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Finance & Development
A quarterly magazine of the IMF
December 2005, Volume 42, Number 4

Letters to the Editor

Survival of the fittest

In " Risky Business" (September 2005), Raghuram Rajan argues that skewed incentives for investment managers may be adding to global financial risks. As savings have been disintermediated and increasingly channeled toward investment managers and away from banks, risks have increased because investment managers have a higher incentive to take risk. The key to his argument is that investment managers—as opposed to bank managers—face a compensation structure with a large upside and little downside, thus skewing their investment decisions toward riskier behavior.

I would like to disagree. Taking it to the extreme, there are two types of incentive structures. On the one hand, bank managers receive a large salary and a small bonus based on the general profitability of their company. Failing performances do not lead to serious punishment, for they are blurred into the overall results of the bank. On the other hand, absolute return high risk investment managers receive a proportionally smaller salary and a larger bonus based on individual performance. The investment manager can reap the profits of a successful performance, but he or she can also lose everything in a failing performance and be out of a job. Absolute return investment managers thus play a continuous survival game, where the key objective is to be able to play the following day. These pressures are what introduce discipline into their actions, resulting in profit maximization.

The symmetric definition of limited liability places absolute return investment managers in a superior risk-reward position. Relative return investment managers (for instance, mutual fund managers) do not face this structure, though, and may be closer to the skewed incentive structure that Mr. Rajan comments on and finds problematic.

Angel Ubide
Research Fellow
Center for European Policy Studies, Brussels

Who should pay for university?

Nicholas Barr ("Financing Higher Education," June 2005) reminded us that graduates earn a large private return to their degrees. It is, therefore, right that these graduates contribute more to the costs of their higher education. Why should low wage taxpayers (whose children do not attend higher education) subsidize the children of wealthier families who do go to university? Certainly poorer students are much less likely to get a degree, as compared to richer students. This inequality is long standing, and worsened in Britain during the 1980s and early 1990s. Thirty years of expansion of higher education has not solved the problem because it is richer students who flock into universities in increasing numbers. Their poor counterparts remain excluded. So the big question is whether tuition fees will worsen this already dire situation?

I think not. Inequality in higher education is attributable to inequality earlier in the system. For a given set of A-level grades, students from richer and poorer backgrounds are equally as likely to attend higher education. The problem is that rich and poor students are not equally as likely to get a good set of grades in the first place. Tuition fees are not harming access because, by and large, poorer students are not doing well enough in school to be eligible to go to university in the first place. If higher fees allow more resources to be spent on early schooling, then we have a real opportunity to reduce the inequality in our education system. Certainly we need to continue to promote access to higher education with bursaries, access regulators, and the like. And student loans must be sufficiently high that students without parental support have sufficient income. But the real challenge for our education system in the 21st century is improving the performance of disadvantaged pupils in primary and secondary school.

Dr. Anna Vignoles
Institute of Education, United Kingdom

Not just for profit,

F&D has once again presented a serious, critical, and in-depth look at elements of the global economic system, this time in its articles on making aid work (September 2005).

That said, a few matters may not have been accorded enough importance. First, the globalizing economic system is generally arrayed against the real goal of development, which, in my view, is to help poor people improve the quality of their lives. The corporations, banks, and individuals who exercise de facto control over the global economy are driven mainly, if not exclusively, by the effort to maximize profit. Profit is not, of course, intrinsically evil. But to subordinate everything to it—including the well-being of hundreds of millions of people—is. Crudely stated, if the development community cannot restrain the power of finance capital, then development, in terms of meeting the Millennium Development Goals (MDGs) for instance, will never be achieved.

Second, I found mention of the external debt of developing countries only in the essay on "The MDGs: Building Momentum," and even there, only as a kind of afterthought. The debt question has been front and center for many years. The new debt relief initiative launched by the Group of Eight (G8) countries is yet another attempt to address it, but to many observers, no debt relief initiatives have succeeded so far. The debt is both a psychological and an economic obstacle to effective development in the developing countries. The conditionality that has been attached to all debt-reduction approaches simply perpetuates the problem.

Martin M. McLaughlin
Arlington, Virginia
United States