Ravi, in Conversation

Energy is finite in nature as defined by the currently known principles of physics and thermodynamics. The process of creating energy cannot be completely efficient and involves the loss of energy in some form or the other and not only that, certain processes or certain outputs can be harmful to the environment around us. Combine this with ever-increasing need so that we keep the engines of economic growth chugging, and we have the biggest problem for human survival in front of us.

Despite the increasing number of options for energy production and dissemination, most of the world depends on proven fossil fuel sources. One reason for this is the availability and concurrent lower cost of producing such energy. But our current model of pricing energy based on supply and demand is heavily flawed since it does not take into account the environmental ramifications of each source of energy. For instance, availability of already built infrastructure and resulting economic and political costs of dismantling such facilities is what drives the adoption rate of newer technologies, rather than the amount of good it does to the world. The environmental costs of a source of energy are completely ignored by the current pricing structure. Take for instance the first generation biofuels initiatives in the United States, many of which are currently proven to be more damaging to the environment that the very fossil fuels that they want to replace. However, an infrastructure, a political mandate and a regime of subsidies is already in place and trying to alter them can be a huge challenge.

When supply and demand are the only factors determining price, of course, along with the volatility due to speculation, we have a situation where we have multiple competing technologies, some with an unfair advantage over others due to factors other than what is best for the long term. As long as fossil fuels remain cheaper than alternative sources, the world will continue with the "drill baby, drill" mantra, piling on economic costs in the form of environmental damage. Imagine a situation where the price of oil was to include a component of cost to clean up the environment. The price of nuclear energy will include the costs of getting rid of nuclear waste. All forms of energy will be pitted against each other based on their inherent worth, and demand will go for the supply that becomes cheaper.

The beauty of such an energy efficient pricing model is that is can even affect the choice of a consumer by increasing the price of the less efficient filament bulb in comparison to a compact fluorescent lamp. An organically manufactured food item can be cheaper than a food that uses growth hormones, and chemical fertilizers. In the same way, your super energy efficient car will be cheaper than your neighbour's gaz guzzler, though the cost of manufacturing your machine was higher. In some way, such a pricing mechanism is revolutionary in terms of bringing transformation in energy choices.

How will one go about implementing such a model? Assuming that energy efficiency is measurable in terms of horse power output for unit input, as long as we consider even environmental factors as input costs, and take disposal of residues as part of the product cost, we should be able to determine a "Cost to Environment" factor from a few samples from each energy production mechanism or energy consuming equipment. The easiest way will be for a global agency to collect this as a tax at source. This tax will be ultimately passed on to the consumer, and the consumer will be paying more. But, the long term effect will be that this pool of funds can fuel further research in the most promising technologies. Since all production mechanisms or consumption mechanisms are lossy, the cost in general will go up. But this ideally will push the demand to the cheapest available option, which will also be the best to the environment. For instance, our auto-makers will finally get an incentive to produce more energy efficient cars. The governments do not have to earmark new funds for research, as the model contains a feedback loop to push it towards better ends.

A small organization has many advantages that a large organization can hardly duplicate. One of them is the proximity between different stakeholders of the organization that fosters synergetic teamwork and an open-minded culture. As much as we enjoy the fruits of this benefit, we often overlook the lurking menace in the form of personal bias. Decisions in a small group often tend to be filtered based on personal judgment rather than what works best. When bias creeps into a small organization, the decision-makers award all the opportunities that arise in that organization to the same set of people, effectively letting them carry home the rewards and, at the same time, further enhancing their prominence among peers.

Some people combine the positive bias that supports them with their personal relationships to take up more opportunities than they can possibly handle. We cannot deny that there are a smaller percentage of people who are in the limelight because of their talent, even though they do not specifically nurture that idea. In smaller firms, the two groups of people mentioned above end up getting more responsibilities than they ever asked for. News spreads fast in a small organization and capable people who do not fall into either of the above groups feel under-utilized and unmotivated. Though we need to give a fair amount of weightage to personal judgment, we can easily see that determining just based on bias can be detrimental to a small organization. For instance, even though Person A and Person B have similar skills to perform a certain Task A, Person A gets selected if Person A had been selected to a analogous role earlier or if the selector has heard about Person A doing well in another unrelated and different Task B within the same organization. But as we can find out, this selection strategy is not always the best. In the first case, it is possible that Person B did not get an opportunity to demonstrate his or her prowess through prior experience though equally capable. In the second case, Person B might have more skill in that specific area of responsibility compared to Person A, even though the decision-making is clouded by Person A’s performance in Task B. But since the decision-makers have already made up their minds, Person B cannot do much to change their verdict. I suggest two alternatives to remove bias and create an environment that prevents some people becoming “more equal” than the others utilizing a favorable bias: distribution of opportunity and process-orientation.

Distribution of opportunity by making sure that one person does not get involved in too many activities at the cost of others who are equally interested or skilled is one way to solve this issue. A pertinent question at this point is the capability of Person B to perform. Assuming that small organizations are usually highly selective, we can imagine that each person is an iceberg, and that 80% of the responsibilities would not require more than 10% of their skills. Even otherwise it is usually the right opportunity that creates leaders, not higher skill, as we can learn from the biographies of world leaders. As we mentioned above, the takers of the first few opportunities usually stand to gain a positive bias for every future opportunity that may arise. By making sure that these first-movers stay away from grabbing every other opportunity, we may find potential talents who may outshine the first-movers. This actually works to the benefit of small organizations who cannot rely on a few people who take all the work and make (Hidden here is some suggestion for a person who joins a small firm and wants to make it big: Grab those first few opportunities – you’ll be there to stay!)

Process-orientation is another approach to solve the bias problem. Process-oriented firms are usually the big organizations – and they implement processes for completely different reasons. Big organizations want to make sure that their size does not constrain them to end up becoming the biblical Towers of Babel. By implementing strictly enforced processes for even minor activities, the big organization tries to make sure that each of its departments work towards the same objectives with complete transparency without a need to employ too many people to manage the show. Also, they can make sure that the work is done in the same manner even when the responsible people move or quit. In other words, big organizations avoid silos through process-orientation. The automation brought in by an efficient process is effective to a small organization where every decision-maker and even every individual acts as a silo, and is prone to personal bias. We need to notice that we often find the small organization to be lacking in efficient processes, mostly because the inputs and the feedback channels to a process have minimal contribution. Small organizations are often reluctant to adopt defined processes and treat them as a burden rather than as a necessary value-add. When we probe deeper, we can find that the culprit is usually the same – it’s personal bias that makes the implementation of processes complicated in a small organization!

Though the finance sector has seen an erosion of jobs, I believe that this is short-term, and just one of the side-effects of being greedy and not focusing on the bigger picture – going too thin to get too deep, whether it is into progress or into calamity. In other words, my premise is that we are limiting a lot of our energy and effort into a subset of economics, viz. finance, without considering the macro-economic implications and micro-economic fundamentals that lie embedded in the time value of money.

The debate between the behavioral economists and the quantitative economists has been widening as new events unfold, and we find ourselves scampering around for all-encompassing explanations and accurate predictions of the future. We still lack an understanding of what we have ourselves created in the likes of asset-backed securities and credit default swaps, their implications, and why we failed to predict what was coming. We do not know what a drop in the interest rates mean, or where the 700-billion dollar bailout package is going to end up. This, I would argue, implies that an influx of fresh talent into finance is increasingly necessary. We can smell opportunities for budding finance professionals who have the credentials to take a long-distance satellite snapshot in order to drill deeper, by effectively integrating other fields of management, literature, history, psychology, biology and technology into our financial thought processes – which essentially means that our future finance practitioners need to come from all other areas of art and science. It is also necessary that these minds are given ample freedom to break-out of routine models to build integrative approaches that can stand the tests of time.

The BRIC economies are all the more in need of such talent that has survived and understood turmoils such as the one we currently face, since these nations would want to progress without struggling at the same stumbling blocks as the present-day US economy does. For instance, in a sector like energy, we can expect huge infrastructure investments in India and China in the days to come (remember the Indo-US nuclear deal, and GE's investment) and we need financial talent to channelize and manage these investments on the basis of interdisciplinary knowledge rather than complicated spreadsheets.

I am not sure whether we will find jobs in such interdisciplinary areas in the near future, but this is certainly going to be the long term trend. So, the best thing for finance professionals to do today is to read, think, understand and prepare oneself for the future. I would suggest to everybody, myself included, to accept jobs that can take us a step nearer to where we want to be, rather than stressing ourselves out because we didn’t get what we set out to achieve.

The same way as a language will survive as long as (wo)men want to communicate, finance will remain as long as (wo)men want to transact.

It is becoming increasingly clear that India is no longer shielded from the global credit squeeze as it once used to be. The effects of the collapse in the financial industry in U.S. and Europe are evident in the heavily U.S. dependent Information Technology sector that has started lay-offs, as well as the Real Estate Industry which is facing dropping property rates. Both I.T. and non-I.T. companies in India are already facing a liquidity crunch as international investors are pulling their money out and banks are becoming more cautious with their lending. Traditional low leverage financial management methods and operational efficiencies are going to be the strongholds for India Inc. to survive this economic turmoil. Unless the recession extends beyond a year, much of this crisis does not seem to trickle down to India’s common man unlike in the West, mostly due to cultural differences due to which people save for a rainy day coupled with the effects of internal consumer demand.

IT and Real Estate

I had heard that Real Estate prices in India, especially in Bangalore, were undergoing huge correction as early as April or May 2008[1]. I believe this correction is going to continue in most other cities as well, because the property valuations have been sky-high until now, triggered by the booming I.T. sector and property purchases by cash-rich NRIs. On the lending side, Indian banks continue to be commendably conservative, and do not carry any “sub-prime”[2] mortgages in their assets like their U.S. counterparts. Indian loans are mostly fixed rate[3] mortgages and the family-backed and savings-oriented culture of the Indian population, combined with the shame of going bankrupt will come to the rescue of I.T. people facing job-loss. Therefore, loan delinquencies will not be too high, and the markets will not turn as sour for the common man as it is happening in the U.S. But definitely the real-estate brokers and land-owners are going to be hit hard[4] - in fact deservingly, because they were until now making too much money way too effortlessly.

The effect on the Indian I.T. industry is two-fold. I.T. companies will lose a string of projects, because the clients themselves are not going to sustain their business. Companies like TCS[5] and Infosys that have a bigger BFSI and retail component[6] will have a higher impact. This said, I.T. companies recognize that there is light at the end of the tunnel. They are sure use this opportunity to prune their workforce by laying-off non-performers, and correct salaries, in a job market which had been highly inflated until a year ago.

In tough times, like for individuals, cash is king for I.T. companies (even for any other company, since credit is soon going to be tight even in India). I.T. companies in India have been traditionally effective in managing their cash, and will be able to survive with what they have for the next year or so. As U.S. and European banks consolidate and re-configure their operations, opportunity knocks in two ways – projects to integrate I.T systems of merged entities, and further out-sourcing of non-core financial analysis activities. Companies like TCS are already active in the latter. With the acquisition of Citi’s BPO division in India[7], TCS is trying to cash-in on the opportunity to bring a larger part of the banking pie offshore[8]. HCL’s acquisition of U.K.-based Axon Group[9] beating Infosys is an effort to provide more value-adding end-to-end services. Acquisitions will trigger growth as long as companies do not compromise their cash position.

All the small I.T. start-ups mushroomed by the thriving industry which are not in a position to offer end-to-end services will eventually get washed away or taken-over as they face a dwindling client-line and worser cash-position. Of course, the super-specialized ones that have a solid value proposition on offer have a chance to survive. The last thing I would want to see in such a scenario is some big company panicking and removing talented people, which will in turn affect all the other players and spiral into a much larger crisis. But I believe that NASSCOM, CII, FICCI and other industry associations are strong and experienced enough to proactively prevent such a situation.

Therefore, not everything is bad for I.T. companies in India. India still maintains a huge though comparative advantage over other countries. This advantage will eventually erode as cheaper economies adopt similar game-plans, but such an effect seems to be a long way away. A recession can even be good for Indian IT[10] because companies suddenly find that land costs are back to normal and talent is getting cheaper helping them bring in more outsourcing investment to the country. Indian I.T. companies have grown large enough to establish themselves outside India as well – going where the money is. Moreover, as long as the dollar remains stronger against the Rupee, the I.T. exporters are better off, and have enough clout that the government will not do much to help the other importing companies for whom stronger dollar brings bad news.

Causes for the crisis and overall effects on India

At the core of the U.S. crisis, is the lack of regulation in two key areas, one, the derivatives market (which led to soaring oil prices, which are back to normal now due to slackening demand) and two, the investment banking area (which led to crazy subprime mortgages and securitization).

Second is the huge dependence of U.S. companies as well as individuals on credit, whereas Indian companies traditionally keep cash in their balance sheets. The bailout package will temporarily ease credit for a few months, but as many economists predict, might not be enough to completely reverse the effects of a recession. In fact most of the effects of the infusion of taxpayers money into the financial system are yet to be seen, and may be beyond prediction since it depends a lot of human behavior in times of crises.

Third but not the least, is the mishandling of the economy by a frightened U.S. government, reducing interest rates and prolonging the effects of recession rather than waiting for the system to cure itself. Allowing Lehman to fall has already shown up a strategic mistake since it triggered a lot of panic among investors, spreading the crisis to Europe and resulting in WaMu’s and Wachovia’s sell-off at a fire sale prices.

The derivatives markets in India are relatively undeveloped, and investment banking activity is limited and regulated. Indian interest rates are still high, and Indian companies are not credit dependent, and do not have a huge investment in the US markets. The only predictable effects on India will be due to the slackening I.T. sector, reduced international trade opportunities and withdrawal of funds by FIIs. As long as Indian consumers keep their jobs and keep spending and infrastructure needs keep growing, India will still keep a healthy 6 - 7 % growth (not as high as last years' 9% or the predicted 8%)[11].

Nevertheless, India should look at this crisis as an opportunity to learn from what went wrong in aggressively capitalist Western economies and proactively implement regulations to avert such a crisis in the future.