Did the bailout of Chrysler by the U.S. government overturn bankruptcy law in the United States?
Almost two years ago, the outgoing Bush and incoming Obama administrations announced a series of steps to assist Chrysler, the struggling automaker, in an extraordinary intervention into private industry. The federal government intervened in Chrysler’s reorganization in a manner that, according to many analysts, subordinated the senior secured claims of Chrysler’s lenders to the unsecured claims of the auto union UAW. As one participant interpreted the intervention, the assets of retired Indiana policemen (which were invested in Chrysler’s secured debt) were given to retired Michigan autoworkers.
Critics claim that the bailout turned bankruptcy law upside down, and predicted that businesses would suffer an increase in their cost of debt as a result of the risk that organized labor might leap-frog them in bankruptcy. A long-standing principal of bankruptcy law requires that a debtor’s secured creditors be repaid, in full, before its unsecured creditors receive anything.
Did the bailout of Chrysler by the U.S. government overturn bankruptcy law in the United States?
How much does management matter for economic performance? Despite a large industry of business schools, consulting firms, and airport books purporting to teach you the secrets of good management over the course of your next flight, the answer until very recently has been “we don’t know”. In a recent review, Chad Syverson goes as far as to say “no potential driving factor of productivity has seen a higher ratio of speculation to empirical study”.
Together with colleagues from Stanford and Berkeley, I have been working for the last couple of years to try and understand how much management matters by means of a randomized experiment among textile factories in India. In common with most firms in developing countries, the firms (with 300 workers on average) we were working with did not collect and analyze data systematically in their factories, had few systems for regular maintenance and quality control, had weak human resource systems for promoting and rewarding good performers, and had little control over inventory levels. The result was a high level of quality defects, large stockpiles of unorganized inventories, and frequent breakdowns of machines. 20 percent of the labor force was occupied solely in checking and repairing defective fabric (see picture).
With millions around the globe feeling the impact of the financial crisis and slower economic growth and job losses, it is important to understand regulatory and policy constraints on entrepreneurs wanting to start a formal business. Entrepreneurial activity is the basis of sustainable economic growth, and the first step for entrepreneurs joining or transitioning to the formal sector is the registration of their business at the registrar of companies. For evidence of the economic power of entrepreneurship we need look no further than the United States, where young firms have been shown to be an important source of net job creation, relative to incumbent firms (Haltiwanger, et al.).
To measure entrepreneurial activity, we’ve constructed with support from the Kauffman Foundation the World Bank Group Entrepreneurship Snapshots (WBGES) – a cross-country, time-series dataset on new firm registration in 112 countries. The main variable of interest is “Entry Density”, defined as the number of newly registered limited liability firms as a percentage of the working age population (in thousands). We employ annual figures from 2004 to 2009 collected directly from Registrars of Companies and other government statistical offices worldwide. Like the Doing Business report, the units of measurement are private, formal sector companies with limited liability.
Foreign direct investment (FDI) can theoretically reduce income gaps between developing and advanced economies. In a neoclassical world, with perfect capital mobility and technology transfer, capital readily flows from rich to poor countries, seeking higher returns in capital-scarce economies. The real world differs starkly from the theory.
Even though southern African countries (the Southern African Development Community, SADC hereafter) are poor on average, per capita FDI inflows are a meager 36.6 U.S. dollars per year (in 2000 value), which is about 18 percent of average per capita FDI in non-SADC countries and 58 percent of the average level for similar-income economies. Moreover, within SADC, country differences are huge: FDI per capita ranges from single digits (Malawi, Zimbabwe, Madagascar, Democratic Republic of Congo, and Tanzania) to 10-30 dollars (Mozambique, Zambia, Mauritania, and Swaziland), to 50 to 100 dollars (Lesotho, South Africa, and Angola), and to 167 dollars in the outlier in this region, middle-income Botswana. And even within this region there is a positive relationship between average income and FDI per capita, a pattern that holds for the world as a whole. Thus, any hope of relying on FDI as a supply-side remedy to catapult poor countries onto a development fast track is not likely to materialize soon.
Do you wonder how the recent global crisis affected access to financial services? Well I do, and a report by the World Bank Group and CGAP just provided the answer: Data show that even as countries were suffering because of the financial crisis, access to formal financial services grew in 2009. Indeed, the number of bank accounts grew world-wide, while at the same time the volume of loans and deposit accounts dropped. The physical outreach of financial systems— consisting of branch networks, automated teller machines (ATMs), and point-of-sale (POS) terminals—all expanded.
That’s a relief. Readers of this blog know by now that I am a strong believer in expanding access. Lack of access to finance is often the critical element underlying persistent income inequality as well as slower growth. But the recent global financial crisis has led us to question many of our beliefs and re-opened old debates. It also exposed an important tension between access and stability. Were we wrong to emphasize access in the light of what happened?
Designing policies that promote innovation and growth is key to development. In many countries there is also considerable corruption, with government officials seeking bribes and many firms underreporting their revenues to the state to evade taxes. Might there be a set of reforms that allow policymakers to kill two birds with one stone, both reducing corruption and boosting innovation? New research suggests financial sector reform may be able to play this role.
In a recent paper with co-authors Meghana Ayyagari and Vojislav Maksimovic, we look at corruption—defined as both bribery of government officials and tax evasion—and how this is associated with firm innovation and financial development. Using firm-level data for over 25,000 firms in 57 countries, we investigate whether firms are victims, who pay more in bribes than they gain by underreporting revenues to tax authorities, or perpetrators, who gain more by avoiding taxes than they lose in paying bribes.
Of particular interest is the effect of corruption and tax evasion on innovative firms. Specifically, we explore the following questions:
Remittances, funds received from migrants working abroad, to developing countries have grown dramatically in recent years from U.S. $3.3 billion in 1975 to close to U.S. $338 billion in 2008. They have become the second largest source of external finance for developing countries after foreign direct investment (FDI) and represent about twice the amount of official aid received (see Figure 1). Relative to private capital flows, remittances tend to be stable and increase during periods of economic downturns and natural disasters. Furthermore, while a surge in inflows, including aid flows, can erode a country’s competitiveness, remittances do not seem to have this adverse effect.
Figure 1: Inflows to developing countries (billions of USD), 1975-2008
As researchers and policymakers have come to notice the increasing volume and stable nature of remittances to developing countries, a growing number of studies have analyzed their development impact along various dimensions, including: poverty, inequality, growth, education, infant mortality, and entrepreneurship. However, surprisingly little attention has been paid to the question of whether remittances promote financial development across remittance-recipient countries. Yet, this issue is important because financial systems perform a number of key economic functions and their development has been shown to foster growth and reduce poverty. Furthermore, this question is relevant since some argue that banking remittance recipients will help multiply the development impact of remittance flows.
Too big to fail has become a key issue in financial regulation. Indeed, in the recent crisis many institutions enjoyed subsidies precisely because they were deemed “too big to fail” by policymakers. The expectation that large institutions will be bailed out by taxpayers any time they get into trouble makes the job of regulators all the more difficult. After all, if someone else will pay for the downside risks, institutions are likely to take on more risk and get into trouble more often—what economists call moral hazard. This makes reaching too-big-to-fail status a goal in itself for financial institutions, given the many implicit and explicit benefits governments are willing to extend to their large institutions. Hence, all the proposed legislation to tax away some of these benefits.
But could it be that some banks have actually become too big to save? Particularly for small countries or those suffering from deteriorating public finances, this is a valid question. The prime example is Iceland, where the liabilities of the overall banking system reached around 9 times GDP at the end of 2007, before a spectacular collapse of the banking system in 2008. By the end of 2008, the liabilities of publicly listed banks in Switzerland and the United Kingdom had reached 6.3 and 5.5 times their GDP, respectively.
In a recent paper with Harry Huizinga, we try to see whether market valuation of banks is sensitive to government indebtedness and deficits. If countries are financially strapped, markets may doubt countries’ ability to save their largest banks. At the very least, governments in this position may be forced to resolve bank failures in a relatively cheap way, implying large losses to bank creditors.
More than 3 billion people in the world today don’t have access to savings accounts. Many of these 3 billion fall below the less-than-$2-per-day benchmark of the world’s poorest people. Why are banks not doing a better job to help them manage their financial lives?
The problem is largely one of cost. Providing financial services to the poor is prohibitively expensive for banks. Each time a client stands in front a of a teller’s window it costs most banks from $1 to $3. If poor clients make transactions of $1 or $2, or even less, banks won’t be able to support the costs.
It’s also too costly for the poor. Most poor people, especially those in rural areas, live far away from bank branches. Let me give one example of a woman in Kenya. The nearest branch may be 10 kilometers away, but it takes her almost an hour to get there by foot and bus because she doesn’t have her own wheels. With waiting times at the branch, that’s a round-trip of two hours – a quarter or so of her working day gone. While the bus fare is only 50 cents, that’s maybe one fifth of what she makes on an average day. So each banking transaction costs her the equivalent of almost half a day’s wages.
Rich countries and emerging markets alike have participated in a rapid integration into global capital markets over the last 25 years. Proponents of financial globalization believed this would bring a myriad of benefits via improved financial intermediation, with a more efficient allocation of capital to productive firms and increased access to finance to those outside the halls of political power.
But the recent financial crisis has given pause to the pro-globalization advocates. The marked increase in capital flows to emerging markets quickly reversed in the wake of the financial crisis, leaving these countries looking vulnerable. Might the globalizers have gotten their prescriptions wrong?
A recent paper entitled Does Financial Openness Lead to Deeper Domestic Financial Markets? finds that, in fact, developing countries have reaped a number of benefits from financial globalization. In particular, the authors of the paper have found that greater financial openness: