Markets in everything: using Coasean bargains to resolve culture conflicts

by Samrudha Surana and Bhargavi Zaveri-Shah.

Introduction

In pluralistic societies with multiple, and often conflicting, cultural, religious, or ethical beliefs, disputes between groups with conflicting norms are highly likely. Take the case of a diverse society such as India. Hindus often complain about the Muslim cleric's call to prayer on loudspeakers, non-Hindus complain about the noise levels during celebratory festivals, Jains complain about the eating habits of other communities, and so on. Often, such conflicts get escalated to courts in the form of disputes, to the government in the form of lobbying for bans, or worse, as law and order problems. Pluralistic societies almost always face the following question: how can differences between conflicting norms be reconciled without resorting to State coercion or violence? In this article, we argue that voluntary commercial transactions between parties with conflicting norms are a powerful mechanism to resolve such conflicts.

Drawing from Ronald Coase's work on externalities and property rights, we argue that the principles underlying Coasean bargaining are not limited to economic contexts, but are also broadly applicable to social and cultural disputes. By internalizing the costs associated with conflicting norms, Coasean bargains enable parties to reach mutually beneficial agreements through voluntary exchanges. We illustrate this through a recent real-world example from India, where voluntary market transactions helped members of two religious communities reconcile their conflicting religious norms. A key policy implication of our argument is that it is imperative for policymakers to minimize the transaction costs for such voluntary transactions.

Coasean bargains in theory

Conflicts arise when one person's actions impose costs on another, creating competing interests that must be balanced. The economist, Ronald Coase, illustrated this through an example of cattle owners and farmers (Coase, 1960). Straying cattle may destroy a neighbouring farmer's crops, benefiting the cattle owner but harming the farmer. Preventing the cattle from straying, however, would impose a cost on the cattle owner. The problem is clear: allowing the cattle to stray increases cattle supply at the expense of crops, while restricting their movement favours crops at the expense of cattle. This is a problem of a reciprocal nature. Resolving such conflicts requires determining the value of what is gained versus what is sacrificed. In such cases, using a stream of case law from the US courts, Coase argued that instead of the State determining the hierarchy of who should prevail, one of the parties could internalize the costs arising to the other, from the exercise by the former of her property right. A Coasean bargain offers a way for individuals to resolve such conflicts through voluntary agreements that align their interests and minimize the costs of the conflict. For instance, a farmer might pay a cattle owner to install fencing, or the cattle owner might compensate the farmer for crop damage. When multiple actors are involved-such as several cattle owners and farmers-the feasibility of Coasean bargains depends on the transaction costs. While high transaction costs may prevent agreements in some cases, parties able to negotiate successfully can still improve their situations by reaching mutually beneficial agreements.

While Coase advocated this framework for the allocation of conflicting property rights, in the next few paragraphs, we demonstrate that the framework has implications for enforcing conflicting values as well.

A Coasean bargain in action

Last year, on the occasion of Eid Al Adha (Bakri-Eid) a festival widely celebrated in India and several countries with a significant Muslim population, a group of people were reported to have raised some money and purchased some goats from an Old Delhi market to rescue them from ritualistic slaughter. This incident was seen as an act of religious intolerance on the part of the rescuers. The undertone of these arguments was that the animal rescue on Eid Al Adha was driven by the rescuers' religious intolerance for Muslims and not genuine compassion towards animals. The rescuers profess Jainism, a religion founded on the value of ahimsa (non-violence towards all life forms). The Jain community is perceived to be populated by rich Jain merchants, who generally vote for the BJP. In a society so deeply divided on religion as India is today, this context creates suspicion for the rescuers' motivations behind this act.

The act of rescuing animals through voluntary transactions between the rescuers and the animal vendors is an example of a Coasean bargain that enabled the Jain and Muslim communities to resolve conflicting values without impinging on the rights of the other community. In this incident, the Jain purchasers perceived a harm from the sale of goats for slaughter . But, to stop the sale of goats would have harmed the seller. If the seller refused to sell to the Jains, the cost of slaughtering goats would have been internalized by the seller in the form of forgone payments from the Jains. In this case, the Jains internalized the costs that would have arisen from the slaughter of the goats purchased by them. Both the buyers and the sellers benefitted from the transaction. The sellers of the animals got value for their goats. The buyers got 'value' for their money in the sense that they managed to use the money to honour a value that they hold. As a Muslim man interviewed by the news reporter said in response to this incident, "It's their religion, and if saving animals (like goats) is part of it, we don't mind. Let everyone practise what brings them peace."

Coasean bargains work where the property rights of the people are more or less clearly defined. For example, consider a hypothetical, but realistic, scenario in a diverse urban neighbourhood where a temple's ceremonies or a mosque's call to prayer disturbs the residents of that neighbourhood. Under a Coasean bargaining framework, a standard example similar to this scenario is that of a firm installing a noise-creating windmill affecting the adjoining property owners' enjoyment of their property. In a world where the law confers property rights on people, a negotiation can start. The firm would offer the people some money in exchange for putting up with the noise, and people sensitive to the noise will perhaps use that money to install noise proof windows. These bargains are possible because nuisance has been defined as a tort under common law. That is, the law entitles people to enjoy their property without disturbance. Similarly, in our hypothetical scenario, in a diverse neighbourhood, the group affected by the noise levels might offer to fund the temple's or mosque's acquisition of a quieter sound system to reduce the noise impact. Alternatively, the temple or mosque may make a similar offer to the neighbourhood residents allowing them to enjoy their property without interruption. In the absence of such clarity on property rights, the scope for arriving at Coasean bargains is extremely limited. Similarly, in instances where the property rights are contested, such as whether the land on which a mosque stands belongs to the trust which runs the mosque, Coasean bargains may not offer a solution. In such cases, it would generally fall upon the courts to define the property right.

Coasean bargains versus coercion

A key benefit of Coasean bargains is that they help build a culture of religious tolerance, as compared to the use of State institutions to address religious conflicts. Even in countries whose constitutions allow their citizens the freedom to practice and propagate a religion of their choice, the State machinery is often used to perpetuate religious leanings. For example, in India, almost every year, like clockwork, several petitions are filed at one court or another in or around the festival of Eid-Al-Adha to restrict ritualistic animal slaughter.

Asking the State and courts to resolve these conflicts is problematic as it empowers them to impose a hierarchy of values on the society at large. For example, in the case illustrated above, a court order restricting the rights of Muslims to slaughter animals would have impliedly placed a higher value on the ritualistic notion of slaughter than the Jains' religious notion of non-violence towards animals. Since courts are designed to enforce rights and interpret laws, they are ill-suited to resolve conflicting values or norms that do not contradict the law. For example, consider the following conflicting values:

1. animal welfare activists rescuing goats from ritualistic slaughter
2. climate activists purchasing ceramic Ganesha idols from the vendors of such idols and disposing them to pre-empt them from being submerged in the ocean
3. climate activists purchasing firecrackers during Diwali and disposing of them to pre-empt noise and air pollution

It is hard for any central institution to explain why one of these values should take precedence over the other, and then impose such preference ordering over the rest of society. In a voluntary transaction, on the other hand, the question of addressing the hierarchy of values is immaterial, since the transaction is based on the subjective value that each party places on their beliefs. A Coasean bargain allows the people practising these conflicting values to order their preferences without forcing them to do so. Further, empowering the State creates opportunities for rent seeking. In electoral democracies, this risks allowing a majoritarian bias to be played out in such conflict resolution, and exacerbates the mistrust of people in the State and the courts.

Voluntary transactions that allow the transacting parties to uphold norms that are important to them are similarly preferable to the common counterfactual of violence, aggression and the exclusion of practices that don't meet one's religious or philosophical leanings.

Conclusion

The Coasean framework underscores the power of voluntary agreements to internalize costs and balance competing economic interests between persons. We extend this intuition to the resolution of conflicting religious and cultural norms, which are likely to exist in any pluralistic society. The incident of Jain members purchasing goats during Eid Al Adha demonstrates how Coasean bargaining through market mechanisms can resolve religious conflicts without state intervention. This case demonstrates that voluntary market transactions, motivated by individual preferences, can yield broader societal benefits by reducing friction between conflicting norms. In a country like India that is ridden with cow protection laws, state sponsored beef bans and religious violence, the volition of this transaction has tremendous significance.

While rooted in a specific cultural context, the insights derived from this example resonate beyond India. The Coasean approach underscores how the market enables each party to achieve their goals while respecting others' freedoms, creating positive societal benefits as an unintended consequence. Many seemingly intractable conflicts between religious communities might find resolution not through legal battles or state intervention, but through Coasean bargaining, where mutual respect and cooperation emerge naturally from the market process, even when religious tolerance itself is not the participants' primary goal.

Finally, as Coase emphasized, the feasibility of these transactions is dependent on the transaction costs. In environments with high transaction costs, such transactions will be fewer, if at all. The goal of the policymaker, therefore, should be to lower the transaction costs to make Coasean bargains between extremely unlikely transacting parties work.

Reference

Coase, Ronald (1960), "The Problem of Social Cost", Journal of Law and Economics, 3 (Oct., 1960).

The authors thank Ajay Shah and three anonymous referees for their inputs.

Facial recognition technologies in India: Why we should be concerned

by Smriti Parsheera.

All around us we are seeing a surge in the adoption of facial recognition technologies (FRTs) -- biometric systems that can be used to verify or identify a person based on their facial patterns. Examples of this range from National Crime Records Bureau's (NCRB) proposal to create a nation wide automated facial recognition system for law enforcement purposes to the Digi Yatra scheme that promotes the use of facial recognition at airports; from Facebook's auto tagging of photographs to Chaayos's use for receiving payments and recording reward points.

The inalienability of a person's face and the convenience with which it can be captured, make it an easy choice for satisfying the ever expanding demands of identifiability in the digital era. This is supplemented by the increased availability of digital images, videos and widespread use of closed circuit television (CCTV) systems, all of which become the fodder for the training and deployment of facial recognition systems. However, this is also the reason why the rapid adoption of FRTs, without any accompanying checks and balances, becomes worrying at many different levels.

In a recent Data Governance Network paper we discuss the growing use cases of FRTs in India and the legal and ethical concerns around it. These concerns include the lack of transparency around the use of FRTs; the threats to privacy and other civil liberties; problems of accuracy and effectiveness; and evidence of biased outcomes. While all of this holds true for the use of FRTs by the government as well as private entities, the imbalance of power between the citizen and the state and the likely consequences from its abuse make it particularly relevant to question the use of FRTs for law enforcement purposes.

Functions and use cases of FRTs

Most of the well known use cases of FRTs can be classified into four buckets based on their underlying functions.

The first function is that of identity verification -- checking if a person really is who they claim to be. For instance, in January, 2018, the Unique Identification Authority of India (UIDAI) had announced that it would allow the use of FRT as one of the modes of authentication under the Aadhaar Act. Through subsequent circulars the UIDAI had also mandated telecom service providers to start undertaking face authentication of their subscribers. While, following the Supreme Court's verdict in the Puttaswamy case, it is no longer possible for the government to mandate Aadhaar based face authentication by private entities like banks and telecom companies, the possibility of it being used by the government for distribution of welfare benefits remains very true.

The use of FRTs for purposes like voter identification, conducting know your customer (KYC) verifications and attendance in schools and offices are some of the other use cases that would fall under this head. For example, Delhi's Indian Institute of Technology has a home-grown solution called Timble that is used to mark student attendance. Proposals are also underway to roll out similar systems to mark the attendance of young school going students in Tamil Nadu's government schools and for all government teachers in the state of Gujarat.

The next function is that of access control, which basically builds on the identity verification function to assess whether a person is an authorised user of a particular space or service. Applications that pursue this function include biometric unlocking of mobile devices, entry into airports, homes or other premises and authorising withdrawals from ATM machines. For instance, in 2018, the Ministry of Civil Aviation launched the Digi Yatra project to create a facial biometrics based boarding system to be launched at various Indian airports. Testing under the project, which is currently voluntary, has already been going on at the Hyderabad, Bengaluru and Delhi airports. Similar systems have already been adopted at airports in many other parts of the world.

The third broad category, which also evokes the strongest concerns, is that of security and surveillance, including use of FRTs for law enforcement purposes. As per the AI Global Surveillance Index released by the Carnegie Endowment for International Peace, 85 percent of the countries that they studied (64 out of 75) were found to be using facial recognition systems for surveillance purposes (Feldstein, 2019). Examples of this include the Skynet and the Sharp Eyes projects in China, live facial recognition systems being tested by the London Metropolitan Police and NCRB's proposed National Automated Facial Recognition System (NAFRS).

As per the tender document released by NCRB in June, 2019, NAFRS is meant to be used for a range of purposes, including the identification of criminals, missing children and persons and unidentified dead bodies. The images that may be used for these purposes may come from the Crime and Criminal Tracking Network System (CCTNS), passport authorities, the Central Finger Print Bureau or the government's missing children tracking portal. The list also contains a sweeping category for "any other image database available with police / other entity". This seems to suggest that virtually each and every database in the country could potentially be linked to this system.

A clarification issued by the NCRB in response to a legal notice sent by the Internet Freedom Foundation (IFF) suggests that the scope of the project may be slightly narrower than what is indicated in the tender document (IFF, 2019). However, even if this were to be believed to be true, the design and scale of the project signal the clear likelihood of a gradual mission creep once such a system is put in place.

In addition to NCRB's proposed system, several state police departments are already deploying facial recognition systems. This includes reports about the use of FRTs by the Delhi Police, the Hyderabad police and under the Punjab Artificial Intelligence System.

Finally, FRTs also serve a number of commercial and business efficiency related functions. This includes photo tagging on social media apps, photo filter functions on chat apps and various uses in the retail and hospitality sectors. For instance, digital signage systems can predict a gazer's age and gender and accordingly display suitable advertisements and content for them. Facial detection and analysis also serves as the building block for other tools like emotion or sentiment analysis, which can offer useful applications in the marketing and entertainment sectors.

What are the main concerns?

Most of the use cases of FRTs, in India as well as globally, can be tied down to the pursuit of greater convenience (contactless payments and shorter queues at airports), efficiency (reduced airport staff), security (scanning crowds for "suspicious" persons), or accountability (checking for teacher absenteeism). While the technology could possibly help in achieving some of these objectives, this is often not established through rigorous and transparent testing. Moreover, the use of FRTs comes at a significant cost, which is not being accounted for by the developers and adopters of such systems.

The primary focus of most of the technical research on face recognition has been on improving the accuracy and efficiency of the technology. In other words, to minimise the false negatives and false positives. While both these metrics are useful indicators for evaluating the effectiveness of machine learning systems, their actual relevance has to be seen in light of the context in which such technologies are being deployed. For instance, false negatives in a system like Aadhaar would lead to the exclusion of legitimate beneficiaries while a false positive in the surveillance and law enforcement context can subject individuals to unwarranted investigation, embarrassment and harassment (Marda, 2019).

However, even if a facial recognition system were to achieve perfect accuracy, that would not make an obvious case for its adoption. This is because the use of FRTs has many other far reaching implications, from a legal, ethical and societal perspective, which need to be taken to account while determining whether and to what extent this technology should be deployed. Following are some of the main areas of concern.

Transparency -- In most situations there is a complete lack of information about when, or the specific purposes for which, FRTs are being deployed. Individuals affected by these systems also do not have access to meaningful information about the sources of training data that were used to develop the system, the sources of gallery images, the criteria for the selection of a particular vendor or technology partner, the accuracy rates of the system and the privacy and security protocols being followed. Transparency about these aspects is a necessary step for enabling independent testing and audits of facial recognition systems.

Information of this sort can become particularly necessary when facial analysis tools are being used to determine whether a person's face matches with someone who is suspected of committing an offence. Civil society groups in the United States are currently contesting a claim before the Florida Supreme Court in a case where a person was convicted for illegal sale of drugs based on the results of a facial recognition algorithm. The accused was the first among a list of probable matches identified by the algorithm with a "one star of confidence" that it had generated the correct match. The person was however not given access to the basis on which this determination was made or the details of the other individuals who were identified as potential matches.

Privacy and civil liberties -- The permanence of one's face and its intrinsic link with personal identity makes facial recognition a powerful tool for identification. The fact that in a large number of cases a person's face is exposed at all times or their images are available in various government and private databases makes it particularly difficult to exercise agency over the use of one's facial data. Some examples of privacy invasive uses of FRTs include its adoption by the Chinese Government for the profiling and tracking of Uighur Muslims and integration of FRTs in body worn cameras used by police forces in many parts of the world.

Widespread use of FRTs can also create a chilling effect on other rights, like the right to free movement, assembly and speech. Visuals of masked protesters in Hong Kong taking down smart lamp posts and surveillance cameras are symbolic of this tussle between the state's use of surveillance technologies and counter-measures being resorted to by protesters. As governments chose to crack down on such forms of resistance through "anti-mask initiatives" this not only affects the rights of the protesters but also those who may adopt facial coverings for various religious, cultural or practical reasons.

Concerns about the overreach of FRTs are however not just limited to autocratic regimes or even to government related uses. Private sector use of facial recognition also poses many significant threats to privacy and security. For instance, researchers have demonstrated how a person's face can easily be used as a personal identifier for pooling together information about them from multiple online sources -- like dating websites and social media portals (Acquisti, Gross, and Stutzman, 2014). Therefore, once a person's images are available online, whether voluntarily or as the result of someone else's actions, FRTs can make it almost impossible for the person to exercise the option of revealing their true identity in one context but remain anonymous in others.

The security of devices that rely on facial unlocking features can become another point of vulnerability for user privacy. The relevance of the differential facial security standards available on different smartphones was brought to light in a study where the researchers found that 26 of the 60 smartphones that they tested were vulnerable to a "photo hack" -- the device could be unlocked using the phone owner's photograph instead of the real person (Kulche, 2019). This illustrates how, given the user profile and characteristics of the Indian market, reliance on facial unlocking techniques on low-end devices could create increased vulnerabilities for consumers.

Accuracy and reliability -- It has been a well acknowledged problem in the field of facial recognition that the results of the system are only as good as the quality of the images that are being run through it. The results are therefore prone to errors on account of differences in the conditions of the images being compared, in terms of appearance, expression, age, lighting, camera angle, etc. This is particularly true in cases where the technology is applied in non-cooperative settings, for instance, using images gathered from a CCTV camera or for real-time biometric processing. For instance, a study on the live facial recognition system being tested by the London Metropolitan Police found that out of the 46 potential matches identified by the system only 8 matches could eventually be verified correctly, indicating a success rate of just about 19 percent (Fussey and Murray, 2019).

Having said that, it is also important to acknowledge that the technical capabilities of facial recognition systems have been improving over time. For instance, 3D facial recognition systems have already managed to overcome many of the technical issues faced by prevalent 2D systems. As per the National Institute of Standards and Technology, the "best performing algorithms" in its 2018 Face Recognition Vendor Testing Program showed significant improvements over the 2015 test results, offering "close to perfect recognition" (Grother, Ngan, and Hanaoka, 2019). Yet, there still remain significant variations in the results among different algorithms and developers, with recognition error rates in a particular scenario ranging from "a few tenths of one percent up to beyond fifty percent".

Bias and discrimination -- The training data being used for FRTs also plays a major role in determining the effectiveness of their outcomes. Buolamwin and Gebru, 2018 have demonstrated how the commercially available facial recognition tools offered by companies like Microsoft, IBM and Face++ showed much higher error rates for women with darker skin tones. This difference arose primarily on account of the under-representation of data belonging to this group in the training dataset. Similarly, a study done by the American Civil Liberties Union using Amazon Rekognition found that nearly 40 percent of the false face matches between members of the US Congress and a database of arrested persons were of people of colour although only about 20 percent of the Congress members actually belonged to this demographic group (Snow, 2018). While most of this research has emanated in the US context, it is easy to draw some parallels with the challenges that would arise in the deployment of similar systems in the context of India's multi-racial, multi-ethic set up.

Research of this nature is valuable in that it can nudge appropriate fixes to the training data and algorithms. However, it has also been rightly pointed out that ensuring better demographic representation in data sets does not do much to solve the larger issues of injustice in the institutional contexts within which facial recognition is being employed (Hoffmann, 2019). For instance, Keyes, 2018 challenges the very premise of deploying automated gender recognition systems, which tend to reflect the traditional models of gender as being binary, physiologically based, and immutable. This works to the specific detriment of transgendered persons, who may not fit into these traditionally defined gender constructs.

Limitations of the supporting ecosystem -- Another important factor, particularly in the Indian context, comes from the realities of the surrounding ecosystem within which technologies like FRTs are sought to be introduced. For instance, the mandatory use of FRTs for marking attendance in rural schools would have to account for real world factors like power outages, network down time, availability of devices and prevailing power structures in the local community.

While these issues go beyond the technical capabilities of FRTs, or even the legal and ethical implications around them, it would be dangerous to adopt such technological solutions without accounting for these realities. Similar concerns have also come up in the context of biometric authentication using Aadhaar, and would continue to remain relevant if facial recognition were to be deployed in this context.

FRTs under the draft PDP Bill

Given the variety of concerns being raised by the deployment of FRTs, it becomes particularly problematic that all of these applications are taking place in the absence of a robust data protection law in India. While the current Information Technology Act, 2000 and the rules under it do classify biometric data as "sensitive personal data" and afford certain protections to it, it is widely acknowledged that the scope and enforcement of the law remain grossly inadequate. Moreover, the obligations under the present law are applicable only to "body corporates", hence excluding most instances where government agencies interact with biometric facial data. It is also worrying to note that there has been no public consultation on the adoption of FRTs in any of the different contexts discussed here nor any systematic evaluation of the costs and benefits of using this technology.

The current draft of the PDP Bill that was recently introduced in the Lok Sabha seeks to take care of some of these concerns by bringing the State along with other private actors who deal with the personal data of individuals within the scope of the proposed law, labelling them as "data fiduciaries". The bill requires that the "explicit consent" of the individual is required for any processing of sensitive personal information, including biometric data. However, it also allows for such processing to take place under other grounds such as an authorisation under law or a court order or judgment.

We have seen an example of such an order from the Delhi High Court which had in April, 2018 directed the Delhi Police to deploy FRTs for tracing missing children. This action reportedly resulted in the identification of close to 3,000 missing children by matching the images of missing children with a photo database of over 45,000 children living in various children's homes. While this was certainly a positive outcome, the episode also leaves us with several unanswered questions. For instance, what happens to the data of the children who were part of this exercise but whose data did not match with the missing children? Will their data be retained and used for other purposes? Could this include use for future investigation of criminal cases?

The other provisions of the draft Bill that are specifically applicable to biometric and sensitive data include a requirement of data protection impact assessment for large scale processing of biometric data by significant data fiduciaries and a requirement that a copy of all sensitive data needs to be localised on data servers in India. Further, the Bill also authorises the government to ban the use of certain forms of biometric data, except as permitted by law. However, there is no guidance on the actors against whom, and the circumstances in which, this power could be exercised.

While many parts of the current draft Bill retain the recommendations made by the Srikrishna Committee's draft that was submitted to the Government in July 2018, we see a sweeping departure from the Committee's recommendations when it comes to the processing of personal data for surveillance and law enforcement purposes.

The current draft of the Bill contains a fairly broad set of exemptions for the processing of personal data for the purposes of prevention or investigation of any offence or contravention of any law. Unlike the earlier version of the Bill, this exemption is not subject to the requirement of fair and reasonable processing of the data by the authorities. It also does not provide that such processing should be "necessary and proportionate" for achieving the intended purpose.

Another important safeguard that was suggested by the Srikrishna Committee was that any data processing involving the victim or a witness would ordinarily have to be done in accordance with the provisions of the law, including requirements like consent, purpose and use limitation, etc, unless this may prejudicially affect the case. By removing this requirement the current draft now offers a much broader canvas to law enforcement agencies. In addition to the exemption of certain types of processing, the PDP Bill also allows the government to completely exempt particular agencies from the applicability of the law on grounds such as security of the state, public order, etc.

To put these exemptions in context, suppose that an order under Section 144 of the Criminal Procedure Code, 1973 (CrPC) is imposed in a particular area directing individuals not to assemble in groups. Any person engaging in a peaceful protest could therefore find themselves acting in violation of the order and therefore the police may invoke the exemption under the PDP Bill to deploy facial recognition tools in order to identify the protestors. Given the wide scope of the facial recognition system being developed by the NCRB and the sweeping powers that are already available to the police to call for any "document or other thing" for investigation purposes, under Section 91 of the CrPC, the PDP Bill could effectively provide a free pass to the authorities to conduct mass deployment of FRTs on the protestors. This may include comparing the available images against the records gathered from a range of sources like CCTVs, student IDs, driving licenses, passport records, etc. This creates new barriers to the exercise of people's democratic right to protest.

In sum, the present draft of the PDP Bill offers wide ranging exemptions to law enforcement agencies, and can be regarded as effectively strengthening rather than checking the use of FRTs by the state.

Way forward

Facial biometric data is one of the most sensitive categories of personal data and therefore any adoption of this technology, either by state agencies or by the private sector, necessarily has to be preceded by the adoption of a robust data protection law. Assuming that a data protection law is brought about along the lines of the PDP Bill, it would determine the basic level of protection for the use of facial biometrics, including requirements relating to explicit consent, transparency obligations, purpose limitation and other usage restrictions.

However, the proposed data protection framework will not secure the degree of accountability that we need from the range of stakeholders participating in the implementation of FRTs. Firstly, a data protection law is not designed to compel the developers and vendors of facial recognition systems (as opposed to its users) to ensure transparency about their underlying models, training data being used, false positive and negative rates and other more granular information. Yet, information of this sort is necessary for there to be any independent checks and analysis on the accuracy, reliability and biases in the systems. We therefore need to look beyond data protection laws to find meaningful ways of ensuring transparency and public disclosure on the development and use of facial recognition systems.

Secondly, it must be noted that the PDP Bill only speaks to a few of the concerns posed by the use of FRTs, namely issues of data privacy and, to some extent, transparency. However, the broader privacy concerns posed by the technology, its accuracy limitations and biased outcomes still remain. Here it is useful to reiterate that with ongoing advances in technology, it is likely that many of the accuracy and reliability related concerns around FRTs might be overcome. However, satisfactory technical performance of such systems is only a necessary, but not sufficient, condition for their deployment. The use of FRTs has to be supported, in all cases, by a robust framework for gauging the suitability and proportionality of applying the technology in any given context and measuring the accompanying risks.

Finally, the wide ranging exemptions available to state agencies under the PDP Bill pose many specific concerns when it comes to the use of intrusive technologies like FRTs. In allowing for the sweeping application of FRTs for law enforcement purposes, the PDP Bill essentially condones the most pervasive and worrying use cases of FRTs. To be clear, such a use would still fall foul of the tests laid down by the Supreme Court in the Puttaswamy right to privacy decision. However, the language in the Bill lifts the statutory burden that should have been placed on law enforcement agencies to ensure proportionate application in each and every case and places the burden on petitioners to challenge the constitutionality of the application before a court of law.

References

Acquisti, Gross, and Stutzman, 2014: Alessandro Acquisti, Ralph Gross and Fred Stutzman, Face recognition and privacy in the age of augmented reality, Journal of Privacy and Confidentiality, 6(2), 2014.

Buolamwin and Gebru, 2018: Joy Buolamwin and Timnit Gebru, Gender shades: Intersectional accuracy disparities in commercial gender classification, Proceedings of Machine Learning Research, 81:1–15, 2018.

Feldstein, 2019: Steven Feldstien, The global expansion of AI surveillance, Carnegie Endowment for International Peace, 17 September, 2019.

Fussey and Murray, 2019: Pete Fussey and Daragh Murray, Independent report on the London Metropolitan Police Service’s trial of live facial recognition technology, The Human Rights, Big Data and Technology Project, July, 2019.

Grother, Ngan, and Hanaoka, 2018: Patrick Grother, Mei Ngan and Kayee Hanaoka, Ongoing face recognition vendor test (FRVT) Part 2: Identification, National Institute of Standards and Technology, November, 2018.

Hoffmann, 2019: Anna Lauren Hoffman, Where fairness fails: Data, algorithms, and the limits of anti discrimination discourse, Information, Communication & Society, 22(7), 2019.

IFF, 2019: Internet Freedom Foundation, NCRB finally responds to legal notice on facial recognition, we promptly send a rejoinder, 8 November, 2019.

Keyes 2019: Os Keyes, The misgendering machines: Trans/HCI implications of automatic gender recognition, Proceedings of the ACM on Human-Computer Interaction, November 2018.

Kulche, 2019: Peter Kulche, Facial recognition on smartphone is not always safe, Consumentenbond, 15 April 2019.

Marda, 2019: Vidushi Marda, Facial recognition is an invasive and inefficient tool, The Hindu, 22 July, 2019.

Snow, 2018: Jacob Snow, Amazon’s face recognition falsely matched 28 members of congress with mugshots, American Civil Liberties Union, 28 July, 2018.

 

The author is a Fellow at the National Institute of Public Finance and Policy, New Delhi. She would like to thank Ajay Shah, Ambuj Sagar, Apar Gupta, Christopher Slobogin, Elizabeth Coombs, Salil Tripathi, and an anonymous peer reviewer for valuable inputs and comments on the Data Governance Network paper titled Adoption and regulation of facial recognition technologies in India: Why and why not?, which forms the basis for this blog post.

Concerns about how the Medical Council of India thinks about medical malpractice

by Shyama Nagarajan and Shubho Roy.

India has approximately 5.2 million medical negligence cases annually. A study for Mumbai showed that medico-legal cases, in courts, against doctors rose from 910 in the period from 1998 and 2006, to 150-200 cases every year.

The responsibility to regulate the medical profession lies with the Medical Council of India: a statutory regulator. However, we get little information about whether or when the Medical Council of India (MCI) disciplines doctors. MCI seems to follow a moralistic approach to regulation rather than a legalistic approach.

Morals v. Laws

A legal system differs from a moral system in three important ways:

1. Specificity: Moral standards are usually generic, and rarely provide clear direction for action, in individual situations. In contrast, legal standards strive to be specific and are cognisant of exceptions to the rule. For example, a moral standard may be a generic statement like: Thou shalt not kill. Law, on the other hand, recognises that killing may be justified under many conditions, like defending oneself from a murderous attack, soldiers killing the enemy, an executioner killing the condemned. All of this is codified in various laws justifying killing of another human being in specific circumstances. These have been extensively thought through and developed through legislation and jurisprudence.
2. Consequences: Morals statements may prohibit some actions, but rarely have provisions to deal with the consequences of violating them. In contrast, laws focus on consequences of violating proscriptions. For example, a moral principle may be drafted as: Thou shalt not kill. The Indian Penal Code, on the other hand, has no statement prohibiting people from committing murder. It states simply: Whoever commits murder shall be punished with death, or imprisonment for life...
3. Enforcement Mechanism: Modern states do not enforce moral principles. For example, there is no enforcement mechanism for people who violate the commandment:"Thou shalt not kill". In contrast, laws are backed by the requisite vast machinery enforcing them. This includes police, judiciary and other supporting laws like law governing trials (Cr.P.C.), evidence, etc.

Medical Code of Ethics

MCI drafted the The Medical Code of Ethics, 2002 ("the Code") to govern medical practitioners. By using the term `ethics', it appeals to a moral principle. However, all aspects of the MCI constitute a legal system under the authority of Parliamentary law (the Medical Council of India Act, 1956). An analysis of a few provisions of the Code shows that while the MCI seems to claim moral authority: It drafts standards in the moral style. Even if it had systems and procedures in place to enforce these standards; the language of the standards would prevent them from being enforced in a legal system.

Let us apply these ideas to reviewing review three parts of the Code, pertaining to medical records, generic drugs and commissions.

Medical Records:

Section 1.3.1: of the Code states:

Every physician shall maintain the medical records (sic) pertaining to his/ her indoor patients for a period of 3 years...... in a standard proforma... attached as Appendix 3.

Appendix 3 expects the doctor to mention: Name of the patient, age, sex, address, occupation, date of 1st visit, clinical note (summary) of the case provisional diagnosis, investigations advised, observations, signature in full, and name of treating physician, etc. The record-keeping obligation on physicians is limited to ``indoor patients'' only. Indoor patients refer to patients in medical establishments (hospitals, nursing homes etc.) for 24 hours or more.

This provision suffers from three defects:

1. Incomplete coverage: This provision covers a very small proportion of patients that a doctor examines. It completely excludes the vast majority of interactions (such as, chronic case management and procedures) between doctors and patients, i.e. outpatient visits. There is no obligation to keep records or even record prescriptions in any standard manner for those interactions.
2. It duplicates work: Medical establishments (hospital, nursing homes, etc.) are already required to keep records for indoor patients. It makes no sense for individual doctors to duplicate the effort. Doctors admit patients in different hospitals and offer consultations, and make clinical rounds in hospitals seeing scores of patients. Maintaining records for each patient/prescription in person with the doctor (not the medical establishment) is irrational.

The code does not specify how MCI will identify and enforce against non-compliance. Neither through legal instruments associated with the MCI, nor through any other enactments, is there an enforcement apparatus which involves issues such as accepting complaints, carrying out inspections, requiring the submission of operational data, etc.
Section 1.3.4 of the code reads:

Efforts shall be made to computerize (sic) medical records for quick retrieval

This is an exhortation and cannot be enforced.

Generic names of drugs:

This provision is designed to prevent doctors from prescribing brands in return for kickbacks from pharma companies. This problem is so endemic that the government proposes to bring a new law to tackle it. The Code has a provision governing this, in Section 1.5:

Every physician should prescribe drugs with generic names legibly and preferably in capital letters, and he/she shall ensure that there is a rational prescription and use of drugs.

This obligation does state a penalty for violation. The code expects that there should be a rational prescription without any form to verify it. Since there are no standards for how prescriptions have to be written for patients, it is impossible to test compliance. A doctor is not required under the Code to write down the diagnosis. Consequently, it is impossible to verify whether the prescription was rational. There are medical texts and standards in training which specify how a prescription is written. However, the code makes no obligation on doctors to follow them.

Commissions

Kickbacks from pharma companies to doctors have become a major problem in India. In February 2016, the MCI amended the Code to insert a new provision governing payments received by doctors from pharma and medical technology firms: clause 6.8.1 of the MCI code. This provision is very different from the other provisions in the Code. It clearly leans towards a more legal system rather than a moral system:

1. Instead of a general prohibition, commissions have been divided into eight headings: Gifts, travel facilities, hospitality, cash or monetary grants, medical research, maintaining professional autonomy, affiliation, and endorsement.
2. Each heading has a definition of what constitutes violation. An example of this is the heading: cash or monetary benefits. While this prohibits receiving money from pharma companies, research grants have been exempted, which could be given to an arm of a hospital.
3. For each type of violation there is a specific penalty. For some, it has been graded depending on the magnitude of the violation. For example, if a doctor receives cash above Rs.1000 and up to Rs.5000 he is liable for censure. However, for receiving cash more than Rs.50,000 but up to Rs.100,000, the penalty is removal of the name from the medical register, i.e. barring from practice, for one year.

As with the other areas, these rules are ineffectual as the MCI has no system of tracking such gratification or the administrative machinery required to investigate and penalise violators.

There are grave problems in India about corruption of doctors in prescribing drugs. We need to do much more in defining and enforcing against these practices. One novel mechanism is found in the US. The government requires doctors and pharma companies to disclose any payments from pharma companies to doctors. There is a website where you can look up your doctor and see what payments he/she has received from the pharmaceutical sector (including medical device manufacturers): Open Payments Data. This has spawned other websites which allow users to analyse the data. Dollars for Docs have used the data to rank doctors and pharma companies.

The way forward

The regulation of medical profession requires a clear understanding of general principles of regulation. There have been many attempts to reform the medical profession, the latest being the Niti Aayog draft bill. However, legislative provisions which drive a sound regulatory process under MCI are missing.

Most drafting of law in India is done by amateurs and lawyers. Drafting laws is, however, not trivial. It requires sound thinking in public administration, law, and economics. There is an entire life cycle of a regulatory system which has to be designed in the law. The typical lawyer, who can support a private person on the legal ramifications of a transaction given a certain section of law, is unable to think about what the law ought to be.

Every regulatory system must be animated by a clarity of objective. The parent law must provide the objectives that should drive the government apparatus that it constructs. Too often we draft Parliamentary law which lacks objective. For example the objective of the Payments and Settlement Systems Act is:

An Act to provide for the regulation and supervision of payment systems in India...

The lack of objective induces a government apparatus that only pursues political objectives and bureaucratic self-interest. The authors of the law need to write down why the law gives powers to regulate: issues such as safety of transactions, safe payment system, competition, innovation and consumer protection.

After regulations are made through a sound regulation-making process, powers and systems have to be put in place to check for compliance with those regulations. This requires powers to obtain information, inspect and in some cases investigate. This requires procedural laws to govern inspections and investigations. It also requires thinking about the State capacity in the regulator. Should a regulator make a law where it has no capacity to check compliance? In health, this problem is compounded by the concept of doctor patient confidentiality. As in banking, we need to develop systems by which regulators can check for compliance without breaching the privacy of customers.

There is great value in using statistical analysis rather than case by case analysis. For example, if the incidence of cesarean operations in one hospital is substantially more than another hospital serving a similar population, the regulator should ask questions. Even for individual doctors, complaint rates rather than individual complaints may help the regulator identify the problem doctors. Such systems require careful recording and classifying complaints, even when they are not investigated.

Every regulatory system needs a quasi-judicial system to penalise or acquit the accused. Penalties should be imposed only after following principles of natural justice and due process. Both patients and the regulator itself should be able to bring complaints and results of investigation before a judicial authority, which is not involved in the investigation. Such an entity should apply some standard of evidence and impose penalties. This requires additional regulations specifying penalties for different types of violations. Penalties have to be proportional to elicit the right response from the regulated. As was known many years ago:

Whoever imposes severe punishment becomes repulsive to the people; while he who awards mild punishment becomes contemptible. But whoever imposes punishment as deserved becomes respectable.  -- Chanakya ("Arthashastra", I. "Concerning Discipline", Chapter 4).

All these functions require additional provisions governing accountability and transparency expected of the regulator. Regulatory governance in any field requires substantial amount of legal drafting and two levels: the governing parliamentary law and the subordinate regulations made by the regulator. An example of this is the draft Indian Financial Code. While the code covers the entire financial sector including central banking, 135 out of 414 (32%) of the provisions deal with good governance practices in regulators and tribunals, and are a useful first draft for economic regulation in other fields.



The authors are researchers at the National Institute for Public Finance and Policy.

What does socialism do to ethics

Marginal Revolution has a post about the moral effects of socialism. In this, we are pointed to a fascinating new paper. Ariely, Garcia-Rada, Hornuf, Mann have a new paper where they analyse the natural experiment of one Germany that was arbitrarily sub-divided into communist GDR and capitalist FRG. They find that people with a greater exposure to socialism are more likely to cheat.And, a paper by Al-Ubaydli et al on PLOS One in March 2013 finds that the framework of markets and trade increases trust in strangers.

I have heard similar concerns about low ethical standards in China as the outcome of many generations of communist rule.

Was it just a matter of stamping out religion? Is the causal chain composed of destroying organised religion that leads to cheating by individuals? This does not square with some other evidence. This paper by Gregory S. Paul in the Journal of Religion & Society finds that highly secular democracies consistently enjoy low rates of societal dysfunction.

In the comments on the Marginal Revolution post, mm says that P. J. ORourke says that he knew communism was not going to work when it managed to convert Germans into lazy workers.

These ideas resonate for us in India, with our experiences with the corruption and cheating that is associated with government-controlled resource allocation. There is a fundamental tension between socialism and our core aspirations like the rule of law, a Calvinist work ethic, and fairness and honesty in our dealings. What mechanisms might be at work in the corrosion of values under socialism? From my observation of India, I may conjecture:

1. When things are available through connections or the black market, this gives everyone incentives to engage in illegality, and to violate the rule of law. When storage is proscribed as `hoarding' and forecasting the future becomes `black marketing', people get used to the idea that illegal activities are to be pursued, and the people who are willing to engage in greater illegality get ahead in life.
2. In the parts of India where land reform took place, it became more acceptable to steal other people's stuff.
3. People became supplicants in front of a powerful State, and detested the bureaucrats and politicians who wielded discretionary power. This created pervasive hatred and disrespect for the State, an environment that was conducive to breaking laws more frequently.
4. When inequality is bemoaned and envy becomes fashionable, there is reduced incentive to engage in hard work as a tool to get ahead in life.
5. A big State employs more people, and employees of government and public sector companies tend to have a diluted work ethic.
6. There is a big gap between all the talk about poor people and the reality of the socialist State. This breeds cynicism about politics and government, and fewer wonderful people get involved in matters of the State.
7. When the political leadership allocates time and money to doing central planning and running welfare programs, this comes at the expense of time and money focused on catching crooks.

If we are able to retreat from an intrusive State, and build the rule of law for a narrow set of interventions that do public goods and address market failures, this will help create a new tone of flesh in the Republic. But the changes in behaviour that come with a socialist phase take many decades to get stamped out. We should change things from here on -- but we will live with the consequences of Indian socialism for a long time.

Hence, questions about ethics are going to be a key feature of the Indian story for years to come. I have written before on related themes: Indian capitalism is not doomed, and Ethics and entry barriers. There are now 40 posts on this blog with the label `ethics'.

My experiments with truth in the Indian capital markets

by C. B. Bhave.

Thank you, Bangalore International Centre, for the invitation.

I joined SEBI in 1992. SEBI was given statutory status in that year and was facing huge hostility from brokers. They thought that their freedom would now be curbed by the new regulator. In any case, they did not think that SEBI knew anything about the markets. Some parts of Government were also hostile to SEBI since they thought that their turf was being encroached upon. In 2014, SEBI is a respected regulator nationally as well as internationally. You must have recently read that according to a study carried out by IOSCO and BIS, Financial market regulation in India was rated among the top 6 in a study of 27 top markets.

In 1996, I quit SEBI and the administrative service to set up NSDL - a depository for keeping share ownership records electronically and for facilitating easy settlements. In 1998, the magazine Global Custodian described the Indian market settlement system as the worst in the world (in a study of more than 80 markets) but facing stiff competition from the Russian market for the last place! By 2001, the same magazine placed India in the top 10 markets in the world. These rankings are in sharp contrast to India generally being placed between 100-120 when 150 countries are compared internationally whether it be on health parameters or on poverty or on corruption. The examples of SEBI and NSDL show that we don’t always have to be among the worst, even though we may be starting there. SEBI’s journey from being a fledgling institution to an internationally respected regulator is both fascinating and instructive. It tells us first and foremost that notwithstanding the enormous challenges, reform and overhaul of huge structures is possible in India.

It appears to me that our resistance to change is on account of our being a risk averse society. We are quick to agree that the existing state of affairs in a given area is no good, but each suggestion for change meets with such a multitude of objections that the status quo appears to be the best option. We need to develop tolerance for failure. By trying to keep away from failure, we miss out on valuable learning. We overdo this to an extent that we lose faith in ourselves. We persuade others as well to lose faith in us.

In 1996, I made the decision to give up the administrative service and set up NSDL, the depository. It was an exciting challenge and it was crucial to further reforms in the market. It is amusing to recall what people said to me then. There were many who believed that the depository would fail in India. The conversation would run like this: "The US and Europe have depositories: we cannot be compared with them. That is a developed world. Singapore has a depository: Oh, it is also more developed and is just a city-state. Even Sri Lanka has a depository. It is a developing country. Yes, but it is again just a small island nation. China is setting up a depository. Where does China have democracy? How can you compare China and India?"

India seemed to be in a peculiar place where the problems associated with paper certificates could not be handled. At least do not give up the Service was the last argument. I had a problem there. If the depository was so likely to fail, how would I carry any conviction with the people I was to recruit? Would they be comfortable with a boss who had a safe harbor or one who would sail and sink with them? I had to burn my boats. The irony was that these were my well wishers telling me why the depository would not work. We, in India believe that we have a problem for every solution. There is a lot of truth in this humour. There is hope, however. Young people are an exception by and large. The India we see today is different from the India of 1996. We seem to be well on our way to `can do' from a position of `cannot happen'.

In July 1993, I was invited to a seminar to be on a panel that was to discuss some fundamental changes that the panelists expected to see in their respective areas. One CMD of a nationalised bank was presiding over the panel. I was the last person on the panel before lunch. As is usual in our seminars, I had very little time because earlier panelists had been generous with their interpretation of the time allotted to them. NSE was expected to start its operations that year and automation of trading was, to my mind the most exciting thing that would change the shape of things in the capital market. I was barely five minutes into describing the changes and the presiding officer declared that I needed to wind up in the next two minutes. I was disappointed but wound up saying that time does not permit me to say more. While the rest of the audience and the speakers made their way to lunch, a group of 15-20 youngsters sat me down and said they wanted me to complete what I was saying and wanted to interact with me. There is hope in the young.

Let me give you another example of how young minds work. We needed to set up our mainframe in September 1996 in order to meet our deadline of starting depository operations in November 1996. This was to be done in a building that was still incomplete. We needed to take the mainframe to the fourth floor. The lift was installed but did not have the lift inspector’s permission to be made operative. We did not want to bribe anyone. The mainframe could not be carried via the staircase. Youngsters in NSDL found a solution. We operated the lift mechanically to load the mainframe. We did not break the law and yet kept to our principle.

Reform can be a long and painstaking process. It is almost never a one shot exercise. SEBI identified `Badla' (a particular method of carrying forward the settlement of a trade by getting a lender to intervene) as one of the structural issues in the trading system in India. SEBI’s initial attempts to do away with Badla met with fierce resistance. So much so that the then SEBI Chairman was moved out! Badla was eventually reintroduced. Most people thought that the issue had been buried forever. It appeared that there would be no way that the Indian Market would ever be rid of Badla. However, there were many reasons why the Badla system was popular. These related to lack of many other legitimate facilities needed in the market. SEBI kept working on these issues. Finally, when Badla was done away with eight years later, there was hardly any murmur. Reforms need persistence.

The proponent of a new idea must take into account the reasons why the existing idea came about in the first place. It may have come into place because something else did not work. These linkages are important. If we act to take care of those aspects as well, reform will be so much the easier. Our market used to have very long settlement periods. Long settlement periods introduce avoidable risk in the market. Despite SEBI’s best efforts we found that delays could not be reduced to less than ten days. A modern depository system was a must before any further reduction could be attempted. Today India has a settlement system that matches with the best in the world. There are less than ten countries in the world that settle as fast as the Indian Market.

In capital market regulation, the regulators find that they will not hear the voice of the retail investors unless the regulator makes a specific attempt to hear them. The big corporations have access to media and the powers that be. They can make sure that their difficulties reach your ears. The intermediaries and the institutional investors are similarly placed. If special efforts are not made to reach out to non-institutional investors, there is a danger of missing out an important piece. This is a difficult job. The non-institutional investors are not very well organized. There are investor associations that serve as a fair proxy for this work. It can sometimes be a thankless job. If, in the process of securing the interests of investors, market intermediaries are hurt, you can face a lot of criticism and voices would be so loud that it would appear that your judgment was altogether wrong. It is important not only to stand firm but communicate your view effectively.

Acting for investors can be a difficult task sometimes. Let us say I am serving one lakh clients and I find a clever way of charging my clients Rs. 10 extra every month. The clients do not feel the pinch of that extra money and if I am clever they do not even know about it. In any case what does Rs 10 buy today? But my gain is Rs 10 lakhs a month. Now if a regulator comes along and stops this practice, I have a huge incentive to cry foul. I would brand the regulator market unfriendly, would advise it not to interfere in small matters and focus on issues of policy. What is the incentive for the man who gained Rs 10 to argue the opposite? Very little. So this may appear a thankless thing to do. Regulators need the will to go the extra mile and do it all the same. When we questioned banks about the float money in IPOs and tried to eliminate it, the situation was similar.

The intermediaries act as agents of investors. One would imagine that their interests would be aligned. That need not be the case. The regulator has to be alert to this. Once interests are misaligned, there will be mis-selling. Brokers routinely take the power of attorney from clients to trade in the clients' account and to debit their accounts when required. The broker gives an incentive fee to his employee based on the brokerage revenue generated by the employee. It is easier to maximise brokerage by churning a client portfolio, than by acquiring new clients and convincing them to invest in the market. This is not in the client’s interest. One might argue that regulators should not micro-manage by getting into the nitty gritty of incentive structures of the employees of an intermediary. It is a good argument, but fails to address the issue of misaligned interests. If the regulator does not address this issue, there is little chance that investors will be able to do much about it.

At times there is confusion about the role of agents. Let us look at mutual fund agents. Whose agents are they? They are agents of the fund manager because they earn their commission from the fund manager and the fund manager appoints them. They claim that they are also agents of the investor because they give advice to the investor on the appropriate scheme to invest in. But the investor does not appoint them nor does the investor control their payment on the basis of quality or quantity of service delivered. When you are the agent of both the investor and the fund manager, and the fund manager has appointed you, in whose interest will you act? It was clear that the whole theory of the agents acting in the interest of investors was just a theory. When SEBI abolished the entry load, we faced criticism even to the extent that we were killing the mutual fund industry. We had thousands of schemes, and constantly new schemes were being floated. This whole operation definitely worked well for the agents and the fund managers. It was not in the interest of the investors. It was like churning a client portfolio for generating brokerage.

One of the lessons we learned in NSDL was that changes like a depository system affect different elements in the market in varying ways. Unless one listens to these carefully and understands the affected party, we may end up with wrong answers. We used to address investors seminars all over the country to explain demat to them. One question used to come up frequently: "If your system is good and will provide excellent audit trail, why will people who have bought shares with unaccounted money join you?" Our initial reply used to be that we were setting up the system for law-abiding citizens of the country. We did not care if people who employed unaccounted money could not use the system. This reply satisfied us but some how did not seem to satisfy the audience though they would keep quiet. We decided we needed a better answer. We brainstormed. Our reply in the next seminar was that if all people with clean money came to the depository the tax department will just have to ask the companies the list of those shareholders who still have shares in paper form. They would be sitting ducks. This drove the point home. One has to speak the language of the consumer to win him over.

We quickly realized that while implementing such a large scale system you cannot achieve your ultimate goals by following a predetermined path. While you need to have an idea of how you intend to get to your goal, you must have the flexibility and humility to change course. On reaching one lakh accounts, when we analysed the pincodes in the addresses of the investors, we found that a vast majority was from Kerala. This was counterintuitive. Mumbai or the state of Gujarat would have been the logical candidates. We realised the reason. We changed the language of our literature and seminars from being merely in English to Hindi and eight regional languages as well. In a couple of years the balance was restored.

The moneyed and the powerful form a cozy club in India. The first rule is that you should mouth the principle of equality before law but must understand that this does not apply to the members of this club. If you act tough with small fry, there will be all round appreciation. If you, however, try to enforce the rule of law on the members of this club, there will be public appreciation and private anger. Retribution will follow. Lack of ethical values and morality in our public life has degenerated so much in the recent decades that it threatens our very core. Citing examples of aberrant behavior in other countries is just fooling ourselves to believe that here the problem is not all that severe. Earlier the unethical needed a place to hide. They carried out their activities covertly. Now, any talk of morality or ethics is seen as a mere fetish, an impractical virtue, an impediment in the path of the getting things done. It is not just that. We first transited from tolerating the corrupt to tolerating the honest. The corrupt are now saying that the honest are too much of a nuisance in this cozy world of give and take. Let us harass the honest. Even if they are foolish enough to fight back and win, the dishonest would still have achieved their goal. After seeing the harassment caused to these honest people, they hope that the succeeding people will not entertain any thoughts of behaving in this odd honest manner, Am I exaggerating? No. Things are so bad that one of the Supreme Court judges who recently retired had this to say:

There are matters pending with the court, but the pressure, tension and strain both of us have undergone is unimaginable. I can't explain. The pressure was reflected on my wife and family. I can't speak much on the Sahara case.

What would one's reaction be, when one hears this? We would be shocked, horrified and wonder `How dare anyone do such things vis-a-vis a Supreme Court judge?' Not one eminent lawyer. His comment was that the judge should not have said this!

A two judge bench had delivered a judgment in that case just a few days prior to this. The entire judgment is instructive and should be read in full. I am just referring to para 147 of the judgment:

The number of similar litigants, as the parties in this group of cases, is on the increase. They derive their strength from abuse of the legal process. Counsel are available, if the litigant is willing to pay their fee. Their percentage is slightly higher at the lower levels of the judicial hierarchy, and almost non-existent at the level of the Supreme Court. One wonders, what is it, that a Judge should be made of, to deal with such litigants, who have nothing to lose. What is the level of merit, grit and composure required, to stand up to the pressures of today’s litigants? What is it, that is needed to bear the affront, scorn and ridicule hurled at officers presiding over Courts? Surely one would need superhumans to handle the emerging pressures on the judicial system. The resultant duress is grueling. One would hope for support for officers presiding over Courts, from the legal fraternity, as also, from the superior judiciary upto the highest level. Then and only then, will it be possible to maintain equilibrium, essential to deal with complicated disputations, which arise for determination all the time, irrespective of the level and the stature, of the Court concerned. And also, to deal with such litigants.

If Supreme Court judges are saying this, you can imagine the circumstances under which regulators work.

That brings me to the point of the recent investigation launched by the CBI regarding the license granted by SEBI to MCX-SX for running an exchange to trade in currency derivatives. They say it is a preliminary enquiry so there are no charges; they are merely investigating. When I asked them what they meant by `a PE against Bhave and Abraham', they said it is an unfortunate use of words. Unfortunate indeed, but by whom and for whom? They leak news all the time. The only time they have come on record is to say `Why all this fuss when there have been no arrests or raids!' Do we expect the citizens of a free country to protest only after they are raided or arrested? The second statement on record is `Thousands of crores of investor money have been swindled by MCX and it was incumbent on the agency (CBI) to look at the very procedure of registration of MCX' by SEBI. This is ill informed and if not ill informed then ill intentioned. The money was lost in NSEL and not in the entity licensed by SEBI. To date, CBI has not revealed whether they are investigating anyone who sanctioned NSEL, the exchange in which people actually lost those thousands of crores. What is our remedy against this arbitrary behavior of an investigating agency? What does one do when they publicly say that the PE is against Bhave and Abraham and privately tell me that it is an unfortunate use of words?

I believe there is no remedy because CBI is an autonomous investigator and no one can question them. In our effort to free CBI from the clutches of the political executive have we gone too far and forgotten the issue of accountability? At last count, CBI’s rate of successful conviction on launching prosecutions is less than 5 per cent. Who questions them about this? We cannot, in a democracy, have an institution exercising coercive powers of the State without any accountability. This question needs the attention of the Government as well as the judiciary.

Is investigation and successful punishment to wrongdoers such a difficult thing? At SEBI we found that investigation and successful conviction is not a rocket science. Robust common sense, and an unbiased evaluation of the material gathered, can help you reach the right conclusion. We need to proceed not because we want to fix someone but because the evidence is against the entity concerned. I do not believe that competence is an issue. People can be trained. It is usual to blame the courts: that they are unreasonably strict in terms of the standard of proof required. That was not our experience. We did not lose a single high profile case launched by SEBI in those years. The inevitable conclusion is that lack of will and objectivity, and not the lack of skill, is the problem.

With such low conviction rates, the general public has lost any faith that the moneyed and the powerful will ever be punished. They, therefore, rejoice when raids are conducted and arrests are made. The society has come to see raids and arrests as a proxy for convictions. In the process we do not realize that if the agency raids or arrests an innocent person, he or she will also be seen as a black sheep by all of us. A raid or an arrest is only an aid to gathering credible evidence and not an end in itself. The agency has to be accountable for the rationale and the timing of the raid or the arrest. Such questions are rarely asked. The NSEL scam came out in the open in August 2013. CBI raided NSEL in March 2014. Our anger against the scam is such that, to us, the raid was the right thing to happen. Nobody asked the question as to what was gained by raiding an entity 8 months after the scam. Was CBI of the belief that the entity would have preserved incriminating documents for full 8 months so that CBI would discover them in a raid?

The whole system is so vitiated that pendency is used as a potent weapon. As long as CBI is investigating something the concerned person better not speak up, otherwise he will face the consequences. He will be denied promotions. If it is an entity there will be no permissions or licenses for the entity. If the government finds some officers’ honesty or outspokenness too uncomfortable, why not start a CBI enquiry or an income tax investigation against him? The chances are that the officer will keep shut. Attempts have been made and they continue even today to harass my colleague Abraham. Fortunately, he has spoken up, refusing to be cowed down. The investigation can remain pending for months or years and no one is answerable for the delay. Procrastinating is not only the norm today but CBI seems to be taking it to a new level. One of the questions they have of us is `Why did we not keep license pending when an income tax raid had been conducted against a related entity'! They want to elevate procrastination from a level of the tool of the timid or the crooked, to being a virtue. They suspect criminality when you do not procrastinate!

There is a section in the Prevention of Corruption Act that is the cause of most of the mischief. The government's attention has been drawn to it. There was some attempt at amending this section. Let us hope that the newly constituted Parliament will take it up as a priority.

Such is our fascination with raids and the details of what was found that we do not see beyond the raid itself. About a decade ago, there was a raid on a senior officer of the central excise department. There were details about how much cash was found in the raid and how it was difficult for the raiding party even to count the cash. There was also description of the moveable and immoveable property discovered in the raid. The officer was suspended. This is not uncommon. We needed to go beyond that. Firms had obviously paid off this officer for getting illegitimate concessions. How about reviewing the major cases decided by the officer in (say) five prior years and getting the firms to pay up what was legitimately due to the public exchequer? I made this suggestion to who ever I could approach in the Government. (I was not in the Government at the time). There was no appetite for this. Why? Your guess is as good as mine. Should we give up? I have not. I still make this suggestion to who ever will hear me. You are my captive audience today, so I am making this point to you.

When you are in authority and people appreciate you for meeting them at the appointed time, when they thank you for returning their calls and when they compliment you for your honesty and for owning up responsibility for your decisions you might feel happy. But may I submit to you, that these things should be a cause for deep reflection. The first two tell you how feudal our mindset is and how free citizens of this country still expect to be treated with disdain by the authorities. They are surprised and thankful that normal courtesy is extended to them! The other two make us wonder if our expectation of ethical behavior is so low that what should be normal behaviour is treated as a great virtue. Should public servants not normally be honest and ready to own up responsibility?

Despite all the gloom around us there are many in the country that have not given up. The recent appointment of the SIT on black money is a case in point. There were some people who did not give up the idea of bringing the tax evaders to book. They used the PIL route to get the attention of the Supreme Court. After some dithering and a change of Government we have an SIT in place. Notwithstanding some pundits who have already declared that nothing worthwhile will come out of this, I have no doubt that a process has been set in motion that will solve at least a part of the problem.

To sum up, ladies and gentlemen, I have tried to make the following points. The state of ethical standards and moral behavior in our society is really down in the dumps. We are in bad shape but we do not have to be that way. There is no reason for us to give up. Reform and improvement is possible. The progress made by us in the area of capital market regulation and infrastructure shows that things can be changed dramatically. Reform is a long and painstaking process. We can make our contribution by standing up for the right causes.

This talk was based on my own experience and observations. The challenge was to talk about my own experience but stay focused on ideas and issues. If I had talked merely about issues and ideas it would have sounded like homilies. If I had talked excessively about my own experience I would have committed the mistake of self-projection. I have tried to achieve a balance. I leave it to you to decide if the balance was right. Thank you for your attention.

CBI preliminary enquiry on MCX-SX becoming a stock exchange

• CBI doesn't seem to know the SEBI order signed by K. M. Abraham on 6 September 2010 which rejected the application by MCX-SX to become a stock exchange. This roadblock was removed through a Bombay High Court decision by Justice Chandrachud on 16 September 2011 followed by something which happened at the Supreme Court on 11 April 2012.
• An interview with C. B. Bhave.
• N. Sundaresha Subramaniam in Business Standard tells us more about the 2008 event.
• See this story by Shaji Vikraman in the Economic Times today.
• Commentary by Dhiraj Nayyar and R. Jagannathan. 
• Raghuvir Srinivasan in the Hindu.
• Mobis Philipose in Mint.

This is a good time to ruminate on the notion that CBI or Lok Pal should have independence. Underdevelopment is where the police are more dangerous than the criminals. Coercive power coupled with independence is a recipe for trouble. What is needed is far more thinking on how to do sound public administration, on the right mix of independence and accountability. Anger about corruption is not a useful source of good thinking in public policy.

This is also a good time to ruminate on the lack of rule of law in the determination of fit & proper.

The investment technology of foreign and domestic institutional investors

Ila Patnaik and I have a recent paper in the Journal of International Money and Finance on the investment technology of foreign and domestic institutional investors.

The question

Do the firms chosen by FIIs do well? What is the stock market performance, and the operating performance, in the period after a firm has been selected for investment by FIIs?

This is an important question for many reasons. Investors (both foreign and domestic) would like to know the information content of seeing an FII or DII present in the shareholding of a firm. If, hypothetically, domestic financial regulation hampers DIIs, there may be a special role for FIIs in rationally allocating capital and alleviating financing constraints. If FIIs fare poorly in security selection, as has often been the case in the international finance literature, these mistakes have consequences for the allocation of capital and the incentives of entrepreneurs. Perhaps what India requires is policies that foster deep engagement with international capital, through which FIIs would achieve better information and thus fare better in security selection.

The opportunity for measurement

There is strong evidence of home bias: foreigners own too little of most Indian firms with an ownership of 0 for most firms. Less than a thousand companies have over 1% investment by FIIs. This is true for DIIs also. This opens up the opportunity to see how the chosen companies fare against those that were not chosen. To construct a quasi-experiment, we identify three groups of firms: 

1. Those chosen by FIIs but not DIIs
2. Those chosen by DIIs but not FIIs
3. Those chosen by neither.

On the 31st of each year, it is possible to make these three lists of firms. An examination of future performance would give us insights into the investment technology of FIIs and DIIs. Specifically, if the firms chosen by FIIs but not DIIs (i.e. Group 1) do much better than those in Group 3, then we would think that FIIs have a valuable investment technology.

Pitfalls in measurement

Institutional investors are different. Institutional investors are different from individual investors. Hence, a fair comparison is between FIIs and DIIs.

Treatment effects or selection effects or both. Why might a firm fare well after FII investment? There can be two channels. There can be a `selection effect' where FIIs identify better firms. There can be a `treatment effect' where FIIs exert governance, and push firms to behave better. Investment technology is about the overall effect, i.e. the reduced form outcome. The economists' perennial quest for separating out selection effects from treatment effects is inappropriate here.

Asset allocation versus security selection. It is well known that the firms chosen by foreign investors are different in many dimensions such as beta, size, liquidity, etc. This hampers comparison. As an example, when Nifty fares well, high beta firms tend to do well. In such times, the portfolio held by foreign investors will look good as they have loaded up on high beta firms.

In order to address this, we utilise the three Fama-French empirical asset pricing factors: size, B/P and beta. For each firm chosen by the FII (but not DII), we find the partner firm (that was chosen by neither FII nor DII) where the Mahalanobis distance in size, B/P and beta is the lowest. If a good match cannot be found, the firm is dropped. This gives us a series of pairs of firms, which are alike in size B/P and beta, where one got FII (but not DII) investment and the partner got neither.

Holding a money manager accountable for security selection after controlling for asset allocation is an old idea in finance. However, the application of this idea into the question of investment technology of FIIs and DIIs is new, as is the matching-based quasi-experimental strategy through which we control for the asset allocation.

Results

We find that the firms chosen by FIIs have exuberant growth in fixed assets in the following 3 years. But their output growth is not commensurately strong; there is some evidence of a decline in productivity. In terms of stock market performance, these firms under-perform over the three years after observation date.

Firms chosen by DIIs are strikingly different. They seem to be firms that are retrenching: both capital and labour drop slightly. But output grows. There is productivity growth. In terms of stock market performance, these firms outperform by 18 percentage points over three years.

These results suggest that foreign investors have a weak investment technology. Their access to information, and their ability to process information, adds up to poor security selection. In contrast, DIIs -- who are present in India and are likely to have ample information about portfolio companies -- fare better.

Implications

Implications for persons analysing Indian securities. A firm which has FII investment but not DII investment is probably going to grow assets but not give strong results. Conversely, a firm which has DII but not FII investment is likely to have slow growth but improve productivity and deliver stock market returns.

Implications for foreign investors. The results of this paper are about the average foreign investor, and there are surely many foreign investors who fare very well on security selection. However, on average, foreign investors need to be more cautious about their activities in India. They need to either amplify their efforts in security selection, so as to achieve strong information and information processing on Indian firms, or not attempt security selection.

How can a foreign investor improve security selection? Two paths are visible: To establish operations in India, and hold the team accountable for security selection using the methods of this paper, or contract-out to money managers who have deep roots in India.

How can a foreign investor harness asset allocation to India without attempting security selection? It is possible to setup index funds for the three Fama-French factors and thus replicate the bulk of the desired portfolio characteristics.

Implications for policy makers. Many of the pathologies of international finance are rooted in asymmetric information and the lack of deep engagement of foreign investors. These results are a reminder that even a large emerging market like India suffers from these problems. It is in India's interest to have a deep engagement with foreign capital, so as to obtain higher allocative efficiency. This suggests a re-examination at the constraints placed against deep engagement by foreign capital:

1. It is difficult for foreign investors to contract-out money management to locals.
2. `Permanent establishment' rules by the tax authorities have encouraged foreign investors to not open offices in India. This hampers deep engagement. Offices in Singapore or London will not be able to match the information and information processing that can be done in India.
3. Source-based taxation, capital controls, and taxation of transactions, give incentives for foreign investors to avoid transacting in India. It is cheaper for a foreign investor to invest through the PN and NDF markets. However, not being in India hampers deep engagement.

How might this change over time?

In my opinion, in the 2000s, a certain kind of Indian entrepreneur started producing companies that look good to foreign investors. But you can't fool all the investors all the time. I think many investors are now more circumspect. Wall Street is changing course, and this is changing incentives for entrepreneurs. When finance rewards honest businessmen, more honest businessmen will show up asking for capital from the financial system. Many years from now, we might say that the results of this paper described a moment in time in the evolution of Indian capitalism.