RACY CASES -28 The Law of Unintended Consequences


 

A V Vedpuriswar and V Pattabhi Ram

 “Man proposes, God disposes,” said China sipping in his third cup of coke.  Wafers scorned.  She trusted no God; she believed that religion and vasthu were the mantras of the insecure soul.  Muscles, studying to become a heart surgeon, stopped her thoughts saying, “that’s not what China means.  What he means is that many things that we do result in unintended consequences.”

Muscles explained.  “Look, things do not often happen the way we expect them to”.  And he dipped into the epics to make his point.  “You know,” he said, “my take is that the Kurukshetra could have been stopped.”  If there was one thing Wafers disliked more than Taxation it was Muscles pontificating. When he did that he was unstoppable.  “In the Mahabarata, Bhishma made the younger Pandu the king ahead of the elder Dhritarashtra.  The logic:  a blind Dhritarashtra would never be able to govern the kingdom effectively” said Muscles.

Wafers wasn’t able to place the significance.  But China had already cottoned on.  “When Pandu died early and Dhritarashtra took over he had a one point agenda: how to perpetuate his dynasty. And that is how the animosity between the Pandavas and Kauravas deepened, leading to Kurukshetra”, he said. Muscles rubbed it in, “Had Dhritarashtra been anointed king in the first place, his confidence in the succession planning mechanism would have stayed high. Probably, he would have remained a titular head with the real powers vesting with Pandu.  Perhaps he would not have been unfair to the Pandavas.” China echoed Muscles.  “Kurukshetra might not have happened”.  And he gave it a name, “the law of unintended consequences”.

Wafers was beginning to understand.  She wondered whether there was a certain analogy in finance. “Like, in Capital Structure. Managers often prefer equity to debt since equity is perceived to be cheaper. Debt involves mandatory principal and interest payments.  In equity, there is no compulsion to pay dividends.  And rarely is equity capital returned to investors.  So managers take things easy when it comes to equity funds”.  China read her mind to a tee.  And remarked, “Yes.  That’s precisely why the dotcoms folded up in the early 2000s. Because they had access to easy venture capital funding, they never understood the importance of equity.” Wafers was aghast.  She cursed. “Could people read my mind like a book?”

Ofcourse she kept her thoughts to herself.  China explained, “Because debt is perceived to be riskier, companies tend to be more careful with the debt money.  And debt often brings in quite a bit of discipline and leads to better financial performance.”  Muscles closed out, “Leveraged buyouts are based on this very same principle”.   Ha, the law of unintended consequences at work.

Wafers nodded. Only the other day her professor, teaching inventory control, had told the class about “just in time.”  He had remarked, “If the Japanese follow JIT (just in time), Indians follow JIC (just In case)”.   She had then smiled. She now understood. Managers maintain inventory because it acts as a buffer against uncertainty.  Inventory comes in handy if a supplier delays delivery. In JIT hardly any inventory is kept. The entire plant stops if something goes wrong.  Hence the risk.  But companies like Toyota, are aware of the consequences of things going wrong in a JIT system. So they ensure that suppliers always deliver in time.  On the other hand, in companies like Titanic (the multi million dollar company that Wafers audited), which hold huge inventory, quality control slacks and vendor management slips.  In short, holding inventory undermines the effectiveness of the plant.  Instead of acting as a buffer, the inventory creates problems! The law of unintended consequences tilting its head!

Knowing Wafers’ weakness for business- oriented examples, China decided to draw an analogy with small-scale industries (SSI).  “After independence, our political leaders decided to promote SSI.  Towards this, many areas were exclusively reserved for them.  They were given special concessions.  The results have been disastrous.  Today, virtually the entire SSI sector is sick. At the scale on which they operate, few SSIs have the financial or marketing clout needed to survive. The few healthy ones have decided to go slow on growth so that they can remain within the ceilings prescribed and continue to enjoy SSI status”! What a shame indeed.

Wafers recalled what she had read the other day in the editorial of a financial daily.  “During the 1990s, successive Indian governments had consciously dropped interest rates downwards. The belief: lower interest rates would boost investments.  But what has happened is otherwise.  Banks have been unwilling to lend to industrial projects, as their risks are not covered at these low interest rates!  Instead they have chosen to invest in government securities.  At the same time, they have done consumer financing where the spreads are higher and the risks lower. The result: consumption expenditure on consumer durables has shot up. Instead of boosting investment, lower interest rates have increased consumption”! Ha, the law of unintended consequences thought Wafers.

China volunteered a global example.  “Germany and France, have imposed restrictions in the labour markets in areas like firing and minimum wages.  The aim: protect workers.  Instead what has happened is that companies have been reluctant to recruit new workers.  Companies know that once they hire workers, it will be difficult to retrench them. In short, labour legislation instead of helping workers has ended up hurting their interests!”  Unintended consequences, again.

Wafers decided to make a mental note of what these tales unfurled.  That actions give a certain appearance on the surface but deep down, they are different.  If we overlook the deeper issues, the most logical decisions will lead to unintended consequences!  Some lesson indeed.

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About Pattabhi Ram

A chartered accountant by profession, a writer by passion and a teacher by accidental choice.
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