The Governor of the Reserve Bank of India has been a source of inspiration for this column on more than one occasion in the past. In tune with the general theme of this column, his utterances have led to reflection upon some aspect of managerial economics or an inquiry into a facet of operations management.
He did not disappoint this columnist even when he has announced he would demit office when his current term ends in early September. Only, on this occasion, it’s not so much what he said while announcing his intention to return to academia as what his critics and supporters in the media and the corporate world are saying about his impending departure, that has provided fodder to one’s journalistic mill.
His supporters are legion, covering individuals from fields as diverse as banking and politics, manufacturing and the film industry. If someone like Soha Ali Khan can tweet her disappointment at Raghuram Rajan not getting an extension, one can easily imagine the rock star status of the incumbent Governor of RBI. They argue that he is the best in the business.
On the other hand, his critics, at least the more sober ones, point to his record of not having cut interest rates adequately enough, neither on lending by it to financial market players nor when it resorted to borrowing from the market as part of a policy of mopping up liquidity. His failure to do so has had a cascading impact on interest rates in the system, to the detriment of growth impulses in the economy.
Problematic assumption
If his supporters had merely alleged that there was politics behind his term not being extended, nothing more need be said. But they have also gone on to claim that he was the best in the business for the role of RBI Governor. That is a problematic assertion.
As Governor of RBI, he is like the CEO of a corporation. To assert that anybody else chosen to head the RBI would be an inferior candidate in comparison to the present incumbent goes against all canons of management theory on the selection of a CEO. Conventional managerial wisdom has it that the process of selecting a CEO is more an ‘art’ than a ‘science’.
In other words, the best that one can say is that the candidate so chosen would deliver on shareholder expectations. Whether a better candidate is available somewhere in the world is impossible to know. This is as it should be. The difficulty starts with objectively establishing the parameters of what the CEO is expected to deliver before one starts evaluating competing candidates on their relative abilities to deliver on those parameters.
Selecting a CEO
There is no dispute with the notion that a CEO must deliver value to shareholders, much like a coach of the national football team must win the Olympic gold. The difficulty lies in assessing what needs to be put in place in order for the soccer team, or the CEO of a company, to secure these outcomes. Absent such a clear perception, the selection process is always going to be a search around vague parameters or attributes with no guarantee of a successful outcome.
That is not all. Even if there is a clear roadmap to reach the goal, it is never easy to assign suitable weightages for the various capabilities of a CEO and their contribution to achieving the desired outcome. For instance, how much weightage should be assigned to whether the prospective CEO has the relevant industry background.
If the task is one of selecting a CEO for an automobile company, should the candidate have already have worked as a CEO in some automobile company? Should he have had the experience of having worked as a CEO in either the automobile sector or in some other industry? How relevant is the CEO experience in a smaller company? All questions that are not easy to answer.
Choosing an RBI Governor
Choosing the Governor of the RBI is as challenging. It is generally assumed that the RBI chief is tasked with ensuring price stability and should simultaneously take steps to promote economic growth. As objectives go, it seems, on the face of it, there is clarity. But shades of fuzziness lie beneath. Questions arise on how compatible these two goals (growth and price stability) are with each other or how much growth one can sacrifice for what degree of price stability. Macro economic theory has no clear-cut answers. Such issues are neatly skirted in the facile belief that they will be tackled as and when they arise.
So, even the goal is not defined anywhere near the precision with which a national football association would be able to say that it sees a prospect of winning the Olympic gold medal. Throw in the difficulty of choosing with any degree of conviction a particular development strategy, and the impact it would have on pushing up economic growth and the time-frame within which it begins to have such an impact the difficulty in spelling out the road-map from a clearly articulated goal can be easily imagined. How does one then say who is best qualified to lead the RBI? Throw in other imponderables such as whether the candidate so chosen should have a Ph.D in economics, experience in public administration, knowledge of commercial banking, and so on… and the difficulties only get compounded. That is not all.
CEO competence and shareholder wealth maximisation are not continuous functions where, for every marginal variation in competence, there is a measurable change in corporate outcome (wealth maximisation). It is possible that it is a discrete function with constant outcome for a wide range of competence levels. Extending that analogy, one could say that given a range of competence levels among prospective candidates for the post of RBI Governor, the outcome of price stability and economic growth would be constant. In the circumstances, to argue that no one else could step into Raghuram Rajan’s shoes would be stretching the argument too far.
Why didn’t he cut rates further?
As regards the criticism that he didn’t do enough on ‘rate’ cuts, one could no doubt argue both for and against such a proposition. But the issue could also be looked at from the perspective of ‘decision theory’. Why did Rajan choose not cut rates further than he actually did? Decision theory offers an explanation. Assume that there is a managerial problem. The ‘manager’ has a choice of taking a certain course of action (decision) or he may choose not to take that decision. A decision once taken, in turn, imposes a commitment to undertake a series of other actions. Each of those actions may or may not have a positive impact on the final outcome. But it is only when all those actions neatly fall in place can the manager be assured of a favourable outcome.
There is every chance that, somewhere along the line, the chain gets broken. But without a favourable final outcome the initial decision is a waste and the manager in question loses credibility. By not taking a decision, an opportunity may have been lost but the status quo is not altogether bad. The ‘manager’ in question is thus predisposed towards not taking a decision.
In the context of the RBI policy action, if nobody can clearly demonstrate that by not cutting the ‘policy’ rates an ‘x’ amount of GDP was lost and the current levels of inflation are acceptable, there is no incentive to cut rates further. On the other hand, the RBI could always claim that by cutting interest rates further, inflation would have soared, and nobody would be able to disprove it. Is it any wonder that Rajan chose to cut rates only to the extent he did?