Monday, August 8, 2011

The incentive mismatch with public resource allotments

Consider the example of a country whose economy is booming and a real estate bubble is inflating. The real estate boom has enriched several local land owners, some of whom have been catapulted to the super-rich category in the matter of few months and years. Some of the already rich and influential, who owned large tracts of lands, too have benefited from the boom. Since money also carries in its wake political patronage, it is no coincidence that some of them become highly influential politically. A few of them position themselves as power brokers, close to the decision-making centers, and with the influence required to "get things done".

External investors, including foreign institutional ones, are attracted by the local real estate and other asset investment opportunities. They explore avenues to purchase lands, or have government lands allotted on preferential basis (in the guise of some economic activity), or get government help in acquiring private lands. Investors with more long-term commercial objectives, like setting up manufacturing facilities, IT centers, industrial zones, etc too are not far behind. They too require large extents of land and preferably at the cheapest possible prices.

It is here that the political economy intersects with economic incentives of all participants. The prevailing exuberant environment engenders stiff competition among such investors. Atleast some of them realize that they can get a better deal from the local government and a swifter access to the action if they work through the local power brokers. It also suits them fine given the hassle-free nature of such transactions, compared to the deeply inconveniencing multiple interfaces of the regular bureaucratic channels.

The power brokers in turn actively reach out to these potential investors, alluring them with the possibility of a "single-window" access to land and other concessions, apart from regulatory clearances. They offer to serve as the informal intermediary for these investors with the government. In fact, given the huge stakes involved, some of the power brokers even become semi-institutionalized as the unofficial interface for the government with private investors, marginalizing all the regular official channels.

The incentives for mutually beneficial transactions are irresistible and most often the investors and brokers form partnerships. A web of crony capitalism results. The power broker emerges as the local partner, with a core competence in facilitating preferential land or resource allotments and expediting regulatory clearances and approvals. The private investor effectively outsources the activity of interfacing with the local government and accessing all the required resources and clearances.

He pays the cost of accessing the land or other resources, and fast-tracked clearances, as a rent or fee to the local partner. In simple terms, in return for a fee (which comes in different forms, ranging from cash payouts or bribes to outright stakes in the investment), the power broker sells his expertise in infiltrating the power-centers and getting favorable government orders to prospective investors.

The incentives are badly mis-aligned for any investor who seeks to break out and go independently. The local power brokers clog all official bureaucratic channels and makes the price of going it alone prohibitive and time consuming. The investors realize that the rents associated with the multiple channels offset most of the gains to be had from their proposed investments. Only the very large business groups (who have access to patronage at the highest levels of political establishment in the country) can afford to defect.

This could be the short summary of resource-allotment based investments in most Indian states. The political economy of such investments necessitates an unholy nexus between investors and local political power brokers. No amount of oversight and strong enforcement can mitigate the incentive distortions that exist in such environments.

The only way to meaningfully address this problem is to fundamentally reconfigure the institutional arrangements within which these transactions take place. Clarity in the terms of allotment and transparency in the process of allotment is a necessary first step in this process. Discretion-based approaches will always remain susceptible to such gaming.

Unfortunately, in the aftermath of the recent wave of resource allotment scams, most of the focus has been on strengthening the enforcement machinery. The more fundamental issue of redefining the rules of the game appears to have not generated the same level of interest.

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