Thoughts on economics and liberty

Tag: Indian economics

India CAN’T cross over the West without fundamental reform of its governance

(I wrote a fairly longish blog post on this topic just now but because of a computer accident I've lost it all. So this will be a brief summary).

Essentially, let's first review this – something I wrote this 13 years ago, here:  

Let us assume that USA per capita income grows at 1.5%, 2%, 2.5% and 3% for the next 250 years (i.e., we have 4 different scenarios).

Given that India's per capita today is 20 times lesser than USA (in PPP terms), and we want India to catch up with USA in 50, 100, 150, 200, and 250 years, what are the growth rates in per capita we need to target in order to reach this cross-over point?
 
We have seen that growth rates of 8-9% in per capita per year are easily achievable (as China has done in the past 15 years), and given two facts:
a) We are at least as smart as anyone else, such as the Korean/Chinese
b) We have recorded all the lessons we learnt from the mistakes of these Asian countries, we can do 10-12% per year for long periods of time.
 
The question is: what is it going to take to beat the USA?
Well, here are the answers.
 
If USA per capita = 20, INDIA = 1, (using PPP), today
The table we need is:
Assumed USA growth rate
Years needed to cross over the USA 
 
50
100
150
200
250
1.5
7.8
4.6
3.6
3
2.7
2
8.3
5.1
4.1
3.5
3.2
2.5
8.8
5.6
4.6
4
3.7
3
9.4
6.1
5.1
4.5
4.2

The fundamental lesson to be learnt is that if we could do 9.4% p.a. we could catch up with the USA in ONLY 50 YEARS, even if it were growing at 3% p.a. That is out of the world, however, a growth rate of 9.4% for 50 years. Also, the USA will be unable to grow at more than 2.5% p.a. for the next 50 yrs. Therefore the target gr. rate for India, for a catch up with USA in 100 yrs, if it grows at 2.5%, is 5.6%.

 
Once more, economic theory and practice tells us that this rate is unsustainable for 100 years at a stretch. What can be done is to target very high gr. rates initially, at over 10% for about 20 yrs, and then the economy will in any case slow down, tapering off in the end to about 2% p.a.
 
[See the figures here]
 
Of course if we continue at the Socialist Growth Rate of 1.7% p.a. which we had since independence, even for another 100000 years also, we will never never catch up.
 
Today, the technology (institutional framework) needed to achieve this catch up is available with Economic science. We know that we have to set up minimally regulated markets, and encourage free enterprise, trade, and competition. We have to Banish Bureaucracy.
 
The question is essentially only one: who is going to bell the cat? It is in my self-interest and in your self-interest to only look after our own families. So, who is going to do the hard work required to reform the brilliant, but confused, Indian mind?
 
Who is going to tell the people of India that this is not a fool's fantasy – the catch up with USA, but a sheer inevitability, if we follow the lessons learnt in Economics over the past 250 years.
 
What is needed is political entrepreneurship of an unparalleled scale and magnitude.
 
Now back to today
Convergence is a simple prediction of growth models, and it has been broadly tested and found to hold. The problem is, however, that  growth rates of 10% or more are not sustainable for long without significant reform.
 
There is extensive literature on this subject, but also this recent paper by NBER (btw, if you are in India, please download and send it to me – it is free in India but costs me money to download from Australia). [When Fast Growing Economies Slow Down: International Evidence and Implications for China, by Barry Eichengreen, Donghyun Park, Kwanho Shin, NBER Working Paper No. 16919,  March 2011]
 
A recent article in The Economist summarised this paper and showed how it is almost inevitable that China will start slowing down in the coming decade. Further, I am certain that given India's extremely poor governance model, it will slow down even before reaching China's per capita GDP when it starts slowing down. India's spike in growth rates is very temporary.
 

My message for India

The 'high' growth rates seen in India today are nothing special. These should have happened anyway, 60 years ago – had the economy been let free. But unfortunately, these growth rates, attributable entirely to the 1990s reforms, are not sustainable. To reach the per capita GDP of the West (which would have further increased its GDP by then), India will need to DRASTICALLY REFORM ITS GOVERNANCE. There is simply no choice for India but to follow most of the suggestions in BFN.
 
Once again, let me repeat the same message I sent out 13 years ago: Please stand up to lead India to the future it deserves. Join the Freedom Team and prepare for a national political movement for reform. 
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India’s decline from an unquestioned position of world leadership

A few weeks ago I had written about India's fall from the unchallenged No. 1 super-power position it had occupied for most of the last 2000 years. Here's the actual table (on relative GDP share) from Angus Maddison's Contours of the World Economy 1-2030 AD.

AD
        1
1000
1500
1600
1700
1820
1870
1913
1950
1973
2003
France
2.2
2.3
4.4
4.7
5.3
5.1
6.5
5.3
4.1
4.3
3.2
Germany
1.2
1.2
3.3
3.8
3.7
3.9
6.5
8.7
5.0
5.9
3.9
Italy
6.1
1.9
4.7
4.3
3.9
3.2
3.8
3.5
3.1
3.6
2.7
Netherlands
0.1
0.1
0.3
0.6
1.1
0.6
0.9
0.9
1.1
1.1
0.9
UK
0.3
0.7
1.1
1.8
2.9
5.2
9.0
8.2
6.5
4.2
3.1
Spain
1.8
1.5
1.8
2.1
2.0
1.8
1.8
1.5
1.2
1.7
1.7
Former USSR
1.5
2.4
3.4
3.4
4.4
5.4
7.5
8.5
9.6
9.4
3.8
USA
0.3
0.4
0.3
0.2
0.1
1.8
8.9
18.9
27.3
22.1
20.6
Latin America
2.1
3.8
2.9
1.1
1.7
2.1
2.5
4.4
7.8
8.7
7.7
Japan
1.1
2.7
3.1
2.9
4.1
3.0
2.3
2.6
3.0
7.8
6.6
China
25.4
22.1
24.9
29.0
22.3
32.9
17.1
8.8
4.6
4.6
15.1
India
32.0
28.1
24.4
22.4
24.4
16.0
12.1
7.5
4.2
3.1
5.5
Africa
7.6
11.4
7.8
7.0
6.9
4.5
4.1
2.9
3.8
3.4
3.2

 

(In this table, I've snipped out relatively minor nations, and highlighted in red the approximate period when a particular nation was at its relative peak of global power).

Note that Africa was a relatively wealthy place well after the decline of the Egyptian civilisation. Italy started losing world share of GDP from after 1500 AD. England peaked in 1870, USA in 1950-1970. Note how the UK overtook the ENTIRE India by 1913, and remained wealthier than India for most of the 20th century. Only now is UK's GDP smaller than India's again. What a superlative performer the UK has been, despite its tiny population.

Before you rush to conclusions, let me point out that this supremacy of the UK (or the West, more generally) was NOT motivated by colonialism but by industrial productivity. While Indians kept digging potatoes from the ground, the British invented highly productive machines.

The data suggest that India and China can, together (should they adopt the technology of freedom), rapidly move towards a 50% share of world GDP. This, however, is not going to happen unless both these nations change their policies from socialism to capitalism.

The writing is on the wall for India: change your policies or remain mired in poverty and corruption. The Freedom Team of India is assembling to lead India to its rightful TOP POSITION in the world. Join FTI or otherwise support it.

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The uncertainties in doing business in India

Came across this piece by Jennifer Hewett in The Austarlian (Rocky road to becoming an economic powerhouse). Particularly illuminating was this story about an Indian who quit his business in England and returned to India seven years ago:

One Indian-born, English-raised executive says shutting down his business manufacturing top-end shoes in Britain and moving to India seven years ago on the ground of cost was the biggest mistake he has ever made. He has to constantly pay off a variety of people to ensure his business is not buried alive by surprise new taxes, changed customs rules or dubious labour charges. There is no prospect of appeal in a legal system, which is another bad joke.

"In England, you go to work to run a business and know more or less what to expect during a day," he says. "In India, you have no idea what can go wrong next."

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Can India catch up?

I'm providing below partial extracts from my notes prepared for a talk I gave on 2 March 2011. I propose to refine these notes over the coming months and write a longish essay if time permits, for publication in a serious journal. Suggestions are welcome. (Don't know if I'll find the time!)

The world is rapidly changing. Far more rapidly than most people know or can imagine. When a big huge country like India gets involved in the change process, expect radical surprise.
 

The context

There are two ways to look at the world today: (a) close-up, by looking into its financial crises or business cycles; and (b) overview of trends, by stepping back. I want to set the context by looking at long term trends, and then draw closer to the current situation.
 
It will be useful to begin this talk by noting that somewhere around 100,000 years ago the current human subspecies came into existence. Most likely this happened somewhere in north Africa, following which humans began to migrate across the earth.  
 
Till about 10,000 years ago nothing much happened. Humans, who started as hunter gatherers[1] and expanded steadily across the planet, modifying and adapting to local environments. But while adaptation took place, it was reactive, not pro-active. We did not directly influence the environment. Also, the concept of critical thinking had not emerged. And so lives were generally brutish and short. The head of the tribe was influential: individual was a mere cog in the machine of the tribe.
 
Perhaps somewhere between 10,000 and 5,000 years ago most humans settled into agriculture (many pockets of hunter-gatherers remained). The fact that agriculture could produce a surplus meant that some people could specialize in culture and learning. From this period onwards we notice the emergence of towns, monarchies, and even empires: civilisation as we know it.
 
At this time, India became a specialized agricultural society. It was soon to become the world’s wealthiest, a position it retained (or at least the second-wealthiest) for almost the entire recorded history of mankind till the industrial revolution. Part of the reason for this must have been the specialization brought about through the caste system.
 

The caste system as an efficient solution to the agricultural era

The caste system was perhaps an efficient solution to the agricultural age in India. It helped create an environment for hundreds of millions of people to live harmoniously in villages, and it helped produced sufficient surplus to feed hundreds of prosperous towns and cities. Not for nothing was India the world's wealthiest nation for thousands of years.
 
With the caste system even the smallest village could guarantee itself a blacksmith, traders, cleaners, and priests to conduct marriage and death ceremonies. That meant that just because the local blacksmith died the village did not have to go miles away to get its ploughs and carts fixed. The caste system also produced soldiers when needed.
 
It was a self-perpetuating solution or equilibrium to a difficult problem of living in remote corners of India without the support network of roads, rail-line, electricity and telephones. Not a paradise, by any means – particularly for the 'lower' castes. But it worked. 
 
This model was not uncommon during the agricultural era. European feudalism comes to mind but I'm sure broadly similar social structures must have been created in China. I know that Japan definitely had its own "caste system" of sorts.
 
It also made sense (perhaps!) in the agricultural age to deify the cow and make it a sacred animal, so as to have sufficient proteins available in the village, given that most people could not afford meat and had to eat just rice and coarse lentils. This clearly did not occur all at once. It took time for the culture to stop eating cows and other animals (indeed, in the hunter-gathering era, till about 10,000 years ago, no one could have survived without eating meat).
 
That is why Hinduism took the shape it did in the last 2000 years – basically a way of life to support an agrarian society.
 
Anyway, as a result India became the world’s wealthiest in 12 out of the past 20 centuries (first to 11th century AD, the 18th century).[2] Its first century share of World GDP was 33%, and 11th century share was 28.9%. In the 18th century, India’s economy once again the world’s largest with a 24.4% share of global GDP in 1700.
 
In 1776 Adam Smith noted that virtually all nations were around the same level of per capita income.
 

The change in the rules of the game

Critical thinking arose in India first, with Charvaka and other similar thinkers, 2600 years ago. India, as a result, came out with the most revolutionary atheistic ‘religions’ like Jainism and Buddhism, with some radically modern ways of thinking, that unfortunately seem to have died out in India and China.
 
These spread to Greece with the Sophists, followed by Socrates. However, these radically creative ideas died out till the Renaissance, being rediscovered primarily through the work of Muslim scholars.
 
The next significant change after the Renaissance occurred with Sir Francis Bacon – with his ideas about the scientific method – and the Reformation. Many other things occurred between roughly 1400 and 1750 that changed the rules of the game, such as the introduction of corporations and banking through the Medici family.
 
The main result of this was that the society went to the periphery, and the individual came to the centre.
 
I don’t intend to recount recorded human history here, and will skip straight to 1750, after the work of Hobbes and Locke had been imbibed, and the Glorious Revolution – and American and French revolutions – had occurred.
 
This was the time when Adam Smith documented the changed rules of the game in his 1776 book The Wealth of Nations.  By 1776 we had learnt that certain laws of human nature lead to certain kinds of outcomes for human society. The invisible hand was a radical breakthrough – showing that by doing well for ourselves (in our self-interest) we end up doing the best for society. It was a radical breakthrough.
 
The Industrial Revolution therefore began, using completely different rules than those applicable to an agricultural society. Places like Australia were soon settled, and scientific discovery was begun in right earnest.
 
Adam Smith had outlined what I call the obstacle theory of development.
 
 
The essence of this theory was that the government should step out of the way! Laissez Faire!
 
This fundamental new rule has not changed since then. All centralized planning efforts have failed, and as Hayek showed, later, are guaranteed to fail. Adam Smith’s book remains the Bible for all policy makers worldwide. Nations who don’t follow Adam Smith (broadly speaking) are destined to remain impoverished.
 
The system of wealth creation – being a set of rules general rules and policies – is best described by the word “capitalism”. Adam Smith called this the system of natural liberty. The proof is in the pudding. There is by now overwhelming evidence that Adam Smith as right.Regardless of the many regressions in the past 150 years through Karl Marx and John Maynard Keynes, the average economist today thinks far more like Adam Smith than like Marx or Keynes.
 
While I’m on this subject let me mention the most important economist and political philosopher since Adam Smith: Friedrich Hayek – who in the 20th century, wrote some of the most powerful books ever written so far (The Road to Serfdom, The Constitution of Liberty). I believe that anyone who doesn’t understand Hayek is basically an illiterate. He showed that each of us knows best our own circumstances and there is no way that any planner can get that information. The price system is the single most powerful means of transmitting that information.
 
Freedom works. That is the key message. Let people be free (subject to accountability), and the magic of wealth creation will automatically occur.
 
No doubt there are numerous matters of detail that need to be resolved in terms of the capitalist society, and many of these keep us busy in our jobs. But the broad framework is what I'm referring to here. India has simply NO CHOICE but to adopt this system. Resistance is futile. There is no going back to the medieval era. There is no going back to the caste system that worked so ‘well’ in the past.
 
A new game is being played, and just like India learnt to play cricket well (a game it did not invent) so also it now has to learn to play the game of freedom.
 

The sudden upsurge of wealth in the West

For thousands of years, agriculture hardly generated a major surplus. Human population barely grew. Malthus’s law (which perfectly describes the agricultural epoch) reigned.
 
But after 1750, per capita incomes in the West suddenly shot up. We entered the modern epoch, called Modern Economic Growth. The divergence in incomes across the world created by these new rules is stunning!
 
The idea that each succeeding generation would be twice as wealthy as its preceding generation would have astounded those who lived before this revolutionary break that occurred in around 1750.
While countries like India remained stagnant, the West leaped ahead like a rocket.
 
In around 1776, when Adam Smith wrote his book, India held a 25% share of world GDP and world trade (the combined Indian sub-continent). But because India did not progress during the next 150 years, being a colony of England, by 1947 its share of world trade declined to 2 per cent, and per capita income barely increased from its 1776 levels. In the meantime the West had increased its income by at least 10 times.
 
Growth started picking up after India’s independence (but share of world trade kept dropping) but it was very slow because of Mr. Nehru’s addiction to socialism. It led to a growth of less than 1 per cent per annum in per capita incomes. Only after 1991 did growth pick up to the current rates, of around 5-6 per cent per capita, at which rate real income doubles about every 10-12 years.
 
By now India’s per capita income is around $3000 in purchasing power parity terms, compared with American per capita of about $50,000. In terms of share of world trade, India’s share is likely to reach 2 per cent soon, compared around 20 per cent, which is roughly its share of world population.
 
After over 200 years of the Industrial Revolution the comparative picture between India, China, and Australia, is very revealing.
 
 
Australia
India
China
8
87
78
3
124
135
World Bank Doing Business (June 2010 report)
10 (with 2 for starting business)
134
79
 

Can India catch up?

Is it inevitable, for instance in India will increase its per capita GDP by 10 times or more, or its share of world trade by at least 10 times?
 
I believe that there was nothing to prevent India from overtaking USA decades ago in per capita income, as countries like Singapore have done, after coming from way behind. Today the Singapore per capita income (in PPP terms) is $ 57,238 compared with USA’s $ 47,123 (IMF calculations, 2010). India’s is a mere $3,290.
 
The answer to this puzzle, of India’s HUGE underperformance lies in our getting a simple and clear understanding of economic growth. While the following is a gross simplification, it captures the key issues involved:
 
Growth = f(policy(F), governance(F), opportunity(F)) = f(F), where F = freedom.
 
"Opportunity" in the above equation reflects the distance to the technical frontier. For instance, India is very far from this frontier, the West is at the frontier; that is why India is so poor. The opportunity to reach the technical frontier always exists with the poorer nations. They simply need to copy what the leading nation is doing. No effort required to re-invent the wheel. However, they need the right policy and governance to achieve this opportunity.
 
Yes, India has (and has had, at least since 1947), the opportunity to advance to the standards of the Western world. No doubt the technology exists and is simply a matter of implementing it in India. But to achieve results for which an opportunity exists, we need right policies and right governance.
 
Governance is crucial. It is the existence of appropriate institutions of governance that ultimately dictates whether policy can be translated to the grassroots. But on that, India continues with a run-down dilapidated colonial model of governance that was further smashed up by socialists, so that today corruption and incompetence is all-pervasive in India. As I have show in BFN, not only has India’s policy been sub-standard, its India’s governance is a disastrously poor. No, there have been no reforms of India’s governance over the past 60 years. With low quality, corrupt people running its government, bad policy is inevitable. Hence India continues to remain poor.
 
Thus, for instance, the great complaint that we have in India about corruption is merely a symptom of the underlying policy and governance problem. The problem is the poor design of institutions (including policy). Bad policy and governance inevitably lead to corruption. Indians don't have immoral DNA, any more than the Chinese have immoral DNA. The Chinese on the mainland are hopelessly corrupt. In Hong Kong the same Chinese lead the world (!!) on integrity. People in all these places are merely responding to policies and governance. In India and China the people have no choice but to be corrupt (or, like I have done – to leave).
 
Can policies be improved in India? Yes! India was given a policy shock by IMF when it almost went bankrupt in 1991 and flew a large chunk of its gold reserves to the Bank of England. That policy shock, unwelcome as it was in socialist India (and administered reluctantly by Manmohan Singh who claims undue credit for it! – even as he has been HANDS IN GLOVE WITH the deeply corrupt Congress party), jolted India to life like an electric shock can jolt to life the heart of a dying patient.
 
That policy shock showed immediate results but has by now run its course. No further policy reform of significant order has since occurred. With bad policy and shabby governance, India has grown since the 1990s only because it had some spare skilled manpower (and some could return from abroad at short notice). It had some spare capacity in infrastructure in the early 1990s.
 
But today all that has been squeezed out. And existing human resources have been fully absorbed. Its cities are virtually collapsing.
 
Consider communication and transport. The mobile phone revolution overcame many market barriers in India. For instance it is no longer possible to exploit the rural farmer for he knows the precise price of commodities in the wholesale market. Prices of mobile phone calls are so low that people can call each other literally for free.
 
However, while information can be transmitted wirelessly, humans and goods can’t be transmitted wirelessly! We need to move through roads and other physical obstacles. Ensuring this requires good governance, which India simply doesn’t have. And so India's villages/ towns/ cities are congested beyond imagination: choking to the brim. No more capacity. Journeys which at one time took 20 minutes now take up to three hours.
 
And no more skilled people to manage the industries and institutions that lead to growth.
 
This has become a huge barrier to India's productivity. And there are no signs of improvement because the governance system has almost totally collapsed.
 
In brief:
 
1) India’s policy and governance failures have restrained it for 60 years and prevented it from exploiting the opportunity to reach the technical frontier. IMF led reforms in some (not all!) policies have led to some improvement, but these gains are coming to an end.
 
2) Further progress – at least the 10 times catch-up needed for India to become rich – is NOT going to happen unless a lot of things change, in both the policy and governance space.
 
Therefore we can conclude that it is not inevitable that countries like India will advance into prosperity. Current policies will make India a middling power by 2050, important but not powerful enough.
 
I have outlined the precise policy and governance reforms that India needs, in BFN. If ever, India does recover its erstwhile super-powerful status, it will be because it followed those recommendations. That much I can confidently say! There is simply no other way.
 
Should reforms be undertaken, nothing is impossible. Join the Freedom Team of India if you want to change India for the better.


[1] They were omnivores, fully adapted to eating meat. I emphasise this point because some people in India believe otherwise. http://bit.ly/eI3QW5

[2] Based on research byAngus Maddison, a great economic historian, in his 2007 book The World Economy: A Millennial Perspective.

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