FROM THE TELEGRAPH OF 5 DECEMBER 2006
Flight is right
The late Milton
Friedman believed that government functions should be pushed down to the lowest
feasible level – to the municipality where possible, and to the states if that
was not possible. National governments should be concerned with little beyond external
relations, defence and justice. His reason was that the smaller the unit that
enforced any laws, the more easily could a citizen who did not like them migrate
to another unit with laws more to his liking.
This principle –
the principle of subsidiarity – is enshrined in the rules that govern the
European Union (EU). Not only do its member states keep laws they had before
joining, but they also retain their parliaments, courts of justice and the
power to enact and amend laws. The EU has no king and no Prime Minister. It has
a President; but he is merely the chairman of a committee on which some (not
all) member states are represented; and the Presidentship is rotated every six
months. (The EU has so many members that even with each President occupying the
chair only six months, it is many years before Presidentship comes by rotation
to a country – a case of Presidential musical chairs.) It has a European Parliament
in Stuttgart, which however it does little business; its membership is a
sinecure that the parties of member states award to worthy senior members whom
they do not wish to see for some time.
But the EU would
not be EU if it did not have a government; and all governments abhor a power
vacuum. In the absence of a political apex, the secretariat – the European
Commission in Brussels – usurps political functions. It is large, since all
member countries must have a share in it. It does not make laws, but comes
pretty close. It lays down principles that follow from the treaties that
created the EU, and shoots off letters to member governments suggesting either
that those principles should be embodied into members’ laws or that the laws
should be brought into conformity with the principles. The EU does not
legislate; but it strives diligently to harmonize member countries’ laws in the
direction of a uniform law. It does not quite dictate the wording; and the body
of laws is so large that it would be decades before the Commission could bring
a modicum of uniformity in them. But it can and does take up topical areas of
law and push harmonization in those; it comes close to persuading countries to
have laws that are similar in substantial respects. This is particularly true
of new areas not cluttered up with old laws – for instance, telecommunications.
How far does the
principle of subsidiarity survive in the face of this pressure for
harmonization? The Commission does sometimes ask countries to amend some or
other legislation. Still, much variety in national laws can persist provided
they do not overtly conflict; and even conflicts can be accommodated as long as
the citizens of each country are satisfied with its laws. The only mechanism
that works towards uniformity is the judiciary. It may happen that a citizen is
dissatisfied with the verdict of the highest court in hiscountry. If he finds
that judges or laws in another member country disagree with the verdict, he can
go to the European Court of Justice and ask it to say who is right.
The processes of
harmonization are so dilatory that considerable variety persists between
national laws. To this extent, a European has the choice of many judicial and
legal systems. But in fact, few Europeans choose to migrate to another country
because of its laws. People migrate to France because it has an abundance of
cheap property in beautiful villages or to Amsterdam because of the ease of
getting drugs there. Many Poles have moved to England to do plumbing or
electrical jobs natives are too lazy to do; but their migration has nothing to
do with a difference in laws.
But Indian companies
have been shopping for jurisdiction. To curry favour with Indian depositors,
Reserve Bank keeps up banks’ deposit interest rates. Government-owned banks
account for three-quarters of banking business in India. They employ many more people
than they need, so their costs are high. So Reserve Bank allows them to lend at
high rates. Indian companies naturally prefer to borrow abroad where it costs
less. Since we are hoping to be a global power, Reserve Bank can hardly stop
them completely. But it does the next worst thing – it rations what it calls
External Commercial Borrowings. Similarly, it cannot stop them completely from
raising equity abroad. Instead, it puts restrictions on the circumstances in
which they can raise it, the uses they can put it to, how long they can keep it
abroad and so on.
If Reserve Bank has
a ball restricting business, Securities and Exchange Board of India can hardly
let itself be left behind. So it rations public issues: very little for rich investors,
a half for Qualified Institutional Investors (QIIs) whom it can control, and a
big chunk for fictitious “retail” investors. They are a category it has
created. Anybody can be a retail investor. But issuing companies cannot allot
him more than a small number of shares. The issue price is negotiated between
the issuing company and QIIs, who use their bargaining power to ensure that the
company sells them shares at a price well below the eventual market price. A
side result is that retail investors also make windfall gains on shares they
manage to get. No wonder they want more shares they can get, and make many
applications. The chances of being caught are small if one is clever. But Sebi
has caught a few, and banned them from applying for more shares. Worse, it has
imposed enormous fines on their depository participants (DPs) and brokers. Now
they will be expected to make sure that their clients are real “retail
investors” and have not made multiple applications. It is physically impossible
to do so; “retail investors” will continue to make multiple applications, Sebi
will catch some once in a while, and milk their DPs and brokers. Nice business.
DPs and brokers will lose some money; but enormously more will be lost by
issuing companies, whose issues will be underpriced.
But as I said,
they cannot go and raise equity abroad; Reserve Bank will stop them. So what
will they do? They will set up companies abroad in jurisdictions that have less
stupid and intrusive regulators. We have seen a spate of Indian companies
buying or setting up companies abroad; London and New York have been their
favourite haunts. Their exploits have led to much self-congratulation amongst
patriotic Indians; they exult at this demonstration of India’s burgeoning economic
might. Might is right. But flight is equally important. We were always good at
keeping foreign companies out of India; now we are getting good at chasing
Indian companies out of India. The consequence in both cases is less employment
and production on Indian soil. But with the economy growing at 9 per cent a
year, who cares? Even in a globalized economy, the government has to have
something to do – whatever the cost to the country.
