The Indian Economy Blog

June 15, 2007

Colonialism As A Cause Of Income Inequality

Filed under: Growth, Basic Questions, Economic History — Dweep @ 12:35 pm

Economist Luis Angeles suggests (in his paper Income inequality and Colonialism) that
we can lay part of the blame for income inequality in the new world on colonialism:

Our paper’s main point is that colonial history is a major explanatory factor behind
today’s large differences in inequality among the world’s countries. We have reviewed the
different colonial experiences of the last five centuries and have classified them in 3
broad categories. Of these three, we argued that one clearly produced and sustained
highly unequal societies. This high inequality group is the one where colonialism brought
into the country an amount of European settlers whose number was considerable but still
inferior to that of the local population. This minority was able to concentrate most of the
countries’ income in their hands, mainly by excluding the rest of the population from
owning land or mining resources. Moreover, and with the exception of Algeria, it was this
minority who took all political power once these countries became independent. This
allowed high inequality to remain a characteristic of these countries up to our times.

It is important to make a distinction here between inequality - the subject of this paper -
and general lack of growth and poverty. In this paper, the countries that are more unequal
(in Latin America, Carribean, and Southern Africa) also generally have higher GDP than
countries that are less unequal (e.g. India).

There is no contradiction whatsoever between the fact that Settler colonies became highly
unequal and that these same colonies achieved a higher level of production per capita
than Peasant ones. This relative economic success was precisely the result of the
European settlers’ growth record. By their cultural background they were able to put at
least partially in place the technology and institutions that made the economic superiority
of Europe and the New Europes.

The paper is also useful for its brief survey of literature on colonialism and economic
evolution, and if the subject interests you see also Guns, Germs, and Steel: The Fates of
Human Societies:

Acemoglu et al. (2001) argue that the pattern of European settlement in the colonies
determined the type of institutions that these countries developed and that these
institutions are a major factor behind their economic backwardness. In those regions
where few Europeans settled, Europeans created “extractive states” and the resulting
institutions “…did not introduce much protection for private property, nor did they
provide checks and balances against government expropriation.” On the other hand, the
authors also propose that the countries that received a large number of settlers “tried to
replicate European institutions” and therefore created the right set of rules encouraging
future economic growth.

By way of New Economist, the paper is available on SSRN and also from the University
of Manchester (PDF). If you’d like to check the correlation, the World Income Inequality
Database (WIID) may be useful, as also the UN Human Development Report (PDF).

Comments (14)

The Indian Army Part 2

Filed under: Politics, Fiscal policy, Business, Miscellaneous, Economic History —

Pragmatic @ 12:18 pm

Budgeting- ‘Guns versus Butter’

The Indian budgeted defence expenditure (DE) for the current year (2007-08) is Rs.
96,000 crore and the Indian Army’s share of this pie is approximately 47%. The DE is
2.07% of the GDP; the corresponding figures for Pakistan and China are 3.4% and 2.8 %
respectively. But there is a caveat – Pakistan military is purportedly controlling more than
20% of Pakistan’s economy (for the myriad details, read ‘Military Inc: Inside Pakistan’s
Military Economy’ by Ayesha Siddiqa, Pluto Press, 2007) and China is widely believed to
be underplaying its budget. For USA and Australia, these figures are above 4% and less
than 2% respectively. Singapore, smaller by far but determined to be prepared against all
contingencies, allocates about 6% of its GDP as DE.

India’s DE as % of GDP

Year DE as % of GDP Year DE as % of GDP

1991-92 2.50 2000-2001 2.35
1992-93 2.35 2001-2002 2.38
1993-94 2.54 2002-2003 2.27
1994-95 2.30 2003-2004 2.18
1995-96 2.26 2004-2005 2.43
1996-97 2.16 2005-2006 2.26
1997-98 2.32 2006-2007 2.10
1998-99 2.29 2007-2008 2.07
1999-2000 2.40

Many in the defence establishment lament these constantly declining figures of India’s
DE as a % of GDP and consider it as a sign of Indian government’s low priority towards
national defence and a lack of strategic thinking at the highest political levels. The
recommendation of the parliamentary standing committee on defence in its 16th report
(April 2007) states this requirement in unambiguous terms.

The Committee therefore, strongly recommend that the Ministry of Defence should take
up the matter with the Ministry of Finance for providing a minimum 3% of GDP for
Defence Services every year in order to ensure a fixed amount to carry out their
modernisation, Capital acquisition and R&D Programme and fulfil the need based
requirements of the Defence Forces.

This recommendation was made in response to a statement of the representative of the

finance ministry. On being asked by the committee, whether it would be possible to fix a
specific percentage of GDP for defence, this representative stated:

“There are many arguments in this regard. This is a matter which has been debated over
several years. The argument is that what is the relationship of defence expenditure with
the external parameter like the GDP? GDP shows you the rate of growth. The defence
expenditure is related to your threat perception, essentially. This debate has not settled. I
am only putting the pros and cons of the situation. It can be argued that, in a country like
India which has a large segments of disadvantaged, not included in the growth process, as
the GDP grows a larger amount should be allocated to the welfare of those people rather
than spending it more on arms and ammunitions. That is the argument. It may not go well
with the Armed Forces. It is a political choice. It is a guns versus butter choice. With this
perspective in mind, this debate remains unresolved as to whether the defence
expenditure should be fixed as a percentage of the GDP. This argument can be extended
to other sectors. But this is a political choice. It is a matter not really left to bureaucrats
like us.” (more…)

Comments (3)

June 12, 2007

Climate Change: Why India Must Act

Filed under: Politics, Growth, Energy, Environment — Dweep @ 1:22 pm

The recent G8 summit did not achieve what Angela Merkel may have hoped for - a new
treaty with binding CO2 emissions cuts for the world’s major polluters - USA, China, and
India. While both India and China were under considerable pressure to accept such
targets, they resisted, promising only to “cooperate”.

India’s position on climate change is simple:

1. 1. Climate change has been caused by the developed world, which must bear the
costs of abatement and mitigation.
2. 2. India is not a significant greenhouse gas (GHG) emitter, and
 3. 3. It will not accept binding emission cuts, without compensation, as that would
conflict with the overarching goals of economic growth.

This position may be good for international negotiations. But as a policy, it is ethically
indefensible, logically and economically inconsistent, and worse - a wasted opportunity.
(more…)

Comments (9)

June 5, 2007
The Indian Education System — Parts 9 & 10

Filed under: Education — Atanu Dey @ 11:58 am

Part 9: Freedom

By liberalizing the education sector I mean that it has to be made totally free of
government control and involvement. Whoever wants to provide educational services
must be free to do so, be it domestic or international, for profit or not for profit, at the
primary, secondary, or tertiary level. What would be the expected benefits of doing so?

The supply of educational services will increase, and the quality will improve. Most
importantly, prices will come down because producers in search of profit have an
incentive to reduce costs, and the competitive market forces the prices to track costs.
These are all everyday first-order efficiency effects of letting markets work. The second-
order effects will be increased productivity, increased production, and better allocative
efficiency within the sector. The third-order effects will arise from the increasing returns
to scale associated with the production of education. Finally, there are very important
forward and backward linkages that bind the sector with the overall economy. One of
them is the use of information and communications technology (ICT) tools. It will give a
boost to the IT sector in a way that is unthinkable in any other endeavor.

Increase in the supply of education is a natural outcome of removing all barriers to entry.
Domestic and foreign institutions will invest in educational institutions. One can imagine
corporations such as Tata, Reliance, Harvard, and Stanford opening shops in India, all
eager to make a profit. This is no different from a large number of automotive companies
starting manufacturing in India to supply the domestic market. The effect is predictable:
an increase in the variety and therefore expanded choice for the consumers.

No longer will one have to fight to get into a good school or college. Instead of a sellers’
market, we would have a buyers’ market where the consumer is king and therefore the
producers will be ever eager to reduce their costs and deliver a quality product. The best
part is that with competition, even the incumbents – the public sector institutions – will
wake up from their “lack of competition” induced slumber. Competition for students will
force institutions to be nimble on their feet and therefore provide education that is
relevant. No longer will the education system be producing graduates the majority of
whom are unemployable.

Think about the waste of resources that accompanies the current supply-constrained
system. Just one example: each year hundreds of thousands of students spend incredible
amounts preparing for the entrance exam for IITs. That is directly unproductive use of
time and money. That spending would be sufficient to fund a dozen IITs every year. Or
think of the estimated US$10 billion that Indians spend in getting an education abroad.

In today’s world, an educated population is more valuable than any natural resource. Yes,
India has a large population with favorable demographics. But only the private sector has
the resources to provide the investment required for educating them. The operative word
is “investment.” Firms don’t invest unless they expect to make a profit. And yes, there is
profit to be made from providing education because education itself has positive returns
and therefore people will pay for education.

Servicing such a large domestic population necessarily implies a very large installed base.
That results in the industry learning by doing, and the economy gains what is called a
comparative advantage in producing educational services. Which means that education in
India will have a quality/price ratio that would attract foreign students. That would make
India the education capital of the world, if India plays its cards properly. India’s income
from producing education could dwarf what it earns from IT and IT enabled services
today.

Which brings us to a very important point. Producing education will be massively

dependent on the use of IT to reduce costs and improve quality. Private firms will use it
intensively and effectively to produce education. Meaning that instead of a few
computers sitting around in a dusty room in your average school, you will find the best
technologies being used in schools and colleges. Students will be learning to use the IT
tools while learning other things. More importantly, one will not have to worry about the
much lamented digital divide: whoever attends an educational institution will become a
digital native.

And who, you may ask, will be attending schools and colleges? My answer is: everyone.
If India liberalizes the education sector, then everyone – rich poor, minority, majority, this
caste, that caste, this religion, that religion, you name it – will be able to get an education.
Only problem will be: the politicians will have to figure out some other way of dividing
the country. But that is their problem, not ours.

[Continue on to the final part.] (more…)

Comments (12)

May 28, 2007

The Indian Education System — Part 2
Filed under: Education — Atanu Dey @ 11:43 am

Education matters immensely when it comes to the health of an economy. There is a

positive correlation between years of schooling and the GDP per capita. Let’s look at the
numbers that are indicative of the generalization. In 2001, “school-life expectancy” and
the ppp GDP per capita for Ethiopia were (4.3 years, and $675); for Indonesia (10, and
$2,844), for China (12.4, and $4,065), for South Korea (14.6, and $17,048), Japan (14.3,
and $25,559), and the US (15.2, and $32,764).

Moreover, there is a correlation between growth and educational attainment. Consider

one measure of the educational level of an economy, the literacy rate of adults (defined as
those above the age of 15 years). In 1970, adult literacy rate in China was 54 percent,
compared to India’s 34 percent. The ppp GDP per capita income of India in 1970 was
$1,034, nearly double that of China’s $571. Yet, twenty years later, China surpassed
India’s annual per capita income: India $1,587, China $1,617. The adult literacy rates in
1990: China 78 percent, India 49 percent. By 2001, China had 86 percent adult literacy
rate and a ppp GDP per capita of $4,065, and India languished at 58 percent and $2,319.

There are many reasons for modern China’s meteoritic rise from its humble beginnings.
But one of the most important factors must be their youth literacy rate, which is defined
for the population between 15 and 24 years of age. In 1970, China’s youth literacy rate
was a whopping 83 percent, compared to India’s 46 percent. It is more than a little
depressing to note that more than half of India’s youth were illiterate, leave alone
educated, as late as 1970. By 2000, India was just at 73 percent, not even at the level at
which China was 30 years before. Now China has achieved nearly universal youth
literacy. The lesson is unavoidable: compared to China, India’s prospects are dim if
education has anything to do with economic prosperity and potential.

It is important to note the sequence of development. Literacy preceded economic growth

for China, as it does for every successful development story. Note that China was more
literate than India in 1970 even though it was poorer than India. Thus poverty does not
automatically condemn a population to illiteracy. It is a matter of choice: like individuals,
countries can also choose to invest in education.

I deliberately chose China as a counterpoint to India in this narrative. I can tell the same
story of how Singapore transformed itself from a mosquito infested swamp to a
developed economy within a single generation. But then the usual objection is that
Singapore is a tiny city-state and a behemoth like India cannot transform itself. It is a
just-so argument, supposed to be compelling enough that no reason has to be advanced
why Singapore’s tiny size in the context of development is relevant.

But another just-so argument is introduced when India and China are compared. It says
that China cannot be compared to India because India is a democracy. Again, no reason is
provided why democracy prevents policy makers from choosing to invest in education.
However, one can argue that India’s political structure has something – naturally – to do
with India’s dismal failure in educating its population. I describe India as a “pseudo-
democracy,” something that has the superficial trappings of democracy but just below the
surface it is anything but.

Democracy, if it means anything at all, is more than mere head-counting. It has

something to do with informed choice of the population at large, which in turn depends
on the population’s ability to understand the issues, which finally rests on the ability to
read, write, and carefully consider the alternatives that confront them. As it happened,
when India achieved political freedom from the British, the population was told that their
emancipator knew best and all they had to do was vote for them, and the government so
constituted would magically take care of their every wish. How that transformed India
from being the darling candidate for becoming a developed economy in the 1950s to
actually being a laggard in economic development we shall briefly note the next time.

[Previous post: Part 1. Continued in Part 3.]

Comments (8)

May 19, 2007

The Future Past

Filed under: Growth — Atanu Dey @ 11:30 am

Flashback

The year is 2020. For nearly 12 years, India has seen an average annual GDP growth rate
of over 12 percent more than quadrupling the per capita GDP from US$500 in 2008 to
$2000, placing India in the league of middle-income economies. Stark poverty is a thing
of the past. In much less than a generation, the population transitioned from being 70
percent rural to being less than 20 percent rural. Agricultural labor is only 15 percent of
total labor participation, down from 60 percent in 2008. Farm incomes are six times what
they used to be. The $3 trillion economy shows no signs of slowing down.

So how did this seemingly impossible transformation happen, I asked the man on the
street.

“The cities. I am hazy about the details but it appears that there was a change of tack.
Somehow they figured that they had to think different, think big. They had been stuck in
a rut created by a poverty of imagination. The problem was that there was no compelling
vision to light a fire in the bellies of the hundreds of millions of people. Then somehow
inexplicably they got out of the rut.”

Can you be a bit more specific? What was the turning point? What did they specifically
do? What made the difference? Who was responsible?
“I was coming to that. Like I said it was the cities. But that was just the instrument, just
the visible part of the transformation. The creation of the cities was the equivalent of the
challenge to land a man on the moon. Remember all that talk about an Indian manned
mission to the moon? Well, how lunatic was that? Nothing new in attempting to do in
2012 what the Americans had done over 40 years ago. Not just that, with all their trillions
of dollars, the Americans themselves thought it was a pointless waste of money to keep
doing manned missions to the moon. And incredibly, impoverished India was willing to
spend a few billion dollars repeating that. I ask you, how retarded is that?”

Why drag in all this talk about missions to the moon?

“Actually, think about it for a second. The challenge that JFK presented to the nation was
the important bit. Recall his words. Quote: We choose to go to the moon. We choose to
go to the moon in this decade and do the other things, not because they are easy, but
because they are hard, because that goal will serve to organize and measure the best of
our energies and skills, because that challenge is one that we are willing to accept, one we
are unwilling to postpone, and one which we intend to win, and the others, too. Unquote.
You must read that speech to get a sense of what the articulation of a real vision is all
about.

“The bit about doing something not because it is easy but because it is hard is important.
And the bit about choosing. The operative word is “choosing” – you choose to do this as
opposed to that. The Indian movers and shakers finally woke and decided to choose. It
was a choice. They thought through what the options were and then made a choice to do
what made the most sense. And the choice they made best organized their resources and
their skills.”

But tell me, how did it all begin?

“I am coming to that.”

[Continue reading the next part.] (more…)

Comments (25)

February 8, 2007
Why Japan Matters To India

Filed under: Business — Edward @ 8:35 pm

Well Nanubhai has certainly stirred up a storm with his overheating post. So now that the
intial burst of energy has started to die-down, and the dust has begun to settle, it may be
well worth sifting through the various pieces that constitute this whole debate, to try and
see what exactly is at issue here, why the issues are important, and what can be learnt
from the episode.
Amongst the many topics of not inconsiderable interest would be to think about what can
be learnt about the whole development process from studying the Indian case, and this
topic is by no means an incidental one, as there are still plenty of countries stuck back-
there in the mire of poverty, and if they can learn anything from the Indian example about
how economic break-out works, then apart from getting the benefits from its own growth
process India can also help others to see how they too might move forward.

So this will be the first of a series of posts to try work through the issues raised, which
have, of course, been accumulating fast, indeed such issues seem to be mushrooming far
faster than our capacity to assimilate them has.

Today I am going to start the process off with an India-Japan comparison, in part since
the India-China one so often generates more heat than light, but also in part since I want
to argue that you cannot make any sense of the current ‘capacity growth’ debate in India
unless you take into account what is happening in Japan, and the impact of Japanese
deflation on the global liquidity situation.

I want to hammer-home here two points concrening what is new and different in the post
turn of the century Indian situation, and underline the fact that the presence of these
changes make all that talk about growth rates in the 1980s and the 1990s rather dated to
say the least.

Firstly India now increasingly forms part of a global economy, so global factors need to
be thought about much more than they were say ten years ago. The most obvious
example of this is to be found in the rapid acceleration of high value services, and the
migration of a lot of ICT related activity to India, a phenomenon which can’t be
understood, IMHO, outside of the 1995-2000 internet boom-bust cycle in the USA.

Now the impact of these high value services has been, as many would note, rather more
strategic than decisive, since they still account for only a very small share of overall GDP.
Thus we could say they have been something of a catalyst to a process rather than the
process itself. By the same token, it is now impossible to look at Reserve Bank of India
monetary policy outside of the general global liquidity context, things just aren’t decided
locally any more.

All this is only going to become even more important as India gradually incorporates in
the global economy, and as the share of external trade in GDP only climbs and climbs.

So what is needed insofar as the economic debate in India is concerned is something of a

change of mindset. There is a rather dated feel about many of the arguments which are
being marshalled around the capacity issue, they seem to have been prepared and honed
in the context of yesterday’s problems, and and as a consequence they are often found to
be woefully lacking when fielded to confront the problems of today, problems which are
in many ways very different from those to be found back in the decade of the 90s. Indeed
I think this is precisely why the Economist article is causing so much fuss, since it may
quite simply be the last gasp of a view of the world which no longer holds, a view whose
closest adherents find it ever so difficult to let go of.

The second point I would want to underline in the appparent high degree of
interconnectedness of so many things we are seeing here. Things have suddenly become
more complex, and what appears to be a small and isolated phenomenon in one country
or region may in fact turn out to have important and significant consequences elsewhere.
I could cite the way in which China’s need for soy beans has fuelled a significant national
grwoth spurt in Argentina or Brazil, or the way in which climatic change may be
accelerated by growth and yet subsequently turn round and have a secondary unexpected
impact on growth itself, but today I simply want to think about what is happening to
interest rate policy in Japan, and why this is important even (or especially) for people in
India.

In order to to this I would refer back to a comment by Andiron in Nanubhai’s post:

“Liquidity has reduced the deficit as payments are lesser, but the risk premium will go up
dramatically. As foreign economies cool, remittances to india will dry up leading to more
current account problem..(>5%)..A large portion of $ 180 bil reserves is a mouse click
away from disappearing.. Lots of palapappans forget, that last 4 yrs were unusual in
liquidity.. It is time to pay higher risk premia..”

Now despite the peculiar way in which this is expressed the comment does go straight to
the heart of the matter. Have the last four years been unusual in liquidity terms, or can we
expect more of the same? This is the issue. In fairness to them I suspect that the writers at
the Economist are sort of making the same assumption that Andiron is, whilst I am
certainly assuming the contrary, and this is precisely one of the big reasons I imagine that
trend growth may well accelerate in India, since cheap finance will be available to make
it possible. Is this in iteslf a good thing or a bad thing? Well people can argue afaiac ad
infinitum on this, the problem is that it is a very probable reality, and what we need to
focus on in this debate is the world we are likely to see, not the one we would like to see.

(Incidentally, I should point out that the liquidity issue is only part of the reason I go with
Nanubhai, there are other reasons which I will try and explain in other posts, but the
liquidity environment is one part of the picture, and an important one).

Now, OK, why is Japan important?

Japan is important due to the existence of something called the “carry trade”. So just what
is the carry trade? Well simply put the carry trade is a phenomenon which is based on the
existence of substantial interest rate differentials between countries (with a secondary
driver being the anticipated direction of future currency movements). Japan has become
an important focus in this trade due to the existence over long periods of time of zero or
near-zero interest rates. So if you want to borrow money in a country like India with
interest rates significantly above zero, and if you anticipate that over the appropriate time
horizon the value of the rupee is going to rise relative to the value of the yen (which
given the large anticipated economic growth differential between these two economies
seems a reasonable enough assumption) then it makes a lot of economic sense to borrow
in Japan and spend in India. The net result of this is that development in India becomes
cheaper than it would have been, since the cost of capital - or the so-called risk element -
goes down.

Now applying normal Econ 101 type market reasoning to this situation you might
imagine that the result of this process would be that interest rates in India would go down
and those in Japan would go up, based on the increased availabilty-of and demand-for
funds. Well if you thought this you would be half right and half wrong. Long term rates in
India will of course be pulled down by this process, and this will give a lot of headaches
to people over at the RBI in implementing monetary policy since their ability to control
both rates and the money supply will be affected. But interest rates in Japan will not
necessarily be affected at all, since Japan has long been caught in a rather strange and
unique situation known as a liquidity trap. Now the easiest way of describing the problem
is to say that the Bank of Japan has created a kind of monetary black hole (via a policy
known as quantitative easing) and what this means effectively is that the more quickly the
bank throws money into the economy the more quickly it disappears, without - and this is
the key point - having any noteable impact on the country’s inflation rate (Japan has been
struggling since the early 90s with a phenomenon know as deflation). As a consequence
interest rates in Japan do not move up, so the two country mini-market model (Japan-
India) process descibed above simply does not equilibrate, and Japan acts as a kind of
negative attractor (deliberately using a term from chaos theory) for interest rates,
gradually sucking in the rest.

Well, it isn’t all quite as simple as this, but I imagine you may be getting the picture.

So just how important is the yen carry trade?

Well as the ever excellent Brad Setser points out (citing the FTs Gillian Tett) no-one
really knows, but the number might be anything up to a trillion dollars. This number is
almost certainly rather on the high side, but that being said, there is a very, very large
quantity of money going the rounds here. As Gillian Tett says:

Just how large the carry trade is, nobody really knows … But whatever the precise
number, what is clear is that carry trades have been fuelling the dash into risky assets in
the past couple of years.

After all, with Japanese interest rates at rock bottom and the yen on a downward path, it
has been frighteningly easy for any hedge fund to borrow in yen, invest in something
yielding, say, 5 per cent a year, apply a bit of leverage and – hey presto – produce returns
of 20 per cent, or more. Conversely, if an investment bank wants to create a
collateralised debt obligation but cannot sell the riskiest debt tranche, it can put this on
its own books – funded by ultra cheap yen. The yen has thus been tantamount to the ATM
of the global credit world – spewing out (almost) free cash.
Given this you can understand just how much the leaders of the G7 would like the Bank
of Japan to start raising rates, and how much this is going to be talked about this weekend
in Essen. And much as I hate to have to disagree with Anantha Nageswaran, I take the
view that the world’s central bankers haven’t stopped trying to intervene in market
processes over the last twelve months, by forcing up interest rates to what they call
normalised rates. In the case of the EUs ECB they have only met with moderate results in
their crusade (and with potentially worrying consequences as we may be about to see in
Germany), and in the case of Japan the most that they have been able to extract is one
quarter point raise. And according to Bank of Japan policy board member Hidehiko Haru,
gioven that internal consumption in Japan is congenitally weak and that there’s no
imminent threat that rising prices will cripple economic growth (indeed there’s every
danger of falling back into deflation) then there’s no hurry to start raising rates again any
time soon.

Also, of course, it isn’t only from Japan itself that the carry trade is at work. Andy
Mukherjee in an interesting Bloomberg column recently drew attention to the possibility
that people might like to borrow in yuan to buy rupees. The rationale for this may seem
strange, but Andy explains it like this:

“According to the ABN Amro economists, the appreciation in the Chinese currency is
already in the price: Forward traders expect the yuan to rise about 5 percent against the
U.S. dollar in one year. The risk of a sudden, large revaluation, from its current level of
about 7.78 to the dollar, is low.Even if you agree with this assessment, how do you
borrow yuan to buy rupees, beating capital controls in both China and India? The
offshore forward markets may offer a solution.”

“The implied interest rate on borrowing yuan for one year, according to my Bloomberg,
is just 0.15 percent in the non- deliverable, offshore forward market where trades are
settled in U.S. dollars. That compares with an inter-bank rate of 0.63 percent on
borrowing Japanese yen.
One-year non-deliverable forward contracts on the Indian rupee currently offer implied
interest rates of 7.93 percent. There is, thus, a neat 7.8 percent interest-rate differential
— or “positive carry'’ — to be pocketed from selling yuan forward (against the dollar)
and buying rupees forward (against the dollar).”

But back to our main topic: just why is it that Japan is finding it so difficult to raise rates
and bring an end to the yen carry trade? Well here’s the rub, at least if you are a writer at
the Economist it is, since the underlying issue is a demographic one, but not this time the
demographic dividend which India is just begining to benefit from at this point, and
which they seem to want to attempt to trivialise so much, but rather the demographic
penalty of an ageing society which is busying diverting resources away from
consumption and towards saving. And what do you think our dear friends at the
Economist have to say about all of this? That Japan is underheating? Not at all: Japan’s
recovery is going from strength to strength. Talk about the world turned upside down.
Footnote: some good background explanation into the real ongoing difficulties Japan has
in raising domestic consumption and interest rates can be found in these two posts (and
here) from Claus Vistesen.

Comments (19)

January 23, 2007

A Brief Introduction To RISC — Rural Infrastructure & Services
Commons

Filed under: Infrastructure — Atanu Dey @ 5:44 pm

I had been pondering about India’s rural development for a while before I signed up as a
Reuters Fellow at Stanford University in Sept 2001. Later, Vinod Khosla and I co-
authored the concept paper. This is a short version introducing the why, what, how of
RISC. There is a distinct possibility that RISC may be piloted some time soon
somewhere in south India.

Why RISC

India’s economic growth and development is predicated to a large extent upon the
development of its 700-million strong rural population. Currently, the majority of India’s
population lives in about 600,000 small villages and are engaged primarily in agriculture
and related activities. Since a very large labor force in agriculture necessarily implies
very low per capita incomes, a substantial portion of India’s current agricultural labour
force has to move to non-agriculture sectors for incomes in all sectors to go up. The
challenge is to manage the transition of a large segment – perhaps even 80 percent – of
the rural population from a village-centric agricultural-based economy to a city-centric
non-agricultural economy, and do so in a reasonable period.
(more…)

Comments (23)

December 19, 2006

The Indian Productivity Miracle

Filed under: Fiscal policy, Capital markets, Labour market, Business, Growth, Economic
History — Nandan Desai @ 2:00 pm

Back in the late 1990s, economists were trying to figure out what it was that led to the
secular acceleration of economic growth in the United States: the longest and
largest peace-time economic expansion in the 20th century (see footnotes). How was it
that a country could grow so much and for so long without causing inflation and
overcapacity? Was the business cycle dead?

Clearly not: the financial crash that followed was swift and brutal – making investment
bankers’ Christmases depressing for all of two years. Indeed, the accompanying recession
was the shortest and shallowest in US history (click to see on the chart below).

During the boom, the US economy benefited from an unprecedented acceleration in

productivity growth. This was driven primarily by the efficiencies created by
technological and financial deepening – particularly in the retail, wholesale, electronics,
semiconductors, and financial services industries. While the dot-com’s and Stanford
techies in pastel suits got the glory, the economy itself was being powered by the Wal-
Marts, Intels, and GEs – who were innovating rapidly – and implementing that
innovation in long-term strategies to enhance their bottom line.

Now before I get to how this compares to India today, a brief economics refresher.
According to neoclassical theory, at the most basic level, a country’s output is powered
by structural and cyclical forces. Structural or long term growth is driven by three factors
inherent to the economy: the number of workers, their productivity, and how much long-
term capital is available to them. Cyclical growth is powered by the various short-term
influences on the economy: wealth effects from the asset markets, monetary and fiscal
policies, etc. In theory, an economy should grow at its structural (or ‘trend’) growth rate
plus or minus the cyclical component. To simplify, a country trend level of annual real
GDP growth should equal:

Y% = (% change in labor force) + (% change in productivity)

This is the rate at which an economy can (and should) grow without causing excess
inflation. The current capacity debate (discussed here, here, and here), in essence, is
about what this number is today. Ajay Shah, the Economist, and various investment
banks (including Morgan Stanley and HSBC) have repeatedly said that India is
overheated – evidenced most clearly by the run-up in inflation, and also by ‘bubble-like’
real estate and equity prices. Skittishness about the policy direction of the current
governing coalition supports the prevaling belief that a crash (or, for the less brave, a
“cooling down”) is imminent. According to them, economic growth and/or asset prices
are both set to decrease in the near-medium term.

They may well be right. Nevertheless, it is worth taking a look at the numbers and
seeing exactly what has been powering economic growth in India over the last couple of
decades. If we want to figure out where the Indian economy is headed over the next 4-5
years (as opposed to say, the next 4-5 quarters), surely this is better than looking only at
the short-term indicators.
Our potential workforce (defined as people aged 15-64) has been increasing at about 2%
a year – and is projected to continue at that rate at least till 2020. However, labor force
participation rates vary substantially from state to state, between the sexes, and between
rural and urban areas – as do unemployment and underemployment. Given that labor
force growth (potential workforce x overall participation rate) has been averaging about
2% over the past 10 years, in the absence of better statistics, it is a safe assumption that
overall employment is growing in the range of 1-2% and gradually accelerating.

The rest of real GDP growth has to come from growth in the productivity of those
workers. In this framework, there is one fixed determinant of productivity growth: the
capital-to-labor ratio. When capital is substituted for labor, then up to a point, this
increases the productivity of labor. The rest of productivity growth is lumped up into a
residual which economists call total factor productivity growth, or TFPG. While there is
considerable debate on this, there is strong evidence at the national and industry level that
TFPG is correlated strongly with measures of competition, deregulation, technology and
innovation (much more on this in a later post). For the purposes of this analysis, we can
simply say that TFPG is the component of growth which captures the extent of the
structural change in an economy.

By running the calculations over the 1980-2005 period using real GDP, capital stock, and
the labor force as the variables, we can see a relatively clear trend in India. Labor force
growth has been fairly steady around 2%, and capital deepening has been a fairly small
contributor to growth (on average 1.5%). Predictably, the acceleration in GDP growth
since 1991 (and through much of the 1980s) has been almost entirely because of an
increased pace of TFPG.

india tfpg.ppt (Updated chart)

The 5-year averages in the chart hide an even bigger change: if you look at the
breakdown from 2004-2006, TFPG has been almost 5%. This acceleration has been
partially due to changes in government policy, but my guess is that a larger portion of it is
driven by the impact of the natural forces of globalization. The internet and the opening
up of global financial markets has allowed a boom in IT enabled and financial services,
and the loosening of trade barriers has boosted industry. Furthermore, there have been
massive changes in the way Indian companies do business: ranging from increased
transparency in order to tap the capital markets, aggressive cost-cutting and outsourcing
of non-core functions, and an increased pace of technology transfers – both from abroad,
and within industries. All of this impacts the productivity of labor (and TFPG) at all
levels of the economy – and in another sense, is the very definition of ‘structural change’.

While there is an eventual limit to how much all these factors can influence productivity,
it is my contention that we are a long way away from that point. When our leaders remind
us that the reform process is “irreversible”, it is not just a diplomatic nicety to appease
investors; it is in fact the truth. The forces of competition unleashed over the last 15 years
cannot proverbially be brought back into the box – they will continue until they run their
course; until all those who want to and can take advantage of the benefits of a more-open
economy, have done so. Further policy changes have the ability to increase or decrease
the magnitude and the speed of this change – but they cannot alter its direction.

If this were the extent of the change, it might alone be enough to help India out of chronic
underdevelopment. Fortunately, the extent is even bigger. Along with the acceleration of
TFPG, we will most likely soon see an acceleration in capital deepening as well, and
soon thereafter in the growth of the labor force. The investment to GDP ratio has risen by
about 5% from 1991 to now. Most economists are expecting a further increase once the
numbers for the current fiscal are released – the prevailing estimates are that it will be
about 29-30% of GDP. Surjit Bhalla of Oxus is even more optimistic, saying that it will
increase to over 35%. As long as this investment boom lasts – and there are some reasons
to believe that a lot of this is long-term capital, not just short-term ‘hot money’ – the
capital deepening portion will continue to accelerate. And, as I mentioned earlier,
sometime between 2009 and 2015, labor force growth will peak around 3.5% - 4%. This
alone would constitute a 2% acceleration from the current trend level of GDP growth.

Now the real heart of the capacity debate centers around this question: what is India’s
trend rate of growth now and what will it be for the next few years? (This is the red
italicized number in the previous chart) If you add up the numbers, it seems to me that at
a minimum, trend growth is at 8% with the capacity to reach 10% in the coming
years. The 6.5% baseline level of growth that the Economist and others use to form their
assessments of the Indian economy is fundamentally flawed. Any judicious accounting of
the productivity trend over the last 25 years, when combined with stable and high labor
force growth, should reveal that, over the long-term, the ‘supply-side’ of the economy is
advancing at an accelerating rate.

Now, all this is not to say that ‘India-bears’ don’t have legitimate concerns: accelerating
inflation, rapidly increasing asset prices, and a lack of sufficient policy direction are all
worrying signs. But one must clearly distinguish between short-term fluctuations, and the
long-term trend. On the fiscal front, the government is clearly too profligate: spending by
the centre as a percent of GDP has increased by 2% over the past three years. The RBI
(on account of persistent goading from North Block) has not increased short-term interest
rates enough, with real rates continuing to decline. And, as our recent discussion about
the real estate “bubble” highlighted, asset values are quite clearly borrowed against future
growth.

However, all this does not necessarily add up to unmitigated disaster. High productivity
growth is the closest thing to a panacea that central bankers can find these days – it tends
to keep long-term inflation expectations down. The recent run-up in prices can be
explained by short-term capacity constraints (particularly in agriculture), and an increase
in oil prices in the first half of the year. Similarly, on the fiscal front, we are extremely
unlikely to see a fiscal stimulus of the type introduced over the last three years (in
particular the employment guarantee scheme). Moreover, high growth and structural
change have allowed the tax base (% of workers that pay taxes and tax/GDP) to expand
rapidly. This has allowed for a gradual change in the nature of government spending, with
direct subsidies growing slower and direct investment growing faster. (Having said all
that, I will admit that state finances are a complete bloody mess).

As for the asset markets – even after the run-up of the SENSEX, India’s market-cap to
GDP ratio is still around 95%, which is lower than countries like South Korea (100%)
and South Africa (240%), as well as developed capital markets (which range from 120% -
400%). Similarly, to summarize our earlier discussion, real estate has exhibited some
disturbing trends in some regions, but on the whole, the jury’s still out on whether this
means that it’s a nationwide price bubble.

To conclude, India faces some real risks in the short-term. If I had to give my top three,
they would be:

1. Supply bottlenecks (particularly in agriculture and industry)

2. External environment (particularly turns in the global growth and liquidity cycles)
3. Frothy asset values (particularly those which are borrowed against unreasonable
future growth)

Nevertheless, any sober analysis will reveal that in the midst of unprecedented structural
change, it will take a lot more to knock India off its long-term growth trajectory. Of
course, we should expect to see fluctuations – sometimes big ones. However even the
most pessimistic observer must see that the fluctuations are happening around a steadily
increasing mean. Amidst this rapid transformation, India’s progress and prospects cannot
be best judged month-to-month or quarter-to-quarter – but rather year-to-year, and in
some instances, even decade-to-decade.

In India, we must see this as a golden opportunity to get our house in order: start cleaning
up governance and the budget; build infrastructure; and balance growth between the
regions. All these things will be much harder to achieve when (and if) the going gets
tough.

In other words: don’t worry too much, but don’t get complacent either.

(If you want to check out my numbers and projections in detail, keep checking back at
www.indianeconomy.org. I will be posting a link to my spreadsheet in the next few
days, once I clean it up a bit)

[1] 107 consecutive months

[2] added $1.7 trillion in inflation-adjusted dollars to GDP between 1995 and 2000
Comments (23)

November 29, 2006

Sizzling, Or Just Right?

Filed under: Business — Edward @ 11:18 pm

Earlier in the week Naveen drew our attention to a recent article in the Economist, Too
hot to handle: Why the sizzling Indian economy is more at risk than China’s?. Now
the article is an interesting one, but it does revisit a theme which we have already
discussed a number of times on this blog, namely just how high is trend growth in India?

Ajay Shah sums the issue up nicely:

“Trend GDP growth has slowly accelerated from 3.5% to 6.5% over the 1979 to 2006
period. This has reflected a combination of economic reforms, a higher investment rate,
and the “demographic dividend” from a bigger workforce.”

That is growth in an economy is the product of a demographic dividend (or penalty)

factor (which may of course be neutral), an economic reforms component and a demand
component (whether this comes from investment or consumption). His guess is that trend
growth is around 6.5% and he does not consider that the rather higher growth numbers
we have seen of late are sustainable:

“Some people believe that India has moved up to trend GDP growth of 8.5%. I believe
this is not the case; that average GDP growth in the next 12 quarters will come out
significantly below this remarkable performance.”

Well I just happen to be one of those people Ajay is talking about: I am even brazen
enough to believe that trend growth may well have moved up beyond 8.5% going
forward, and that indeed within 5 years we may well see India overtaking China in terms
of average quarterly growth rates (of course this may well vary from one quarter to
another, a phenomenon known as volatility, and of course 5 years from now the Chinese
economy may not still be sustaining the very high growth rates we see today).

But obviously Ajay is not alone in taking the view he does, the Economist, by and large,
agrees with him:

India’s trend growth rate has almost certainly increased but it is still nowhere near as
high as China’s. Mr Prior-Wandesforde estimates that it is now around 6.5%, up from 5%
in the late 1980s. But India’s recent acceleration largely reflects a cyclical boom, thanks
to loose monetary and fiscal policy. The Reserve Bank of India has raised one of its key
interest rates by one and a half percentage points to 6% over the past two years, but
inflation has risen by more, so real interest rates have fallen and are historically low.
This makes the economy more vulnerable to a hard landing.

India cannot grow as fast as China without igniting inflation because of its lower
investment rate, particularly in infrastructure, and labour bottlenecks.

Now just one small point on this before I get more into the substantive issue, the
Economist really does need to make up its mind what it is advocating, since this rather
unfavourable investment comparison with China does rather conflict with earlier opinions
they were voicing about the unsustainability of the investment/export driven model China
seems to have, and how India was more balanced given the key role of domestic
consumption, but let’s leave that on one side for the moment.

Neither am I, of course, alone in thinking India’s trend growth rate may be considerably
higher than many imagine it to be. Surjit Bhalla, for example, seems to hold a somewhat
similar view:

Some, however, believe that an investment boom is under way. A recent report by Surjit
Bhalla of Oxus Investments, an economic research firm and hedge fund, has caused a stir
by estimating that investment in the year ending in March 2007 will reach between 38%
and 42% of GDP. Such investment, he says, would allow India to sustain 10% annual
GDP growth.

The Economist will of course have none of this:

Sadly, Mr Bhalla’s estimate for investment is almost certainly too high. Unless saving
(29% of GDP in 2004-05) has also surged over the past two years, an investment rate of
40% would imply a current-account deficit (which must equal the gap between saving
and investment) of close to 10% of GDP. This does not square with trade figures and, in
any case, it would hardly be a sign of economic health. Nor does a significant increase in
saving look likely given strong consumer spending this year and only a modest fall in the
government’s budget deficit.

Curiously though what Surjit is saying does rather fit in with what we talked about on this
post here (which examined the state of play as far as potential for infrastructure
investment in India goes).

And as it happens Bloomberg today have an article on the same topic in anticipation of
the latest quarterly GDP numbers expected tomorrow:

India’s $775 billion economy has grown more than 8 percent in five of the past six
quarters. China’s $2.2 trillion economy, Asia’s second largest, expanded 10.4 percent in
the quarter ended Sept. 30, the quickest pace among the world’s 20 largest economies
and almost four times the 2.6 percent gain in the 12 European nations sharing the
euro….

General Motors Corp., Royal Dutch Shell Plc. and other companies have invested in
about 3,000 new factories and expansion projects worth about $21 billion in India since
May 2004 to cater to growing demand, according to Finance Minister Palaniappan
Chidambaram.

“India’s high growth trajectory is here to stay,'’ said Brijmohan Lall Munjal, chairman of
Hero Honda Motors Ltd., India’s biggest motorcycle maker, currently building its third
factory for $420 million. “Incomes are rising, the government is spending more money to
improve infrastructure. Economic growth will only get stronger from here.'’
The creation of new jobs in the software industry and at call centers is putting more
money in the hands of some 350 million middle-class Indians. For example, Dell Inc., the
world’s second-largest personal-computer maker, opened its fourth customer-service
center in India this month as it seeks to reduce costs to shore up declining profit.

Growth in India’s economy is also benefiting from Prime Minister Manmohan Singh’s
decision to increase spending on roads, ports and other infrastructure by a quarter to
992 billion rupees ($22 billion) in the year that started April 1 in a bid to attract
overseas manufacturing companies and spur growth to 10 percent over a decade.

Infrastructure spending is spurring demand for steel, cement and electricity in India,
which spends a seventh of China’s $150 billion investment in public works each year
according to Morgan Stanley.

So what we seem to have here is a win-win type cycle where an initial increase in
domestic consumption (fueled to some extent by the outsourcing boom) is now moving
over to an investment driven infrastructural and industrialization one. Not that this is
going by any means to be an easy process to manage, but the potential for very high
growth rates is there, and that, at the end of the day, is what this debate is all about. Of
course India needs more efficient capital markets, of course she needs labour market
flexibilization, of course the regulatory infrastructure needs to be improved, but this isn’t
the point. The argument here is, even in the absence of all of this in the short term how
fast can India grow, and my feeling is that it can grow a lot faster than the Economist
seems to think. My reasoning? I tend to give a lot higher weighting to the demographic
component than most other commentators seem willing to do, and I also think that
conventional analysis often ignores the speed with which behavioural change spreads
(and this at the end of the day is an important part of the productivity picture) in an age of
mobile phones and internet connectedness (which is another way of saying that we
should expect ‘convergence’ to be much more rapid today than it was in the past.

So who is right and who is wrong here? Well the data will tell us, now won’t it, and the
first little test will come tomorrow, when we should get to know just what third quarter
GDP growth has actually looked like.

Comments (12)

October 21, 2006

Demographic Cognitive Dissonance

Filed under: Basic Questions, Media & Economics — Atanu Dey @ 6:11 pm

People who don’t practice what they preach are not necessarily hypocritical. Perhaps they
are merely not sufficiently intelligent to realize that what they do is inconsistent with the
logical implications of what they preach. This gap between what they insist to be true
while doing something which reveals their words to be false can be attributed to what is
politely called cognitive dissonance but more accurately should be termed as stupidity.

Examples of cognitive dissonance abound, in people great and small. My favorite

example of a deluded person is our omnipotent ruler of the world, POTUS G W Bush.
His ranting and raving about weapons of mass destruction possessed by others is a study
in cognitive dissonance (or stupidity, if you prefer.) But we mere mortals are also subject
to varying degrees of this mental illness. We are spared the ignominy of our affliction
behind the veil of our anonymous lives. But newspaper columnists lose that protection
when they hold forth on subjects that they haven’t thought through entirely. They
willingly reveal their cog dis to the world at large. Why they don’t follow that cautious
rule of “keep your mouth shut and be suspected a fool, rather than open it and remove all
doubts” is a mystery to me.

At this point you may ask what the devil am I going on about. I was coming to that. You
see, one astute reader of this blog (and you are all astute, dear readers, I hasten to add)
wrote to me pointing out a column by one Mr Swaminathan Aiyar in The Times of India
of 23rd September, 2006. Rohit, the said astute reader, wrote to say that he finds
something not quite right with that column. My abiding interest in population matters is
well known to readers of my blog (the population category has about 36 articles, some of
which are worth reading even) and Rohit asked me to comment.

Without someone’s prompting, I am unlikely to read a rag such as The Slimes Times of
India. I scanned the article, shook my head in disbelief, and promptly decided to blog it
one of these days. As is my wont, I equally promptly moved on to other distractions and
forgot about the unbearable silliness of Mr Aiyar’s musings. I would have been writing
about the cog dis of the POTUS right now (which I will have to get to later, for sure) but
for the fact that Rohit revealed himself to be not just astute but persistent as well. Thank
goodness not all the readers of this blog (astute as a bunch) are as persistent as he is. Else
I would be busy writing all my promised pieces all day long and have no time to surf the
web. Anyway, time to get on to the point that I want to make.

Mr Aiyar’s column is cleverly called “Swaminomics” and I suppose he is an economist of

some sort or the other. One cannot be sure, of course, since there was “Reaganomics” and
Mr Reagan, a minor actor and later a major POTUS, did not even act as an economist in
movies, leave aside be one. Just adding “-nomics” to your name therefore does not reveal
what your day job is. For all I know, you may be a computer programmer with a diploma
from NIIT on J2EE or something mysterious as that. Still, to have a regular column
dealing with matters economic in a national newspaper could mean that one was an
economist. But then one has to remember that it is The Times of India we are talking
about after all and perhaps we are justified in having our doubts.

The column titled “Lalu Yadav’s Demographic Dividend” says that Lalu, the ex-chief
minister of Bihar, fathered nine children and thus bequeathed an example for all Indians
to procreate with abandon which will undoubtedly lead to India’s GDP growth while
China’s GDP growth sputters out due to its misplaced emphasis on population control
through its draconian one child per couple policy. Lalu, claims the column, moves as
mysteriously as God himself.

Perhaps Mr Aiyar was just being facetious. Perhaps he is not serious and the aim of the
column was to poke fun at Lalu Yadav who, as Mr Aiyar admits, presided over the
“economic and social stagnation” of the state of Bihar. Not mentioned is the broad-
daylight shameless looting by Lalu of public funds by the thousands of millions. Perhaps
Aiyar does not seriously admire neither the man’s mendacity nor his fecundity. But I
doubt it. I think that the columnist is indeed seriously peddling nonsense, and it is errant
nonsense at that.

Briefly, the column talks about three demographic phases: first, there is a baby-boom
with its high dependency ratio; in the second stage, there is a baby bust, accompanied
with improving dependency ratio and a “demographic dividend” from more savings; the
third stage – the write forgets the third stage. Perhaps each “demographic dividend” is a
distinct phase. I am confused about the phases bit. But let me get down to a few details.

He writes,

“[T]he middle-class remains shocked that Lalu has fathered nine children, worsening the
population explosion (viewed by this class as one of India’s top problems).

Yet, economists are now unanimous that rising population is giving India a ‘demographic
dividend’ that will soon help it grow faster than China. Seen in this light, Lalu Yadav’s
contribution to the demographic dividend may outstrip his contribution to the railways.”

Never mind who is responsible for the recent so-called success of the Indian Railways. It
is a dismally mismanaged public sector monopoly and a few public-spirited bureaucrats
may have been responsible for promoting some good policies which, given the massive
inefficiencies already present, resulted in the easy picking of some low-hanging fruits.
Crediting Lalu with improving the railways is silly at best; perhaps it would be more
appropriate to praise Lalu for not yet stealing (as far as one can tell) the 50 million tons of
steel rails scattered along the railway lines. But enough about Lalu.

Let’s examine “growing faster than China.” GDP growth rates don’t mean a whole lot.
Like many extremely poor countries, India’s GDP growth rate is much faster than, say, a
developed country like the US. What matters is the absolute per capita GDP and to some
extent the growth in the per capita GDP. The operative phrase is “per capita.” Let me put
it in more personal terms.

It could be that the peon in our office is getting a 20 percent raise every year while I am
stuck with only 5 percent raises annually. Yet, if I earn 40 times what the peon earns, the
peon would be happy to be stuck with a low annual rise as long as he gets my salary.
Rates of growth have to be read in the context of what the base is.
So even if China’s GDP were to grow at 5 percent, and India’s were to grow at twice that
rate, if China’s GDP is three times that of India’s, then in absolute terms China adds more
production than India every year. Sure, if the differential growth were to persist for 25
years, India will catch up eventually. But 25 years is the long run (and as Keynes noted,
in the long run we are all dead) and what happens 25 years hence is not going to bother
us.

The story gets even worse when you move to per capita GDP growth rate. If the
population is growing at rate x and GDP is growing at rate y, then the per capita GDP
growth rate is (y – x). Since compared to China, India has a lower GDP growth rate and a
higher population growth rate, India’s per capita GDP growth rate is lower than China’s.
What matters is the per capita GDP (which is another way of stating the income of the
average person) and to some extent the per capita GDP growth rate, not the GDP nor the
GDP growth rate. I would rather be stuck with an average American income growing at 2
percent a year than have an average Indian income growing at 8 percent a year.

Reading that column once again underlined my conviction that those who refuse to do
arithmetic are doomed to speak nonsense. All you have to do is pull out an Excel sheet
and do a bit of figuring. I just did that. If today India’s per capita GDP is $700 and
China’s is $2,000, and if India’s per capita GDP grows at 10 percent a year while China’s
grows at only 5 percent per year, India’s per capita GDP in the year 2031 – 25 years
hence — will be $6,143, still lower than China’s $6,268. The average Chinese will still
earn more than the average Indian despite (an unlikely) twice the per capita GDP growth
rate compared to China. And even if India were to have the same GDP growth rate as
China, if India’s population growth is higher than China’s, then India’s per capita growth
rate would be lower than China’s.

This is all very tedious. I should not have to poke around in an Excel sheet to make my
point. I blame the pathetic Indian education system that even some columnists for
newspapers (rags or not) are innumerate. I am forced to go on about GDP, per capita
GDP, GDP growth rates, and per capita GDP growth rates because of a silly column when
it should be absolutely clear to the average 7th grade student what it all means. My
patience, and I am sure yours as well, is wearing thin at this point. But we have a few
more points to address. So stick with me.

The story Mr Aiyar is telling appears to be this: “Indians have been having more children
than the Chinese and that is good because India’s GDP growth rate will be higher than
China’s sometime in the future. And therefore India is better off. So having a higher
population growth rate is good. Therefore Lalu Yadav is god. And all you who were
promoting lower fertility were ignorant neo-Malthusians. And the Supreme Court of India
is ignorant of “demographic dividend.” So Lalu’s nine children is a miracle of nature, not
ignorance of contraceptive methods.”

Seriously, why do we “neo-Malthusians” fret about India’s population. The answer is

simple: because we care about the quality of life, not just about quantities. Here are some
numbers. India has about 17 percent of the world’s population and 2 percent of the
world’s land area, and about 1.7 percent of the world’s fresh water. Those who are
reading this blog have access to adequate quantities of fresh water, but the majority of
Indians don’t have clean water to drink, leave alone for personal hygiene. More than half
of children below the age of five are malnourished in India. These and many more facts
like them paint a simple picture: that we have more people than we have resources.

That is the basic incontrovertible fact: there is an imbalance between the number of
people and the amount of resources available for them. When you do the arithmetic, the
average figures are deplorable. But then, averages don’t matter to those who write
newspaper columns because they are sitting pretty with umpteen times the average
amount of resources at their disposal. So they can comfortably write about neo-
Malthusians scaring the middle-class people. That there are those who are above average
merely implies that there are many who are below even the deplorable average. The
suffering of those hundreds of millions don’t matter to those who are comfortably
sprouting nonsense about the demographic dividends.

The age structure of an economy matters, of course. Demographic transition is a well-

understood phenomenon. You cannot study the development of economies without
realizing that at some point in the path to development, an economy will reduce its
fertility rate and move towards a lower population growth rate. The critical question is
not whether but when. And it my contention that that point should have been decades ago
instead of being some decades hence. It should have been earlier because it has to be at a
point where the balance has not gone so askew that too many people are living with too
few resources.

There will be a demographic transition in India’s future. It will have to go through the
population bottleneck. But instead of going through the population bottleneck at an
earlier stage (with less pain), now we will go through it with a great deal more pain at a
later stage.

Why do so many otherwise seemingly educated people who should know better not pay
attention to the damaging fecundity of the poor? I think I have an answer. It is because
the damage that the poor do by multiplying beyond reason is primarily to themselves; the
rich actually enjoy what I would call a “population dividend.” The higher the numbers of
the poor, the lower their wages, and consequently the higher the standard living for the
non-poor.

You may notice that there is a construction boom in most urban areas in India. You need
people to do the slave labor. The US had imported slaves from Africa. Urban India gets
its slave labor from the rural areas. These laborers live in horribly deplorable conditions.
And they procreate. Women laborers at construction site often have three or four children
hanging around. Children as little as toddlers play barefoot among the rusting steel,
cement and other construction material. It is heart-breaking to see how the children have
little future other than being labor for future constructions – and a significant percentage
will never see adulthood, I am sure.
These are disposable children and are sacrificed to those who write glowingly about the
demographic dividend.

Remember I started this piece with the matter of cognitive dissonance and hypocrisy?
This is why I did that. If a person really believes that the more people there are, it is
better, then they should behave consistently with that belief. That is, he or she should
immediately go out and bring 20 or maybe 40 people home and thus increase the
household income growth rate. They don’t because they realize that merely adding people
who are below the average household income will not increase the average household
incomes. Only by adding people whose incomes are greater than the current household
incomes will the average household income go up.

That is what Mr Aiyar needs to ponder. He has to understand that it is not the number of
people that matters, but rather what resources these people have at their disposal matter.
Nine children born to a couple who can barely feed, clothe, and educate even one means
that there will be nine under-nourished, illiterate, unproductive people who will actually
slow down, not speed up, economic development.

Hypocrisy or cognitive dissonance? You decide.

Comments (17)

October 19, 2006

Investment And Infrastructure In India

Filed under: Business, Regulatory reforms, Infrastructure — Edward @ 12:21 pm

Last week Cherian Thomas and Anand Krishnamoorthy had an article on Bloomberg
where they suggested that lack of clear investment rules may impede the inflow of
investment funds which could make possible the truly daunting programme of
infrastructural works which are needed in India between now and 2010.

Indian Prime Minister Manmohan Singh may struggle to convince investors to help fund
$320 billion of infrastructure spending by 2010 because he can’t persuade his
government to draw up investment rules.

Singh, 74, doubled his budget for roads, railways and ports in New Delhi on Oct. 7,
saying industry regulators are needed to spur investment and balance higher returns with
low user charges. Railway Minister Lalu Prasad, who needs $66 billion to upgrade the
world’s second-biggest rail network, rejected the plan.

Infrastructures are hugely strained:

Infrastructure utilities are strained. Highways, which move about 70 percent of the goods
transported in India, account for only about 2 percent of the country’s 3.32 million
kilometers (2.1 million miles) of roads. It takes an average 85 hours to unload and reload
a ship at India’s major ports, 10 times longer than in Hong Kong or Singapore,
according to government figures.

Regulators are needed, but there is no consensus on what kind of regulators India needs,
or what objectives they should be pursuing:

Railway Minister Prasad opposed Prime Minister Singh’s idea of establishing a

regulator for Asia’s oldest network, which moves 6.6 billion people a year. He contends
only the government will be able to balance fares and returns on investments.

“We can’t have regulators as we have social obligations which only the government can
deliver,'’ said Prasad, whose ministry employs 1.5 million people and has a separate
budget. Indian Railways subsidizes passenger fares by charging freight customers more,
losing half its share of the goods transport market to road operators in Asia’s fourth-
biggest economy.

So resources are constrained, and competing objectives complicate the decision making
process. In addition, as has been argued in the last post, fiscal excesses in India in recent
years mean that the role of public funding in the infrastructure programme will inevitably
be relatively limited:

Singh wants to spur investment by setting up public-private partnerships to build air,

land and sea facilities. Attracting private capital can be successful if there is a policy
framework regarding returns, tariffs and service quality, he said.

“Public resources available for investment in infrastructure will be limited,'’ Singh said.
“Our experience shows that public-private partnership is best suited for the
infrastructure sector. The telecoms sector is a case in point.‘’

Now given my continuing and profound ignorance about the details of how such matters
work in India, I thought it might be useful to avail myself yet one more time of the more
detailed knowledge of commenters Aninda, Nandan and Venkat, to find out just how they
see the situation. You can read their main input in the comments below, here, for now, are
some brief extracts:

Aninda

Increasing investments by such a large extent in such a short time with such little
planning seems rather far fetched to me. The Bloomberg article discusses the regulatory
impediments to public-private partnerships and these could be challenging, given the
scope of the PMs stated objectives.

At current rates of 8% trend growth and a rising I/GDP ratio that goes from 28% today to
33% by 2010, with incremental capital deepening of 11 to 12% per year, the $160Bln of
additional capital –the base case- is easily attained, with a sustained incremental-capital-
to-output-ratio (ICOR) of just over 2.

However, when you get to doubling the required investment outlay, to prompt the
economy to grow at 10% between now and 2010, the incremental capital deepening
doubles per year, and the ICOR deteriorates sharply by 40% to 1.3.
(continued below)
Venkat

The size of the infrastructure investment needed for india is enormous : USD 150 bn -
USD 300 bn - USD 500 bn. The numbers are in 3 digit + USD bn, and this is
significantly more than the total investment in the country : personal + corporate +
infrastructure + government! This is nothing new.

Yes the country has made some progress

a) Indian telecom : Is the usual poster boy. The kickstart to this sector came thru the
introduction of new technology : mobile telephony, which customers liked. This led to
competition - different players (indian - foreign - telecom cos - financial investors)
wanted a share of the pie hence new technologies and new areas were exposed. To ensure
that it was not chaos allround - the regulator had perforce to step in and we now have a
sector which is about 100 mn mobile connections + about 50 mn fixed line connections +
2 mn broad band. All this while, I think Indian telecom : voice - mobile - leased line for
data would be amongst the cheapest in the world. Quality wise it is slowly improving.
(continued below)

Nandan

Manmohan Singh? He is a reformer and an economic progressive; but I fear he might be

too irretrievably attached to the old order to have a substantial impact on the future. What
about Narayan Murthy and the Infosys guys? Perhaps; they would probably get the most
NRI votes. But, tellingly, that might be because their biggest customers are abroad. In my
view, the honor belongs to Dr. E. Shreedharan, the chief architect of the Delhi Metro.
(continued below)

Edward Again

Just one final point, since I am in no position to make a substantial contribution to this
debate: the global implications (since the global economy is something which I do, to
some extent, know about). The numbers that are being talked about here are enormous,
and an inflow of funds into India on this sort of scale would have important consequences
across the global economy. Now, assuming, as I am inclined to, that China more or less
maintains the present head of steam up to the 2008 Olympics, and imagining that what is
being talked about here really starts to happen, then this may well place a lower platform
*under* next years global slowdown. In other words we may well see a soft landing in
the global context (so eat your heart out on the US housing “crash” Nouriel Roubini for
one), but if we do then it will be for quite different reasons from the ones which most
commentators have been suggesting would be the case. In general the expectation was
that the German and Japanese economies would take the strain on global growth as the
US and China slowed. This is not happening, and the Japanese and German economies
both seem to be slowing in their turn. But what we may well have in front of us is a
situation where infrastructural (and possibly in the case of China, consumer) demand in
the two newly developing global giants generates the momentum and velocity needed to
help the rest of the globe avoid driving straight into the proverbial brick wall. This is
truly new, and very exciting.

Comments (7)

September 12, 2006

Uncharted Water

Filed under: Business — Edward @ 10:02 pm

India’s industrial production grew in July at the fastest pace in a decade (12.4 percent
from a year earlier, which was the largest increase since June 1996) according to data
from the Indian Central Statistical Organisation today.

“Power companies almost doubled electricity output in July to keep up with demand from
factories producing cars and textiles, while government spending on roads and ports
boosted sales at Steel Authority of India Ltd. Accelerating production growth in Asia’s
fourth-largest economy may prompt Reserve Bank of India Governor Yaga Venugopal
Reddy in October to increase borrowing costs to the highest in more than four years.”

“Growth in consumer goods production more than tripled to 19.9 percent from a year
earlier after a 5.6 percent rise in June, today’s report said. Manufacturing increased 13.3
percent from 9.9 percent in the previous month.”

“India’s $775 billion economy expanded 9.3 percent from a year earlier in the quarter
ended March 31, rounding off the financial year with growth of 8.4 percent, the fastest
after China among the world’s 20 biggest economies.”

What is clear is that the Indian economy is currently gathering steam, and this at a time
when there is a general consensus that the political will for reform isn’t what it used to
be. Strange isn’t it?

My meaning here isn’t that reforms aren’t necessary, but that there are other factors at
work, and in particular demographic ones. The importance of these demographic factors
generally can be seen from the fact that it is now the newly developing countries (China,
India, Brazil, Chile, Thailand, Turkey) who are pulling the global economy (and in the
process pushing up energy and commodity prices). The developed world - which makes
up say 50% of global GDP is growing much more slowly than the developing world - and
some of this for ageing related demographic reasons. Global GDP is forecast to grow at a
5% annual rate this year, yet the US is growing at around 3.5%, Japan 2.5% and the
eurozone around 2%. So you tell me, who is pulling who here?

And this is why I say we are moving into uncharted territory. Economists used to have a
little model which worked on the assumption of each economy having a certain growth
capacity in any given moment. But could any one tell me, what *is* the growth capacity
of China or India? I certainly have no idea, and I haven’t seen anyone else make a
convincing case on this topic. The magnitude of the growth we are now seeing in the
developing world is beyond all historical precedent.

And there’s more, since, as US economist (and former chief economist at the IMF) Ken
Rogoff keeps pointing out, with the rapid spread of globalisation the very idea of national
economic capacity needs to be modified since it is not clear what it can mean any more.
Globalisation among other things means the rapid movement of capital, labour, goods
*and* technology and this makes it possible for some areas to grow very quickly indeed.

Of course this doesn’t mean you can just sit back and watch, since with Inflation over 5%
and salaries predicted to rise by 7.3 more than inflation in 2006 there is nothing to be
complacent about. If the huge transition which is currently taking place in India is to go
forward as smoothly as possible then inflation needs containing. On the other hand the
Central Bank may want to move cautiously, since the US economy is evidently slowing,
and it is not clear just what the impact of this will be for everyone else (in an interlocked
world), and especially what this will mean in China, which is much more locked into the
US than India is.

Some are already warning China of the dangers which a slowdown represents. I
appreciate the concern, but I think momentum in both India and China is sufficiently
strong to withstand a downturn. This doesn’t mean there will be *no* effect, just that the
oft predicted ‘hard landing’ is very unlikely, and especially since China is a long way
from being a market economy, and the government can and will intervene to take up the
slack.

Which is not the same thing as saying that - in the event of a global slowdown - global
prices may not get a huge push downwards from the price reductions the Chinese export
industries will be forced to make to sell all that added production which is only now
coming online.

This post is not a plea complacency, but it is a plea to keep to the measure of things (such
as we are able to estimate them). There is much to be done, let’s go to it!

Comments (29)

December 22, 2005

Lee Kuan Yew on India - Part 3
Filed under: Business — Atanu Dey @ 4:30 pm

The recent performance of India’s private sector has underlined an important economics
lesson, that competitive markets work where too often the command and control system
founders. Within your arm’s reach is a device which is a miracle of modern technology—
the cell phone. It took the government telecom monopoly 45 years—from 1951 to 1996
—to install around 14 million land lines. Between 1996 and 2000, with the liberalization
of the telecom sector, India’s installed capacity doubled to around 30 million lines. In the
next five years, India’s telephone companies added another 90 million lines (of which 70
million were cell phone lines.)

Imagine if the government had continued to monopolize the sector and had continued the
installation of capacity at the pre-1996 rate. It would have taken about 300 years—or till
2300—to reach today’s installed capacity. Astonishing things happen when the
government gets out of the business of business, or at least allows the private sector to do
its thing without trying to cripple it. Take another sector where the government allowed
private firms to compete—the airlines. I recall those days where one was often reduced to
begging a government employee at the airlines office for the privilege of being treated
rudely by the airline staff on flights that more often than not delayed. Those were the
days my friend, we thought would never end.

The license quota permit control regime was instituted with the express purpose of
making sure that essential goods and services were affordable and available to the people
and thus was the sole prerogative of the government. An admirable socialist goal of
reaching the commanding heights of the economy. The outcome should not come as a
surprise: shoddy goods and services, affordable and available to only those who had the
clout and could bribe the officials. Bajaj scooters had a waiting time of 7 to 10 years!
They were prized as dowry; want your homely daughter married soon, promise a scooter
to sweeten the deal.

While the Indian economy has done better since the government has started relaxing its
chokehold on it, there is much that is left undone. Until the bureaucrats and the
politicians let go entirely, the Indian economy has a hard row to hoe. It is imperative that
we ask and clearly understand what motivated the policy-makers to hobble the economy
for so many decades. Without that frank enquiry, we may never fully understand which
mistakes were made and therefore continue to stumble into the same traps.

By now, even the minimally awake observer may conclude that the private sector can do
business better than the public sector can. For instance, India’s private sector uses capital
very efficiently. Lee Kuan Yew points it out in his lecture (see part 1 here and part 2 here
of my commentary):

A factor worth noting: India gets a much better economic return for the investment it
makes in its economy because India’s private sector capital efficiency is high. If India
opens up fully to FDIs, the results will be profitable for the investor and add considerable
employment and added GDP growth for India. With jobs there will be a trickle down of
wealth to millions of Indian workers, as there has been in East Asia.

Globally, there is a savings glut which is looking for investment opportunities. India
would be the destination of this massive investment but the economy needs liberalization.
If I am asked what I thought of the liberalization of the Indian economy, I would echo
Gandhi (the home-grown one) and say, “I think it would be a good idea.”

The liberalization so far is too little but I sincerely hope it is not too late. LKY points to
some stellar examples—they are miniscule in the context of the Indian economy but they
are indicative of what is possible.

What India has achieved since 1991 should not be underrated. There have been many
successes. The Delhi Metro is one. Bharat Forge, the largest Indian exporter of auto
components and the leading global chassis component manufacturer, is another example
in the manufacturing sector. There are others. The question is why there are not many
more of them?

Why indeed. The Indian private sector can do much better but can’t. Why? Here is my
conjecture on what LKY thinks is the reason: the mendacity, greed and ignorance of
Indian politicians. LKY is a shrewd observer, of course. But even dim-witted people have
realized that when it comes to greed Indian politicians are a class apart. Exposing that
greed, mendacity and ignorance is fast becoming a thriving cottage industry as evidenced
by Tehelka and Cobrapost.

Being a scholar and a gentleman, he really could not come right out and tell the
politicians to their face that they are the problem. So he used a well-worn technique of
deflecting the blow by saying that it is politics that is to blame. More over, he did not
present it as his own conclusion but let other well-known Indians speak:

There is no dearth of excellent analyses by Indians about this problem. An entire library
could be assembled on the subject. I consulted two books: The Future of India by Bimal
Jalan, who was Governor of the Reserve Bank of India from 1997 to 2003, Chairman of
the Economic Advisory Council to the Prime Minister and has represented India at the
IMF and World Bank; one other book, Governance by Arun Shourie who has held several
government portfolios and is a well-known writer. To sum up their arguments for the
failings of the system in a single word: politics.

There you have it. The failing of the system are centered around politics. And who
engage in politics? Therefore politicians. He said it to their face, however a bit more
politely than I would have. He quotes Dr Singh’s interview in which Dr Singh pleads that
his inability to govern arises from the coalition that he has clubbed together to do the job.
But LKY does not let him off the hook.

Earlier this year, Prime Minister Manmohan Singh gave a wide-ranging interview to the
McKinsey Quarterly. He rated his own government’s achievement as 6 out of 10, a
performance he said was unsatisfactory. He acknowledged the need for better
infrastructure, for more FDI, and also the need to move ahead in manufacturing. When
asked whether the pace of implementation was fast enough, he replied:

” … economic policy and decision making do not function in a political vacuum. It takes
a lot of time for us to take basic decisions. And furthermore, because we are a federal set-
up, there are a lot of things that the central government does, but there are many things,
like getting land, getting water, getting electricity - in all these matters the state
government comes in, the local authority comes in ….. …. I do recognise that at times
it gives our system the label that it is slow moving. In a world in which technology is
changing at such a fast pace, where demand conditions change very fast, we need to look
at a more innovative mechanism to cut down on this rigmarole of many tiers of decision-
making processes.”

Prime Minister Singh added, “We are a coalition government and that limits our options
in some ways.”

It is a sad sight: the Prime Minister of the country making excuses. Straight talk would be
appreciated, instead of the mealy-mouthed equivocation emphasized above. Say, “our
system is slow moving” instead of “at times it gives our system the label that it is slow
moving.”

LKY responds to that excuse by rejecting it. He also rejects the notion that because India
is a “democracy,” it is slow.

Politics is a fact of life in any country. And coalition politics is a fact of Indian political
life.

It has been suggested that India’s slow growth is the consequence of its democratic
system of government. Almost 40 years ago, Professor Jagdish Bhagwati wrote that India
may face a “cruel choice between rapid expansion and democratic processes”.

But democracy should not be made an alibi for inertia. There are many examples of
authoritarian governments whose economies have failed. There are as many examples of
democratic governments who have achieved superior economic performance. The real
issue is whether any country’s political system, irrespective of whether it is democratic or
authoritarian, can forge a consensus on the policies needed for the economy to grow and
create jobs for all, and can ensure that these basic policies are implemented consistently
without large leakage. India’s elite in politics, the media, the academia and think tanks
can re-define the issues and recast the political debate. They should, for instance, insist on
the provision of a much higher standard of municipal services.

I agree with LKY. Fundamentally, what we finally achieve is what we are willing to settle
for. This true at all levels of organization. As individuals, we pretty much end up where
we have set our goals. Our achievements reflect to an unusually large extent what we set
out to do. At the aggregate level, the society we end up having is determined by what
type of society we desire. It is a cultural thing: the obtained level of corruption, poverty,
filth etc is determined by how our culture accepts, tolerates, and takes as normal certain
levels of corruption, poverty, filth, etc. It is the tolerance of corruption, poverty, filth that
allow them to exist to the extent that they do.

So he says that politicians cannot hide behind the excuse that politics is what explains the
poor performance.

By way of example, Chinese politics have always been plagued by factionalism. China
also has great regional diversity. Like India, China also has powerful vested bureaucratic
interests. But Deng Xiaoping forged a basic consensus among all political factions and
the bureaucracy on the economic development and the necessary opening up to the
outside world to succeed. A similar consensus can be achieved in India.

Next he goes on to point out that we have some great opportunities which must be taken
to their logical conclusion instead of half-hearted implementation.

The passage of the Special Economic Zone (SEZ) Bill by the Lok Sabha (Lower House
of the Indian Parliament) in May this year was an important move. SEZs can finesse
some difficult internal issues blocking liberalisation. Singapore has some experience with
SEZs in China. If India thinks it useful, we are willing to share our experiences with you,
building upon what we have done in the Bangalore International Technology Park. I must
conclude with a word of caution. SEZs, once embarked upon, must be made to succeed,
which means total and sustained commitment from politicians and bureaucrats at
national, state and local levels.

When they succeed, they will have a powerful effect on the whole economy, give a boost
of confidence and spark off a healthy competitive dynamic between different states and
regions. Successful SEZs also will erode opposition to reforms because their benefits
become self-evident, as has happened in China.

He concludes this part of his talk with a wonderful example of the mendacity of the
communists. West Bengal, once upon a time the most valuable jewel in the Crown, is a
basket case, now more known around the world as the “Gutter” (thanks to the tireless
working of the “Saint of the Gutters” who enriched her own organization by show-casing
the poverty of Bengal). How did this remarkably sorry transformation take place, you
may ask. The secret sauce: communists.

A few months ago, in August, the communist Chief Minister of West Bengal was in
Singapore to drum up investments for his state offering market incentives to attract
investors. He said: “The lesson from the collapse of the Soviet Union and from China is
that [India] must reform, perform or perish.” That very same month, members of his own
party in Lok Sabha in New Delhi forced a retreat on India’s privatisation programme.
This is India’s party politics.
Pondering the imponderables is next on LKY’s mind. He lets Prof Pranab Bardhan speak
about the important distinctions which lie at the base of the differential performance of
China and India.

There are some imponderables. American commentators believe that China’s political
system is too rigid, that it does not have the flexibility of pluralistic politics and
democracy with freedom of speech, the media, assembly and respect for human rights. So
China will encounter severe problems and setbacks. Professor Pranab Bardhan of
University of California, Berkeley, has explained the problem this way:

“China’s authoritarian system of government will likely be a major economic liability in

the long run, regardless of its immediate implications for short-run policy decisions.

“But inequalities (particularly rural-urban) have been increasing in China, and those left
behind are getting restive.

”With massive layoffs in the rust-belt provinces, arbitrary local levies on farmers,
pervasive official corruption, and toxic industrial dumping, many in the countryside are
highly agitated.

“China is far behind India in the ability to politically manage conflicts, and this may
prove to be China’s Achilles’ Heel.

”Over the last fifty years, India’s extremely heterogeneous society has been riddled with
various kinds of conflicts, but the system has by and large managed these conflicts and
kept them within moderate bounds. For many centuries, the homogenizing tradition of
Chinese high culture, language, and bureaucracy has not given much scope to pluralism
and diversity, and a centralizing, authoritarian Communist Party has carried on with this
tradition”.

Prof Bardhan’s assessment is that India’s ability to politically manage conflict better than
China could be a reason to believe that India holds at least one good card in its hand.

LKY diplomatically states that he believes that China will learn how to manage conflict
in time and that it is not realistic to imagine an unchanging Chinese political system. As
he says in the conditional below, India will draw ahead in the longer term only if the
Chinese make the mistake of not transforming their political structure.

If they are right, India will draw ahead in the longer term.

Such analyses assume that the Chinese political system will remain static. If China’s
political structures do not adjust to accommodate the changes in its society resulting from
high rates of growth, India will have an advantage because of its more flexible political
system in the longer term.
But Bardhan also cautions: “India’s reform has been halting and hesitant. India’s
heterogeneous society has been riddled with conflicts, but the system has by and large
managed these. There are many severe pitfalls and roadblocks which India and China
have to overcome.”

Both India and China are huge countries with vast populations and long histories. They
have to evolve standards of governance that is consonant with their cultures and the spirit
of their civilisations.

The implicit assumption of that last statement is that Indian and Chinese cultures are
different. To me, cultural distinctions explain the varying performance of different groups
of people. In some sense, it is a dismal conclusion because it means that to succeed,
ultimately one must change a dysfunctional culture, and success is not going to be easy.

At stake is the future of one billion Indians. India must make up for much time lost.
There is in fact already a strong political consensus between India’s two major parties
that India needs to liberalise its economy and engage with the dynamic economies of the
world. The BJP led coalition government of former PM Atal Behari Vajpayee continued
and indeed extended the economic liberalisation policies of Manmohan Singh when he
was Finance Minister in PM Narashima Rao’s government. India now has a strong, able
and experienced team with Manmohan Singh as PM. The time has come for India’s next
tryst with destiny.

The first tryst with destiny did not work out as planned, if you pardon the pun. Too much
planning can lead to failure of plans. Indian leaders and policymakers have a seemingly
hypocritical attitude towards the people. The people are assumed sophisticated enough to
figure out who should rule the nation, but they are not smart enough to make simple day
to day market decisions; for the latter, they have to have a patronizing government
official in charge.

If I were the one making pretty speeches for the next tryst with destiny, I would
recommend a few things such as trusting the people a bit more, and trusting the
bureaucrats and politicians a bit less.

In the next and final bit I will summarize what I learnt from LKY’s speech.

Comments (8)

December 21, 2005

The Structure of Global GDP

Filed under: Business — Edward @ 11:48 am

Sun Bin has a very interesting series of maps on World Population and GDP. Dave Altig
at MacroBlog picks up on one of the maps, the sevices sector share as a % of GDP. Since
one mark of economic development is the services share this is indeed revealing. As
Dave points out China has clearly be come a significant outlier among would-be
developed economies in its reliance on manufacturing share. This is unbalanced growth,
and China needs to address this problem. Even after this weeks data revisions China is
still a very services-light economy. What I found most surprising about the graph is the
extent of services development in Brazil, Chile and Argentina. Are there some lessons for
India from what has been happening in China. Raising GDP per capita at the end of the
day also means moving up (not down) the value chain.

Comments (7)

December 19, 2005

Lee Kuan Yew on India - Part 2

Filed under: Miscellaneous, Basic Questions — Atanu Dey @ 9:49 pm

{The first part of this series is here.}

Reading Lee Kuan Yew’s lecture is edifying at various levels. As an observer, he is

incomparable. But he did not merely observe; he hinted at solutions and did so without
being rude. You know the Hindi saying, samajhdar ko eshara kafi hota hai (to the
intelligent, a mere gesture suffices). Unfortunately, his talk to the Congress and other
assorted disciples of Nehru must have been as useful as a bicycle to a fish. Nothing that
LKY prescribed for India is surprising or counter-intuitive. Yet it is good to hear it from
one who has not only talked the talk but actually walked the walk.

LKY transformed a third-world mosquito infested swamp into a rich developed city state
within one generation. An autocrat to the core, he sequenced the changes and orchestrated
the development of his city without apologizing for what he had to do. Singapore is one
of the least corrupt economies of the world. He made Singaporeans clean up their act,
both figuratively and literally. No other dictator has been able to achieve that sort of
transformation. It is a random draw from which dictators are drawn. India drew a lousy
hand and got saddled with dictators that were incompetent to the core. And staggering
from one calamity to another, the country got rid of the dictators and with only a brief
break, got a government that is headed by a foreign-born rather reluctantly naturalized
citizen of India and supported by a bunch of treasonous communists.

There is sweet irony in LKY delivering the Nehru Memorial Lecture: a successful
dictator lecturing the family members of a failed dictator who made a mess of the
economy that was so full of promise. Just in case it is not entirely clear, Nehru was a
dictator, never mind the fact that there may have been an election. The laws of the
universe do not preclude the democratic election of dictators. Adolf Hitler was also
elected, and he enjoyed the confidence of the majority just as much as Nehru enjoyed the
confidence of the people of the newly minted republic of India. There was no opposition
worth its name and Nehru did precisely what he willed.
Based on Nehru’s policy prescriptions, the Indian economy grew at a sorry 2 or 3 percent
a year—the aptly named “Nehru rate of growth.” Per capita figures were even more
dismal than that because the population grew rapidly. The Nehru dynasty continued to
favor policies that kept India locked into the Nehru rate of growth until about 1991. Then
economy grew at a more respectable rate but only compared to the Nehru rate of growth.
In absolute terms, the “post-reform” growth rate was nothing to write home about. China
had been growing for over a decade and at a much faster rate.

Compared to the dismal performance of the Nehruvian socialistic system, anything would
look good. But that is not enough. LKY warns that today’s India should stop comparing
itself to Nehru’s India. LKY put it thus:

India should benchmark itself not just against its own past, but against the best in
Asia. And India can take heart from the achievements and performance of Non-Resident
Indians (NRI) in free market economies such as the US, UK and even Singapore, where
large numbers of NRIs have assumed high corporate positions in multi-national
corporations. {Emphasis added.}

It is important to acknowledge precisely what makes NRIs tick whereas RIs don’t tick. It
is a combination of nature (internal) and nurture (external) factors. The successful NRI in
the US, for instance, are largely those who are innately intelligent, hardworking,
ambitious, well-educated and driven to excel. They were born lucky, worked hard in
school, and then ended up in a fine environment which allows and encourages people to
do their best and move up. The external – environmental – factors that goes with a market
economy is missing in India.

Considered as any large group of humans, Indians are no better or worse than others.
There is genetic diversity and variation within the group. A specially selected subset
could be constructed with arbitrarily extreme characteristics such as “very successful
NRIs.” But the fact that the large group does poorly compared to other large groups is
then entirely due to the environment. The environment can be changed but with great
determination and foresight, as LKY did to Singapore.

One of the commonest objections I come across is, “Don’t compare Singapore to India.
India is very large while Singapore is very small.” First of all, I am not comparing
Singapore to India. I am comparing the culture and quality of the governance of
Singapore to that of India. The values that are expressed by the leaders of a society are
independent of the physical size of the society. Values and standards are thus not like
physical goods. The value of not tolerating corruption applies with equal force whether
the field is large or small. Just because India is a few hundred times larger than Singapore
does not mean that the determination to not tolerate corruption has to be a few hundred
times the determination required in Singapore’s case.

LKY then quotes growth statistics which should make Indians hang their head in shame.
China is a very large country. So comparing China and India cannot evoke the standard
response that is given when Singapore is mentioned in any way with regard to India. Of
course, the objection raised is then that India is a democracy while China is not. I have
not yet figured out why being a democracy should be a valid explanation for a
dysfunctional economic system.

The US, if I have my facts correct, is also a democracy, as are the Western European
nations. Their populations do not subsist at the edge of starvation. Of course, all rebuttals
to India’s dismal economy cleanly sidesteps the fundamental problem which is that
India’s economic policies suck chrome off the bumper of a truck parked a hundred yards
away. Open up any newspaper if you dare on any day of the week, and you will see the
next asinine brain-dead scheme being proposed by the heirs of Nehru. Yesterday, for
example, the government proposes to impose reservations and quotas for private sector
jobs. No, not merit or competency—what will matter is if the applicant has the right
caste, the appropriate religious affiliation, belongs to the correct vote bank.

Here is a stark demonstration that economic policies matter. LKY reports the differential
growth rates of China and India. Were his audience, the honorable head of the Indian
government and the Prime Minister Dr Manmohan Singh, paying attention?

Both India and China have both done much better than most of the world. In the decade
from 1994 to 2004, India’s GDP grew two-fold from US$310 billion to US$661 billion.
But during the same period, China’s GDP grew three-fold from US$542 billion to
US$1,649 billion. In 1984, India’s GDP was about 30% smaller than China’s. A decade
later, it was more than 40% smaller and by 2004 it was about 60% smaller. Such a wide
disparity is unnecessary. India can and should narrow the gap by embarking on a new
round of reforms.

Wide disparity unnecessary? Almost nothing that the various governments of India have
done have been necessary. Futility has been writ large on each hare-brained scheme that
the illiterate narrow-minded bigoted bunch of psychopaths have imposed on the
economy.

I have been following the shenanigans of the government of India for a few decades. To
quote Groucho Marx, “He talks like an idiot, and behaves like an idiot. But don’t let that
fool you. He really is an idiot.” The Indian policymakers behave like idiots, and talk like
idiots. Don’t let that fool you. They are actually a bunch of idiots.

Anyway, enough of this rant. Let us go back to LKY. He asks, “Can India keep pace with
China’s growth?” and responds, “Yes, if India does more in those sectors where China
has done better.”

That statement, ladies and gentlemen, is worth drumming into the heads of India’s
movers and shakers. Are you paying attention, Dr Singh?

Where did China do better? Manufacturing. That is where the foundation of a large
economy lies. That is where it makes sense to distinguish between a small state like
Singapore and a large ones such as India or China. A small economy of only a few
million people can get by with only a services sector. But a large country with a billion
people needs to have a correspondingly large manufacturing sector. When I say large, I
do not mean that it should employ a large percentage of the people. I mean that the value
of the production of the sector should be large. Why? Because manufacturing produces
goods and it is the availability of goods that make people non-poor. Here’s LKY—

… But India cannot grow into a major economy on services alone . Since the industrial
revolution, no country has become a major economy without becoming an industrial
power.

Just as China is learning from India to improve its performance in the IT sector, so India
must emulate China’s success in attracting FDIs and the jobs they create in
manufacturing. It can do this by building infrastructure and educating and raising the skill
levels of its workers.

Infrastructure and education. Actually, education is also part of the infrastructure—the

supporting foundation upon which one can build an economy. Neglect of primary
education rivals the neglect of other infrastructure such as roads, ports, power generation,
railways, etc. Many decades have passed since India’s constitution was adopted in which
primary education was given priority. Like pretty speeches, it is a non-starter. A very
large percentage of Indians cannot read the constitution of India.

Yet—and this is the most baffling puzzle to me—I hear the claim that India is an
information superpower endlessly touted by journalists, writers, and even the President of
India. Cognitive dissonance on a social level or is it just plain stupidity?

LKY is right in his assessment that a country cannot leap-frog the agriculture and
manufacturing stage and go directly to a services economy. He says:

Arvind Panagariya, a professor of Indian political economy at Columbia University,

USA, puts the issue clearly. He noted that some have argued that India can focus on IT,
grow rapidly in services, skip industrialization, and yet transform itself from a primarily
rural and agricultural country into a modern economy. He dismissed such ideas as
“hopelessly flawed” and “far-fetched”.

IT is less than 2% of India’s GDP. While services have grown rapidly, the bulk of the
growth is from service sectors where wages and productivity are low. Business services,
which include software and IT-enabled services, account for only 0.3% of GDP. Only
manufacturing can mop up India’s vast pool of unemployed, narrow the urban-rural
divide and reduce poverty.

Professor Panagariya concluded:

“The right strategy for India is to walk on two legs: traditional labour intensive industry
and modern IT. Both legs need strengthening through further reforms ….”
LKY comes back to the mantra—education and production of stuff. In the manufacturing
sector, he notes that reform in labor laws is critical.

India’s relatively young population can be an asset if they are universally well educated.
UN forecasts that India’s population will outstrip China’s by 2030. Job creation through
faster GDP growth is therefore an urgent necessity. Growth in IT and other services will
not create enough jobs. IT-related jobs make up only one quarter of one percent of India’s
labour force.

To create jobs the main thrust of reforms must be in manufacturing. That requires a
change in labour laws to allow employers to retrench workers when business demand is
down , streamlining the judicial processes, reducing the fiscal deficit, loosening up the
bureaucracy, and most of all improving infrastructure. Let me focus on the last two as I
believe they are crucial and inter-connected.

Industrialisation cannot take off without adequate infrastructure: better roads, and a
reliable supply of power and clean water, better ports and airports. By one estimate,
economic losses from congestion and poor roads alone are as high as US$4 to 6 billion a
year. Another estimate is that the cost of most infrastructure services in India is about
50% to 100% higher than in China. The average cost of electricity for manufacturing in
India is about double that in China; railway transport costs in India are three times those
in China. China has spent over eight times as much as India on its infrastructure. Three
years ago, China’s total capital spending on electricity, construction, transportation,
telecommunications and real estate was US$260 billion or more than 20 percent of its
GDP as compared to US$31 billion or 8 percent of India’s GDP.

Why do I think that India’s policy makers are incompetent? Because it should be clear to
the meanest intelligence that industrialization depends on infrastructure and that that
should be a priority. Which part of this simple statement don’t they understand. And if
they do, why are they preventing the building of infrastructure? No money to finance the
infrastructure? LKY says let the private sector do it.

If there are budgetary constraints , the answer is to privatise these infrastructure projects.
There are well established construction companies, Japanese, Korean and others, that
have done many such infrastructure projects on franchise terms.

One area where India has done well is its telecommunications infrastructure. This has
been a critical factor for India’s IT success. India needs to aggressively privatise
infrastructure development and open it to foreign investment. Then FDI flows will
increase. And the bureaucracy must not impose onerous conditions that will hamper this
privatisation.

Good luck Mr Lee Kuan Yew. Bureaucracy not impose onerous burdens? That is their
raison d’etre.
The Political and Economic Risk Consultancy (PERC) based in Hong Kong, recently
surveyed expatriate businessmen on bureaucracy and red tape in Asia. India was rated
worst out of the 12 countries covered. PERC’s conclusion was that:

“The Government would like to liberalise many sectors, and there are plenty of
announcements of new initiatives to do so. But when push comes to shove, bureaucratic
inertia has been extremely difficult to overcome.”

Asking bureaucrats to stop throwing spanners into the works is like trying to teach a pig
to sing: it cannot be done and it annoys the pig.

The World Bank has also done its own study. It found that in India it can take a decade to
close a business through insolvency proceedings. It also found, among other things, that
official fees amount to almost 13 percent of a property transaction in India as against just
over 3 percent in China.

My secretaries asked Singapore businessmen with investments in India what, apart from
infrastructure, they found as major constraints. To a man, they replied it was the
bureaucracy.

I am sure that there must have been senior bureaucrats in the audience. Did they feel
uncomfortable? Or are they too thick-skinned to understand how much damage they
inflict on the nation.

Last year I was at a policy makers’ roundtable in Chennai. The topic under consideration
was how ICT can enable development. Lots of hot air was generated by impassioned
speeches on how the Internet and the PC would enable rural India to leap-frog
development. When it was my turn to speak, I started off with, “First we kill all the
bureaucrats.” The bureaucrats at the round table were not amused. Perhaps it was because
they did not recognize that it was Shakespeare localized for Indian conditions (“First we
kill all the lawyers.”) I continued that bureaucracy ruthlessly strangles with hands of gold
the Indian economy and no amount of ICT will change India’s fortunes unless the
bureaucracy is fixed first.

OK, maybe I was a bit too blunt. LKY is polite and says it like it is:

They believe it is a mindset problem. The average Indian civil servant still sees himself
primarily as a regulator and not as a facilitator. The average Indian bureaucrat has not yet
accepted that it is not a sin to make profits and become rich . The average Indian
bureaucrat has little trust in India’s business community. They view Indian businessmen
as money grabbing opportunists who do not have the welfare of the country at heart; and
all the more so if they are foreign businessmen. Deng Xiaoping said at the start of
China’s open door policy, it was glorious to be rich. The sequel is reported in Forbes
Asia, November 14 2005, where it listed over 300 China’s richest, 40 of them with
thumbnail CVs in a centre -fold. All are new entrepreneurs creating jobs and spreading
wealth. Now, after private enterprise and the free market have generated wealth in the
coastal provinces, China’s leaders have concentrated on spreading growth to the inland
provinces by building infrastructure and offering generous economic incentives for
investments.

One Singapore businessman told me this story. He entertained a former senior Indian
civil servant to lunch in Singapore. Some months later when he was in India, the former
civil servant reciprocated by hosting a dinner at which several other guests were present.
His host made this surprising comment that he was amazed to see that in Singapore, a
business could be successful without being dishonest.

India must find some way to reward bureaucrats who facilitate, not hinder investments
and enterprise whether Indian or foreign.

India needs reform in various areas. The most critical area is the bureaucracy. Why India
got saddled with a dysfunctional bureaucracy is easy to understand: the British were in
India to exploit and extract wealth and created the bureaucracy with that objective. When
the British left, the bureaucratic infrastructure was not jettisoned because it was the
perfect tool for the “command control license permit quota” Raj which began with Nehru
and still impedes India’s progress.

I think I will take a break and get back to the rest of LKY’s speech tomorrow. Au revoir
until the next time and the case is sol-ved.

Comments (14)

December 18, 2005

Lee Kuan Yew on India - Part 1

Filed under: Miscellaneous, Basic Questions — Atanu Dey @ 10:54 pm

Lee Kuan Yew was invited to deliver the 37th Jawaharlal Memorial Lecture on 21st Nov
2005 in New Delhi. He called it “India in an Asian Renaissance.” I am an unabashed
admirer of Lee Kuan Yew and I should also add that I am a very severe critic of
Jawaharlal Nehru. So I decided to read Yew’s lecture and also read between the lines and
make a few comments

I am going to pretty much quote the whole lecture in this post, interleaved with my
comments. So if you wish to read Lee Kuan Yew without interruptions, you may wish to
click this link.

He starts off with quoting from Nehru’s famous “tryst with destiny” speech of 14th Aug
1947 which he heard as a young student at Cambridge. I suppose it is de rigueur to quote
those lines about “Long years ago we made a tryst with destiny, and now the time comes
when we shall redeem our pledge, not wholly or in full measure, but very substantially. At
the stroke of the midnight hour, when the world sleeps, India will awake to life and
freedom. A moment comes, which comes but rarely in history, when we step out from the
old to the new, when an age ends, and when the soul of a nation, long suppressed, finds
utterance.”

I must hand it to Nehru—he did make pretty speeches. The problem was not lack of
flowery language; it was all about lack of substance behind the form. All talk about
stepping out of the old into the new is meaningless if the same structure of bureaucratic
control and a meddlesome government is imposed with a vengeance that even the British
could not match.

LKY said

The destiny Nehru envisaged was of a modern, industrialised, democratic and secular
India that would take its place in the larger historic flows of the second half of the 20th
Century.

Nehru never doubted India’s place in the world.

Certainly not. There is little point in doubting the greatness of the country that you feel is
your birthright to rule.

LKY

…Nehru’s speeches resonated with me. I shared intellectual and emotional roots with
Nehru because I had also experienced discrimination and subjugation under the British
Raj and admired Nehru for his vision of a secular multiracial India, a country that does
not discriminate between citizens because of their race, language, religion or culture.

Again, Nehru’s vision of a secular country not discriminating among its citizens based on
religion conflicts with the reality that he imposed on the country. It was he who set the
country on a path where the laws that apply to a person are based on a person’s professed
religion, where the privileges you enjoy depends on what your religion is. Want
admission in an educational institution? Well, depending on what religion you are, you
may or may not get in. If this is non-discrimination, then we are using Orwellian-speech
from his novel 1984.

I know that LKY is not ignorant of the real state of discrimination in India. I conclude
that he was making a point by highlighting the blatant discrimination in India.

As prime minister, LKY met Nehru twice in India – in 1962 and in 1964. He must have
regarded Nehru’s attempt at “scaling the commanding heights of the economy” with
bemused contempt. Of course, in his speech he put it rather diplomatically, thus:

Like Nehru, I had been influenced by the ideas of the British Fabian society. But I soon
realised that before distributing the pie I had first to bake it. So I departed from welfarism
because it sapped a people’s self-reliance and their desire to excel and succeed. I also
abandoned the model of industrialisation through import substitution. When most of the
Third World was deeply suspicious of exploitation by western MNCs (multinational
corporations), Singapore invited them in. They helped us grow, brought in technology
and know-how, and raised productivity levels faster than any alternative strategy could.

Import substitution industrialization was stupid and even in those times it was known to
be an impractical idea. Many people defend Nehru’s blunder by making the trite
observation that he was product of his times and therefore cannot be held accountable for
his mistakes. I don’t see what that defense has to do with the price of tea in China. Well,
LKY was also a product of his time; he did not give in to the insanity of ISI. I have a
theory about why Nehru blundered the way he did, which I have outlined before
elsewhere (reference given later.)

LKY then goes on to sugar-coat the pill he administered. He admits that Nehru was all
pretty speeches and no substance.

Nehru had a great vision for India and for Asia and his elegant style of writing and speech
captivated many young minds in the British empire. He had insights into the causes of
India’s problems, but, burdened by too many issues, he left the implementation of his
ideas and policies to his ministers and secretaries. Sadly they did not achieve the results
India deserved.

Nehru’s ideal of democratic socialism was bureaucratised by Indian officials who were
influenced by the Soviet model of central planning . That eventually led to the “Licence
Raj”, corruption and slow growth.

Then LKY notes that change was forced on India and that the Congress was dragged
kicking and screaming from the clutches of Nehruvian socialism. As a guest, he did his
diplomatic best in noting that the first term of Rajiv Gandhi accomplished little.

The end of the Cold War and the collapse of the Soviet Union undercut the strategic
premises of India’s external and economic policies. By 1991, with the country on the
verge of bankruptcy, India had no choice but to change. Some Indians believe that, had
Rajiv Gandhi lived to serve a second term as India’s Prime Minister, he would have
pushed for major reform. But he was cut down before he was able to.

Ah, if only Rajiv had another term, surely he would have transformed India. LKY is
devastating with faint praise. I bow deep in recognition of the maestro’s skill.

LKY then proceed to list the numerous postponement of India’s “tryst with destiny.”

… In January 1996, I visited New Delhi and spoke to civil servants and businessmen on
the changes that Prime Minister Rao and his team were putting into place. I said that
India’s ’tryst with destiny’ had been repeatedly postponed.
And the reason for the delay is not hard to figure out. The bureaucrats and the politicians
had a wonderful time with the “license control permit quota” raj. With the machinery that
Nehru had engineered, they could continue to rob the country with impunity. The racket
they had going was –and it still continues to be– too lucrative to give up.

LKY—

When I published the second volume of my Memoirs in 2000, I wrote “India is a nation
of unfulfilled greatness. Its potential has lain fallow, under-used.”

I am happy to now revise my view. Nehru’s view of India’s place in the world and of
India as a global player is within India’s grasp.

Yes, it is. But the dead hand of Nehru’s socialism has still not released its grip on the
economy.

To put the best spin on the numbers about India, LKY as the gracious guest, presents
aggregate figures for India and China, not India’s figures alone. For instance he says

… The rise of India and China is changing the global balance. Together they account for
about 40 percent of the world’s working age population and 19 percent of the global
economy in PPP (purchasing power parity) terms. On present trends, in 20 years, their
collective share of the global economy will match their percentage of the global
population, which is roughly where they were in the 18th Century, before European
colonialism engulfed them.

Reading between the lines, it is clear that India’s figures alone would be too dismal to
mention. Then with a caveat, he adds:

… If there are no mishaps by 2050 the US, China, India and Japan will be economic
heavyweights , as will Russia if it converts its revenue from oil and gas into long term
value in infrastructure and non-oil industries.

India is an intrinsic part of this unfolding new world order. India can no longer be
dismissed as a “wounded civilisation”, in the hurtful phrase of a westernised non-resident
Indian author (V.S. Naipal). Instead, the western media, market analysts, and the
International Financial Institutions now show-case India as a success story and the next
big opportunity.

This is a comforting development for the US and the West, that a multi-party India is able
to take off and keep pace with single-party China.

I am sure it is comforting the US and the West because India can be a useful
counterbalance to China. Being used as an instrument is a relief only in comparison to the
alternative of being an inconsequential bit-player in the greater global drama. Again,
LKY puts the brightest spin he could manage quoting media reports:
Forbes Asia recently reported that US venture firms will raise US$1 billion for India by
the end of this year. India has emerged as a power in IT sector. It is the largest call-centre
in the world. Almost half of the largest global corporates now do at least some of their
back office work in India. Indian R&D centers of American technology firms are reported
to file more patents than Bell Labs. This year, India announced more than 1,300
applications for drug patents, second only to the US and 25 percent more than Germany,
way ahead of the UK and Japan.

The US is now courting a nuclear India as a strategic partner. The EU has also launched a
strategic partnership with India, and Japan wants a global partnership with India. These
are indices of India’s growing weight in the world. Many countries, including Singapore,
supported India’s bid to be a Permanent Member of the UN Security Council. Nehru’s
vision is within grasp and India’s leaders must realise it in the next few decades.

Sweet vision that Nehru had. I cannot pass on this one without mentioning that India
would not have had to grovel and be repeatedly humiliated in trying to become a
permanent member of the UNSC if way back when Nehru had not in his infinite wisdom
turned down the offer when India was asked to join in the first place.

Back to the speech. He compares China and India:

I have always taken a keen interest in both China and India. Like all democratic socialists
of the 1950s, I tried to forecast which giant would make the higher grade. I had rather
hoped it would be a democratic India. By the 1980s, however, I accepted that each had its
strengths and weaknesses and that the final outcome would depend on their economic
policies, the execution of those policies, the responsiveness of the government is to the
needs of the people, and most of all the nature of the culture of the two civilisations.

… At independence in 1947, two years before the Chinese Communist Party liberated
China, India was ahead in many sectors. Both lost steam by adopting the planned
economy. But because of its “great leap forward” and “Cultural Revolution”, China
suffered more. However Deng Xiaoping was able to acknowledge China’s mistakes and
China’s course dramatically change when he returned to power in 1978.

Subtext: China’s leaders learnt from their mistakes and took corrective action. India is
still hung up on Nehruvian socialism to make real progress. One should read LKY’s
statements very very slowly. They are the words of a person who is not only immensely
bright but amazingly perceptive of the nature of the world. Of course I am sure, to the
illiterate bunch of corrupt politicians and bureaucrats listening to the man in person, the
words carry no meaning. I should mention that the ruling dynasty of India does not have
a single university degree among the whole lot of them, starting with the celebrated
Nehru whose name graces scores of universities and colleges around the country.

But let’s get on with the China/India comparisons. I read the comparison and wish he
would sugar-coat it a bit more; it hurts to be reminded how poorly my country fares
compared to China – and recall that China was poorer than India in 1980.
India has a superior private sector companies. China has the more efficient and decisive
administrative system.

China has invested heavily in infrastructure. India’s underinvested infrastructure is

woefully inadequate. India has a stronger banking system and capital markets than China.
India has stronger institutions, in particular, a well developed legal system which should
provide a better environment for the creation and protection of Intellectual Property. But
a judicial backlog of an estimated 26 million cases drags down the system. One former
Indian Chief Justice of India’s Supreme Court has given a legal opinion in a foreign court
that India’s judicial system was practically non-functional in settling commercial
disputes.

There you have it. Straight from the master’s mouth. A non-functioning judicial system is
worthless. It is one of the major reasons for India’s pathetic economy. Economic
production and growth depends on the ability to establish and enforce contracts. If
contracts cannot be enforced, the cost of trades goes up, welfare losses accumulate, and
finally in about 50 years, you have a country with about 300 million people at the edge or
below starvation levels.

A poor economy then leads a hand to mouth existence and cannot invest in education.
About 400 million Indians cannot even read; about half of Indian children drop out before
completing primary school. Here is the comparison:

Both India and China have excellent universities, at the peak of their systems. India’s
institutes of technology and management are world class. China is determined to upgrade
its top 10 universities to world class status. Overall China’s education system is more
comprehensive. China’s illiteracy rate is below 10%, India’s about 40%. India’s narrower
band of educated people will be a weakness in the longer term. And although top quality
Indian manpower is in high demand, large numbers of engineers and graduates lack the
skills required in a changing economy and remain unemployed. However India has a
larger English speaking elite than China. But only over half of each Indian cohort
completes primary school, a big loss.

After liberalisation, China and India have followed different models of development,
maximising their respective strengths. China adopted the standard East Asian model,
emphasising export-oriented manufacturing. China has been immensely more successful
in attracting FDI. India has focused on IT and knowledge-based services. Job creation is
much slower in India and will continue to remain so until India’s infrastructure is brought
up to date to attract the many manufacturers who will come to use India’s low cost
workers and efficient services.

India’s “low cost workers” is a euphemism for very low average productivity in India.
Wage levels reflect average productivity because aggregate wages and aggregate
production must approximately balance. Average income therefore reflects average
production levels. I shudder every time I hear India’s “low cost workers” trotted out as a
badge of honor.
Well it’s time to do the numbers:

China’s GDP for manufacturing is 52%, India’s 27%; in agriculture China’s is 15%,
India’s 22%; for services China’s 33%, India’s 51%. Over the last decade, in the service
sector India has averaged 7.6% annual growth, China 8.8%, in manufacturing India’s
growth is 5.7%, China’s 12.8%.

I see that I have only about half way through the lecture. I think I will stop here and put
the rest in a follow up post.

Comments (16)

November 1, 2005
The Indian Consumer Cometh

Filed under: Business, Basic Questions — Reuben Abraham @ 1:24 am

Stephen Roach is back from his third trip to India. This time, he’s ga-ga about the Indian
consumer and India’s domestic consumption-led growth model. In case you’re wondering
why an article by Roach matters, you certainly are underestimating the man’s influence
(for better or for worse) among the movers and shakers in finance and industry in the
U.S.

The consumption story — the organic sustenance of sustainable growth and development
— casts India in a very different light. Don’t get me wrong — the Indian consumer is
hardly a powerful force on today’s global stage. As the accompanying chart shows,
India’s per capita income and consumption levels are about half those of China’s. But it
is growth at the margin that always drives powerful macro and market trends. And the
Indian consumption story is, first and foremost, one of accelerating growth off a low
base. The potential comes from the structure of the Indian economy: Private consumption
currently accounts for 64% of Indian GDP — higher than shares in Europe (58%), Japan
(55%), and especially China (42%). India’s transition to a 7% growth path in recent
years is very much an outgrowth of the emerging consumerism of one of the world’s
youngest populations. The increased vigor of private consumption provides a powerful
leverage to the Indian growth dynamic that is rarely found in the externally-dependent
developing world.

This came through loud and clear on my recent travels through India. Over a span of
four days, I met with a number of corporate executives, investors, and senior government
officials. Everywhere I went, the focus was on the Indian consumer. I met with the
managements of a good cross-section of India’s major consumer companies — Hindustan
Lever (softgoods), Pantaloon (retail), Raymond Textiles (clothing), and McDonald’s (fast
food). I also spoke with executives from banks and drug companies — all of whom have
important consumer businesses. And I met with leading industrial companies such as
Reliance, where a major five-year initiative has just been announced for the development
of nationwide chain of hyper-stores and super-markets. I even went to the Phoenix
shopping mall in Mumbai, which was bustling with activity. I have made similar trips to
malls in China. There was one key difference between these two experiences — the locals
were buying in India. This is consistent with what I heard from most of the consumer
companies I saw — solid acceleration in same-store sales comparisons over the past six
months.
…
Most of India’s major consumer players are looking for an imminent consolidation of the
country’s highly fragmented retail sector. Currently, there are over three million retail
outlets in India — an industry structure that is ripe for efficiency enhancement. The
threat of foreign competition is already spurring a big consolidation push. Wal-Mart is
apparently poised to enter India as soon as restrictions on retail FDI are lifted. That
appears to be no more than 18 months away. In the meantime, local players like
Pantaloon and Reliance are scaling up in an effort to meet the coming Wal-Mart
challenge head-on. The competitive juices are coursing through the veins of India’s
consumer industry. Unlike other Asian economies, India’s entrepreneurs are eager to
compete.

Roach certainly makes a good point of booming domestic demand in India, especially
when compared to export-led (exports and fixed asset investment add up to 80%+ of
Chinese GDP, growing at 30% pa) growth in China. Liberalisation of the retail sector can
help consumption a lot more, which is why it should become a top priority for the Indian
government.

If you’ve gone to the Morgan Stanley website, you’ll notice the article I linked to is
missing the charts Roach refers to. If you’d like a PDF version of the Roach piece with
complete charts, let me know and I’ll mail it to you.

Comments (7)

October 28, 2005

The Economist on Indian Economic Reforms

Filed under: Politics, Infrastructure, Basic Questions — Reuben Abraham @ 2:01 am

Taking note of the 8.1% growth recorded by the Indian economy, The Economist is
carrying a couple of stories on the constraints on the Indian economy. The magazine has a
leader on India and China, followed by a special report on India called Democracy’s
Drawbacks. The report addresses all the usual issues, including the Left’s protection of its
narrow political base, namely organised labour, which means it doesn’t really have to
care about workers at large. Another issue that is raised is the shocking 14%-15% of GDP
spent on subsidies, to which we can add another 1% of GDP courtesy of the REGS. After
detailing all of the problems, the obvious question is posed: how can the economy be
doing so well, if everything is as messed up as it seems?
There are a number of reasons. The biggest is that the Indian economy is so strong,
structurally and cyclically, that it can ride out a period of wobbly policy. India’s young
population gives it a fast-growing workforce and a declining proportion of dependants.
Over the next few decades, that will be good for savings and investment. Industry,
meanwhile, has recovered from a splurge of over-investment in the mid-1990s. It has
improved efficiency and is now both reaping the benefits and investing again in new
capacity.
…
Almost every budget since 1991, including this year’s, has cut import tariffs and freed
more industries from “reservation” for small firms, a big hindrance to competitiveness in
businesses that might benefit from economies of scale. This year, moreover, saw the
introduction of one long-planned reform, a standardised value-added tax imposed at
state level. Typically, politics meant that not all states fell into line, and implementation
has been patchy. Yet the tax may eventually not only bring new fiscal stability, but also
reduce the burden of cascading excise and sales taxes that is one of the biggest
handicaps facing manufacturers. Modest, piecemeal reform, in other words, is not quite
dead.

The government’s priorities—investment in infrastructure, agriculture, basic education

and primary health care—are also right, given that the big macroeconomic stuff was
mostly done in the 1990s. But they all need money, and that requires fixing the budget.
India’s fiscal deficit is now 8% or so of GDP if both state and central governments are
counted—an improvement after six years of double-digit deficits, but still too high.
…
The deficit, which goes largely on interest payments (40% of recurrent spending),
defence, subsidies and civil-service wages and pensions, leaves little room for big capital
investments.

What about the Left Front? Will they eventually realise the damage they are doing to the
economy and the country?

Jairam Ramesh, a Congress member of parliament who played a big role in writing the
“common minimum programme” that defines relations between the UPA and the Left
Front, floats the interesting theory that, now that Congress has enacted the Employment
Guarantee Act that the Left was so keen on, the Left may prove a little keener on asset
sales. They would, after all, be a way of paying for all those jobs. From the Left Front
come faint signs of accommodation. Prakash Karat, the general secretary of the CPI (M),
the most important party within the group, is, like Mr Ramesh, adamant that full-scale
privatisation of profitable public enterprises is not on the agenda. But he says the party is
“ready for a discussion” on how to raise resources for spending on the poor.

Ironically, the most telling statements about the nature of power without responsibility, an
artform mastered by the Left ideologues in Delhi, came from veteran communist leader,
Buddhadeb Bhattacharjee.
On September 30th, the day after Communist-affiliated trade unions had brought his
capital, Kolkata to a halt, he could scarcely conceal his exasperation. He told The
Economist that the trade unions—and many of his party comrades—had become “one-
dimensional”, representing only the interests of the 30m or so workers in India’s
“organised” sector. Mr Bhattarcharjee concedes that some of his colleagues in Delhi do
not seem to grasp that economic reform could benefit a much bigger number of workers
than those who belong to unions. If they do, they perhaps see political benefits in
ignoring it. But “Here, we are running a government. We have to fulfil the aspirations of
the people.”

Exactly, Mr. Bhattacharjee. Now, if only you could convince your Stephanian brethren of
exactly this!!

Comments (5)

September 15, 2005

Good Intentions. Bad Ideas

Filed under: Labour market, Regulatory reforms, Infrastructure — Amit Varma @ 1:49
am

A version of this piece was first published in the Asian Wall Street Journal (subscription
link).

The road to hell is paved with good intentions—and nobody knows that better than
India’s poor. There can be no better intention than removing poverty but, for more than
half a century, a well-intentioned and bloated state has only perpetuated it with misguided
policies and regulations. And New Delhi still hasn’t learned from these mistakes. The
Indian government is soon to embark on perhaps the grandest waste of taxpayers’ money
yet: the Rural Employment Guarantee Bill.

The REGB, recently passed in parliament with unanimous support across political
parties, is supposed to provide 100 days of work in a year to every rural household across
the country that wants it. This is expected to cost Rs. 40,000 crore (around US$ 9.1
billion), which amounts to 1.3% of GDP. And by some estimates, costs may reach four
times that figure. The bill is in line with the rhetoric of the Congress-led coalition
government, which came into power last year disdaining the liberalization policies of the
preceding BJP government, and promising to introduce “reforms with a human face.”

The problem is that there is no evidence that the Indian Government is capable of
properly implementing any social welfare plan. Former Prime Minister Rajiv Gandhi
remarked in 1987 that only 15% of the money spent by the government actually reached
its rightful recipient. The rest was wastage. Similar distribution schemes–such as the
Public Distribution System and the 1976 Employment Guarantee Scheme in the state of
Maharashtra–fell victim to inefficiency and corruption, and have all failed to achieve
their stated objectives.

These failures have much to do with the the vast Indian bureaucracy, which is designed in
such a way that inefficiency is inevitable, and corruption likely. Bimal Jalan, a former
governor of India’s central bank, put it succinctly recently when he pointed out that “the
most important problem in governance and administration of projects or schemes
launched with great hopes is the involvement of a large number of agencies and
ministries in decision-making and implementation. It is also common experience that
these multiple agencies do not work in unison to resolve any administrative issue.”

Whatever money does make it through all the confused bureaucracy is prone to being
siphoned away at the end of the line, where local distribution is meant to take place. The
recently passed Right to Information Act, a welcome move that is supposed to increase
transparency by forcing the government to make its paperwork available to anyone who
wants to see it, can only be of limited help. Most of the country does not even know
about it, or would not dare to use it against an oppressive local government.

The REGB will also have economic consequences. Labor markets could be distorted at
local levels if the wages paid by the scheme are more than the local rate decided by the
market. If the government runs short of funds and makes drafts on private savings held by
banks, interest rates could go up. Then there’s the obvious fact that the money spent on
this scheme could certainly be put to better use somewhere else. New Delhi could use it
to build much-needed infrastructure like roads, ports and power installations, enabling
greater participation in the economy and generating more sustainable employment.

The key to generating employment lies in less government intervention, not more. The
government needs to reform India’s archaic labor laws, whose inflexibility hampers
industrial growth as well as employment. In a variety of repressive ways, firms are not
allowed to enter into free contracting, and cannot manage their workforces according to
market conditions. In theory, labor laws are supposed to protect workers from being fired,
but in practice such laws discourage industrial units from being set up, and hamper
entrepreneurship and industrial expansion. The effect is that employment is far lower than
it would have been in a free market.

India also needs to shut down its “License Raj,”–the oppressive web of regulations that
acts as a massive disincentive to entrepreneurs and businessmen. It is no coincidence that
India ranks 118th on the Heritage Foundation Economic Freedom Index, and 127th on
the UNDP Human Development Index. Economic freedom and development go hand in
hand, and India could have done as well in manufacturing as it has in services had its
entrepreneurs been given the freedom to set up businesses without having to apply for
myriad licenses, bribe numerous officials, and sometimes spend years in the process.
Increased entrepreneurship and industrial growth would have been far more effective than
the REGB in generating long-lasting employment.
India’s 58 years since independence have been ones of lost opportunity, with a waste of
human capital and millions of lives lost to needless poverty. Successive Indian
governments have made all the right noises about reducing poverty, and then followed all
the wrong policies. Sadly, the REGB looks like more of the same.