and their
contribution is nearly 13% if the incremental growth in GDP
is considered. By 2020, India will be the youngest country in
the World with around 547 million people below the age of
25. According to Goldman Sachs report (2003) ‘Dreaming
with BRICs : The path to 2050’, India is expected to take
over Italy, France and Germany by 2025 and Japan by 2032
in terms of GDP with European and US economy entering
into recession and India not being effected much by this may
overtake these countries faster than expected.

India is not having massive production capacity like that of

China. Similarly its exports is also not as high as China. Its
exposure of export to US and Europe in comparison with
China is less in proportion. India is not investment and
export oriented economy. India’s IT sector is more vibrant
206
with IT export of $ 31300 mn. IT sector exports constitute
22.1% of total exports.

The exports are mainly to US and Canada (67.7%) and

Europe (21.3%). Unlike China India is not holding big
percentage of public debt of USA. (estimated to be 10% in
case of China) and its exposure to US Treasury is also lesser
than China. Indian banking system is robust. Its non
performing loans are $ 30billion (4% of GDP) in comparison
with $ 133 billion of China. China’s NPL is said to be at
least three times more than this figure. China has fragile
banking system in comparison with India. India’s share is
24th in US export and 18th in US imports. United States is
India’s second largest source of FDI (after Mauritius)
accounting for 17.08% of total FDI inflows in to India. Many
US multinationals corporations are doing active business in
India. In comparison with China, India’s exposure to US is
less and hence the impact is limited. Another strength of
India has been that the domestic consumption in India is
67% in comparison with China’s 37%.

207
The Fall Out.

 Large sales of holding of FIIs on stock exchanges.

FIIs (Foreign Institutional Investors) till October
2008, sold shares worth $ 10 billion in comparison
the inflows of $ 17.3 bn in 2007 and $ 8 bn in 2006.
 Reduction of forex inflows for investment.
 Industries having exposure to large global markets
like textile, automobile, IT industry etc are badly
affected.
 The lenders having become jittery due to falling
stock markets are insisting for higher collateral
securities or for pledging of more shares by
promoters.
 Real estate being one of the worst hit, Reserve Bank
of India is insisting that as soon as loan to a builder is
restructured, bank must classify the loan as non
performing asset. Therefore the banks are putting
pressure on builders to cut prices, sell properties to
service the loans.

208
  Goods for US are not getting cover from ECGC
(Export Credit Guarantee Insurance Corporation) or
ECGC is placing restriction on cover to single buyer
exports on fears that several US companies many fail
to pay up.
 Many corporates which had rushed to take dollar
loans during the past few years are sitting on huge
mark to market losses because of sharp currency
movements. For the fiscal ended March 31, 2008,
Indian Corporates had borrowed $ 30.95 bn overseas.
 Indian companies will find it hard to raise capital in
international debt equity markets.
 If the crisis spills over to India’s real economy, there
is a danger of lower consumption, investment
declaration and slower job creation, even as inflation.
 Fall in oil and commodity prices has benefited India.

5 Lakh Workers Axed

As per the sample survey conducted by the labour ministry, 5
lakh workers lost their jobs in just three months from
October to December, 2008. The affected workers belonged
to 20 sectors in 11 states and union territories. These sectors
included textiles, metals, gems and jewellery, automobile,
transport and IT/BPO.

The Gulf Party Comes to An End

209
Kerala exports maximum number of manpower to Gulf. The
Kerala economy depends heavily on the inward remittances
from NRIs settled in Gulf. Of the 5 million overseas Indian
workers, 90% have job in Gulf and South East Asia.
Migrants from India have increased from 4.66 lakhs in 2003
to 8.09 lakhs in 2007. Workers including professionals,
technicians and low skilled workers contribute nearly 40% of
the $ 27 billion in overseas remittances which accounts for
3% of GDP.

Lethargy Turned in to Virtue

India has been more fortunate, thanks mainly to the

 Slowness of financial reforms
 Slower dismantling of regulation constraints.
 Cautious approach to permitting foreign investors

210
 6

Roll Forward and Roll Backward:

British Model

Origin And Development Of Public Sector In Britain

In Britain and other Western European countries, the public

sector was no the result of an oppressive intervention of a
malign, highly centralized state apparatus. On the contrary,
public intervention occurred in a wide spread, decentralized
way in recognition of the inadequacies of market provision.
In the early nineteenth century local commissions were
established to provide street lighting, cleaning, road building,
sewers, water supply and public health. Later local
authorities began to build low-cost public housing to get the
urban population out of the slums, and local education

211
authorities were set up to provide mass education to those
neglected by the private schools. Finally, to ensure a low
cost, reliable service, public utilities were established by
local councils providing public transport, water, gas and
electricity supply.

The post 1945 expansion of the nationalized industries was

pursued by the Labour Government which stressed the
essential irresponsibility of private capital, the failure of the
market system to provide the investment necessary to sustain
the efficiency of the industry, or to provide even essential
services (such as health care) to those who could not afford
to pay. The welfare state was designed, it was thought, to
protect the rights of the individuals without wealth or
property. Cross – subsidy could ensure a comprehensive
service was available to all. The purpose of nationalization
and the Welfare State therefore, (rather than the narrow
pursuit of profit maximization,) was the creation of a stable
economic infrastructure and reliable social provision. The
policy was built in to the pricing structure of public
industries, which often meant they made losses. However
losses in the public sector were conceived as a vital subsidy
to the private sector of the economy, providing low cost
utilities and healthy, well educated workforce. Though this
difference should have been widely understood, it was rarely
acknowledged in more recent years when public sector
212
enterprises were subjected to critical comparison with profit
motivated private structure, despite the fact that simple
comparison of the efficiency and effectiveness of private
sector and public sector management cannot readily take
account of their very different objectives. The fact confounds
comparative assessments of public and private sector
efficiency (Lapsley and Wright 1990:49)

Criticism Of Performance Of Public Sector

As the scale of public sector continued to grow in the 1970’s

and public expenditure consumed a highest proportion of
gross national product, criticisms of the performance of the
public sector began to increase. In one sense these were
inevitable since the public sector was providing goods for
which there was an ever expanding demand. For example, in
education and health care, which it was impossible to fully
satisfy. However, many of the complaints concerned how the
public sector used the resources it did have to satisfy the
consumers. Moreover, the centralized bureaucratic styles of
the public sector began to be recognized as not only
inefficient and inflexible but as oppressive and unresponsive
to employees and consumers alike. Managers in the public
sector complained of tight control of their finances and of
recurrent undue political interference which made strategic
planning difficult. Necessary investment in public industries
213
was denied by governments faced with external constraints
upon their growing borrowing requirements, and mounting
losses were experienced by industries such as the railways
which found they were increasingly unable to compete with
private transport due to modern infrastructure and trains.

Margaret Thatcher, the former Prime Minister of the UK. In

her own words, as written in her biography ‘Margaret
Thatcher – the Downing Street Years’ “Privatization, no less
than tax structure, was fundamental to improving Britain’s
economic performance. But for me it was far more than that:
It was one of the central means of reversing the corrosive
and corruptive effects of socialism. Ownership by the state is
just that - ownership by an impersonal legal entity: it
amounts to control by politicians and civil servants; and it is
a misnomer to describe nationalization as the labour party
did, as ‘public ownership’. But through Privatization –
particularly the kind of privatization which leads to the
widest possible share of ownership by members of the public
- the state‘s power is reduced and power of the people
enhanced.”

214
Public Sector Reforms In Britain
Thatcherism : Political Economy of Privatisation

The Government recognized the need to improve the

efficiency of the public sector and introduced a series of
reforms to attempt to ensure efficiency and value for money
in the public sector. These included applying strict cash
limits to the expenditure of public sector industries, rather
than allowing them to draw indefinitely on the public purse,
limiting employment level within public companies;
introducing the assessment of staff at regular interval;
establishing periodic reviews of functions and organizations;
having regular internal and external audits; regular studies of
comparative costs and outputs; contracting out work to
competitive tender which could not be done efficiently in
house and setting performance indicators and performance
measurements (Pliatz Kay).

THATCHER – The Champion of Privatization :

215
Margaret Thatcher was not satisfied with these measures.
She thought unless the companies are wholly privatized,
these adhoc measures will not yield long term results. The
projective and methodology of British Privatization is well
explained by Mrs. Thatcher, the Champion of British
Privatization in her biography ‘MARGARET THATCHER –
THE DOWNING STREET YEARS’ “Privatization, no less
than the tax structure, was fundamental to improving
Britain’s economic performance. But for me it was also far
more than that: it was one of the central means of reversing
the corrosive and corrupting effects of socialism. Ownership
by the State is just that – ownership by an impersonal
legality: it amounts to control by politicians and civil
servants; and it is a misnomer to describe nationalization as
the labour party did, as ‘public ownership’. But through
privatization particularly the kind of privatization which
leads to the widest possible share ownership by members of
the public – the state power is reduced and the power of the
people enhanced”.

A Conservative Politician N. Lamson Said in 1980 “

………… the conservative party has never believed that the
business of government is the government of business”. (The
Political Economy of Privatization, by Thomas Clarke and
Pitelis).

216
The drive of the three Thatcher Governments of the 1980’s
towards the commercialization and privatization of the
public sector has much more to do with ideological belief
than economic analysis and comparative assessment of
performance. The government regarded privatization a priori
as serving multiplicity of self reinforcing objectives,
economic freedom: The management of privatized
corporations would be free to invest in market opportunities
and the consumer free to choose; efficiency : the disciplines
of the product and capital market and the profit incentive
would enhance the pursuit of enterprise efficiency; Wider
Share Ownership : Privatization would promote popular
capitalism by dispersing shares widely.

Privatisation Of Natural Monopolies

Privatisation of natural monopolies like Electricity, Water,

Coal, railways, telecommunication and health services is
more challenging in comparison with privatisation of
corporations. Privatisation of natural monopolies throws up
challenge to privatisation since these products or services are
used by all as a necessity. Provision of this also forms part of
governments responsibility. Since it affects rich and poor
alike, government has to consider all the pros and cons in
detail before privatising. This particular chapter has more
relevance in developing country like India since Indian
217
population heavily depends on subsidised service of these
provisions. Hence a detail study of these natural monopolies
is undertaken.

Electricity

The essence of privatisation remains the change of

ownership, but in the case of electricity supply in England
and Wales, it has been accompanied by a change in
regulations relating to pricing and quality of supply, and by a
liberalisation in the encouragement of new entrants and the
removal of previous barriers to entry at different stages of
the output process.

Generation, now open to unrestricted entry, has been

vertically separated from the rest of the industry, and an
attempt has been made to establish a competitive spot
market. Transmission remains a monopoly in the form of the
National Grid Company which acts as a spot market
auctioneer and load dispatcher with authority over the
operation of generating stations in the spot market.

The National Grid Company’s wires are, however, open to

common carriage by third parties and a set of regulated

218
prices is published for this service. The regulations are in
the form of a price-cap.

The buyers in the pool are the twelve Regional Electricity

Companies (REGs), but unlike there nationalized
predecessors, the area boards, their activities are separated
into two distinct businesses: distribution and supply, with
distribution charges being incorporated into supply charges
as transfer prices. Both sets of charges are price-capped.

Entry to distribution is not permitted, in order to retain the

benefits of non –duplication of the natural monopoly
networks, but the network wires are also open to common
carriage under regulated charges.

All these common carriage provisions are designed to

facilitate entry to the supply market where distribution
companies, generators, and industrial co generators may be
in competition for contracts to supply final consumers.
Initially the supply market is subdivided into a monopoly
franchise and an open sector, but this was scheduled to
disappear by 1998.

At each stage of the production process where entry is least

partially restricted that is, all except generation- there is a
regulatory cap on prices and charges.
219
2. Uk Gas Industry

The British Gas Corporation was privatized as a single entity

in November 1986 and as a monopolistic buyer of natural
gas, a monopolistic supplier of gas to the UK market, and a
dominant retailer of gas appliances. British Gas (BG) is also
a dominant player in the broader energy market and at the
time of privatization it was estimated to control some 60
percent of the domestic energy market, 75 percent in areas
where gas is available, and 36 percent of the industrial
market (Price and Gibson).

Following privatization, a new regulatory regime was

established. It involved granting to British Gas (BG) a
license or authorisation to be a public gas supplier and the
establishment of an Office of Gas Regulation (Ofgas) to over
see the regulatory regime. The regulator may with BG’s
agreement modify the conditions of its authorisation. In
addition, Ofgas is responsible for the implementation and
oversight of the regulatory regime based on the RPI – X
formula and its adjustment from time to time. If BG is

220
alleged to have abused its monopolistic position then its
regulated activities may be investigated by Ofgas and its non
regulated activities, which are subject to the general rules of
competition policy by ‘Monopolies and Mergers
Commission. RPI –X was based on the recommendations of
Mr. Little child who envisaged such a regime of temporary
nature, saying: ‘Regulation is essentially a means of
preventing the worse excess of monopoly; it is not a
substitute for competition. It is a means of “ holding the fort”
until competition arrives (Little child)

British Gas Privatization has many lessons to learn, which

were mentioned by Trefer Jones in the article in “The
Political Economy of Privatisation”.

British gas privatization illustrates the failure of government

policy towards British Gas which placed the main emphasis
upon privatization without paying much attention to the
subsequent market structure and the development of
effective competition. The result was a failure to achieve the
expected results of privatization in that, competition failed to
develop, and the newly privatized monopoly abused its
market power in its non-regulated activities thus attracting
considerable criticism of the privatization process.

221
 Privatization Of Water Industry

Before privatisation of water industry there were nine

regional water authorities in England and one in Wales.
Under the 1989 water Act, provisions were made for water to
become a private sector industry under public regulation and
ten companies were formed. Shares in all the companies
were offered to the public.

Each company had a local monopoly but the government

claimed that there was ‘Yard Stick Competition’ in that their
performance profits and charges could be compared against
each other.

Earlier water charges were levied by local authorities on the

basis of value of domestic property. Since the rates had been
abolished, water companies were given, under water Act
1989, the opportunity to device a new system of changes by
the end of the century. The alternative were (I) flat rate: (II)
Change related to property banding; or (III) changes based

222
on meter consumption as is the case with industrial and
commercial property.

The companies are subject to a system of price control and

the Director General of Water Services who heads the Office
of Water Services is responsible for protecting the interest of
consumers and supervising the industry. In addition there is
the Drinking Water Inspectorate.

The National Rivers Authority, set up at the time of

privatization, is concerned with pollution control and
management of water resources.

Even with all these Regulatory Authorities, the problems of

privatizing a natural monopoly like water supply, was faced
by the poor people as observed in the Guardian in 1992.
National Association of Citizen’s Advice Bureau commented
regarding water disconnections to the Department of the
Environment. ‘If financial interest takes precedence over
social considerations now, how much greater will the
pressure be when the water Authorities must account their
shareholders? The worst fears of the Association were
realized in 1991/2 with an increase in water disconnections.
With evidence of dysentery breaking out among those
without a water supply for washing and toilet facilities, Ian
Gregoy has claimed, it is clear why the 1985 Housing Act
223
dubs any house without Water supply as being unfit for
habitation’. But with Ofwat and the DSS doing too little too
late the water companies, monopoly suppliers of the most
essential commodity, seem set to extend the drought to more
of Britain’s poor (The Guardian)

Survey Results On Privatization Of Natural Monopolies

A Survey conducted to know the impact of privatisation of

natural monopolies gives vital information about the
problems faced by such privatisation.

Industry Percentage of Survey Agency

Opposition
British Gas 57 Gallup & NOP
British Telephones 56 Gallup & NOP
Water & 72 Crewe 1988 42-3
Electricity 79 Harris
Water

Source: The Political Economy of Privatization -Thomas

Clarke & Christos Pitelis.

Role Of Regulator In UK Privatisation

Role of Regulator is the most important contribution of UK

Privatisation. In a privatised environment, without strict
regulations in place will lead to exploitation of the
consumers. The inventor of the most important price cap
formula RPI – X, Mr. Little child said that, “Regulation is

224
essentially a means of preventing the worse excess of
monopoly; it is not a substitute for competition. It is a means
of holding the fort until competition arrives.” (Little Child )

The UK privatisation programmed has had one consequence

not foreseen by its initial advocates who sought market
liberalization. That is the emergence of a powerful group of
industry regulators. Most of the privatisations, and the
electricity industry is no exception, underestimated the
complexity of the new market structures which would
emerge. In addition most were carried out rather quickly,
and with an emphasis on the fund-raising involved in the
initial flotation of shares. This has put the regulators in the
position of having a powerful and immediate impact on the
evolution of the industry. It is difficult to see, for example,
how the regulator can forever ignore the duopolistic nature
of generation of electricity, and therefore this liberalized
market is likely to see either more regulatory intervention in
future or more divestment of the existing firms.

The regulator is likely to face demands for detailed

regulation of environmental and energy saving policies as
fears about global warming increase. He or she is also likely
to have a major ongoing role, as the regulatory review
procedure becomes an increasingly important part of the

225
industry’s evolution. The initial idea that regulation of the
utilities would wither away as competitive forces emerged
has turned out to be something of an illusion.

Nevertheless, we can see that a bold experiment has been

undertaken, and that a revolutionary new form of regulatory
framework is delivering efficiency gains and innovations that
were totally absent from the old nationalized industry
performance.

Lessons From Privatisation

The status and role of public enterprise has been profoundly
questioned by the advocates of privatization. In some
countries, including the UK, the political rush to privatize
neglected the opportunity to develop competition and made
more difficult to effective regulation of the privatized
companies. This diminishes the likelihood of the
achievement of the major efficiency gains promised at the
time of privatization. Evidence is now emerging of the
performance of the privatized enterprises in the medium term
which such improvements in efficiency were based on
restructuring carried out prior to privatization or were due to
reductions in service of quality of products or asset sales is
not entirely clear.

226
The question of whether any short and medium term
efficiency gains are sustained for any length of time remain
an open one. Anyway, the frequent intervention of the
regulators has clearly been a crucial factor in maintaining the
responsiveness of the privatized monopolies to customer
concerns. Anxieties concerning the behavior of privatized
monopolies supplying vital utilities to the public have not
been entirely assuaged. The UK privatization programme has
frequently been presented by politicians, industrial
consultants and by some academicians as a resounding
success and a major contribution to the revival of the
economic fortunes of the country. More analytical and
critical assessments have emerged particularly the influential
study of Vickers & Yarrow. However, much of the focus
within the economics literature has been upon the failure of
privatization policy to achieve the efficiency and
performance gains possible due to the failure to introduce
effective competition by restructuring public sector
monopolies into competitive concerns as an essential part of
privatization process.

Privatisation and its impacts can be broadly studied under the

following heads :
1. Gains from privatisation
2. competition and efficiency
3. Cost benefit analysis
227
4. Commercial performance
5. Retention of shareholders
6. Distribution of share holding pattern
7. Consumer Democracy
8. Post privatisation effects on employees

1. Gains From Privatisation

Abromeit

The privatization policy marks a decisive U turn in the

governments monetarist policy, of which it has meant to
form an integral part; the rules have turned in to an easy
means to circumvent the fiscal constraints, following from
restrictions of the money supply which ought to be the core
of monetarism. Monetarism is clearly in tatters when, as The
economist has noted, ‘state assets are sold because State
treasures want to raise money without printing it’.

Thomson

Privatization proceeds disguised the fact public expenditure

had raisen to pay increased levels of social security payments
to the unemployed. As receipts from privatization sales rose
dramatically in the late 1980s the government policy began
to change also.

228
The government turned towards more overtly supply-side
policies. In this context the proceeds from the privatization
programme could be used to offset other expenditure and
finance the government’s tax reduction aspirations – all this
and the PSBR continuing to be reduced or becoming a
surplus. Thus the financial objectives changed somewhat, to
providing room for desired tax cuts in the name of their
supposed supply-side incentive effects.

Thomas Clarke

Privatization was pursued for political reasons related to the

Government’s troubled attempt to manage the economy and
stay in power, rather than to the economic pursuit of
efficiency in the industries concerned. This explains many
other inconsistencies in the way in which privatization was
approached and undertaken.

Steel and Heald

Those who opposed the policy were worn down. Public

Sector managers who had doubt about privatization found
that life in the public sector was made unbearable by tight
Treasury-imposed limits upon external financing : they
complained they were told that such ‘Public Sector
constraints’ were an inevitable consequence of their

229
nationalized status and the only why to relax them would be
to set the industries ‘free in the market place’, life
unnecessarily unpleasant for the nationalized industries thus
became a convenient spur to a change in management
attitude towards denationalization. Nationalized industry
directors were prepared to do anything the government
required, as long their corporations were allowed to retain
their monopoly position.

Pliatzky

A senior civil servant at the Treasury and the Department of

industry wrote that, at the top management level, the
industries were mainly concerned to keep their enterprises
intact on privatization and to insist fragmentation into
competitive elements; once this had been secured, the Boards
looked forward to escaping from government control and
joining the ranks of the self perpetuating corporate
oligarchies which dominate the modern industrial scene.
Public versus private ownership (as distinct from public
expenditure versus tax relief) has ceased for good or ill, to be
a live issue in British politics for the distinct foreseeable
future, though acute problems remain about the
accountability and regulation of privatized monopolies.

230
Competition And Efficiency

Prosser

Where a successful disposal at a good price conflicts with

liberalization, it is liberalization, which loses out.

Kirk Patrick

The transformation of public monopolies in to private

monopolies was a safer and easier option though it
undermined the government’s claim concerning the future
efficiency of the companies, and contradicted the economic
theory. Government propounded : ‘allocative efficiency is a
function of market structure rather than ownership’. Thus in
the absence of competition, denationalization is unlikely to
result in major gains in efficiency performance.

Cleggard Dunkerley

The private sector is as prone to the erection of large scale,

complex and remote bureaucracies, as the public sector, as

231
Max Weber and many other organization theorists have
argued.

Vickers and Yarrow

In the long run the British privatization programme will be

judged in terms of its effect on economic efficiency. By
failing to introduce sufficient effective frame work of
competition and regulation before privatizing such industries
as telecommunications and gas, the government has lost a
major opportunity to tackle fundamental problems
experienced in the past under public ownership.

Bees Leyland Little Child - [ Known supporters of

privatization ]

Privatization is intended to change motivations of

management towards profit making. A privately owned
company will have greater incentive to exploit the monopoly
power commercially. To the extent this is not limited,
consumer benefits from privatization will be less than they
might be. Second, a privatized company will be less willing
to provide uneconomic services. The resources so released
will be used more productively, but particular set of
232
consumers will lose by change. This raises the question of
how much losses, often thought of as social obligations,
should be handled.

Gretton et al

In the absence of competition, the creation of regulatory

agencies was the only means to rescue the consumer from
the possibility of naked exploitation. The establishment of
regulatory agencies-including [Ofgas, Oftel, Ofwat and
Offer] was remarkably unexpected result of privatization; the
case of major utilities such as BT and British gas, the
Government rolled back the boundaries of the State as far as
the immediate responsibility for the supply of services was
concerned. However…they immediately rolled them
forward again by setting up regulatory bodies to ensure fair
play between the industries and the consumers on one hand,
and between the industries and their potential competitors on
the other.

3. Cost Benefit analysis of raising Government

revenue

(I) Virtually all the privatized concerns now have a

market capitalization far greater than the amount
raised by the government in the sale of assets. It

233
 might be suggested significant loss to the public
purse of valuable assets that this difference represents
which were sold off cheaply in order to ensure the
privatization programme succeeded.

(II) Privatization shares were consistently deliberately

under valued at the launch, and the moment the share
began dealing the government recorded losses, which
amounted to billions of pounds, including an
immediate loss of $ 1300 million on the day of the
British Telecom sale. Large discounts on share
prices were consciously provided by the government
to entice subscribers, but this was done in an
unnecessarily extravagant way as successive sales
were consistently subscribed several times over. In
addition the government had paid hundreds of
millions in fees to the merchant banks, accounting
firms, stock brokers and advertising agencies who
prepared the companies for privatization. The
National Audit Office calculated that by the time of
electricity privatization in 1998 the process would
have cost the government $ 2,375 millions, more than
half of which spent on the recent electricity and water
privatizations (Beauchumps). As Buckland has
concluded, ‘by every yard stick, (this) policy has
been costly to the tax payer’.
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4. Commercial Performance

(I) Much of the restructuring of the corporations took

place as preparations for privatization with the
injection of massive amounts of public money. For
example, the Water authorities had $ 5 billion of
debts written off and received a further $ 1.6. billion
‘green dowry’. The National Audit Office
subsequently noted, ‘the Department (of the
Environment) took considerable care to establish
financially stable companies that would achieve the
profitability and cash flow requirements necessary
for floatation. Thus in addition the privatized water
companies received costs-pass-through concessions
relating to new legal requirements including EEC
Directives, the possible cost of installing domestic
water meters, and beneficial corporation tax
treatment which means that no water company is
likely to pay corporation tax over ten years because
of the billions of pounds of unused capital allowances
available to be off set against pre-tax profits.

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(II) The turn around may not have been through the hard
work of reducing costs, improving quality and
expanding sales. Cruder but effective devices such as
increasing prices, selling-off assets, reducing
manpower and cutting unprofitable services were
available as these companies capitalized on their
monopoly positions. Thus one survey of the
literature concludes, ‘a common consequence of
privatization is increased prices to customers’
(Marsh). If they had abandoned their commitments
to social responsibility, the former public
corporations could have recorded higher profits by
precisely these means at any time, though whether
this would have benefited the wider economy or
society is open to question.

(III) The cost of privatization included the high cost of

redundancy payments and unemployment benefits to
the workers who lost their jobs as a result of pre
privatization restructurings; the loss of revenue from
the public industries which were profitable the loss
of the capacity to meet directly social and economic
priorities through cross subsidization; the increase in
retail price index and the resulting inflationary
pressures caused by those privatized industries that
increased their profitability largely by increasing

236
 their prices or failing to reduce prices by what
efficiency gains allowed; and the harmful effects
upon the performance of the rest of the industry of
having to pay higher prices for basic utilities.

5. Retention Of Shareholders

CLARKE
Massive inflation of the number of shareholders appears to
be very temporary phenomena. It is revealed that the
percentage of original shareholders who retained their shares
is an average significantly below the 66 percent claimed by
the government, and since this data was compiled by Bishop
and Kay in 1988 has drifted down towards 40 per cent
retention over all. The majority of those new shareholders
quickly disposed off their investment having secured the
benefit of the initial discount, and the government realized
that the number of shareholders could only be sustained at
this inflated level by the repeated issue of massive amount of
shares in new privatization. With the loss of several million
shareholders each year, eventually the government would
run out of public assets to privatize, at which point there was
real danger The number of shareholders would gradually
collapse back over a period of years in the direction of the
original figure.

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6. Distrubution Of Shareholding Pattern

Behind the expensively erected façade of privatization there

was little real change in distribution of property ownership
in Britain: 70 percent of the Shareholders had a modest
investment of $ 3000 or less. As indicated by tables majority
of personal Shareholdings are extremely modest and could
not be claimed to provide a real stake in the system. As
Howard Hyman of Price Waterhouse put it:

“Although the percentage of adults owning Shares has

dramatically increased the proportion of the total controlled
by individuals rather than institutions continues to decline.
Between 1963 and 1981 the proportion of the stock market
directly owned by individuals fell from 54% to 28%.
Statistics available for 1986 indicate that out of total equity
market valued at 368 billion pounds, some 88 billion pounds
was owned by individuals or 24 percent”.

Marsh

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Despite appearances to the contrary, the impact of
privatization has not served to reverse this trend: a great
majority of privatized shares have ended up with the
financial institutions. As a result of privatization there has
been a widening but not a deepening of personal share
ownership in the UK.

Buckland

The privatization programme, therefore, is unlikely to be

making much impact upon equity ownership in the UK. The
deregulation of share trading and marketing in October 1986
and the expansion of decentralized information systems are
likely to have more far reaching and durable effects. What
the programme has undeniably done is shift the median line
of the UK’s public sector and redistribute large amounts of
public sector wealth to share purchasers particularly the
financial institution.

7. Consumer Democracy

In fact, consumer complaints increased markedly in almost

all the privatized companies as consumers found they were
paying more for services which often had been reduced. For
example, price increases of 13 percent in electricity charges
in 1992 were expected to push profits up to pound 1.43

239
billion up 43% on 1991. Similarly in the water and telecom
industries rapidly escalating prices were accompanied by an
explosive growth in profits. In the mid 1980s BT faced
mounting public complaints about quality of service and
made only hurried efforts in 1987/8 to repair the 23 percent
of phone boxes out of order when offered entry in to the
phone box network; though they were only interested in the
prime city centre sites. Public disillusionment with BT
spread when it increased domestic tariffs where the
likelihood of competition was slight due to the extent of sunk
investment in order to reduce business tariffs, a market in
which Mercury were interested in. The worry about
privatization was the effect upon the quality and range of
provision, and access to it, as the elimination of cross
subsidization undermined a comprehensive service. These
tendencies have reached an extreme in the market based
society of the United States, whereas Goodman and
Loveman suggest, private sector managers may have no
compunction about adopting profits making strategies or
corporate practices that make essential services unaffordable
or unavailable to large segments of the population. A profit
seeking operation may not, for example, choose to provide
health care to the indigent or extend education to poor or
learning disabled children. (Goodman and Loveman)

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The fear of the consumer bodies is that privatization of vital
utilities of water, gas, electricity and telephone will seriously
threaten the most vulnerable sections of the society as
directors demand higher profits and shareholders higher
dividends, both taking precedence over service, with falling
standards, higher prices and greater number of
disconnections. The worst fears of National Association of
citizen’s Advance Bureau were realized in 1991/2 with an
increase in water disconnection. With the evidence of
dysentery breaking out among those without a water supply
for washing and toilet facilities, Ian Gregory has claimed it is
clear why the 1985 Housing Act dubs any house without a
water supply as being unfit for habitation. But with ofwat
and the DSS doing too little to hate the water companies,
monopoly suppliers of the most essential commodity, seem
set to extend the drought to more of Britain’s poor.

8. Post Privatization Effect On Employees

1) Salary increases of up to 352 percent in the income of

top company executives have been recorded in the
three years of privatization. whilst paying ordinary
workers annual increase of 6 percent to 7 percent,
senior executives have happily authorised themselves
up to ten times this figure, free of constraints of any
real form of public accountability. As each industry
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 has been privatized in turn, executives have been
more blatant in their greed as electricity industry,
privatized in 1990, indicates (see table)

Chairman’s pay & price increases in UK electricity industry

December 1990 to June 1991

Company Chairma Chairman’s Changes since

n’s Share December 1990
salary options
(pounds) (pounds) Salary Prices
Southern 2,20,000 2,19,000 +253 +13
Eastern 2,10,000 79,000 +237 +14
East Mids 2,05,000 1,47,000 +229 +15
Seeboard 1,90,000 1,24,000 +205 +13
Manweb 1,85,000 1,69,000 +197 +13
Midlands 1,81,790 2,47,000 +191 +12
Norweb 1,75,000 1,03,000 +181 +11
London 1,62,000 1,88,000 +160 +11
South West 1,58,595 2,74,000 +155 +14
South Wales 1,55,000 1,77,000 +149 +13
Northern 1,41,511 95,000 +127 +13
Source : Sunday Times (London), 7 June 1992.

II) Job Security:

Not only wages, but job security and conditions did not fare
quite so well in these industries, and the impact on the
morale of directors looking after themselves, whilst
neglecting the welfare of other employees should not be

242
under estimated. Invariably these were the same directors
who had managed the public enterprises prior to
privatization.

Commenting on the directorial salary increases in the water

industry, the management Guru Henry Mintzberg has
argued:

“How can you have any real sense of commitment to a

company when as we have seen recently, top management
takes huge salary increase at the same time as every one else
is being cutback. People keep saying it is the market, the
market. Well, I think that is complete nonsense. Those guys
in the water companies in the UK were willing to hold the
top jobs before they were privatized: why do they now need
twice the salary to do the same job Why did they take the job
in the first place It is a disease. There are lots of good,
honest, devoted people. But acts like this are a reflection of
deep malaise in organization”. (Lioyd)

Meanwhile life has not been so comfortable for the rest of

the employees in the privatized companies. Trade union
bargaining and consultation rights have been restricted;
benefits too have been eroded, including index linked
pensions. Along with reduction in manpower, accident rates

243
have increased. Those workers who have been subjected to
harshest changes have been the once affected by contracting
out of work from the public to the private sector. Often they
have found they have had to compete with others for the
work they were already doing, and the only way they have
been able to remain in employment in by accepting much
lower wages, more work and worse conditions.

Private contractors cut corners to increase profits; private

employees often have little training or loyalty to the Job; and
contracting out undermines wages, conditions and manning
levels and trade union rights. With reference to National
Health Service competitive tendering a House of commons
Social Services Committee, stated. The whole exercise,
which has now been underway for around four years, has
involved a considerable amount of management time and
effort; has caused disruption and discontent, not exclusively
among NHS staff directly employed in these services, and to
date has not brought home the bacon.

Contradicting the extravagant claims of government

regarding cost savings is often evidence of contractors as
they have been introduced, inefficiently lower standards in
the public services.

Thomas Clarke a critique of the experience of the

privatization experience in Britain contests in ‘Political

244
Economy of Privatization’ the usefulness of the UK model
for other countries to adopt. According to him there was little
coherence or consistency to the UK governments approach
to privatization, and although it amounted to a fundamental
change in economic direction it was secured at some cost and
the strategy did not achieve what was claimed in terms of
transforming the efficiency of industry. The apparent success
in creating a shareholder democracy could prove a limited
and temporary phenomenon, there is little guarantee
consumers will benefit from the switch of public utilities to
the private sector and employees have not enjoyed the
benefits from the change which their directors have awarded
themselves. If privatization is not as successful as officially
insisted and if future privatization in the UK are likely to
prove more difficult to implement than greater emphasis may
be placed upon achieving a transformation of the remaining
public sector to attain more efficiency and customer
responsiveness. The solution to current economic and
organizational problems in the public sector does not lie
simply with the resort to private ownership and the market
system.

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 7

Global Financial Crisis:

Socio Economic Cost and Political Fallout

Socio Economic Cost

So far so bad:

20 million migrants jobless in China

The Chinese government released a fresh survey saying 20
million migrant workers have lost jobs. After city based
factories threw them out and they have returned to villages.
Some of the provincial governments had feared protests and
demonstration by unemployed workers returning home from
the cities. Joblessness has affected 15.3% of the 130 million
migrant workers.

246
Japan Recession Worsens
Japan sank deeper into recession with industrial output
tumbling and inflation slipping in to almost zero. Industrial
production fell a record of 9.6% in December 2008, with
companies forced to cut output as demand for their cars,
electronics and machinery waned.

US Economy Shrinks
US economy shrank at its fastest pace in nearly 27 years in
the fourth quarter, 2008 as the consumers and business cut
spending. The advance report from the commerce
department showed consumer spending which accounts for
two thirds of US economic activity fell 3.5% in the fourth
quarter, 2008.

Reduction in Capital Expenditure

Companies in Europe and Middle East are planning to slash
capital expenditure in 2009 by a third according to Fitch
Ratings. The effect is significant since business investments
accounts for roughly 10% of GDP.

GDP and Poverty

According to Marilon Uy of The Word Bank, for every 1%
fall in growth of GDP, 20 million more people are trapped in
poverty.

247
Global Pensions lose $ 5 trillion in 2008
Global pension fund assets in the 11 major pension markets
fell by $5 trillion in 2008 hit by volatile markets, a Watson
Wyatt report said that over 2008, global pension assets fell to
$ 20 trillion from $ 25 trillion, a fall of 19% which took
assets below 2005 levels.

IMF Forecast
 Britain is facing the deepest recession of any being
industrialized economy and the UK economy would
shrink 2.8% in 2009.
 World economy would suffer its worst performance
for more than 60 years in 2009.
 The world out put measured at market exchange
rates, would fall in 2009 for the first time since the
second world war.
 Forecast for UK is 1.5 percentage points below its
previous estimate. Britain will grow by only 0.2
percent in 2010.
 The US economy is forecast to contract by 1.6
percent, the euro zone by 2 percent and Japan by 2.6
percent.
 Growth in Arab Gulf states will almost halve from
6.8 percent in 2008 to 3.5 percent in 2009.

248
ILO Forecasts – International Labour Organisation.
 Recorded unemployment could rise by more than 50
million from baseline 2007 levels to 230 million or
7.1 percent of the world’s labour force by the end of
2009.
 In the same scenario number of people in “working
poverty” earning less than $ 2 a day, could rise to 1.4
billion or 45 percent of all workers, from 1.2 billion
in 2007.
 This would leave as many people below the poverty
line as there were in 1997, wiping out all the gains
over the past decade and marking a return to a
situation in which more than half of the global labour
force would be unemployed or counted as working
poor”.

Global financial crisis is badly affecting the socio economic

thread in all most all the countries. In certain countries the
effects are bad to worse. Loss of jobs, reduced income,
business losses, loan defaults, repossession of houses,
seizure of factories, sale of assets have created depression
and psychological disorders. Countries not having social
network or health care are the worst hit.

249
The stock market crash, real estate downturn, job loss are
increasing the number of suicides. The recent incident of
Eervin Antorio lupoe of Los Angles killing self and wife
along with lovely 5 children is extremely disturbing.

Social Unrest in China

Labour unrest has already broken out across the country. It is

Half of China’s toymakers have gone bankrupt throwing
millions of factory workers in to the streets. While cabbies
are angered by gas prices and rioted and burned police
vehicles. The sudden compression of economy has brought
millions of untold tragedies. China’s suicide rate – at least 23
people out of every 1,00,000 per year is more than double of
US. This figure will increase in the coming years. The
Shanghai Mental Health Centre reported that incidence of
depression in Shanghai has quadrupled in the past decade.
Sale of anti depressant pills has gone up many times
everywhere. China has poor record of health care and lack of
social network for the unemployed.

It is reported that proposed marriages are being cancelled,

divorce rate is increasing, health care is being neglected and
psychosomatic diseases are increasing.
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Divorce rate drops as recession ends jobs:

Most couples choose to be in bad marriages rather than lock

in losses in asset values. New York matrimonial attorney has
said that the year – old recession yanked the rug from under
the value of investments, homes and art. The standard and
poor’s 500 index has dropped 39% in 12 months; the
housing market is in free fall; partnership distributions and
bonuses have withered; and the art market has dropped.
Resulting disparities in asset valuations make outcomes
unpredictable.

Social Cost in a nut shell

1. People intake of nutritional food reduces.

2. People postpone major operations and medical
treatment.
3. Increase in divorces and instability in family.
4. Increase in demand of pharma products like anti
depressant and drugs.
5. Increase in the number of suicides and psychosomatic
diseases.
6. Increase in need for public health care systems.
7. Overall quality of life comes down.

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 Political Fallout

The social unrest created by economic crisis is going to pull

down many governments. The political leaders will react in
an irrational manner to protect their political interests. Even
in country like USA, which depends on huge imports from
China and also exports too many countries is raising the
slogan of ‘Buy American Goods’. The US congress has
barred firms receiving government bailout from hiring
Indians and other foreign workers through the skilled worker
USA (H1-B) program, if they are replacing American
workers. Restricting hiring of H1-B visa holders forms part
of American. Recovery and Reinvestment Act, widely
known as Stimulus Bill. These kinds of decisions in USA
can be classified as ‘crazy’. It is USA which advised all the
countries to open up their market and it is USA which has
enjoyed the open market benefits. But in an economic crisis
of this scale any ‘crazy’ things are possible. It is proved by
the fact that, a highly capitalistic country like USA is

252
nationalizing banks as if it is a socialistic country and is
bailing out companies instead of allowing them to wind up.
If this is the state of affairs in USA, then one can imagine the
nationalistic fervor or retaliation measures in other countries.

Many articles in US journals are advising China as to how it

should conduct its business during this period of crisis. US is
more concerned with China’s reaction than the other way
round. About the American advise, after the crisis, former
advisor to China’s Central Bank Yu Yong Ding said,
“Suddenly we find our teacher is not that excellent, the next
time when we are designing our financial system, we will
use our own mind more”.
Hope generated by election of Obama in US can turn into
disillusionment if people don’t see that enough is done by
Obama to create jobs and provide social security network.
Social unrest in China caused by millions of job losses is
really worrying China. Millions of people have gone back to
villages. In the coming years this will increase. China is
having poor health care system and no social network. So,
China’s authoritative regime is sitting on a hot volcano.
Guardian reported on 1st February, 2009 that, “revolt is in
the air”. There are waves of protests that are sweeping
Europe, angry at the failures of governments to deliver
secure and sustainable economic and social policies.

253
France is paralyzed by a wave of strike action, the
boulevards of Paris resembled a debris strewn battle field.
The Hungarian currency sank to its lowest level ever against
euro, as the unemployment figure rised. Greek farmers
blocked the road leading to Bulgaria in protest against low
prices for their produce. Now figures from the biggest bank
in the Baltic show that the three post-Soviet states there face
the biggest recession in Europe. In Athens, students and
young people protested against lack of jobs prospects, the
failings of the education systems. In Riga, the old Baltic
Trading City, which kicked out Russians and over threw
communism faced for the first time unruly mob of more than
10000 people. They converged at the 13th century cathedral
to show the Latvian government. It ended up in late night
rampage as a minority headed for the parliament, battled
with riot police and crashed the part of old city. The
following day there were similar scenes in Vilnius, the
Lithuanian capital next door.
After Iceland, Latvia looks like the most vulnerable country
to be hammered by the financial and economic crisis.
In Iceland it is revolution time. This country was proud of its
status as world’s most developed, most productive and most
equal societies. The IMF bailout teams have moved in with $
11 billion. The national currency, the Krona, appears to be
finished. Iceland is a test case of how one of the most
successful societies on the globe suddenly failed.
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Macro Micro Matrix
A Step towards effective solution.

Davos Meet
Davos meet 2009 turned out to be a talk shop but not a sweat
shop. Senior advisor to Obama said that, “Our economy is
global, our crisis is global and our solutions must be global.”
Gordon Brown, Prime Minister of UK said, that “This is a
global crisis. We need global co-operation and action to cope
with it”.
Premier of the people’s Republic of China, Wen Jiabao
summed up the crisis as “This crisis is attributable to variety
of factors and the major ones are: inappropriate
macroeconomic policies of some economies and their
unsustainable model of development characterized by
prolonged low savings and high consumption; excessive
expansion of financial institutions in the blind pursuit of
profit; lack of self-discipline among financial institutions and
rating agencies and the ensuing distortion of risk information

255
and asset pricing; and the failure of financial supervision and
regulation to keep up with financial innovations, which
allowed the risk of financial derivatives to build and spread”.

Instead of indulging in blame game, the best thing is to take

effective steps. None of the countries including USA have
drawn up plans for making sincere effort to come out of the
crisis. There are no concrete steps. These bailouts are knee
jerk reactions. Instead, these countries should start working
at two levels. One at the national and second at the
international level. Every country should draw plan
depending on its political and economic model. Every
country’s plan will be different due to its own limitations.
Every one should accept the fact that, this is a long term
problem. Need to be solved keeping a target of 3-5 years
followed with short term plans of less than a year. Having
drawn their plans, they should identify areas of reconciliation
and should meet to thrash out the differences. There is no
magic formula. The model MACRO MICRO MATRIX is a
bird’s eye view of indicatives steps involved towards
effective solution. It is a sweat shop not a talkshop.

256
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 8

Economic Patriotism

Capitalism at Cross Roads

It is seen with the experience of US and privatization

experience of Britain that unregulated capitalism is nothing
but a crony capitalism.
The famous eighteenth century political economist Adam
Smith in his treatise “The Wealth of Nations” published in

259
1776, had warned about the greediness of the businessmen
leading to exploitation of the public in free market economy.
Milton Friedman’s Capitalism with least interference from
the Government is also not realistic model according to
Nobel Laureate Krugman.
J.M. Keynes said, private enterprise economies are subject to
periodic booms and slumps in trade. During the depression
phase of cycle there is considerable waste of both human and
non-human resources. During the boom phase, inflation
produces problems of different kind followed eventually by
the collapse of the prices which accompanies the movements
of the economy in the direction of slump. Various kinds of
activity in the public sector are necessary to stabilize the
economy on a steady course of expansion at full
employment.

Noble Laureate in Economics Joseph Stiglitz has said that

“market can’t rule themselves”. He says that, we are in the
middle of a “made in the USA” crisis that is threatening the
entire world. He continues to say that, if we are going to
address this worldwide crisis and prevent recurrence we
must reform and reconfigure the global financial system.
The quote one of the greatest management thinker Peter
Drucker, “Today’s new realities fit neither the assumptions
of the Left nor those of the Right. They don’t mesh at all
with “what everybody knows”. They differ even more from
260
what everybody, regardless of political persuasion, still
believes reality to be. “What is” differs totally from what
both the Right and the Left believe “ought to be”. The
greatest and most dangerous turbulence today results from
the collision between the delusions of the decision makers –
whether in governments, in the top managements of
businesses, or in union leadership – and the realities.” This
he had said in a different contest but it is most relevant for
today’s times.
Capitalism is at cross roads. It is at the cross roads because
of greedy capitalists, irresponsible regulators, politicians
who believed in “least governance”. Capitalism per se, is not
bad but it is capitalists. Capitalism will survive and thrive. It
is a natural choice. Similarly socialism is also an acceptable
model – more acceptable in crisis. Growth model of
socialism bends towards capitalism and crisis model of
capitalism bends towards socialism.

Economic Patriotism
‘Economic Patriotism’ is convergence or confluence of
capitalism and communism in the interest of economic
development or dominance. In this economic process of
development, developing and developed countries think alike
to gain economic supremacy. This thinking of gaining
economic supremacy is fully aided, abated, accepted and

261
acknowledged through the process of globalization. If 17th &
18th centuries were feudal economy of kings, 19th & 20th
centuries were that of capitalism and communism. The 21 st
century is going to be dominated by economic patriotism.
All “Isms” will merge and give way for economic patriotism.
The process of “ism merger” is clearly evident in the way
China bends its communism fences to let in capitalists for its
economic development and dominance. US of America and
European countries are marrying BPO and moving towards
emerging economies to maintain their economic edge over
other countries. Country like India – a developing country
dreams and declares that it is going to be an economic
superpower. All this is a reality because of Economic
patriotism.

Economic and military supremacy to become a global

superpower has taken a new form. It was in various forms
time immemorial. Over a period of time, the form has
changed due to various developments. These developments
can be classified on the basis of various important periods of
history. During earlier period of Alexandar the great, Ashoka
the great, the history shows that expansion of the border of
the country, acquiring land, gold, valuables and establishing
supremacy in the form of military and commercial gain
remained a permanent goal of all the rulers.

262
The second period is that of Vascoda Gama, Columbus and
British. East India Company played an important role in the
history. As a corporate entity, it headed the economic and
military invasion. This was the period when East India
Company entered India as a trader then spearheaded as a
military arm of British. This company was totally supported
by British Government and it was probably world’s first
multinational corporation. It was a period of British
Supremacy in all fields. It had attained global supremacy.
Then came the period of German invasion through Hitler and
ended up in second World War. In this period, Germany
progressed in various scientific and technological fields.
Germany ruthlessly started claiming the racial supremacy to
achieve global supremacy. But it could not succeed to great
extent because its supremacy in economic and military was
regionalized and was not having support in world forums.

After the second world war, USA occupied centre stage in all
the fields. British power started shrinking around the world.
Sun started setting in the land where sun was never supposed
to set. USA’s progress is truly capitalistic. Many of the
companies of USA who were mainly multinational in nature
started occupying various corners in the world through their
corporate dealings. These companies were and are supported
by US Government. Many of these MNCs are bigger than
many countries in their financial strength. US became
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superpower in economy which contributed for its military
ambitions.
During this period another gaint in Asia woke up i.e. Japan.
Japan is recognized through its well known companies like
Sony, Toyata, Honda etc these companies or the Government
of Japan flexed their corporate excellence and piled up huge
trade surplus. Japan had no military ambitions.
USSR and USA – fought bitter cold war. But due to lack of
entrepreneurial skills, lack of capital and democratic
institutional support, USSR could not effectively challenge
and succeed against USA. Breaking up of USSR made USA
Numero Uno.
In the end of 20th century the world started shrinking due to
technological developments. World Trade started becoming
order of the day. Many developing countries started getting
into the cake of developed countries. The negative aspects of
developing countries like its manpower, cheap labour started
becoming its strength. In a capitalistic, competitive world,
corporate survival is most important than any thing else. To
retain competitive edge and to occupy the top positions
corporates go to any extent. The growing market of
developing countries, cheap skilled labour, eagerness of
these governments to invite multinationals to exploit their
assets created a huge market of BPO. The developed
countries in Europe are entering into recession. In this great
corporate churning China with its productivity and India
264
with its soft skills will occupy the centre stage in 21 st
century. Capitalistic economy of USA, socialistic economy
of China and mixed economy model of India will be growing
irrespective of their political and economic model. Every
country is working towards its own economic growth i.e.,
economic patriotism is at work.
Economic patriotism is not nationalistic fervor. It is broad
based. It is a team spirit. It is not ‘beggar thy neighbor
attitude’ It is growing together. In the present world, any one
country can’t grow at the cost of other country.

New Power Equation:

The changed scenario of the world due to emerging

economies, shrinking developed economies and unipolar
position of US being checkmated by other countries, the new
power equation will come into existence. Farid Zakaria
author of The Post America has summed up the
circumstances that will lead to this change. According to
him, “Since the collapse of the Soviet union, the United
States has operated in the world with no constraints of
checks on its power. This has not been good for its foreign
policy. It has made Washington arrogant, lazy and careless.
Its decision making has resembled General Motors business
strategy in the 1970s and 1980s, a process driven largely by
a vast array of internal factors but little sense of urgency or
265
awareness of outside premises. We did not have to make
strategic choices; we could have it all. We could make
blunders, anger the world, rupture the alliances, waste
resources, wage war impetently – it did not matter. We had
more than enough room for error – lot of error.
British is a different world out there if Iraq cast a shadow on
US political and military credibility, this financial crisis has
eroded America’s economic and financial power. In the short
run, there has been a flight to safety – towards dollars and
T-bills-but in the long run countries are likely to seek greater
independence from an unstable superpower”.

US is under pressure. It is loosing its global super power

status in economy. Thereafter its control over Bretton Wood
twins IMF and World Bank will come down. Which will in
turn effect its military supremacy and its unipolar world.
Brand US is threatened and is loosing its sheen. The only
hope so far is that, there is no currency to substitute dollar as
reserve currency. The day on which this happens, that is
curtain down for the great US show on earth. Of course,
there is a long way to go.
China by financing nearly 10% of the public debt of US, by
having huge trade surplus and healthy GDP growth rate is
becoming economic superpower faster than India. China has
efficient and ruthless political machinery to execute its

266
ambitions. Its military power is also well developed. China
will tilt the power equation to Asia.
India has many advantages like democracy, judiciary, free
press, soft skills, cultural and religious freedom. Its major
drawback is self serving politicians and corrupt bureaucracy.
This will eat away all the advantages.
Even though Russia looks like a mute spectator of all the
happenings around the globe, it is not a spectator but it is an
active player. US tries to ignore Russia but it cann’t afford to
do. This reality is known to US but has no courage to accept
and reconcile to new power equation. Russia being close to
China and India geographically as well as politically it may
initiate the process of forming East Block consisting of
Russia, China, India and other Asian countries.
The nationalistic fervor goes to another extreme in case of
crisis. After 2008 crisis the countries may take extreme step
to protect their economy and may stop importing and
exporting depending on their balance of payment position.
Instead of bending the fences they may raise the fences.
Which in turn will hurt other countries.
The nationalistic fervor may also create new blocks like
European Block, Anglo Saxon Block, Asian Block, East
Block and Islamic Block. In the interest of world trade, the
leaders should see that such block formation is avoided. US
and other G-8 countries have to soften their stand in trade
negotiations and should realize that their position of strength
267
is no more in existence. This softening also has to take place
in institutions like IMF, World Bank and UN. They have to
accommodate emerging economies and make these
institutions truly representative.
‘How to fix the world’ attitude of US should be changed. If
Obama means CHANGE, that change should come in the
form of democratization of these international bodies.
Economic embargo or military action should be exercised
by these truly representative (when it happens) international
bodies but not suo mota by US. Capitalism and democracy
should not be used as a tool to enrich and strengthen US at
the cost of others. That should CHANGE. World needs
CHANGE.

Consequences of Economic imbalance

The principal architect of the Bretton Woods System Harry
Dexter White said that, “The absence of high degree of
economic collaboration among the leading nations will . . . . .
. . . . inevitably result in economic warfare on an even vaster
scale”.
Cordal Hall, the United States Secretary of state from 1933
to 1944 believed that, fundamental causes of the two world
wars lay in economic discrimination and trade warfare.
The writing on the wall is very clear that economic
collaboration among leading nations is in the interest of
world peace.
268
True peace is not merely the absence of
tension; it’s the presence of justice.

Martin Luther King Jr.

References

Wikipedia
Socialistic economics
Derivative (finance)
Subprime Lending
Communism
Credit Default Swap
Bretton Woods Systems
Joseph Stiglitz
Reaganism. The legacy of the 40th US President
About the Great Depression
Great Depression in the United States
Capitalism: A Treatise on Economics – George
Reisman
John Maynard Keynes
Glass Steagull Act
Adam Smith

269
Informal Sector
Economy of India
The Indian Economy
Economy of United Kingdom
Economy of Germany
Economy of France
Economy of People’s Republic of China
Economy of United States
US Economy
Brazil Economy
France Economy
German Economy
The US Economy
China Economy
Global Economics Paper No. : 99
Dreaming with BRICs: The path to 2050 – Goldman
Sachs
Gramm-Leach-Bliley Act
Milton Friedman
Capitalism
Laissez. Faire.
Non Performing loan deal in Europe losing steam
Natural Economy
Subsistence Economy
Global Financial Crisis, 2008

270
 The global economic crisis: An historic opportunity
for transformation
Emergency Economic Stabilization Act of 2008
Socio-Economic Consequences of the Global
Financial Crisis – Marilon Uy, The World Bank

Economics of Public Finance: L.Hey (Pitman)

Indian Economy: Ruddar Dutt & KPM Sundharam (S.Chand
revised edition 2008)
The Daily Drucker: Peter F Drucker with Joseph &
Maciaiello
Doctoral Thesis on Privatisation of Public Sector
Undertakings – An Indo British Comparative Study
– Dr. Vijay R. Thite.

News Week
December 29,2008
The Neighborhood that wrecked the world: Matthew Philips
December 2008
MARKETS can’t Rule Themselves : Joseph E. Stiglitz.
December 22, 2008
The Age of Bloomberg: Fareed Zakaria
The Fall of American Inc: Francis Fukyama
Name that Economy: Jacob Weisberg.
The Monster that ate wall street- Mathew Philips

271
December, 2008
A path out of the woods: Fareed Zakaria
Who’s watching The Money?: Michael Hirsh and Daniel
Gross
Why Beijing is in a Risky Place: George Wehrfritz
Obama’s Third Way: Fareed Zakaria
November 24, 2008
Murder at the Drum Tower: Melinda Lin.
A Risk worth taking: Daniel Gross
November 3, 2008
We need a Bank of the World: Jeffrey E Garten
October 27, 2008
The First Disaster of the Internet Age: Paul Kedrosky
600,000,000,000,000? : Barret Sheridan
Not all has been lost: Stefan Theil and William Underhill
October 20, 2008
There is a silver lining: Fareed Zakaria
Awakening from the All-American Dream: Zachary Karabell
December 31, 2007
The Rise of a Fierce yet Fragile Super Power : Fareed
Zakaria
Mao to Now: L Milinda Lin

Time
February 16, 2009

272
How to spend the stimulus: Michael Grunwald
February 9, 2009
America’s Broken Banks: Stephen Gandel
Dec22, 2008
Wanted a new miracle: Bill Powell
Small man, Big Legacy : Michael Elliott
Reassessing Risk: Barbara Kiviat
December 15, 2008
Is this Detroit’s Last Winter: Bill Saporito

The Economist
September 15th, 2007
Magnets for Money : Julie Sell

Business World
9.2.2009
Made in America : Nayana Chanda
13.10.2008
None Too Big to Fall – Srikant Srinivas
Are Bailouts Successful?

Outlook Business
5th June 2006
The Asian Century- Ashish Gupta
The Engines of Global Economy- Vivek Gupta
Making Sense of China Inc-Mahesh Vyas

273
The Confucian Consumer – A Naidu

Business Today
Nov 2, 2008
Crunch Time: Puja Mehra
October 5, 2008
After Lehman, Who’s Next? – Rachna Monga.

Economic Times
5 Feb 2009
Leash ready for fat cuts - Reuters

4 Feb 2009
UK under pressure to nationalize banks

17 January 2009
Citi Splits

26 November, 2008
Fed Launches $ 800 Billion life line - Reuters

11 November, 2008
Asia will recover faster- Interview with Kathryn A.
Mathews.

26 October 2008
London now turns against hedge fund - Coroline and Elisa

274
15 October 2008
Wall Street Crisis: Implications for India

25 October 2007
Buffett finds Chinese Stock Market too hot to handle - Zhao
Yidi & KB Cho

13 October 2008
EU works on rescue act- Reuters

8 October 2008
Dominoes: Europe first, India later – SSA Aiyar

29 September 2008
US senate sends big : spending bill to Bush

25 September 2008
China Shuns Paulson’s free market push - Zhao Yidi &
Kevin Hamlin

20 September 2008
Lessons from Global Financial Crisis- AP Parigi
London hands back finance – hub status to New York-
Mathew Lynn

19 September 2008
The party’s over in Europe too - Jill Lawless

13.October 2007
Jittery Lenders call for higher collateral - Dev Chatterjee &
R. UnniKrishnan

275
Goods for US get no cover - Maya Shetty

25 May 2007
Is it time for the US to bolt from the World Bank?-Kevin
Hassett

Times of India

6 Feb, 2009
Slump Jolts Gulf: Jobless Indians Head Back Home - S
Parshar & others

30 September 2008
$ 2289 trillion derivatives bubble busts - Subodha Varma

3 February 2009
20m migrants jobless in China- Salbal Das Gupta

29 January 2009
Man loses job, kills wife, 5 children and self

19 September, 2009
What this means for Us - MK Venu

16 April 2008
Let’s Revisit Capitalism - Arun Maira

19 November 2007
US could face $ 2 trillion shock - Sachs

276
27 October 2008
The Corporatization of greed- Santosh Desai

Business Standard
13 October 2008
The Post-crisis financial system : some concerns- Abheek
Barua

A sleep at the wheels - A.V. Rajwade

Acknowledgements

The Global Financial Crisis which erupted when I was in

Goa in September 2008, really made me to spend sleepless
nights. It made me to spend lot of my time on research of
sieving through huge database and innumerable publications.
Research of this size in a short time of four months is
impossible but for my continuous interest and study of global
economy for the last one decade.

I was ably guided and assisted by many people. Encouraging

words for all my endeavors from Dr. P.B. Sattur, a Senior
Scientist, Dr. A.H. Chachadi, Dean and Director of Kausali
Institute of Management Studies, Karnataka University, Mr.
R.S. Hugar, the past Chairman of Corporation Bank, my
brother Dr. Mohan Thite of Griffith University, Australia
and other learned men and women helped me to complete
this book.

277
The manuscript was read by Dr. Chachadi, Mr. Pawate, Mr.
Ananth Hombali and others. My staff Praveen Nargund and
Vikram did an excellent job of type setting the whole book.

The cover page was conceptualized by my 19 year old son

Vaibhav. An excellent concept which was appreciated by
many. The art work of the cover page was executed by Mr.
Girish Joshi of Graffik Artz. Kaulgi Studio took an excellent
photo of mine for the book. Mr. Haridas of Vikram
Publications and Institute did a wonderful job of bringing out
a quality book.

My fountain of encouragement for the last two decades is my

wife Pooja. She has stood like a solid rock for all my
extremely diversified work culture. My cute little daughter
Prarthana is 13 years and is trying to treat this book as the
new member of the family.

I am sure the blessings of my parents have made this book an

ultimate reality.

278
 Chapter wise subject index

Political Economy
Adam Smith
Private Ownership
Tragedy of commons
Dispersed Knowledge
Residual Claimant Theory
Capitalism
J.M. Keynes
Failure of the Market
Warning from Adam Smith
Communism
Marxism-Leninism

Global Financial Crisis Made in USA

Government Intervention USA – Regulation and Control
Economic Regulation
Monetary Policy
Public Finances
Economic Indicators
Imports and Exports
External Trade Data
US Trade By Nation
Effect of Military Expenditure

279
The Great Depression
Roosevelt and the New Deal
Unemployment
Agriculture
Industry and Labour
Glass Steagull Act, 1933
Bretton Woods
US Dollar as Reserve Currency
International Monetary Fund (IMF)
International Bank For Reconstruction And Development
(IBRD)
Milton Friedman
Krugman
Anglo-Saxon Capitalism
Laissez-faire Economic Philosophy
Reaganism
Causes of Financial Crisis
Legal Changes
Regulators
Technological Developments
Investment Bankers
Exotic Financial Products
Credit Default Swap (CDS)
Growth of CDS
Mortgage Backed Securities
Derivatives
Growth of Derivatives
Trading Value in Derivatives Market
Super Leveraging
Sub prime Lending
Sub prime Mortgages
Sub prime Credit Cards
US Sub prime Mortgage Crisis
Credit Rating Agencies
Consumerism and Credit Culture – Heart of US Economy
Vicious Circle
The Global Fall Out
Why the Crisis is Global

280
Political Economy of Bailout Packages and Takeovers
Government Intervention
US Bailout Packages
Federal Reserve Take-over
Other Take-overs
Are Bailout Successful ?
Themes From Bailouts
Reasoning Against Bailouts
Bailout Costs
Capitalism To Nationalism
Political Economy of Reforms
Political Desirability
Political Feasibility
Political Credibility
Free Market Fundamentals
Market Critical Factors
Market Structure
Management Issues
Regulatory Authorities
Stock Markets
Corporate Governance
Risk Assessments
Compliance Mechanism
Fraud is a fraud is a fraud
Federal Governance
Top B Schools of US
Biggest Pool of Economists
IMF and World Bank
Job Loss in USA
The American Problem

Political Economy of Global Financial Crisis and Europe

Economy Models in Socialistic Economy
Western Europe

United Kingdom
Global Financial Centres
New York and London Financial Centres

281
The things that changed the system
United Kingdom : Economic Indicators

France
Dirigisme and decline of dirigisme
France : Economic Indicators

Germany
Financial Services
Germany : Economic Indicators

Global Financial Crisis : Impact on Europe

European Banks too Big to be saved
Banking in Crisis – Select Club of Survivors
Why They Survived
Banco Santander
HSBC
Advice from Emilio Botin

Political Economy of Global Financial Crisis and China

Maoism
Socialistic Market Economy
Planning and Execution Process
Regulatory Environment
Financial and Banking System
External Trade
Foreign Investment
China : Economic Indicators
Business Environment
US Trade and Investment with China
China : Biggest Creditor of US
China and American Meltdown
China’s Problems
The Stimulus Package

Political Economy of Global Financial Crisis and India

Mixed Economy – Indian Model
India: Economic Indicators

282
Demography
Business Environment
Public Sector Undertakings
Highlights of CPSE Performance
India’s Top 10 Private Sector Companies
Top 10 Net Exporters
Top 20 Public Sector Undertakings
Strengths of Private Sector
Weaknesses of Private Sector
Role of the Government in the Economy of the Country
Privatisation: Purpose and Process
India – A Case Study for Privatisation
Global Financial Crisis-Impact on India
The Fall Out
5 Lakh workers Axed
The Gulf Party Comes to an End
Lethargy Turned into Virtue

Roll Forward and Roll Backward : British Model

Origin and Development of Public Sector in Britain
Criticism of Performance of Public Sector
Public Sector Reforms in Britain
Thatcher : The Champion of Privatisation
Privatisation of Natural Monopolies
Electricity
UK Gas Industry
Privatisation of Water Industry
Survey Results of Privatisation of Natural Monopolies
Role of Regulators in UK Privatisation
Lessons from Privatisation
Gains from Privatisation
Abromeit
Thomson
Thomas Clarke
Steel and Heald
Pliatzky
Competition and Efficiency
Prosser

283
Kirk Patrick
Cleggard Dunkerly
Vickers and Yarrow
Bees Leyland and Little Child
Gretton et al
Cost Benefit analysis of Raising Government Revenue
Commercial Performance
Retention of Shareholders
Clarke
Distribution of Shareholding Pattern
Marsh
Buckland
Consumer Democracy
Post Privatisation Effect on Employees
Job Security

Global Financial Crisis: Socio Economic Cost and

Political Fallout
Socio Economic Cost
So Far So Bad
20 Million Migrants Jobless in China
Japan Recession Worseness
US Economy Shrinks
Reduction Capital Expenditure
GDP and Poverty
Global Pension lose $5 trillion in 2008
IMF Forecast
ILO Forecasts
Social Unrest in China
Divorce Rate Drops as Recession Ends Jobs
Social Cost in a Nut Shell

Political Fallout
Macro Micro Matrix – A step towards Effective Solution
Davos Meet

Economic Patriotism
Capitalism at Cross Roads

284
Economic Patriotism
New Power Equation
Consequences of Economic Imbalance

285