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Hyderabad: At the age of 31, Pankaj Ghemawat became the youngest professor in the history of Harvard Business School, after joining as faculty in 1983 when he was 23. Currently a professor of global strategy at the IESE Business School at the University of Navarra in Spain since 2006, Ghemawat is no stranger to holding strong views. He famously contested New York Times columnist Thomas Friedman’s theory, saying the world is not yet flat. Author of Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter, Ghemawat cautions against too much fear triggering too much regulation. He spoke with Mint on the sidelines of the “Emerging India: Strategic Innovation in a Flat World" conference last week in Hyderabad. Edited excerpts:

What are the key reasons for the failure of the US economy and its impact on the world?

Straight talk: Ghemawat is not very optimistic about the economic situation changing in the next two quarters at least. Bharath Sai / Mint

It’s about finding the optimal balance between fear and greed. There was too much greed, say 12 months ago, and the concern now is that there may be too much fear. We might overshoot in that direction and shut down all credit. Small enterprises around the world are dependent on such credit to keep businesses going. Those are the companies who are reeling right now, even though they did not do anything financially unorthodox.

What kind of regulatory revamp does the US crisis warrant?

I remember asking the former head of a major international financial oversight body and the former head of one of the world’s largest bank, both of whom used to be the poster children for financial industry self-regulation. When I asked them about self-regulation, they started laughing. They don’t believe in it either. The notion that people who are fascinated about money, a little more than the average person, can be trusted to keep everything up is very naive. Clearly more regulation is needed.

The second thing is that information disclosure is an important piece of legislation that warrants separate mention. Nobody had any idea as to what was going on. This has to be something about information tracking and disclosure. They were all operating really in the dark and there were financial institution CEOs in the US who had no idea, months after (the) crisis broke, about how much bad loans there is on the book or about how much their assets need to be revalued.

I think that a better understanding of how imperfect the information that markets operate on, is a little bit of a curative for market fundamentalists because even well-trained economists would agree that with imperfect information, you can’t always expect markets to perform well.

How long will it take for the global economy to revive?

I think it would certainly take more than a year. I am not very optimistic about things changing in the next two quarters.

What role would do you like to see governments playing in addressing the unfolding slowdown?

The key thing to watch out for is this naive, “let’s fix this current problem and forget about other objectives" approach. The specific form that can take here is, “let’s remove any suspicion of anybody taking unwarranted risk". The principal problem with that is I am not aware of any mechanism that can perfectly protect against unwarranted risk that also doesn’t affect warranted risk, which you would want to undertake. It is a danger right now, those in the US political system particularly know well that it works the same everywhere.

Politicians are really uncomfortable, because they are accused of sleeping on the job. What is going to happen in the US is a little bit like what happened post-Enron. There is going to be a witch-hunt, and certainly financial industry executives will not have a very pleasant time, having to face lot of congressional hearing and such.

The worry is whether the politicians or policymakers (will) start dialling up regulation too much. Clearly not all financial innovation is good, but there are still some that are good. Many small and medium-sized companies still don’t have very good access to finances, an indication of under-served markets that need new kind of financial instruments. I’m a bit worried about politicians, who in a bid to look good or to come across as punishing the guilty, end up over-regulating. Access to capital for mid-sized companies is important, and the regulation should not affect it.

Like (the) private sector, governments also have a tendency to overshoot with regulation. Taking a view that higher capital adequacy is important, but taking it to the level of fetish will kill the economy.

What’s your advice to governments chalking out stimulus packages?

I’m a microeconomist. But the interesting thing about stimulus packages is, especially given the remarkable amounts of money involved, how little the macroeconomists seem to be able to tell us about how it will be spent and what will happen when it is spent. I remember while (Henry) Paulson (US treasury secretary) was going around the US Congress saying that this (the banking bailout package) is what is going to restart the flow of funds to families and the next day a senior JPMorgan official saying, “oh no actually, but we might actually use it to buy other banks".

So, I am really worried right now about political factors as much as the economic factors. There are a lot of middle-class families who are very, very, mad and understandably so. And trying to manage their doing is critical. But it is important not to get carried away by political reasons and try to engage in competitive populism by trying to come across as “who can beat up the bankers most". It may not be the most popular thing to say, but we do need bankers.

When will such packages start bearing fruit?

(The) usual lead time is definitely more than a quarter. Nothing, virtually nothing, happens macroeconomically within a quarter. It is important to have a stimulus package that stimulates the people that you want it to stimulate as opposed to just getting stuck somewhere between the source of the money and where it is supposed to actually go. So it is important to ensure that the money reaches people who it is intended for, rather than be in a hurry to disbursing it to somebody higher up in the pyramid.

Going forward, how do you look at the capital spending by governments and companies?

This was a big thing that preoccupied (John Maynard) Keynes. We’ve known for a while now that there is excess volatility around investment decisions and, hence, it is important to have elements of policy that promote stabilizationand counter-cyclicality. That should be part of various governments’ intervention strategies. As for the private side, we know that business investment tends to fall more in response to drop in demand. So there is a little bit of concern that industry is going to overshoot on the side of caution and cut back on everything.

What strategies would you suggest to developed economies in general, and the US economy in particular, to come out of the economic crisis?

What management strategy you could follow depends on how much cash you have at hand. For companies, it is good to get used to the idea of getting return on capital investments over a period of next 10 to 20 years, rather than the next few quarters as well as to realize that it is a good time to construct new plants and hire new people now than at market peaks. Also they should remember that acquisition targets are once again reasonably priced.

But it is interesting to see that some companies from developing economies have already come to the conclusion that things have hit the bottom and that it is a good time to invest a couple of billion dollars in the US.

What strategies would you suggest to Indian companies?

It varies from sector to sector. But a flat expense cut across the board is not the way to go. Some sectors like forging and chemicals companies might have to look at diversifying to tap opportunities other than the automotives market as that is getting impacted. For example, for the Indian IT companies, there will be huge opportunities in the financial integration that will be happening in the developed world.

What would be your advice to consumers? To save or to spend?

Depending on what various local governments’ policies are, disperse your money across various banks so you have some degree of coverage. I have been hearing some very intelligent and sophisticated people talking about pulling money out of banking system. Shows you how much the trust has been shattered.

What do you think will reaffirm consumers’ faith in the financial system, and spark demand again?

Having said that the government could over-regulate, I will say it is desirable to have some amount of government guarantees and regulation to instill some kind of “the government is watching" feeling among people. It is going to be a slow process because people have become very sensitive.

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