April 5, 2009

Institutions and votebanks

Issue 25 - Apr 2009

Changing policy needs new institutions

THE PERCY Mistry report and Saving Capitalism from the Capitalists both mention the importance of institutional or intermediary investors. A mutual fund, pension fund or an insurance company owns shares on behalf of a multitude of small investors. This way, the small investors get rewards proportional to their holding, but exert governance control disproportionate to it as each one gets the benefit of the voter rights enjoyed by all the fund holders taken together, and exercised singly by the intermediary. The intermediary is also more qualified than the individual small investors to analyse the actions of the management. To use James Surowiecki’s jargon, the small investors have eliminated the co-ordination problem of getting together and exercising governance control together by passing it on to the intermediary fund manager.
This is theory. We saw it in practice to an extent during the Satyam fiasco, when the Maytas merger attempt was scuttled by outraged institutional investors who pulled their weight and forced Ramalinga Raju’s hand.
So what is happening here is that confronted with a principal-agent problem—the management trying to rip-off the small shareholders—the solution is actually another agent in between. But because it costs less than the costs of co-ordination and organisation, and because the incentives of the fund investors and the fund manager are broadly aligned, it generally works, and the degree of control is much better than it would be otherwise.
Now let’s look at politics and governance.
Here too, we have agent—the government of India—which has been appointed to provide public goods such as national defence, law and order, roads and dispute resolution. Tragically it has gone rogue and instead of following these objectives has gone on a reckless diversification binge, acquiring banks, and running oil companies and airports. It also provides extravagant perks to its executives, and generally bleeds resources.
The constitutional solution to the problem of executive branch gone wild is analogous to corporate governance—in the way shareholders pick a board of directors, voters elect a cabinet of ministers (though this process is not direct) to exercise control. Unfortunately we again have a co-ordination problem between the voters.
Can the financial market solution work in this context? Have a qualified intermediary to aggregate the voters, represent their interests, and exert combined control which benefits everyone? Actually, this already exists. Political parties are the intermediaries, and voters are the ‘fundholders’. But the qualified intermediaries too have decided to look out for themselves rather than their principals.
Why is this? To start with, there is no instant feedback. Political parties face feedback only every five years, at election time, unlike mutual fund managers who face the threat of instant redemptions. This is something you can’t do anything about unless you alter the Constitution and write in provisions for electoral recalls. But you don’t need to go that far. Exit is only one way of expressing dissatisfaction. The other is voice. So how do we take opinion out of the public and newspapers, and into political parties in an effective way that results in action? That requires institutions which serve as connectors between people and political parties. Building these institutions is a challenge but probably a less formidable challenge than changing the Constitution.
To some extent these institutions already exist in the form of caste- or religion-based vote banks. The trouble is that they are terrible banks which exercise no diligence—they aggregate votes and disburse them but don’t monitor performance after that.
So we need new institutions which aggregate voters and their individual power, and channel it effectively. But we also need these new institutions to be open to people on any basis, not just the identity they were born with.
Won’t institutionalising external voices in political parties leave the government vulnerable to lobbying? It will, but the government is already lobbied by the rich, powerful, and influential. Transparent institutions will provide that sort of access to the poor and poorly connected too.
This is one way of mitigating the principal-agent problem. The other is to have US-style primary elections. An objection to this is cost, especially at the scale at which they’d have to be held in India, but clever technological solutions could take care of this. The real objection is that major political parties show no inclination to adopt primaries.
One ray of hope is the smattering of new, very tiny political parties which are swearing by internal democracy, and which may eventually become competitors to the incumbents, forcing them to adapt and adopt internal democracy as well. But this is likely to be a very long, very slow process. Another is in judicial challenges and ombudsmen to ensure internal democracy. But there is no guarantee that this would work better than any government regulation.
The middle class desires change. But does it have the ability to effect change? What has appeared so far is lots of outrage, lots of protest marches and placards, lots of reactive support for ideas like ‘No Vote’, and so on. But there are no ideas for change.
There are two ways to deal with this.
The first is to claim that this is because the middle class is fundamentally immoral, ineffective and retreats from anything more intellectually challenging and feel good than a protest march or candlelight vigil.
The second is to understand that altering policy or making a meaningful impact on politics is a capability, and must be built up through institutions, and that mass outrage by itself does not develop this capability. In this view the institutions are the missing pieces—you will need to have institutions that develop policy alternatives, institutions that communicate said alternatives to the middle class, institutions that sustain middle class people coming together even after the outrage has faded. What these institutions will accomplish is a lowering of the transaction costs of people coming together and pushing ideas into policy.
So, when we talk about going out and voting it  is like appealing to people to save so that there is capital for investment. But we need to talk about how do you ensure that the information conveyed within the vote is not lost? For that—just as you need a banking or market system to intermediate savings into capital, you need political interface institutions to intermediate opinion or expressed/ unexpressed desires into policy.

Change can come from new votebanks
Ravikiran Rao

One result of the principal-agent problem is that voters themselves end up seeking sub-optimal policies. The caste- and religion-based groups are an example of this. Suppose that there are two choices to improve your condition in a particular town. You could either have a good quality road built to it, or you could have someone from your caste get the contract for the road and build a substandard road. Governance is so bad that people end up choosing for the latter because they have no hope of getting the former.
A similar problem afflicts the “leader”. He would like nothing more than cutting out the intermediaries and form a contract directly with the people. But because of the party system, the parliamentary system and the nature of India’s governance, he has no choice but to pander to the intermediaries. So, you can either build a road and make lots of people happy, or give the contract to a caste-leader so that he is happy and he gets you votes from his caste. In theory, the former option should be more cost effective for you. The problem is, unless you have superlative administrative and political capabilities, you will end up with a bad and long delayed road anyway, and you end up making enemies out of intermediaries. The last decade has been marked by attempts by leaders to break out of this logjam. Chandrababu Naidu’s was the most famous attempt, but there were others. Digvijay Singh tried it in Madhya Pradesh. It is only now, though, that we are seeing the first stirrings of success—Narendra Modi and Naveen Patnaik have been succeeding in providing good governance and getting votes on that basis.
So, that is one path to improved governance—disintermediation, rather than an improvement in quality of the intermediaries. Quite clearly, that is not sufficient. We also need improved quality of intermediaries. The real hope is in the rise of mass movements among the middle class. Back when we did not have a real middle class, the faux middle class used to get things done by pulling strings for themselves—for instance, by making phone calls to friends of friends who had access. This, needless to say, was opaque and exclusionary. The poorer classes used to work through their ‘leaders’ who of course enriched themselves and gave only caste pride in return for votes. Now, we have a real middle class that can and is demanding institutional changes. Even if these changes are for themselves, it is less opaque than what they were doing earlier and more scalable. Television, technology and urbanisation is enabling this change.
As to the speed of the change, there is no need for pessimism. First, these kind of things take time. Second, because of the nature of India’s political system, the progress will be discontinuous—the middle class is larger than its political influence is. The political influence is small because even though the size of the middle class is large, it are not large enough to influence outcomes in any one constituency. When this eventually changes, it will change in a lot of constituencies. Third, it take less time than expected—the pro-urban delimitation should prove an inflexion point. Mumbai, for example, has a strong tradition of citizen activism and local institutions that go beyond Facebook groups. If we are to see a change, we should see it first there, and indeed we can. In Bandra, citizens have managed to elect as corporator, an activist with the rather charming name of Adolf D’Souza.  Fourth, we will see that change comes, it will not be in a shape we can recognize.
The last point requires some elaboration. It is a mistake to assume that the Facebook groups and the groups that conduct candle light vigils represent the real media through which change will be effected. These are like the Indian Nationalist movement before Tilak and Gandhi converted it into a mass movement.  They will provide a starting point that will be adopted by the “real” middle class in unintended ways. While the actual outcomes will be discontinuous, the underlying trends that cause those changes will probably be a continuation of existing ones. We may not see a party of pure good governance in the near future. But good governance in coalition with national security, national pride and greatness and cultural nationalism? Maybe we will get it.
Finally it is accurate to characterise voting as an enabler. True, it is not a sufficient step—but it is a necessary one. Whether change will come about through existing parties hearing middle class voices or through new institutions, the factor that will decide whether candlelight vigils are heeded or not is whether those vigils are backed by votes. Even if the algorithm for your vote is “Throw the current set of rogues out and bring in the new rogues”, as long as you do it  repeatedly, you increase the chance that one of those rogues figures out that he can retain power by being less of a rogue.

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