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THE average selling price of a residential unit on Penang island today has far exceeded the average yearly income of a household, says Socio-Economic and Environmental Research Institute senior fellow Dr Lim Mah Hui.
“The average annual household income in Penang is RM42,000, while the average house price is RM578,000, or 14.2 times more.
“The national average annual household income is RM38,987, while average house price nationwide is RM180,000, or 4.6 times,” he said at a recent forum on housing affordability in Penang.
Among the speakers present were Raine & Horne senior partner Michael Geh and Real Estate & Housing Develeopers’ Association (REDHA, Penang) chairman Datuk Jerry Chan.
A place to call home: Terrace houses on Penang island are now selling from RM700,000, say realty experts.
Lim said the selling price for a condominium unit had now increased to RM350 per sq ft from RM250 two years ago.
“In some areas, the selling price per sq ft has increased to RM500, while new projects have a price tag of RM600 per sq ft.
“Terrace houses are now selling from RM700,000 onwards, compared to RM520,000 in the second quarter of 2009. In some locations, a new terrace house is selling for RM1.2mil,” he said.
Speculation was responsible for the high house prices in Penang, said Lim, adding that special financial packages introduced last year further fuelled the speculative trend.
Raine & Horne senior partner Michael Geh said that over the past two years, there had been developers on the island who invited speculators to take up over 50% of their newly launched medium-cost condominium schemes priced around RM220,000 and RM250,000.
”The speculators then re-sell these units at a higher price, making between RM50,000 and RM100,000 from each sub-sale.
For more affordable units: The Government should be responsible for low-cost projects as this will remove the low-cost subsidy borne by developers, says an expert.
“How much they make de-pend on the time that they sold. Such speculation has caused the price of medium-cost housing to rise by more than 20%, compared to two years ago,” he said.
Meanwhile, Chan said the Government should be responsible for low-cost housing and community projects as this would remove the subsidy for low-cost housing borne by developers who pass the cost to house buyers.
“Developers can then price their property more affordably.
“The plot ratio guideline in Penang is also outdated, as developers are allowed only to build less than one sq ft for every one sq ft.
“In Singapore, the plot ratio is 2.8 times to five times. The plot ratio guideline should be revised to give developers more scope for innovation and creativity which allow them to develop units with a variety of prices,” he said. By DAVID TAN, Star, also in
The rancorous argument about global payment imbalances and the yuan’s valuation is exposing a surprising and dangerous economic illiteracy among policymakers and commentators.
Before pressing China to allow a maxi-revaluation of the yuan, western commentators need to think through the consequences carefully. The idea that devaluing the dollar (and by extension euro and yen) will cause payment imbalances to disappear and boost employment in the West with little or no impact on inflation and living standards is a pipe dream.
MAXI-DEVALUATION
First some notes about terminology. Proponents generally phrase their argument in terms of an appreciation of the yuan (which keeps the focus on the alleged currency manipulators in China). But it could just as easily be recast as a depreciation of the dollar (which is a much more controversial formulation, highlighting the fact that the exchange rate problem reflects U.S. weakness as much as China’s strength).
Since most observers assume bilateral relationships between the dollar and other major currencies would not alter significantly, China is in fact being pressed to permit a balanced depreciation of the dollar, euro, yen and other major currencies.
Finally, we are not talking about small changes but very large ones. Observers have suggested the dollar might be overvalued as much as 25-50 percent. Devaluing it 5 percent is unlikely to cause a substantial adjustment in China’s trade surpluses with the United States and globally and will not remove the political tensions and the root of the crisis.
Only a very large reduction in the dollar’s value over a period of years, in effect a “maxi-devaluation”, could hope to adjust the relative trade performance of the two countries.
ADJUSTMENT WITHOUT INFLATION?
Within the United States and euro zone, the main impact would be to raise the price of tradable goods and services relative to their non-tradable counterparts. Exports would become more competitive while imports would become significantly more expensive. Demand would switch from domestic consumption and imports towards exports and import-competing firms.
Normally, such expenditure-switching adjustments would need to be accompanied by expenditure-reducing tax hikes, spending cuts and interest rate increases to shrink non-tradable industries to expand export and free up resources for import-competing sectors, allowing adjustment without triggering inflation. The combination of expenditure switching and reducing policies is the standard prescription at the heart of an IMF structural adjustment programme in developing countries.
However the recession has already created plenty of slack in U.S. and European manufacturing. Supporters think the United States could achieve a maxi-devaluation, a big rise in exports and a fall in imports without triggering significant inflation or driving the Fed to raise interest rates. Adjustment would be essentially painless.
THE DOLLAR IN YOUR POCKET
It is important not to underestimate how big the impact could be. Cheap manufactured imports from China and the rest of Asia, combined with easy credit and rising debt, have been the main engine of rising living standards in the United States and some of the other advanced industrial economies over the last 20 years as real wages have stagnated. If imports become significantly more expensive, households will feel much poorer.
Devaluation supporters often suggest China’s manufacturers might absorb a proportion of the exchange rate change to protect market share, cushioning the blow. Apart from defeating the object of the devaluation, there is no way China’s manufacturers could absorb the full impact of the sort of 25-50 percent maxi-devaluation that would be needed to eliminate the payments imbalance, according to some U.S. economists.
While devaluation’s impact on the cost of manufactured imports might be (slightly) lessened, the biggest impact would be on the cost of raw materials such as crude oil and industrial supplies that trade in global markets.
By boosting the purchasing power of Chinese businesses and households, and their consumption of oil and other raw materials, a maxi-devaluation would drive oil and other commodity prices sharply higher in dollar terms, and cut deeply into real household incomes in the United States.
I have written elsewhere that there is no real, fundamental link between oil prices and changes in the dollar’s trade-weighted value. Correlations are mostly driven by self-fulfilling perceptions. Commodity price changes reflect the relative pricing power of producers and consumers; exchange rates add nothing to the analysis.
But that is only true for relatively moderate changes in the dollar’s value against the euro, yen and other major traded currencies of the sort seen almost continuously for the past 20 years.
In contrast, a maxi-devaluation would lead to a re-pricing of oil and other commodity prices, redistributing real income and consumption away from the United States and Europe to households and firms in China. The United States and Europe are simply too large to devalue their way out of trouble without triggering big shifts in commodity prices.
CENTRE OF GRAVITY SHIFTS
By revaluing the output of China’s businesses and households, maxi-devaluation would also massively increase China’s “weight” in the global economy, accelerating the rapid shift in the centre of gravity in the world economy from the economies of the North Atlantic to East Asia.
Proponents of devaluation (and they are numerous) often portray it as a simple panacea. But maxi-devaluation would trigger a series of wrenching structural shifts in the advanced economies and globally. It might create more jobs in the United States, but all U.S. households would feel noticeably poorer as their real purchasing power is slashed.
It would ram home the fact that U.S. and even European households have been living far beyond their means — enjoying a high standard of living only because of an overvalued currency and the hard work for limited rewards common in China and many other parts of emerging Asia.
Exchange rate realignments are a necessary and inevitable part of the global adjustments that will be necessary in the next few years. In some ways they will make explicit the huge shift that has already been occurring for the past decade, but masked by China’s reserve accumulation and cheap credit in the western world.
But let’s not pretend they will be painless for households and businesses across the United States and Europe. Extra jobs and more exports will be purchased by lower real consumption. Living standards will fall, reflecting the reduced external value of U.S. and European output.
CAMBRIDGE – In a report just filed with the United States court that is overseeing the bankruptcy of Lehman Brothers, a court-appointed examiner described how Lehman’s executives made deliberate decisions to pursue an aggressive investment strategy, take on greater risks, and substantially increase leverage. Were these decisions the result of hubris and errors in judgment or the product of flawed incentives?
After Bear Stearns and Lehman Brothers melted down, ushering in a worldwide crisis, media reports largely assumed that the wealth of these firms’ executives was wiped out, together with that of the firms they navigated into disaster. This “standard narrative” led commentators to downplay the role of flawed compensation arrangements and the importance of reforming the structures of executive pay.
In our study, “The Wages of Failure: Executive Compensation at Bear Stearns and Lehman Brothers 2000-2008,” we examine this standard narrative and find it to be incorrect.
We piece together the cash flows derived by the firms’ top five executives using data from Securities and Exchange Commission filings. We find that, notwithstanding the 2008 collapse of the firms, the bottom lines of those executives for the period 2000-2008 were positive and substantial.
Most importantly, the firms’ top executives regularly unloaded shares and options, and thus were able to cash out a lot of their equity before the stock price of their firm plummeted. Indeed, the top five executives unloaded more shares during the years prior to their firms’ meltdown than they held when disaster came in 2008. Altogether, during 2000-2008, the top executive teams at Bear Stearns and Lehman cashed out about $1.1 billion and $850 million (in 2009 dollars), respectively.
These payoffs to top executives were further increased by large bonus compensation. During 2000-2007, the top executives’ aggregate bonus compensation reached (in 2009 dollars) $300 million at Bear Stearns and $150 million at Lehman. Of course, the earnings that provided the basis for these bonuses evaporated in 2008. But the firms’ pay arrangements did not contain any “claw-back” provisions that would have enabled the firms to recoup the bonuses that had already been paid.
Combining the figures from equity sales and bonuses, we find that, during 2000-2008, the top five executives at Bear Stearns and Lehman pocketed about $1.4 billion and $1 billion, respectively, or roughly $250 million per executive. These cash proceeds are substantially higher than the value of the holdings that the executives held at the beginning of the period. Thus, while the long-term shareholders in their firms were largely decimated, the executives’ performance-based compensation kept them in positive territory.
The divergence between how top executives and their companies’ shareholders fared raises a serious concern that the aggressive risk-taking at Bear Stearns and Lehman – and other financial firms with similar pay arrangements – could have been the product of flawed incentives. The concern is not that the top executives expected their aggressive risk-taking to lead with certainty to their firms’ failure, but that the executives’ pay arrangements – in particular, their ability to claim large amounts of compensation based on short-term results – induced them to accept excessive levels of risk.
It is important for financial firms – and firms in general – to reform compensation structures to ensure tighter alignment between executive payoffs and long-term results. Executives should not be able to pocket and retain large amounts of bonus compensation even when the performance on which the bonuses are based is subsequently sharply reversed. Similarly, equity incentives should be subject to substantial limitations aimed at preventing executives from placing excessive weight on their firm’s short-term stock price.
Had such compensation structures been in place at Bear Stearns and Lehman, their top executives would not have been able to derive such large amounts of performance-based compensation for managing the firms in the years leading up to their collapse. This would have significantly reduced the executives’ incentives to engage in risk-taking.
Indeed, calls for comprehensive and robust reform of pay structures should not be viewed as mere responses to populist anger. Such reform could do a great deal to improve incentives and prevent the type of excessive risk-taking that firms encouraged in the years preceding the financial crisis – thereby enhancing the value of companies and the wealth of shareholders.
Reforms that redress these destructive incentives should stand as an important lesson and legacy of Bear Stearns, Lehman Brothers, and the crisis they helped to fuel.
March 19 (Bloomberg) -- Morgan Stanley Asia Chairman Stephen Roach said a “baseball bat” should be taken to economist Paul Krugman over his call for the U.S. to pressure China into allowing the yuan to appreciate.
“We should take out the baseball bat on Paul Krugman -- I mean I think that the advice is completely wrong,” Roach said in an Bloomberg Television interview in Beijing when asked about Krugman’s call, characterized as akin to taking a baseball bat to China. “We’re lashing out at China rather than tending to our own business,” which is raising U.S. savings, Roach said.
“I’m a little surprised at Steve for saying that,” said Krugman, the Princeton University professor and Nobel laureate in economics, in a telephone interview when asked to respond to Roach. “What I said is actually based on pretty careful economic analysis. We have a world economy which is depressed by China artificially keeping its currency undervalued.”
The debate between the two economists echoes verbal clashes between the nations, with Chinese leaders repeatedly saying that their yuan policy isn’t the cause of the U.S. trade gap. American lawmakers have urged the Obama administration to step up pressure on China for keeping its exchange rate unchanged, a stance criticized as providing an unfair advantage.
Yuan Stance
Premier Wen Jiabao’s government has kept the yuan at 6.83 per dollar since mid-2008 to shield exporters from the global recession and a contraction in world trade. It allowed the currency to appreciate 21 percent in the three years before that.
The country has accumulated a record $2.4 trillion of reserves, and $889 billion of U.S. government debt, partly a consequence of its exchange-rate policy.
Global economic growth would be about 1.5 percentage points higher if China stopped restraining the yuan and running trade surpluses, Krugman said at an Economic Policy Institute event in Washington March 12. He said the U.S. may need to get more aggressive in its talks with China, perhaps by treating the exchange-rate as a countervailing duty or other export subsidy.
“I’m a little curious what Steve thinks would happen if the U.S. increased savings” without a stronger yuan, Krugman said today. “Where would the demand” for goods and services come from, he asked. Boosting savings should be done “in the long run,” not now, he also said.
‘Bad Advice’
Krugman is “giving Washington very, very bad advice,” Roach said in a later interview when asked to respond to Krugman’s reaction to his remarks. “I totally reject his idea that savings is bad.”
The U.S. trade deficit is due to a shortfall of savings, and any attempt to address the bilateral gap with China would just cause a shift to another country as Americans kept up their spending, according to Roach. He added that while Krugman and he have been in agreement for years, they are in total disagreement right now.
“What the world needs is a shift in the mix of saving,” Roach said in a further e-mail. While China has a “major surplus saving imbalance,” it’s “highly debatable” whether it’s because of the yuan stance. Efforts to boost Chinese consumer spending will be a more effective way to address the issue, he said.
Roach has since 2007 served as senior representative of New York-based Morgan Stanley to clients, governments, and regulators across Asia. He was previously the investment bank’s chief economist. Before joining Morgan Stanley in 1982, Roach worked at Morgan Guaranty Trust Company and on the research staff of the Federal Reserve Board in Washington. He has a Ph.D. in economics from New York University.
Nobel Prize
Krugman has worked at Princeton University in New Jersey since 2000, previously serving at the Massachusetts Institute of Technology, the International Monetary Fund, and Yale University. He won the Nobel prize for economics in 2008 for his theories on world trade, and earned his doctorate in 1977 from MIT.
Premier Wen said on March 14 in Beijing that “I don’t think the renminbi is undervalued,” using another term for the yuan. “We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency.”
The U.S. trade deficit was $37.3 billion in January. It has shrunk from a record $67.8 billion in August 2006 as American consumers slowed spending amidst the recession. Net exports have contributed to gross domestic product the past two years.
Five senators including Charles Schumer of New York and Lindsey Graham of South Carolina this week introduced legislation to make it easier for the U.S. to declare currency misalignments and take corrective action. The Treasury Department is set to decide next month whether to label China as manipulating its currency.
‘Height of Hypocrisy’
“Isn’t it the height of hypocrisy an American can articulate a particular position in its currency but the Chinese are not allowed to do that,” Roach said today. “Especially since they as a developing economy with an embryonic financial system need a currency anchor probably a lot more than more ’sophisticated economies’ like the United States.”
The U.S. envoy to China this week said that the “recent turbulence” between the world’s largest and third-biggest economies was part of “the natural cycle” and wouldn’t harm long-term ties.
“I am convinced that blue skies are already on the horizon,” Ambassador Jon Huntsman said yesterday in a speech at Tsinghua University in Beijing.
--With assistance from John Liu and Li Yanping in Beijing. Editors: Michael Heath, Michael Dwyer To contact the reporter on this story: Chris Anstey at canstey@bloomberg.net To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net
Trade war looms over differences between US and China’s perception of their currency values.
SINCE the opening up of its economy three decades ago, China has been prospering and powering ahead with enviable high growth rates over the last 10 to 15 years. Providing a low-cost environment, many manufacturing companies sprouted across the country, producing a wide range of goods (from toys and textile to electrical and electronics) to satisfy the demand of global consumers. With that, China has earned the tag of the “factory of the world”.
From an impoverished nation to a socialist market economy, the miracle of China’s growth is mainly attributable to its thriving exports. The growing global demand for China’s produce has been pinned on the fact that the prices of its goods are found to be much more cheaper than those produced in other countries.
For some countries, particularly developed nations such as the United States, however, there’s been a negative effect. With cheap China goods flooding the market, these developed nations claim that many of their local manufacturers have been put out of business because they could not produce goods to match the prices of China goods.
On the Chinese side, the government continues to intervene in the financial markets, in particular over the pegging of the exchange rate of the yuan against the US dollar, to keep the prices of its goods competitive in the global market and as a means to further promote its exports and attract foreign direct investments.
While the strategy has worked well in its favour, China has over the years faced continuous pressure from developed nations, particularly the United States, to allow its currency to appreciate.
The yuan was pegged at 8.27 per US dollar from 1995 to mid-2005. The Chinese government subsequently adjusted the value of its yuan upwards to 8.11 per US dollar and lifted the peg and allowed its exchange rate to fluctuate against a basket of currencies, including the US dollar, euro and yen.
In July 2008, the Chinese government allowed a 21% appreciation of its currency against the US dollar and the value of yuan has since been pegged at around 6.83 per US dollar to this day.
Many economists from developed countries claim that the yuan is currently still undervalued by a wide margin of between 20% and 40%. Hence, the rising pressure from the international community, particularly over the week, on China to let its currency appreciate.
For instance, the International Monetary Fund (IMF) and the World Bank on Wednesday lent their support to the United States to urge China to allow its yuan to float.
Addressing the European parliament, IMF managing director Dominique Strauss-Kahn said “this cannot be avoided; in some cases exchange rates have to appreciate, and that’s the debate which is very well-known about China and the value of the yuan”.
The Chinese government manages to keep its yuan at the pegged rate by buying US dollar. The US government calls this currency manipulation, and will decide by next month whether to declare China as a currency manipulator. The sentence will be stiffer tariffs for all China goods to compensate for the unfair advantage that the dragon economy has been enjoying all these years.
While stating its reluctance to adjust the value of its currency, China has called such pressure on it to comply as a trade protectionism measure on the part of the US government. The Chinese government has indicated that it would respond with the same sort of import tariffs on US products should its export goods be levied with tariffs by the US government.
Economists see such development as a rising risk of trade war between the two major economies, which could be destabilising for global economy.
“With two giants fighting, there will surely be some spillover effects on the other economies in the world,” RAM Holdings Bhd chief economist Dr Yeah Kim Leng says.
There is certainly room for accommodation, especially on the China’s side to allow its currency to appreciate. But economists point to China’s main concern on the impact of the yuan appreciation on its industries, which are mainly export-driven. In other words, many factories, particularly those that are labour-intensive and have low profit margin, could possibly close down if global demand for their goods fall, as a higher yuan could render their goods less competitive in the global market.
While Western economists say the appreciation of the yuan is the most effective way to address the global trade imbalances, some Asian economists contend that currency alone cannot help fix the situation.
Put house in order
“Developed nations have to put their house in order first, and not just depend on Asia to adjust their currencies,” CIMB Research chief economist Lee Heng Guie explains, pointing to the low savings rates as one of the key issues that developed nations has to address.
Nevertheless, many believe that there will be a gradual appreciation of the Chinese currency. Some quarters say the appreciation of the yuan would likely start towards the second half of this year, as its domestic economy continues to strengthen amid the country’s rising inflationary pressure.
“There are benefits and economic justification for China to allow its currency to appreciate,” Yeah says. These include the need to control inflation and prevent the overheating of its rapidly growing economy as well as to increase its purchasing power to import more goods and services and to acquire foreign assets, Yeah explains.
Regional currencies, including the ringgit, will likely track how China can accommodate to the pressure on its currency to appreciate in the days ahead.
“Certainly, any movement of the yuan, which is the anchor currency of the region, will affect the movement of regional currencies, including the ringgit,” Lee says.
Over the past one year, the ringgit has been strengthening against the US dollar. Year to date, it has gained about 3.5% against the greenback to trade at around RM3.30 per US dollar.
As it stands, there are some contrasting views over the performance of the ringgit towards the end of the year. While many believe the Malaysian currency will strengthen as a reflection of its strengthening economic fundamentals (or as it tracks the trend of the possible rise in yuan), a local bank analyst sees the possibility of a weaker ringgit by the end of the year.
He reasons that the strength of the US dollar would likely return by the second half of the year on expectations that the US Federal Reserve would raise its interest rates sooner than expected.
For a worse-case scenario, he values the ringgit at RM3.45 per US dollar by year-end, while others think the value will stabilise around RM3.30 per US dollar.
“It’s still fluid at the moment as the trends of the economy keep changing. Many factors come into play, and we need to monitor developments in other economies,” an analyst says.
THE banana kingdom was in deep trouble. After the failure and rescue of Banana Bank, the government poured lots of funds into the bank and enjoyed a temporary revival. But the economy fell back into recession and unemployment grew.
The king was very worried, because his ministers gave him lots of conflicting advice. The public blamed the bank managers for incompetence and insisted on more regulation.
The bankers complained that more regulation was killing the golden goose that gave the kingdom so much prosperity before. No one was happy.
In desperation, the king summoned the wisest of the monkeys – an old sage well-known and respected for his frugality and his integrity.
“Please help me get out this problem, Master. Teach me how to deal with our difficulties,” the king pleaded.
“Remember the golden rule,” said the sage. “He who has the gold rules. But who has the gold now?”
“You are right, wise sage”, admitted the king. “We spent so much money rescuing Banana Bank that the kingdom is deep in debt. In fact, the bankers are now richer than before and are major lenders to the kingdom.”
“So are you the ruler or the bankers? You must know the monkey rules, before you can rule them,” said the sage.
The first rule is “never let monkeys look after bananas.”
“Yes, I learnt this to my cost,” said the king, “but the monkey was so convincing because he was able, brilliant and well dressed.”
“He went to the best business schools and was so polite and able to explain things so beautifully that I felt it was in my best interest to trust him.”
“Exactly,” smiled the sage. Did the monkey banker not say to you, “you pay peanuts and you get monkeys?’’ “Yes and because of that I paid him a lot of money and bonuses.”
“Rule number two is, an expensive monkey is still a monkey.”
“So, the crisis must be due to the derivative banana products which are very bad and dangerous? We should ban them,” said the king.
“The derivative game looks very complicated, but it is very simple. You should not look at all the banana leaves, but look at the banana trees. Where is the fruit? Who has eaten the bananas? The banana derivative products are only tools, which can be both good and bad. Guns do not kill people, only people kill people. So you should not blame the derivatives.”
“You are right. But where did I go wrong in the bank rescue?” asked the king.
“There is a time for a tree to live and a time for a tree to die. A tree dies when it has taken all the goodness from the soil. When it dies, it returns the goodness to the soil so that new trees to grow. Life is cruel, but for every death there is new life. Instead of allowing a bad and sick tree to die, you rescued the dying tree. Now the sick tree is sucking more goodness from the soil, so that new trees cannot compete for the sun and soil.”
“But I did it for the good of everyone”, protested the king.
The sage nodded. “You have a good heart, but good intentions do not always have good outcomes. The monkey understands well that the secret of making money is to buy low and sell high. When you rescue him, you are buying high and selling low. If you always buy high and sell low, how can you win?”
Rule number three is therefore: “When you rescue a monkey, it’s no longer the monkey’s problem, but your problem.”
“I now understand that it’s all the monkey’s fault,” said the king.
“No,” said the sage firmly. “Monkeys are not born bad. Neither are monkeys born good. It is not wrong for them to love bananas. You put a monkey in charge of monkeys,” quipped the sage, “because you thought you wanted an expert who understood how monkeys behave. But management that is part of the problem cannot be part of the solution. They will want to protect their interests.
“If you are not careful, the monkeys will become the owners of the banana kingdom, not you, my lord.”
Rule number four is that there are no permanently good monkeys or permanently bad monkeys. There are only permanent interests.”
“You are right”, admitted the king. “I now see that tools and monkeys cannot be my master. But I still blame the monkey for making a mess of the situation.”
The sage shook his head sadly and sighed deep and long.
“Your highness, it was you who allowed the monkey to look after the bananas. You who appointed a monkey to look after the monkeys. So now that the bananas are gone, are you the monkey or are they the monkeys?”
Rule five is that you are ultimately responsible for your own mess.
The king at last saw the light. “You are wise, my master, but what should I do?”
“You are kind and your ministers push only those policies that are popular. But what is popular today is not what is wise tomorrow. If the monkeys eat all the bananas, there will be no seeds for the trees to grow. If there are no trees, there are no bananas and everyone will starve. So even monkeys understand that short-term excess consumption means starvation tomorrow.
Rule six is you have to be cruel to be kind.Do what is necessary for your people, even if it means sacrificing yourself.”
The king saw the light. He gave up his kingship for his son and asked that he and his children swear to learn the Monkey Rules. The first thing the new king did was to banish the monkey banker, clean up the system and ordered that the banana plantations be rejuvenated.
Then the old king followed the monkey sage up the mountain to become a monk.
Source: THINK ASIAN, By ANDREW SHENG
● Datuk Seri Panglima Andrew Sheng is adjunct professor at Universiti Malaya and Tsinghua University, Beijing. He has served in key positions at Bank Negara, the Hong Kong Monetary Authority and the Hong Kong Securities and Futures Commission, and is currently a member of Malaysia’s National Economic Advisory Council. He is the author of the book, From Asian to Global Financial Crisis.
Applying group-think and sell-by date concepts in business
LAST time I discussed whether lack of board diversity was the cause of group-think and failure as a result. My view is that lack of diversity per se does not create group-think, though board dynamics do.
Dominant CEOs and chairmen are often highly successful people and it is this track record of success that makes it hard for independent non-executive directors to challenge them.
Yet challenge constructively they must because strategies have sell-by dates and so recipes for past success can become guarantees of future failure – at its worst, manifested in systemic failure.
For 20 years, Jack Welch followed an immensely successful growth strategy of milking General Electric’s (GE) industrial businesses to invest in the faster-growing financial services sector – to the point where banks complained GE had an unfair competitive advantage as a financial institution because of its AAA rating resulting from being classified as an industrial company.
Their successful lobbying stopped GE continuing to grow in financial services. Welch’s successor Jeffrey Immelt took over a company whose growth engine was in neutral, having to face the problem that the industrial businesses were short of new products because not enough had been invested in research and development (R&D).
Turning that R&D deficit around took years of cash-consuming investment with no immediate payoff. So it is hardly surprising that compared with the Welch years, the Immelt years do not seem stellar. Yet Immelt’s problems were of Welch’s making.
I am sure that it must have been very difficult for independent directors to challenge Welch’s strategy and argue that his drive into financial services was unwise – all the more so since the strategy was lauded in business schools and written up in top-selling management books.
Group-think does not just happen within the board – conventional wisdom is just another form of groupthink and directors on GE’s board from diverse backgrounds would have been influenced by what they had read.
In the case of GE, the strategy sell-by date was caused by continuing with it for too long. Perhaps this is what Toyota is facing at the moment. For decades, its strategy has been astonishingly successful. It reached global No. 1; it had an unparalleled reputation for quality; it taught the world “Lean Manufacturing” – how to make not just cars but anything with concepts such as “Just In Time”, “Kaizen” and quality circles.
It was the low-cost leader in its industry that also managed to differentiate itself with luxury models such as Lexus, disproving Michael Porter. It was hugely cash rich, so that it could almost be regarded as a bank. Such a track record of continued success must have been immensely hard to question, regardless of whether the board had the diversity recommended by The Economist or not.
“If it ain’t broke, don’t fix it” is just another way of describing group-think and of failing to recognise that strategies do have sell-by dates.
In Toyota’s case, its chase for market share may have led it to drive down supply chain prices just that bit too far, outsourcing to one new factory in a new country too many, where its cardinal principle of quality was not adequately understood.
Sharing platforms across models, sourced from all over the world only amplified any glitch so that one defect affected millions of models across the range, damaging the brand across the board as opposed to being containable in just the affected model.
Just as it will take GE time to recover from going past its strategy sell-by date, it may also take Toyota longer than people realise because unwinding what has been done so well for so long is really difficult, if that is what it has to do to recover its reputation.
That brings me to systemic failure, often the result of group-think on a board with diverse backgrounds – though the groupthink here is of a different kind – the kind that caused the global financial crisis.
This is group-think caused by the herd instinct: the argument that if other people are doing it and making lots of money, then we should be doing it too. This may not be sound thinking, but it reflects the pressure boards of financial institutions were under from shareholders and analysts when their results were being compared with other companies that were in opaque derivatives.
When one or two institutions behave irresponsibly to make supernormal returns, it does not threaten the system (the famous “free rider” problem in economics), but for all to do so will cause the system to collapse.
That is what happened with subprime, collateralised debt obligations and credit default swaps, termed “dancing” by Chuck Prince, then CEO of Citigroup, when he explained that everybody was on the dance floor as was Citigroup – the trick being to get off before the music stopped – i.e. before the strategy had gone past its sell-by date.
The writer is CEO of Securities Industry Development Corp, the training and development arm of the Securities Commission.
For more affordable units: The Government should be responsible for low-cost projects as this will remove the low-cost subsidy borne by developers, says an expert.
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