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Monday, December 25, 2006

India's Growth Path

My friend Aninda made a number of useful an interesting points to me in a recent mail.

"The real economic underpinnings for a sustained surge in productivityand capital deepening growth is there. But the political/policy underpinnings to manage such a referenced 'underpinning' along side socio-political and investor expectations, still, in my view, fall short."

Well this is the big issue isn't it. I don't think that any of us doubt the weaknesses on the policy front, the key problem seems to be just how much growth can be achieved despite this.

I mean if we call the rate of GDP growth Y*, then we could say something like this:

Y* = f(L*, EL*, T*, I*)

Where L is labour force, EL is effective labour force (ie a human capital component), T is the technology level, and I is a measure of institutional quality. Now the difficulty is just what weighting to we give to each of these. L isn't hard to estimate, since it is to some extent determined by the demographics, but obviously not by this alone, since the growth in labour participation will also to some extent be influenced by I, eg just how dynamic the labour market is and how good at job creation it is.

The others are much less easy to get to grips with. EL can be measured by changes in formal education, but in a rapidly growing economy like India's, and with a rapid expansion in unskilled jobs, learning by doing can be even more important, and again in the north of India maybe you need another proxy like H (health) to assess just what can and can't be done.

T will depend a lot on the investment rate, and this is what we will need to watch closely in 2007, but again there are reasons ex-India to imagine that the flow of funds can increase significantly, since the quantity of investment opportunities in relation to the availability of funds may be constrained (the investment dearth, which is simply the other side of the savings glut). So any assessment of trend growth in India would need to take into account the external environment, and how this is changing, and just how rapidly India is integrating with that global environment (which again, of course, depends on I*).

What we don't know is how rapidly the institutional environment can change, but one thing which should be borne in mind is the fact that a market economy is effectively a self-organising system. In an environment where so many people put the emphasis on markets, it is strange how people often tend to ignore this fact (or refer us to the law of unintended consequences). It is precisely because outcomes can RARELY be the intended ones that markets are so important, indeed this is the whole theoretical underpinning of the market economy case, and of course the basis for the critique of soviet-style planned economies (although, of course, don't miss what France has actually managed to do with a far higher planning element than the US).

Which is not at all to say that you don't need to develop a high quality institutional environment, but is to say that when the river is flowing fast enough, the water will simply work its way round the blockages. This is what we may be about to witness in India.

Also, if we look at the growth theory correlation studies of the 1990s, what is surprising is just how LITTLE correlation people were able to find about institutional factors, apart from Health (which was the strongest correlate) and education.

So I think we do need to be careful here.

"Here, too, excessive optmism needs to be tempered by India's rich history of mishaps, mismanagement, corruption, etc."

Well look, all of this is certainly true, but just how much of a guide to the future is the past here? Just how rapidly can things change? We simply don't know, but all the recent evidence points to the fact that things are changing much more quickly today - everywhere - than they were 20 years ago, for example. So if there are to be surprises here, oughtn't we to expect them on the upside?

"I believe it is incorrect to say India's politics do not matter
anymore, or that its economy is increasingly divorced from political or policy constraints. "

No, but I don't think that any of us are going quite that far, we are simply asking the fairly reasonable question of, even on the slightly worse case scenarios, what could we expect?

There is an unusual comparison here which springs to mind, since most of the analysts out there seem absolutely ready to buy the Goldilocks Germany and Japan stories, whilst not buying the Indian one. I would suggest they apply the same criteria to their analyses of Germany and Japan that they apply to India, not the other way round.

But why does this difference exist? I think it exists because people tend (following academic theory prejudices - Darren Acemoglu for eg , who IMHO simply hasn't got a clue what he is doing in the last life expectancy/fertility correlate he ran, but more on this in another moment) to give a high weighting in the little equation I outline above to the I factor, and don't think enough about the structural components of L* and EL*. You need to think about BOTH, but my big beef is that one set of parameters are being ignored here, and in BOTH the Japan and the India cases, which are really only two different sides of the same coin.

"Demand side growth, financial market valuations and social
expectations are in danger of pulling ahead of supply side capacities (and political commitments)."

I think we need to differentiate pretty rigourously when we refer to 'demand' here, as I have often pointed out to Brad Setser, you need to think about BOTH investment and consumer demand. Now I think we are all agreed that the consumer driven end of things has now reached its natural limit, but what Nanubhai and I are arguing is that there is another leg, and that this is investment, and then, of course, the secondary consumer multipliers. So the place where Goldilocks may actually get to eat all that honey is much more likely to be India, since the push-start which came from the consumer demand leg could now move over to a full throttle investment one. External global push could be as important here as anything internal IMHO (don't forget the Dooley at al debt swap thing, maybe I should come back to this in another moment).

I would say that this is a question of the irresistible force (global push) meeting the moveable object (the mountain of rural labour just waiting to flow towards it in India). All this more than likely simply needs one big push.

"Even with the current pace of growing infrstructure
(still at an incipient phase) for us to engage in socio-economic
theorizing about how many hundred million of India's villagers would need to move from agri to industry/svcs and in how much time, is still too fanciful and hardly conclusive! "

I think Aninda here hits the proverbial nail on the proverbial head. I recently used the expression "when the damn breaks" somewhere, and this would be exactly the point, economic development almost always involves large scale internal migrations. Spain in the 1960s would be a perfect example, China in 1998 would be another, remember Andy Xie estimated that there were some 200 million people out of work and on the move at that point. Of course this river has now largely stopped flowing in China, and as Nandan was also pointing out to me last nigh, wage inflation in China is on the rise. This, however, won't push them out of business, but will simply lead to structural reform and a shift up the value chain as happens everywhere else.

But this does begin to open up a hole at the bottom for India. And the rural population is getting desperate. Growing numbers and a diminishing share of GDP are simply not sustainable, with or without the well-known conservatism of the rural poor in India.

So I am saying they ARE going to move (yes, I am sticking my neck out, but this will be testable), and if they start to move then the network feedback process will be massive. Indeed this can all become quite dramatic at some point.

Of course I could be wrong, but everything I feel about this points in this direction. What we need is to start to gather data here. Odd articles in the WSJ are neither here or there in this sense.

"Is it appropriate to boost demand, socio-political expectations and promises of economic and financial abundance NOW with the hunch (regardless of how stronglysuch a 'hunch' might be felt) that the supply-side will catch up? "

No it isn't. I am not saying this. What we may well see in the short term is increasing hardship for hundreds of millions of people. The river of births which have been taking place in the north virtually guarantee this. Look at this post from New Economist:

China's poor grew poorer at a time when the country was growing substantially wealthier, an analysis by World Bank economists has found. The real income of the poorest 10 per cent of China's 1.3bn people fell by 2.4 per cent in the two years to 2003, the analysis showed, a period when the economy was growing by nearly 10 per cent a year. Over the same period, the income of China's richest 10 per cent rose by more than 16 per cent.

I would say that it is almost inevitable that India repeat this experience, ie that many people get worse off short term before they get better long term.

And indeed today there is more news to this effect:

China’s income gap grows despite pledges

China’s widening income gap is approaching Latin American levels, according to a report by the Chinese Academy of Social Sciences, a state think-tank.

The development flies in the face of two years of efforts by China’s leaders to make addressing the gap between rich and poor a priority. Hu Jintao, China’s president, has pledged to promote “social equality”. Although the government has abolished an agricultural tax and pledged to expand the social security network in both rural and urban areas, it is under considerable pressure to announce more ambitious policies.

The think tank report is the latest by governmental or international groups to conclude that economic inequality is rising rapidly in China, despite the continued growth in the economy and the millions of people who have been lifted out of poverty.

and please don't miss this bit which, IMHO, is going to become ever so important in the developing world:

In its annual report on social development in China, the Cass academics also warned rising medical costs were becoming an ever-greater problem and were pushing some back into poverty.

According to the Cass report, rising healthcare costs have become a big concern among Chinese, with medical expenses now accounting for 11.8 per cent of household consumption, more than transport or education.

“This is a very high percentage, even compared to developed countries,” said Li Peilin, a sociologist at Cass and the report’s editor. “Soaring medical costs have plunged many rural and urban Chinese back into poverty.”

1 comment:

Anonymous said...

There is an income disparity ratio that is calcuated from 0 to 1 (0 being perfect equality and 1 being perfect disparity) and India fared pretty goood at 0.33, while China had a score of 0.48 and Brazil, Russia has over 0.5, and even US has more score than India.

Goes to show how wrong Indian analysts were in saying about growing disparity. In fact, India shows a much better income distribution than most developed countries in the world.

Another proof of that is the extremeley fast growing middle class and skyrocketing consumer durable consumption. For China, Brazil and other countries the domestic consumption of the middle class items are very low, showing how balanced Indian growth had been compared to them.