Markets Can Punish Better Than Courts

Any civilised, healthy society needs  good governance and accountability. Yet  both have deteriorated sadly in India. Our legal system has become a joke, unable to convict anybody resourceful. Those with money and muscle can put the fear of death into witnesses, who dot not believe the government can protect them. Which is why witnesses have turned hostile in the Jessica Lal case and BMW case, save for one witness who happens to an NRI and so beyond the reach of local thugs.

Obviously such a moribund state is incapable of  jailing perpetrators of communal killings, and so communal revenge takes the place of rule of law. Supposed enemies of the state caught for the 1993 Bombay bomb blasts are still on trial, and will doubtless die of old age before beyond convicted beyond all stages of appeal. Just as happened in Harshad Mehta’s case. The Babri Masjid case is more than 100 years old and still unresolved.

Yet all is not lost. While the organs of state deliver less and less accountability, the rise of competitive markets is  greatly improving accountability and justice. This is not obvious, and needs elucidation.

Look at Enron and its auditor, Andersen, in the USA. Enron was the seventh biggest company in the world, and Andersen is one of the Big Five in global audit/consultancy. Yet Enron is now in liquidation, and  Andersen  seems headed for extinction. The  US Justice Department says it will prosecute  Andersen for obstructing justice by shredding documents relating to Enron. This has further accelerated the flight of customers from  Andersen.

Now big companies have huge assets and unrivalled access to credit and political influence. Why could behemoths like Enron and Andersen not use these to save themselves?

Because in competitive markets, size does not matter and reputation does. Business history is littered with the carcasses of giants that failed. Only two of the 30 companies that made up the original Dow Jones index are still there.

By simply switching their custom to rivals, the smallest and apparently most powerless customers can bring the biggest corporations to their knees. Remember Pan American Airways, Xerox,  Polaroid.  Size and entrenched positions yield an advantage only if rivals face  entry barriers such as  high import tariffs and quotas, industrial licences, and special tax-breaks. In India’s licence-permit raj, entrenched players could exploit consumers with impunity. But not in the USA.

Companies that get into trouble need time and credit to  rectify their errors. But access to credit depends, quite critically, on reputation. If a company is seen to be guilty of undesirable behaviour, misleading balance sheets, or concealed debt and expenses come,  the credit tap can  suddenly be shut off. This  explains how Enron, which had never reported a loss in a single quarter, collapsed within a month in late 2001. Having lost credibility after admitting it had cooked its books, it suddenly found itself unable to raise the money needed to settle maturing debts.

So far, there is no evidence that Enron committed any crime. It resorted to creating accounting, but so do dozens of companies. Its balance sheet was certified by a top auditor like Andersen. But whether or not it broke the law, its behaviour was seen as unethical and unacceptable. And so the markets, by refusing custom and credit to Enron,   inflicted on it a punishment far harsher  than any court could have. The market delivered its verdict and punishment within weeks, not after years of wrangling as courts would have.

Enron’s huge political clout could not save it. In the USA the White House cannot order nationalized banks to keep lending to businessmen. In India, alas, politicians can.   Thus do controls and misuse of PSUs in India thwart accountability and good governance.

Competitive markets are not enough. Countries also need speedy justice, for civil suits no less than criminal. Top managers at Enron and Andersen face huge civil damages whether or not their companies are found guilty of crimes. And civil damages can be far higher than official fines. In India, alas, legal delays thwart such accountability.

What lessons flow from this? First, we need competitive markets to the maximum extent possible.This means lowering entry barriers to competition like such as high tariffs and licences. It means reducing the patronage network of politicians, reducing controls and privatising PSUs and banks. Finally it means comprehensive judicial reform.

Half-baked economic reform has increased competition and reduced government patronage somewhat. Many barriers and controls remain. Yet accountability has clearly improved in the supply of goods and services.

Customers have been empowered through choice. No longer is their choice of cars limited to Premier Automobiles and Hindustan Motors. For almost all goods and services, citizens can now hold suppliers accountable by switching their custom if dissatisfied.

Consumers can now get credit from dozens of rival financiers for buying anything from homes to washing machines, and do not have to go to the LIC for a housing loan or to a nationalized company for life insurance. The resultant power of choice has bankrupted substandard suppliers. Remember Premier Automobiles, remember DCM.

Where the supply of public goods by the government has failed, private supply has entered, bringing some little accountability. The government cannot prevent crime, so people employ guards, who can be sacked .People go to private doctors,  hospitals and schools. In every case they can switch their custom if dissatisfied. Government monopolies are shrinking everywhere from telecom to banks to ports, and privatisation is taking the process further.

This remains  a very imperfect form of accountability. The market can do only so much. Governance can never be satisfactory if the state does not deliver. However, the silver lining in India is that the rise of competitive markets and decline of government monopolies have increased accountability in many areas, offsetting the deterioration in state services. It is not good enough. But it is cause for hope. We are not all condemned to Biharisation.

What do you think?