1. Class Exercise: Quiz Time!
 Quizzes of the Karnataka Quiz Association (of
which I was founder secretary in 1983!),
there‘s a concept called a Theme or Connection
 You get bonus points if you can connect the
answers to a bunch of questions by a theme
that holds them together
 Let‘s try one such Theme/Connection round
 Put down your answers and raise your hands
when you think you have the Theme
 You‘ll have to justify why you think your
answers to individual questions connect with
the theme
 Don‘t announce your answers aloud … PLEASE!

2. 1. Identify the country

3. 2. Who took this picture?* What
does it depict?
*Hint: She featured in a film showcasing an Indian icon

4. 3. Identify this man (really, he‘s a
man, not a God as previously thought)
PS: Bonus points for identifying origin of painting

5. 4. Ripley‘s Believe It or Not!
This guy is a professor! Who?

6. 5. Who‘s the magician, in this
doctored image of a TIME cover?

7. 6. Identify this gentleman

8. And the Theme?

9. CHALLENGES OF REGULATION

10. We actually got something right!
 When the worldwide bull run/bubble was
going on, ―We kept wondering if they had
figured out something that we were too
dense to figure out. It looked like they were
smart and we were stupid.‖ Luis Miranda,
ILFS Infrastructure
 Instead, India was the smart one, and we
were the stupid ones –Joe Nocera, NY Times.

11. An American Journalist Talks to
Indians
 How could we have brought so much trouble
on ourselves, and the rest of the world, by
acting in such an obviously foolhardy
manner? Didn‘t we understand that you can‘t
lend money to people who lack the means to
pay it back? The questions were asked with a
sense of bewilderment — and an occasional
hint of scorn. Like most Americans, I didn‘t
have any good answers. It was a bubble, I
would respond with a sheepish shrug, as if
that were an adequate explanation. It isn‘t,
of course.
 Joe Nocera, New York Times

12. How India Was Saved
 ―In India, we never had anything close to the subprime
loan,‖—Chanda Kochhar, ICICI ―All lending to
individuals is based on their income.‖
 ―Indian banks are not levered like American banks.
Capital ratios are 12 and 13 percent, instead of 7 or 8
percent. All those exotic structures like C.D.O. and
securitizations are a very tiny part of our banking
system. So a lot of the temptations didn‘t exist.‖ –
Chanda Kocchar, ICICI
 ―When the bubble was going on, we did not change any
of our policies. We did not change any of our systems.
We did not change our thought process. We never gave
more money to a borrower because the value of the
house had gone up. –Deepak Parekh, HDFC

13. Reasons for India‘s Escape-1
 Part of the reason is cultural. Indians
are simply not as comfortable with
credit as Americans. ―A lot of Indians,
when you push them, will say that if
you spend more than you earn you
will get in trouble,‖ an Indian
consultant told me. ―Americans spent
more than they earned.‖

14. Reasons for India‘s Escape-2
 But there was another factor, perhaps the most important
of all. India had a bank regulator who was the anti-
Greenspan. His name was Dr. Y. V. Reddy, Governor of
the Reserve Bank of India.
 70% of the Indian banking system nationalized, so a
strong regulator is critical, since any banking scandal
amounts to a national political scandal as well.
 Reddy was the right man in the right job at the right time.
 ―He basically believed that if bankers were given the
opportunity to sin, they would sin,‖ said one banker
 For all the bankers‘ talk about their higher lending
standards, the truth is that Mr. Reddy made them even
more stringent during the bubble.

15. Bankers Lavishing Praise
 The underlying risks of having ―a majority
of loans not owned by the people who
originated them‖ was not apparent during
the bubble. Now that those risks have been
made painfully clear, every banker in India
realizes that Mr. Reddy did the right thing
by limiting securitizations. –Chanda
Kochhar, ICICI
 ―At times like this, you tend to appreciate
what he did more than we did at the time,‖
–Rana Kapoor, Yes Bank.
 ―He saved us,‖ –Deepak Parekh, HDFC.

16. Let‘s Hear Yaga Venugopal Reddy
 'India has been largely protected because of the
decisions we took,' –YV Reddy
 'This was because of the regulatory framework
that restricted exposure of our banks and
financial institutions to risky financial products,
specifically, complex derivatives.
 'What is happening across the globe is due to
regulatory failure. Firstly, some parties such as
hedge funds and rating agencies were regulated
very, very lightly. Then there was a failure to
understand derivative products,' –Y V Reddy.

17. Regulatory Failure Worldwide
 How did it happen?
 What are the consequences?
 The case of the Global Financial Crisis

18. A Crisis that puts us on the Verge
of Another Great Depression
 Paul Krugman, Nobel Laureate 2008
 ―this crisis bears some resemblance to
the Great Depression‖
 Well, the current mess in the Global
market is THE WORST since the great
depression on 1929.
 The US bore the brunt of the Great
Depression; this time the effects are
spread across the globe

20. The Key Differences
 Unlike during the Great Depression, when
governments acted too little or too late, this time
around governments around the world are
rallying to rescue the financial system
 In the Great Depression there was no work and
there was widespread poverty. People struggled
through the winter with no heating and no food.
 Then, a quarter of all Americans were without
jobs. Today, unemployment in the US is at 6.1%
… bad but not disastrous
 And the US of today is still an inventive,
resourceful, resilient nation

21. How Did This All Happen?
Root Causes of the Crisis
 Mortgage Backed Securities
 Innovative Financial Instruments
 Derivatives
 Credit Default Insurance
 Insufficient Regulation
 Globalization of Finance

22. Root Cause: Faulty Assumption
& the Housing Bubble
 Created by the assumption that housing
prices will continue to go up without end
 Mortgage brokers get paid for sourcing
new mortgages—incentive is to sell more
 Thus sold mortgages to people who did
not have ability to pay: SUBPRIME loans
 Logic: since house prices will go up, even
if a loan defaults, you still make a profit

23. Risk Spreading and Derivatives
Markets, Globalized
 The last few decades have seen risk being
extracted, packaged, and sold globally through
innovative financial instruments like Collateralized
Debt Obligations—CDOs
 (It‘s when these became illiquid and homeowners
started to default on the underlying securities that the
market collapse started)
 And the ―quants‖ at investment banks have created
all sorts of new derivatives
 These help to manage risks & create new markets
but are not fully understood by regulators or firms
 In particular, Credit Default Swaps, were not
regulated carefully

24. Rating Agencies‘ Failure
 Moody‘s, Standard & Poors, and other rating
agencies were supposed to evaluate these
mortgages and CDOs and rate their risk levels
 Instead, they gave bogus high ratings to
trillions in dubious mortgage-related
investments and CDOs
 ―The story of the credit rating agencies is a
story of colossal failure,‖ Rep. Henry Waxman,
D-Calif., chair of the House Oversight and
Government Reform Committee

25. Other Systemic Factors
 Financial Times:
 The deep squeeze on household and
corporate incomes from the commodity
boom of the first half of 2008, which almost
no one predicted, weakened the non-
financial sector before banks had any
chance to repair the damage from the
subprime crisis and was a crucial element
of the disaster that unfurled this autumn"

26. Swaminathan S Anklesaria
Aiyar‘s List of Culprits
 Alan Greenspan & Federal Reserve
 Presided over bubbles in housing, credit, and
stock markets
 US Politicians
 Wanting to provide a home for every American,
they pushed Fannie Mae and Freddie Mac to
underwrite 80% of US mortgages, without
sufficient regulation
 Fannie Mae & Freddie Mac
 Bought toxic debt wanting short term profit

27. …
 Financial Innovators
 Derivatives provided cheap, easy credit,
leading to global boom of last 5 years
 But complex instruments hid risks
 Credit Default Swaps insured bonds against
default. But grew to $60 trillion. When
markets fell and defaults widened, those
holding CDSs faced disaster
 Regulators
 Everywhere did not intervene carefully

28. …
 Banks and Mortgage Lenders
 As they were packaging and selling loan
portfolios, they did not check the
creditworthiness of borrowers
 Investment Banks
 Borrowed heavily to play the market
 Rating Agencies
 Allowed BBB mortgages to be seen as AAA
 Basel Rule for Banks
 Relaxed rules; Iceland banks had 10 x GDP

29. …
 US Consumers
 Spend far more than they earn, leading
to zero or negative savings
 Asian and OPEC Countries
 Undervalue currency to stimulate exports
and generate trade surpluses with US
 Buying US securities lowered interest
rates thereby leading to more borrowing
 Everybody
 Nobody wanted to be the party pooper

30. Warnings Were Ignored
 Northern Rock Bank collapse in UK
 Bear Stearns bailout in US
 Warnings by ―Dr. Doom:‖ Nouriel Roubini of New York
University
 Hedge funds short selling was curbed
 This could have sent correct signals
 But there is concern about speculative and market
manipulating short selling
 Overall, it seems governments have little institutional
memory: remember Long Term Capital Management,
the Savings and Loan Crisis, etc.
 And real-estated induced crises in Japan, Sweden, etc

31. Scale of the Underlying Problem

32. Impacts
 Collapse of US Investment Banks
 Liquidity and Solvency Crunch
 Collapse of Economies: Iceland
 Potential Worldwide Depression

33. Liquidity Crisis Impacts in US
 Fannie Mae and Freddie Mac placed into
conservatorship, i.e., nationalized
 Lehman Brothers declared bankruptcy after
failing to find a buyer
 Bank of America agreed to purchase Merrill
Lynch
 AIG got an $85 billion rescue package;
Federal Reserve would receive an 80% public
stake in the firm.
 The biggest bank failure in history occurred
when JP Morgan Chase agreed to purchase
the banking assets of Washington Mutual

34. Further Damage Possibilities
 Job Losses
 Leading to Credit Card Debt Default
 And the Big 3 Automakers Now Want
Help!
 Chrysler is being sold to FIAT
 And the US government is buying up a
large share of the iconic General Motors

35. US Government Actions
 Initial estimates $700 billion to $1 trillion
 As of mid-November, it was estimated that the new
loans, purchases, and liabilities of the Federal Reserve,
the US Treasury, and FDIC, brought on by the financial
crisis, totalled over $5 trillion:
 $1 trillion in loans by the Fed to broker-dealers through
the emergency discount window
 $1.8 trillion in loans by the Fed through the Term
Auction Facility
 $700 billion to be raised by the Treasury for the
Troubled Assets Relief Program
 $200 billion insurance for the GSEs by the Treasury, a
 $1.5 trillion insurance for unsecured bank debt by FDIC

36. So What Are We Witnessing?
 A transition from a capitalist economy to a
socialist regime?
 No, the financial sector has always been
regulated intensively
 Now the difference is that we are trying to
ensure that the failures in the financial
sector and its regulation do not cripple the
functioning of the larger economy
 And so we are rethinking the role of
government, in line with the ideas of John
Maynard Keynes

37. A New Keynesianism
 Keynes: To combat depression,
governments should jump start
growth through aggressive
public spending
 Public spending has a multiplier
effect but will also increase fiscal
deficits (print notes!)
 But this is OK as long as
economies recover and grow
 Along with cash, we need to
maintain Confidence
 Hence the bailout of large
financial institutions

38. Then and Now

39. Class Exercise:
Identify this Innovative Company
 It began as an energy producer in 1985 following the
merger of Internorth & Houston Natural Gas.
 It was the first to realise energy and water could be
bought, sold, and hedged just like shares and bonds. …
 It became a huge "market-maker" in the US, acting as the
main broker in energy products, also taking financial
gambles far bigger than its actual core business.
 As a result, in just 15 years it grew from nowhere to
become America's seventh largest company, employing
21,000 staff in more than 40 countries.
 Fortune magazine named it "America's Most Innovative
Company" for six consecutive years from 1996 to 2001.

40. And then things began to unravel
 Its trading operations relied heavily on
complicated transactions, many relating to deals
many years in the future.
 Many of these gambles on future energy prices
were losing money, and to disguise this a network
of dubious "partnerships" were created - devices
for keeping debts off the balance sheet (& in
offshore settings) & thus keeping profits high and
shareholders happy.
 It is alleged that these partnerships bought losing
businesses from the company to boost its balance
sheet.

41. Until the sh*t hit the fan
 Many executives allegedly made massive profits
by selling shares before the company's problems
went public and its stock price collapsed.
 It achieved infamy at the end of 2001, when it
was revealed that its reported financial condition
was sustained mostly by institutionalized,
systematic, & creatively planned accounting fraud.
 As it collapsed, it left behind $31.8bn of debts, its
shares became worthless, and 21,000 workers
around the world lost their jobs.

42. If you haven‘t figured it out by now …
 Who is this?
 She spearheaded
this company‘s
entry into India?
And built this.

44. So How Did All This End Up
Happening?

45. George Will
Conservative Commentator …
 The problems revealed by Enron‘s collapse are ―rooted in
recent changes in US legal, financial and accounting
professions,‖ [and] an ―epidemic of aggressiveness in the
1980s, when all three professions began to think of
themselves as ‗can do‘ people—‗problem solvers‘ who ‗think
outside the box.‘‖
 The result of this mentality and the increasing use of stock
options, was a ―hyper-aggressive management cadre
continually trying to impress analysts with ambitious targets
for growth in stock values. When the targets were met, the
analysts raised the bar, and sometimes the ever-higher
expectations could not be met without financial and accounting
practices that were the equivalent of steroids.‖
 The primary cause of Enron‘s ―risky behaviour‖ was the
―growing arrogance of executives who became confident that
no-one was looking over their shoulders, watching—and
understanding—what they were doing.‖

46. Paul Krugman
Economics Guru …
 ―Crony Capitalism: American Style‖
 ―The Enron debacle is not just the story of a
company that failed; it is the story of a system
that failed. And the system didn‘t fail through
carelessness or laziness; it was corrupted.‖
 ―The Enron affair has revealed that the
institutions governing the capitalist economy,
including modern accounting rules, independent
auditors, securities and financial market
regulation, and the prohibitions against insider
trading have been corrupted.‖

47. Impacts of the Enron Collapse
 In 2002, the Enron scandal caused the
dissolution of Arthur Andersen, which at the
time was one of the world's top five accounting
firms.
 Arthur Andersen was convicted of obstruction of
justice because key partners shredded
documents related to its audit of Enron
 Since the U.S. Securities and Exchange
Commission does not allow convicted felons to
audit public companies, the firm agreed to
surrender its licenses.
 In 2005, the Supreme Court overruled the
conviction on technical grounds

48. Enron was hardly the only company
rigging the system
 Many other companies took advantage of regulatory
gaps such as insufficient enforcement of disclosure
requirements, excessive reliance on peer review for
auditors, and inability to keep brokerage and
investment banking activities separate.
 Brokerage firms took fees for offering a preferred list
of firms. For example, Morgan Stanley had failed to
inform investors of the compensation it received for
selling certain funds.
 Under diffuse shareholding and independent
managers, as prevail in the US, the information
asymmetries between the principals and their agents
become acute and require active regulatory
intervention.

49. Regulatory Reactions to Enron
(and Other Corporate Scandals)
 As a direct result of Enron and other scandals, the US
Congress passed a tough new law, called Sarbanes-
Oxley, which imposes stricter rules on auditors &
makes corporate directors criminally liable for lying
about their accounts.
 The Act establishes a new quasi-public agency, the
Public Company Accounting Oversight Board, to
oversee, regulate, inspect, & discipline accounting
firms in their roles as auditors of public companies.
 The Act also covers issues such as auditor
independence, corporate governance, internal control
assessment, and enhanced financial disclosure.
 Considered among the most significant changes to US
securities laws since the New Deal in the 1930s.

50. How Did Enron Get Away With
All This?
The Political Economy of
Lobbying

51. Enron‘s Lobbying Prowess
—All Perfectly Legal
 Enron had the loyalty of Texas until it collapsed
 Houston's "kingmaker" Kenneth Lay, CEO of Enron,
secured that loyalty through a potent combination of
money, lobbying and a ―revolving door‖ through which
employees went in and out of government
 Enron spent $10.2m influencing Washington
politicians. During 1997-2000, it gave $1m to Texas
political action committees and state candidates, and
spent $4.8m on 89 Texas lobby contracts
 Justices of the Texas Supreme Court (who are elected)
received $134,058 from Enron since 1983.
 In 1996, a conflict arose when the justices reversed a
lower court decision to cut $15m off inventory taxes Enron
owed a school district.

52. The Political & Economic Payoffs
 Ken Lay‘s friend, Gov. George W. Bush's "gifts" to Enron:
 Deregulated the state electricity market
 Went easy on corporate air polluters
 Supported laws protecting business from lawsuits.
 Enron was able to convince people it was the future:
 "The message Ken Lay peddled is, 'We are going to be the
most important company in the world. We are going to
change every market'." It was a message the Texas
government was eager to hear and promote for the
betterment of the state.
 Enron paid Wendy Gramm, wife of Texas senator Phil Gramm,
$50,000 a year to be on its board. Enron hired her in 1993,
within weeks of her leaving the top job at the Commodity
Futures Trading Commission, where she started the
deregulation of energy futures markets.

53. Perspectives on Regulation

54. What is Regulation?
‗A government imposed limitation on the
behavior of individuals or organizations.‘
Regulation can be defined as government
intervention in markets to influence
those decisions of private agents that
would otherwise not fully consider public
interest.

55. Justifications for Government
Intervention and Regulation
 Correction of Market Failures
 Correcting Externalities like Environmental Pollution
 Regulating Actions of Natural Monopolies
 Utility Pricing
 Merit Goods and Setting Standards
 Health care related areas, public morals
 Redistribution and Equity
 Minimum wage or rent controls

56. Techniques of Regulation
 Control of price
– Aimed at preventing predatory pricing and over
charging.
 Control of quantity
– Universal service obligation, maximum production
limits.
 Control of entry
– e.g. in long distance telecoms and NYC taxicabs
 Control of quality
– e.g. of emissions, customer service levels, safety etc.

57. Instruments of Regulation:
Environmental Policy Case
 Command and Control
 Bans
 Standards
 Technology Choices
 Economic Incentives
 Taxes (Fees)
 Subsidies
 Liability
 Tradeable Permits
 Information Provision
 Check www.scorecard.org

58. Theories of Regulation

59. Public Interest Theory of Regulation:
Pigou
 Regulation needed to correct for market failures,
including lack of competition (monopoly)
 Assumptions:
 Government are benign and capable of
taking care of these market failures
effectively
 This justification for Regulation is seen as
promoting growth of government.
 Counterarguments:
 Private players will behave well—Reputations matter
 Cartels usually collapse
 Markets subject to potential entry by competitors

60. Regulatory Capture & Rent Seeking
George Stigler: The Economics of Regulation

61. Stigler‘s Economics of Regulation
 Regulation is actively sought by the regulated party
 Rational political class provides it
 Concentrated interests provide votes and resources to
political sector to attain goals
 Preferred over direct transfer of resources to industry as
subsidies encourage new entrants
 Diffuse nature of loss ensures no significant opposition
 Methods: tariffs, quotas, occupational licensing
 Capture: information for regulator comes from regulated
 Justifications: public interest [oil security (Oil Import Quota),
helping airlines grow (Air Mail Subsidy), quality health care
(American Medical Association)]

62. Example: The Oil Import Quota
 Public Interest Justification:
 In the interest of national security, it is important
for the USA to have a strong domestic oil industry
 Therefore the import of foreign oil should be
restricted through quotas
 Thus dependency on outside entities minimized
 Economic Impact:
 Higher cost, domestic oil producers get assured
captive share of the market
 No wonder the regulated seek regulation!

63. Civil Aeronautics Board &
Regulation of Airlines, USA
 The Civil Aeronautics Board was set up to help the
fledgling airline industry take off
 It allocated routes and regulated pricing
 Captured by regulated entities
 Throughout its tenure, no new airlines were set up
 It was disbanded in the 1970s, during Jimmy
Carter‘s presidency
 Main airlines in regulated era—TWA, Braniff,
Eastern, etc., collapsed once competition came in
 Since deregulation, there has been a shakeup in
the US airline industry and re-consolidation
 Prices are low on busy routes & high elsewhere

64. Regulation is Political: Rent Seeking
 Every interest in society will try and create a
monopoly position for itself, using the government
to ensure this (or at least entry/trade barriers). This
way, that interest will capture (monopoly) rents for
itself at the expense of the consumer.
 Rent seeking techniques: tariffs, quotas, &
government contracts; favorable regulatory action
 Rent seeking leads to inefficient expenditures
(bribes, bureaucratic angling for key posts,
suboptimal investments, wasteful competition
between economic interests for government favor)
 In a sense, regulatory arena is another marketplace
where interest groups compete for spoils

65. Wilson‘s Critique of Economic Analysis
of Regulation
 Economic arguments interesting but too simple
 World is full of regulatory activity that affects
concentrated economic interests harshly (e.g.,
EPA regs & auto industry, FDA regs and drug
approval)
 ―Captured‖ regulatory bodies like CAB got
eliminated
 Look back at origin of regulation, typically in
public interest & large coalition support (Civil
rights, environmental protection, drug safety, etc)
 Lots of opponents out there in society to
counterbalance concentrated economic interests

66. The Enforcement Theory of
Regulation
Andrei Shleifer: Understanding Regulation

67. Regulation: Between Disorder & Dictatorship

68. Design Regulatory Frameworks
Based on Prevention of Abuse
 All strategies for social control of business are imperfect
 Optimal institutional design involves a choice among these
imperfect alternatives.
 The enforcement theory specifically recognises a basic trade-off
between two social costs of each institution:
 Disorder—the ability of private agents to harm others
 Dictatorship—the ability of the government and its officials to
impose such costs on private agents.
 As we move from private orderings to private litigation to
regulation to public ownership, the powers of the government
rise, and those of private agents fall.
 Social losses from disorder decline as those from dictatorship
increase
 This tradeoff is called the Institutional Possibility Frontier

69. Regulatory Enforcement and India:
The Case of Bt Cotton

70. Bt Cotton
 Bt Cotton is produced by inserting a synthetic version
of a gene from the naturally occurring soil bacterium
Bacillus thuringiensis, into cotton.
 The primary reason this is done is to induce the plant
to produce its own Bt toxin to destroy the bollworm, a
major cotton pest.
 The gene causes the production of Bt toxin in all parts
of the cotton plant throughout its entire life span.
 When the bollworm ingests any part of the plant, the
Bt cotton toxin pierces its small intestine and kills the
insect.
Source:
http://www.greenpeace.org/india/campaigns/say-no-
to-genetic-engineering/ge-crops-in-india-the-story

71. Why use genetically engineered
cotton when pesticides exist?
 When cotton farming was introduced as a lucrative
alternative to food crops in the 1980s, farmers
invested in expensive varieties of seeds and
pesticides. When crops failed, small farmers found
themselves severely indebted.
 Indebtedness triggered a spate of suicides.
 Crop failure was caused basically by the resistance
the American bollworm insect developed to all kinds
of pesticides and pesticide cocktails.
 Farmers found themselves on a ―pesticide treadmill'
where higher pesticide use led to greater resistance
which in turn led to even higher pesticide use, …
 Manufacturers of Bt cotton argued that the
genetically engineered plants would be resistant to
pests at low costs

72. Risks of Bt Cotton
 Economic risks:
 Crop failure possible even with the use of this technology
 Ecological risks:
 Increased Pest Resistivity:
As the insects feeding on the Bt crops are exposed to the
toxin regularly, they can develop quicker resistance. If this
happens, both the genes in transgenic plants and Bt
sprays will be rendered ineffective.
 Gene flow to wild relatives=>Super Weeds:
As Bt crops are grown close to their wild relatives, it is
possible that the Bt gene can spread to them through
pollen transfer. The new genes in the wild plants may
produce enough toxins to ward off insects that normally
feed on them. Some of the wild plants could grow hardier
and act as weeds. This technology can also contaminate
other species, as transgenic plants displace other plants.
 Political risks:
 NGOs active in opposing Bt cotton; taking direct action

74. NGO Opposition to Bt
Cotton & GM Crops

75. So when Monsanto applied for
permission to sell Bt cotton seeds,
government decided to regulate
 Regulatory Response relied on hierarchy
 Expertise driven—led by scientific establishment
 Multiple ministries involved—Biotechnology,
Environment; some less so (eg, Agriculture)
 Top down—driven by Delhi; states less involved,
even though they have to implement
 Field level science not well integrated—agricultural
university scientists not fully involved
 Non-formal voices kept out—NGOs, Farmers

76. Rational vs Hybrid Regulation:
Scoones (2005)
 Professed Ideal
 Rational, science-based process, whereby guidelines
developed centrally by experts are enshrined in law and
implemented by bureaucrats with assent of politicians
 Actual Reality
 Regulations emerge through a political process of
negotiation among a wide range of actors in multiple
sites … an uneven compromise based on technical,
social, political and sometimes moral considerations
 Thus
 There is a process of ‗co-construction‘ of regulatory
policy, operating in a hybrid world that straddles
science, business, and government interests

77. Regulatory Process for Monsanto-
MAHYCO
 Elaborate scientific tests of Bt Cotton
seeds
 Monsanto-MAHYCO goes through long
testing period before field trials
 Testing process highly contentious on
ground with NGO protests, e.g.,
destroying test beds
 Various protection measures insisted
upon—refuges of non-Bt cotton
 Process may have been significantly
long and arduous because applying
party was Monsanto
 Process subject to significant NGO
scrutiny, particularly using courts

78. The Regulatory Assumptions versus
The Ground Reality
 Regulators grant approval based on safety
measures, e.g., refuges
 Small farmers unable to provide environmental
refuges of non-Bt cotton
 Regulators assume that state and district
administrations can police Bt cotton use
 State and district administrations not up to task
 Seed market fragmented, unorganized, non-formal
 Regulators assume scientists inspect correctly
 Scientific teams feel process inadequate
 Attention entirely focused on Monsanto

79. Meanwhile, back on the farm …
 Farmers in Gujarat found to be planting
seeds with Bt
 Seeds obtained from Navbharat, which
claims its their own hybrid
 Legal action against Navbharat initiated by
government and MAHYCO
 Central government orders destruction of
Bt cotton crop
 Gujarat state government balks—says it is
unable to compensate growers for cotton
destruction
 Uneasy regulatory stalemate prevails

80. So, the Bt is Out of The Bag
 Bt cotton seeds are now
widely available
underground/camouflaged
 Hybridization with local
cotton variants rampant
 Regulation of seed sellers
practically impossible
 Growing practices do not
emphasize safety
 Overall, a failure of the
regulatory process

81. The Regulators

82. Behavior and Politics of
Regulatory Players
 Behavior of agency: depends on appointee type
 Careerists: work to cover their flanks, risk averse, but
also pass strong rules to survive
 Politicians: may take activist role, especially in
preparation for future political office
 Professionals: peer group outside agency, in profession,
eg, law, medicine, => activism
 Perceptions key:
 If any group seen as unfairly benefiting at nation‘s expense,
there will be a countervailing force to eliminate this. Lots of
interest groups exist to counter and fight
 Political process accessible; e.g., thru media, judiciary
 (Bad implementation because of nature of challenge?)

83. Regulatory Actions and Paradoxical
Outcomes

84. Paradoxes of Regulation
 A Regulatory Paradox is a Counterproductive Regulation:
 eg, A Clean Air Act that actually makes air dirtier
 Overregulation produces underregulation:
 Implementability difficult/unjust so bureaucrats/judges
won‘t implement regulation/law;
 eg, 3 strikes & you‘re out law => more out of court
settlements
 Stringent regulation of new risks can increase overall risk
levels:
 Older, riskier cars & drugs stay; new versions kept out
 Best Available Technology retards technological development
 Industry has no incentive to show feasible improvements

85. …
 Redistributive regulation harms those at bottom of
socioeconomic ladder
 Minimum wage laws freeze out marginal job seekers;
 Rent control laws dry up rental property provision
 Disclosure requirements make people less informed
 overload, people process information differently
(heuristics & biases); inability to counteradvertise against
tobacco
 Independent agencies are not independent
 Can get captured or influenced by regulated entities
 Magnitude of counterproductive reaction is key:
Sometimes some amount of inefficiency is OK

86. Former US Sen. Mike Gravel on
Legalizing Drugs
 http://www.youtube.com/watch?v=3
8ma-nUmySo&feature=related

87. India‘s Regulatory Environment

88. Liberalization: Government as
Facilitator
 India liberalized its economy in 1991
 Since then many sectors have been thrown
open to private participation
 The government has worked to create
appropriate regulatory frameworks
 Opening of some sectors to participation by
international players has meant that Indian
regulatory institutions and frameworks
have to meet international best practices

89. The Challenge of Capital Market
Regulation in India
 Capital markets provide effective
intermediation of savings, allocation of
investment, price discovery, pricing and
hedging of risk; but they are subject to
information imperfections, excess volatility,
and market manipulation.
 The regulator has to be something like a
policeman, but a smart one, who preserves
market integrity through clear and self-
enforcing rules of the game while
encouraging the game itself.

90. SEBI and the Financial Sector
 Securities and Exchange Board of India,
tasked with:
 Regulating securities and stock markets
 Establishing monitoring, surveillance and
implementation of world class rules
 Regaining investor confidence after major scams
(Harshad Mehta, Ketan Parekh)
 Creating a deeper market that protected the
small investor
 Successfully pushed systemic reforms, drove the
movement toward paperless transactions, T=2
settlements, etc.
 Still considered weak in terms of enforcement of
penalties against violators

91. Telecom Sector
 Challenge:
 How to provide a level playing field in
the presence of a dominant publicly-
owned player with bureaucratic support?

92. Department of Telecommunications and
Telecom Regulatory Authority of India
 DoT
 Allocates territorial licenses for mobile telephony
 Criticized for numerous changes in policy
 Criticized for allowing backdoor entry to
Reliance into mobile telephony
 Highly politicized?
 TRAI
 Sets rates
 Enforces Universal Service Obligation
 Weak in terms of enforcement power
 Packed with retired bureaucrats rather than
other sector experts

93. Courts as Regulators: The PIL

94. Courts step in when Bureaucracy Fails
 Bureaucracy (& legislature) fail to regulate or
enforce pollution laws effectively
 Normally, since pollution costs are diffused
over society, collective action problems would
have prevented public opposition
 But courts have allowed individuals to file
Public Interest Litigations (PILs) on behalf of
an affected public: judicial innovation!
 Has led to courts having more impact on
pollution control than legislature or executive
 E.g., forced Delhi government to act on CNG

95. Role of Judicial Process
 Courts have admitted cases under
Article 21 (Right to Life) (MC Mehta‘s
PILs)
 Courts have:
 Invoked ―polluter pays‖ principle
 Given a clear market signal that polluting
activities of industry will not be tolerated

96. Limitations
 PIL-based litigation seems to depend
on individual judges and their
propensity to be activists
 Judicial intervention is too often too
late and many cases are dismissed as
the damaging actions have already
occurred and can‘t be overturned
easily.