RBI dips into credibility balance

Quick off the blocks, Ms. Usha Thorat has written a good comment on the RBI monetary policy decision. Her last line was masterly.

As she points out in the first paragraph itself, RBI has increased the growth forecast, flagged fiscal policy risks and other inflation risks and yet, lowered the inflation forecast for the current financial year 2018-19. It is a tough one to explain away.

So, it is clear that they had set a goal for the policy meeting outcome today and worked backwards with the rationale. Of course, most human beings do that in most situations.

Frankly, there is so much uncertainty about both the growth and the inflation outcome right now for 2018-19 that one can pretty much justify any combination of projections.

Persnally, I would not set too much store by the recent uptick in some cyclical data. Hence, if I were in RBI, I would not have revised the growth projection higher.

Among the ‘forward looking’ surveys, the Consumer Confidence Survey must be a huge worry for the government. Together with inflation expectations, they present a double-whammy. Consumers are more pessimistic about their economic situation and expect inflation to be slightly higher as well! Would be a surprise if it is not reflected in the voting prefereences in the upcoming Assembly elections.

Consumer Confidence survey summary

Also, the Industrial Outlook survey (81st round) is not all that rosy. Check out Tables 15 and 16 on the availability of finance from banks and from foreign sources respectively.

Finally, one thought for the central bank’s credibility. The central bank sounded hawkish in February. Its Chief Economist keeps voting for rate increase. Suddenly, it turns soft on inflation forecast when all the logic (including faster GDP growth) points to the risk of a higher inflation rate.

But, financial markets do not call out the central bank for this ‘tangled web’ of projections. It takes them at face value and rallies! Mission accomplished! It does redound to the institution’s credibility that financial markets, instead of calling its bluff, lap up its projections and policy action.

What does it say about the financial markets, of course?  It continues to prove Eugene Fama wrong – day in and day out.

(Cheekily, I wonder if the decision,  the inflation projection, the growth projection and the dovish commentary are all a compensation for the Gandhi Nagar speech?)


Why and how Finance sucked up (or, sucks up) engineering talent

I had posted the following comment in response to this article in FT:

Much of the comments on this article focused on the micro behaviour of individuals who chose to join financial institutions and hence were, for the most part, defensive about their behaviour and hence, critical of the article. But, that lens is the wrong one.

The article points to a paper that highlights the attractiveness of finance to engineers as opposed to other jobs that were more suited to their education. It is a social phenomenon and the responses have to be in the policy domain, if it is established that there has to be a policy response. As individuals, engineering graduates who joined the banking industry were doing the sensible thing for themselves and their families. This commentator and Andrew Hill would have done the same, in all likelihood. But, we need to move away from that frame.

Why did finance attract so much talent? A corollary question that poses itself is why was finance able to pay so much that talent flowed to it? Well, finance made so much of profits that it was able to pay. Actually, the attraction of talent, high wages and profits became mutually reinforcing trends later. But, what was the source of profits?

Finance, in modern times (post-1980s because that is when financial liberalisation, de-regulation and liberalisation of capital flows started in right earnest), has not been doing anything unique in comparison to the past.  It facilitated much secondary trading of financial securities. But, the compensation for it has come down considerably and the fees for active asset management have, for the most part, proven to be wasted and wasteful compensation. So, what was the source of it?

Andrew Haldane, in his contribution to the volume, ‘The Future of Finance’ published by the London School of Economics in 2010 (‘Contribution of the Financial Sector: Miracle or Mirage’) has pointed out that finance generated extraordinary profits because it wrote deep out of the money options (think Credit Default swaps and sub-prime securitisation). Deep out of the money options earns premium for the writer but once in a while these options get in the money and the writer has to pay up to the options owner. That is what happened in 2008.  Second source of profits was that much of the profits were risk-unadjusted. One source of risk is that many assets were valued as per models and hence shown at fair value. Second source of risk is high leverage ratios in investment banks’ balance sheets. The third arose out of creating products that, willy-nilly, drew the buyers into the web of financial leverage. In fact, that is where the engineering talent was needed.

High profits were required to maintain stock valuation in deference to the pressures exerted by institutional investors. Second, compensation of higher executives was linked to stock price performance. Hence, showing consistently rising profits was an obligation. That required generation of complex financial products which, though based on complex mathematics, were essentially built on unsuspecting clients assuming financial leverage. Developing these products required engineering talent. Ergo, the phenomenon that the paper and the article cover.

Now, the question for policymakers is whether any of this is welfare enhancing. Evidently, they are not. Their welfare-destruction was evident in the crisis of 2008. Have the policy responses changed the demand for engineering talent and the attraction of finance to such talent? Not much, if at all.

So, this is a socially negative phenomenon even though it is positive at the personal level, somewhat like the paradox of thrift that Keynes had discussed, in a different context.

In this context, it is worth noting that Bloomberg reported last evening that bonuses in Wall Street reached their highest level since 2006.

Getting off the arm-chair

These two articles remind us of where our utility as public policy commentators lies.  Real (intellectual) discoveries (epiphanies, in a way) await us when we dig deeper. The first article tells us of the author’s discovery that gun control is probably not the answer to the United States’ gun related violence.

The second story is about a Harvard Medical School study that looked into U.S. health care that is much derided.

It is a coincidence that these wo articles came into my space on a day when my column in MINT dealt with the real issue behind India’s declining Gross Fixed Capital Formation to GDP ratio. It is not, as we think, because of businesses not investing. It is because, as per official data, household capital formation has stalled. Household capital formation has stalled because household savings rate has really dropped from 25.2% in 2008-09 to 16.3% in 2016-17.

That does merit a proper investigation as to the causal factors. In my column, I allude to one: failure of the governments to provide public goods necessitating private expenditure on them. So, household savings and GFCF failure is governance failure and not ‘jobs’ failure. The column is here.

The Thiruvadanthai trilemma

Although my friend Srinivas Thiruvadanthai did not mean to pose the question as such, I thought I would credit him with a ‘Trilemma’ that, I hope, will remain for posterity! His blog post triggered the following thoughts:

Another thoughtful and thought-provoking post as usual, Srini. The last paragraph of the post has been the rallying cry of BIS economists from White to Borio (including Cecchetti or not?).

I found the paragraph on the ‘ex-post criticism’ of the Fed not being easy enough in mid-2008 to be particularly insightful. Hindsight is a gift for critics that is denied to policymakers in real time!

The blog post can be considered a formulation of ‘Thiruvadanthai Trilemma’ between free-market finance, financial stability and economic stability. You can have two of the three but not all of them.

Notice that I have taken interest rates out of this trilemma. That is deliberate. In other words, the problem that there is no one single interest rate that stabilises the financial economy and the real economy at the same time disappears if (a) we remove the paradigm that ‘markets know best’ particularly for the financial sector and for financial markets (in a sense, I believe, the comments by Ms. Carolyn Sissoko reflect that) and if (b) the relevant horizon to evaluate the correctness of the monetary plolicy setting was long enough.

Let me take up my point (a) above. The question is whether regulating finance alone is both necessary and sufficient to enjoy both financial and economic stability at the same time. Yes, some would say.

That is what Ms. Caroline Sissoko has said in her coments on his post. But, is that really the case? We will never know because two things were at work in the post-Great Depression period and, in particular, in the post-WW II period. Economic growth was a low-hanging fruit. Therefore, it is possible that, regardless of how the financial sector or financial markets behaved, sustained high growth would have washed away all sins – with or without tight regulation. We will never know.

Therefore, it logically follows that in the era of slower growth that we face now, the case for financial sector and financial market regulation becomes stronger and not weaker.

Critics would object that this would further jeopardise the already lower growth. Well, the IMF has the answer. In a paper that is now a book, ‘Too much Finance’, the authors argue that financial development in advanced nations has already crossed the theshold at which it is beneficial for economic growth.

So, financial sector/financial market regulation will take care of the ‘Thiruvadanthai Trilemma’.

Fortifying that will be a monetary policy setting that chooses its relevant horizon more carefully than what central bankers have done in the last three+ decades. It should be longer than the business cycle so that it encompasses the financial cycle. I am merely paraphrasing the arguments made regularly by BIS economists. That is my point (b) above.

In a long enough time horizon, the dilemma, of fixing a high enough rate that handles financial market exuberance without hurting real economic activity or a low enough rate that allows financial intermediation to repair or to resume while the economy is overheating, solves itself.

In recent times, I beleive that the former dilemma has imposed much bigger long-run costs on the economy and on the society than the latter dilemma, in the above paragraph.

If unelected and technocratic policymakers optimise their decision over a reasonably long time frame, then the need for (or, the impossibility of) multiple policy rates is avoided or obviated.

If they cannot do that in practice that easily, then another approach is to have the domestic economy counterpart of ‘unremunerated reserve requirements’ that is applied to regulate capital flows. There can be a counter-cyclical credit surcharge (or discount) that the central bank, in its capacity as a banking regulator, prescribe for credit allocation, on the top of the policy rate. There can be times when this surcharge (negative or positive) can be zero. In that case, the policy rate works both for the financial economy and for the real economy. This can be on top of (and not in lieu of) countercyclical capital buffers that regulators now want to impose on banks.

Some recent very good reads on China

(1) On Thursday, U.S. time, the Trump administration raised tariffs on China goods. Whether the tariffs amount to USD50.0bn or that they were being levied on USD50bn worth of Chinese imports is not yet clear.

An investment bank wrote the following, this morning, in its daily missive:

Our economists note that news reports differ on whether the tariffs would apply to $50bn of Chinese imports, or whether they aim to raise $50bn in revenue. If it is the latter then they would apply to $200bn, or about 40%, of Chinese good imports. The only thing the USTR (US Trade Representative) mentions is that the unfair Chinese trading practices are estimated to cost the US economy at least $50bn / year. The extent of the tariffs is one uncertainty, another is the extent of the response by the Chinese.

The same research note made the remarks below:

Although the US decision elicited consternation abroad and calls from allies not to escalate to a trade war, Trump’s decision received cross-party support in the US from Senate Democrat Leader Chuck Schumer, who said Trump is “exactly right” and “I’m very pleased that this administration is taking strong action to get a better deal on China.” White House trade adviser Peter Navarro meanwhile told reporters the measures are a “seismic shift from an era dating back to Nixon and Kissinger, where we had as a government viewed China in terms of economic engagement… That process has failed”. This suggests that the decision has the weight of the US policy / geopolitical strategy establishment behind it, especially after Trump purged his advisors of pro-free trade voices and replaced them uniformly with China hawks, and is not simply a political tactic ahead of midterms or a Trump-specific impulse.

In a way, it made me think of how much Trump, the outsider, has managed to thumb his nose at conventional wisdom that binds both the major political parties in the United States. He is governing, for better or worse, as a true outsider. In India, in some respects, that is still missing despite the election of Mr. Modi in 2014 who, in a way, overcame the established leadership in his own Party to become its national leader but yet, he has not stamped his authority on policy.

(2) Only this morning, I managed to read the ‘Executive Summary’ of the report of the US Trade Representative on China’s WTO compliance. Of course, the media had featured this comment prominently. But, it is worth putting it out all over again:

Given these facts, it seems clear that the United States erred in supporting China’s entry into the WTO on terms that have proven to be ineffective in securing China’s embrace of an open, market-oriented trade regime. [Link]

Again, this is in line with what many sensible observers have written in the last two to three years.

(3) Notwithstanding the cop-out/finessing in the last paragraph of their article, Kurt Campbell and Ely Ratner, pretty much, vindicate Trump and they are also extremely consistent with the message of John Pomfret in his wonderful book, ‘The Beautiful Country and the Middle Kingdom’. The article could be behind a paywall.

Very brief extracts:

Nearly half a century since Nixon’s first steps toward rapprochement, the record is increasingly clear that Washington once again put too much faith in its power to shape China’s trajectory. All sides of the policy debate erred: free traders and financiers who foresaw inevitable and increasing openness in China, integrationists who argued that Beijing’s ambitions would be tamed by greater interaction with the international community, and hawks who believed that China’s power would be abated by perpetual American primacy. ……..

…….. Washington now faces its most dynamic and formidable competitor in modern history. Getting this challenge right will require doing away with the hopeful thinking that has long characterized the United States’ approach to China.

(4) A good friend had sent a speech delivered by Kevin Rudd, former Australian Prime Minister to the students at the U.S. military academy at West Point, earlier in March. It is worth the investment of time going through that speech. My reactions are as follows:

(1) Clearly, it is a Master class that the Indian political establishment needs to hear.

(2) Do Indian political leaders know the kind of intellectual concepts or are they capable of the intellectual thinking that Kevin Rudd attributes to Xi Jinping?

(3) Why has NITI-Aayog idea of inviting international experts to address Indian parliamentarians stopped? Was there anyone after DPM Tharman and Bill Gates? (Yes, there was Michael Porter on competitiveness of nations and states in May 2017)

(4) I was struck by his penchant for numerically layered arguments: Three characteristics, three aspects of the economic transformation post-2013 (or lack thereof) esp. with respect to private sector and then seven concentric circles.

(5) His explanation of how China chose to pursue the path that it is currently pursuing after deliberating upon alternative models is fascinating but equally it is silent on the contradictions and vulnerabilities of the model chosen eventually – single party dominance and encroachment.

(6) He has completely underplayed any discussion of China’s vulnerabilities or weaknesses or limitations. I would not say that it is due to a certain veneration or that he is in awe of China but, may be, because he believes that it is good to over-estimate an adversary rather than do the opposite.

(7) His discussion on the method that Xi has chosen to accommodate (or, suppress or ignore) the demand for political freedom after economic freedom is too thin or weak or almost non-existent. He says that Xi’s answer to that is ‘ideology’. Does not elaborate as much as he could have or should have.

(8) In the same breath, I can also add that his discussion of China’s economic limitations is too weak. May be, that is not his forte. He assumes that China will overtake American GDP and also mentions a time frame. But, risks to such a facile view are not mentioned, let alone discussed.

(9) What is clear to India is that there are no easy ways with China. In fact, I might even say that, in a sense, Xi’s ‘Presidency without limit’ makes many things clear. There is no equality or parity with China. They do not want India to have its own sphere of influence. They scoff at it. They may, at one stage, come to that understanding with the U.S. and that too, on their terms, later. But, they could rather have India as a supplicant and not as a strategic adversary or a partner.

India, proud of its civilisational past, now should know what its path is. It has to be prepared to confront and be prepared for confrontations through many flanks – economic, diplomatic and military and not be squeamish about its alliances with other democracies in the region and the USA – ‘the dance of the democracies’.

(5) Separately, I went through the testimony given by John Garnaut, former journalist and advisor to Prime Minister Malcolm Turnbull to the U.S House Armed Services Committee on March 21, 2018 although the document puts the date wrongly as March 21, 2008 (I wonder). That speech which comes with his article in ‘Foreign Affairs’ attached is, in some ways, a good counterpoint to the somewhat relatively benign way in which Kevin Rudd has painted the developments in China.

From mining bitcoins to Qatari hostages to the tyranny of convenience to opoids – recent great reads

Andrew Sullivan’s piece in ‘New York Times Magazine’ on the Opoid crisis in America made for grim and sad reading. Of course, some of the causes he alludes to strike a chord even if it is hard to empirically verify them or establish them. You can read the article here.

A British-American friend responded thus:

It’s difficult to analyse how the US has got itself into this position. There are many factors, including a collective cultural desire to be anaesthetised from whatever is disturbing or difficult. That’s been made easier by having a medical profession that’s symbiotically in cahoots with the insurance industry, making the feeding of addictions a win-win situation for both sectors.  The human fallout is horrifying and there is probably not a family in the country that does not have someone who has been affected by this.

Reading this article (ht: Rohit Rajendran) in the ‘Politico’ magazine made me recall the movie, ‘It is a mad, mad, mad world’.  I think the movie came in the Sixties. The extent to which electricity is consumed to ‘mine’ bitcoins boggles the mind. More fascinating are the quarrels and the social effects it has caused. It is a good piece of journalism.

The article does a very good job of explaining what ‘mining’ bitcoins is about and what forms a block and a blockchain, etc. I get it (kind of). But, I really wonder if it can ever threaten the monopoly of the State on money. If it does, its issuers become an alternative State. If it does not, it is a fad and a bubble. As long as the number of bitcoins does not exceed 21 million of them, its artificial scarcity value can be maintained. If it is increased, then it would begin to create doubts in the minds of authorities. Read it here.

Srinivas Varadarajan shared the link to a very thoughtful article on the ‘Tyranny of convenience’. Some sentences that stood out for me:

Particularly in tech-related industries, the battle for convenience is the battle for industry dominance.

Convenience and monopoly seem to be natural bedfellows.

Today’s technologies of individualization are technologies of mass individualization.

Convenience is all destination and no journey.

Struggle is not always a problem. Sometimes struggle is a solution. It can be the solution to the question of who you are.

We give other names to our inconvenient choices: We call them hobbies, avocations, callings, passions. These are the noninstrumental activities that help to define us.

Rajesh Raman shared the link to a long story in New York Times on how members of the Qatari royal family were taken hostage and the dizzy geopolitical calculations behind it. Worth reading, if only to understand a bit of the conflicts between nations (or, tribes) in the Arab Peninsula.

I liked this blog post of MarkGB on the demonisation of Putin. There are no villains nor heroes but only an understanding of high stake games that nations play. I am yet to figure out why the West is hellbent on driving the Russians into the hands of China.

Soeren Kern has a detailed blog post on the political correctness behind unreported rape and assault cases in Germany. What is the rationale for the political correctness or squeamishness?

India at 2030: of possibilities and pitfalls

This is the draft of an essay I had submitted to ‘Industrial Economist’, a magazine published out of Chennai. The magazine celebrated its Golden Jubilee last week in Chennai. Surely a proud moment. They had requested me to contribute an essay on the above topic to the Golden Jubilee Special issue. Below is the original version I had submitted.


India’s challenge to achieving middle-income status is productivity.  Corporate governance is hurdle to higher productivity of labour and capital in the private sector. Government’s control and moralising mindsets are barriers to productivity in the overall economy. Both need to change for India’s potential to be realised, especially since easy growth-pickings such as growth in the global economy and in global trade, that was available to East Asia (first to Japan,  then to the Tiger economies and then to china), are not longer available.


India at 2030: of possibilities and pitfalls

On January 31, the Central Statistical Organisation in India released its first revision to India’s Gross Domestic Product Statistics. In the year ending March 2017, it projected that India’s nominal GDP stood at Rupees 152.54 lakh crores (or, Rupees 152.54 trillion). In the year ending March 2017, the average US dollar/Indian rupee exchange rate was 67.05. That translates into a nominal GDP in U.S. dollar terms of around 2.275 trillion. Now, if we simply assume that, over the next thirteen years, the India’s nominal GDP in rupee terms will grow at 10% per annum, then in rupee terms, the Indian economy will be 527 trillion rupees big. If we assume an average exchange rate of 60 rupees to a dollar, then, in dollar terms, the Indian GDP will be around 8.8 trillion. Many assumptions lie behind this estimate. Are they realistic or, are they conservative?

First, we have assumed a nominal GDP growth rate of 10%. Most of us know that nominal growth has two components – a real component and an inflation component. I had assumed a real GDP growth of around 6% per annum and an inflation rate of 4% per annum. The real GDP growth assumption of 6% is conservative if one compared it to the real GDP growth rate that China achieved in its growth years from 1979 for nearly thirty years. Based on official World Bank data, China’s nominal GDP growth averaged 16% per year between 1979 and 2009. Real GDP growth averaged 10%.

The three Ds and the Indian economy

As Ruchir Sharma had noted in an article, for Foreign Affairs last year, global economy is in the grip of three Ds – depopulation, deleveraging and de-globalisation.[1] That is one of the reasons China too has resorted to increasing reliance on debt, especially since the 2008 crisis. It has also launched the ‘Belt and Road initiative’ to put its domestic capacity to use and create growth opportunities for its industries and for the economy. However, getting growth back to levels seen before 2008 will not only be hard but may also be harmful. One needs to recognise and accept the hurdles that have come up before attempting to defy them. Countries, as much as individuals, need to be clear-headed about the factors that they can control or influence and the factors they cannot. They need to work on the former and wait for the right opportunities on the latter. Where does India stand with respect to the three Ds that Ruchir Sharma had identified? Answer to this question has a bearing on India’s economic growth and size potential in 2030.


The developed world’s population and labour force growth is slowing. Even India’s population growth rate has slowed. At around 1.2%, India’s population growth rate was lower by 0.1% than the global population growth rate in 2016. For the world and for India, population growth rate peaked in the Seventies. But, the world growth rate slowed faster than India’s.


De-leveraging is not India’s problem yet. Indian public debt – Union and State governments combined – at 68% of GDP is on the high side. Indian private non-financial sector (includes companies, unincorporated businesses and households excluding banks and other non-banking financial entities) has borrowed heavily from capital markets and form banks in the last fifteen years. This sector’s debt/GDP ratio was around 36.0% in 2002. It had risen to a peak of 62% in 2014. But, in the last four years, de-leveraging has been underway. The debt ratio has come down to 55.9%. India’s households have very low levels of debt by global standards. There is scope for them to catch up. Hence, despite the government’s high debt ratio, India’s overall debt ratio at 124% of GDP is on the lower side. Debt can be harnessed to boost growth.

However, India’s financial sector, dominated as it is by the government, is not in a position to provide debt capital. As long as banks remain under the control of the government, the government’s budget constraint will be binding on banks’ ability to raise capital. Without adequate equity capital, they cannot grow their assets, i.e., expand lending. The current crisis could have been an opportunity to pass the banking system on to private hands with safeguards and regulations for ensuring systemic stability and for ensuring that Indian banks did not repeat the mistake of their counterparts in the West. But, that opportunity has not been grasped yet. Crises are the best times to whittle down political resistance to fundamental changes that affect entrenched interests. Perhaps, in the unique Indian style, we might get there – a banking system that is not dominated by government shareholding – by stealth and in our own opaque and convoluted manner.


De-globalisation is a bigger threat than is understood. India routinely sets out export targets for the economy. Frankly, that is a futile exercise. Exports are determined by global demand and by the competitiveness of the goods and services that India seeks to export. The latter is in India’s control, to a large extent. The former is not. Hence, the government can set targets for improving the quality, indispensability and competitiveness of Indian exports and then hope that global buyers notice that. Unfortunately, one does not see targets in areas where the target-setter has influence. IN any case, despite setting such targets, India’s export performance has been disappointing in recent years. During the global boom era of 2003-2008, India’s exports rose briskly year after year. Since then, they have struggled.

According to World Bank annual data, after the global crisis of 2008, India’s export growth recovered to nearly 20% in 2010. Since then, the growth rate has been declining, contracting 5% in 2015 before posting a modest increase of 4.5% in 2016. This performance mirrors India’s yo-yo export growth record between 1975 and 1990, a period marked by government dominance of the economy, hesitant liberalisation, political uncertainty and fiscal imprudence culminating in the Balance of Payments crisis of 1990. The unimpressive export performance symbolises a much bigger problem with productivity and scale inefficiencies in India. They constitute a big risk for optimism on India’s aspiration to join the Economics Big League by 2030. We will deal with that later.

A reasonably large part of the problem lies with changing attitudes to foreign trade and imports along with changing attitudes to immigration.  Nations are becoming more protectionist and protective of their economies. Whether that is the correct attitude or not is a separate issue. The reality of these unfavourable changes globally, at the margin, and their adverse implications for India’s exports must be understood when we try to assess India’s growth prospects for the next twelve years. Even India is not immune to these trends.

Right after the Prime Minister’s speech at the World Economic Forum in Davos in January, the Indian government proceeded to increase import duties on several items in the Budget for 2018-19. U.S Trade representative has called the admission of China into the World Trade Organisation (WTO) in 2001 a mistake. America has imposed stiff duties on washing machines and steel items. Both America and the European Union refused to grant China ‘market economy’ status at the WTO. The American President walked out of the Trans-Pacific Partnership – a comprehensive trade and investment agreement among nations from Chile to Vietnam – soon after he took office in January 2017. There are rumours that he would pull America out of the North American Free Trade Agreement (NAFTA) that President Clinton signed with Canada and Mexico in 1993, coming into effect in 1994.

East Asian countries, led first by Japan and now followed by China, especially since 2000, had improved their economies and reached middle income status mainly due to strong export market performance. Emphasis on exports raises the bar on domestic manufacturers with respect to scale and productivity. Exports can easily add a percentage point or two to economic growth, making up for domestic slack. India, due to a combination of internal and external factors, is likely to miss out on that for several years, if not longer. Boosting export growth is not easy because India is simply not used to sustained high export growth. The culture of export reliance is missing. It takes years to form that habit. China is way ahead of India in this respect and it too is now vigorously competing to retain its market share amidst dwindling global growth and rising protectionism.

Srinivas Thiruvadanthai, Chief Economist at the Levy Forecasting Institute in New York, laid out the challenge that India faces in no uncertain terms[2]:

“India needs to brace itself not just for a flood of cheap imports from China but also a potential reversal in the long trend of globalization. Trump’s message on economic nationalism, hitherto banished from polite conversation, is likely to experience a revivalism across the world in the years ahead. As global trade shrinks, the positive-sum aspects of it will dwindle, making it harder to paper over the negative aspects of trade. A trade war is a distinct possibility. What steps India’s policymakers take to proactively address the challenge posed by China and a potential global trade war will be hugely consequential for its long-term destiny.”

In other words, boosting economic growth and export growth is as much a productivity challenge as it is going to be a political economy challenge for India. Is India’s statecraft up to it? It is beyond the scope of this article to go into the latter but we will examine the former as it is more important and has a direct bearing on domestic growth.

Internal Growth Barriers

The productivity challenge

In January 2018, credit-rating agency, Fitchratings published a report[3] on the growth outlook for developing economies including China. Among the economies it analysed, it placed India’s real economy growth potential at 6.7%. So, our calculations based on a growth rate of 6% is a tad conservative. That is as it should be. In these matters, Indian governments talk before the economy walks. It is better to be modest on matters that are largely outside one’s control. Despite putting India at the top of the pecking order on potential growth (the growth rate that the economy is capable of generating), Fitch analysts noted two big concerns. One is that India’s labour force participation rate is rather low. Far too few women are in the labour force and there is also a problem with skill endowments of youngsters that prevent them from being absorbed into labour force. The second concern is India’s abysmal Total Factor Productivity Growth.

TFP is the extent of economic growth (or, output growth) that is not explained by growth in inputs. If we define output (or, production) growth as a combination of input growth (the more inputs one uses, the more output one generates) and productivity growth. So, TFP growth is the output growth rate that is over and above the growth rate in inputs. India’s TFP growth rate was 0.6% in the last several years. Fitch notes, “Sluggish TFP growth in a low income per capita country such as India (which has the lowest GDP per capita in our sample of countries covered in this report), which has more room to play catch up, is all the more disappointing.”

Disappointing export and productivity performances signal the formidable underlying challenges that India faces or has failed to tackle adequately in the last few decades. The factors that have led to this sluggish TFP growth are many. Not only labour laws and regulations and hiring practices but poor education and inadequate skilling hold back labour productivity. Corporate governance as much as government approvals and clearances holds back capital productivity. The private sector is diffuse and it is difficult to offer a template to all of it. I will confine myself to what policy can achieve to overcome India’s productivity barrier to economic growth.

The psychological challenge

Clearly, India has come a long way since the 1990s. Economic growth rate had picked up. Per capita income growth had picked up. Literacy rate has climbed. Infant mortality rates have declined. Life expectancy has improved and the poverty rate has declined. Nominal per capita income is around Rupees 10,000.00 now. All these have been accomplished without taking recourse to too much of debt (unlike China) and within a noisy, often disruptive and dysfunctional, democratic political setup. That is the good part. The not-so-good part is the fact that GDP growth rates and per capita income growth rates have slowed in recent years. Savings and investment rates have declined.

Some of this slowdown is due to global factors and slowing population growth, etc. But, throughout this essay, we had emphasised that individuals, institutions and governments must focus on their spheres of control and work on improving outcomes within those spheres. The Indian government embarked on economic liberalisation in the 1990s. But, their commitment to liberalisation has not been steadfast. Since 2004, it may even have reversed. Control instincts usually triumph over the instinct to let go. There is an atmosphere of distrust and mistrust between the governing and the governed. Governments have not delivered to the degree promised or is possible on health, education and infrastructure. That is a breach of contract.

The Comptroller and Auditor General of India in its report on the finances of the Union Government (Report No. 44 of 2016-17) noted that over the last ten years, the Indian government had collected around 840 billion rupees of education cess. But, this amount has not been earmarked in the Public Accounts of India and nor has any appropriate scheme notified to make use of the amount collected for education. Essentially, it is backdoor taxation or cheating of the public. To offset that, the government exempts the vocal classes from certain taxes or raises the tax threshold. The tax base shrinks. Others feel persuaded to evade. It is a downward spiral.

The government has to take the initiative to break this spiral of lack of trust in the society and in the economy. It has the instruments and the authority to verify. So, it can trust. The public does not have the tools – beyond the democratic elections once in five years – to hold the government accountable for its promises. Hence, the onus is on the government to trust and let go. It is the control mindset, blended with a moralistic attitude towards economic activity that obstruct creation of capacity and scale in the private sector. I may be accused, legitimately, of oversimplifying. But, the important role of government and regulatory attitudes towards size in keeping India’s potential economic growth and productivity improvement down cannot be understated. In listing the ‘Six Big Economic Mistakes’ of the present government, I had identified ‘anti-big’ bias as one of them[4]. The second chapter of the Economic Survey 2012-13 has a detailed analysis of how India’s laws and regulations constrain economic growth[5]. The Economic Survey of 2017-18 also refers to the anti-capital bias that has crept into the Indian public and political discourse constraining policymaking.[6]

A more vivid demonstration of that occurred recently when the Government defended the re-introduction of the Long-Term Capital Gains tax in India for gains in the stock market in the budget for 2018-19. The bureaucrat defended the tax saying that the stock market gains did not need any effort. In an era of abundant liquidity and herd-like investing, that might be true but policymaking cannot be guided by such intrinsically dismissive attitude towards such an important part of the modern economy (whether we like it or not).

It is not feasible to go into the depth of these arguments given the space constraints in this essay. The short point is that limits on India’s growth placed by low productivity could be a manifestation of psychological limitations. It is neither easy nor correct to draw a one-to-one correspondence between personal and public morality. The more the Indian policymakers are freed of their inherited, acquired and cultivated psychological shackles, the more the Indian economy will be able to break free of its growth shackles. If that happens, a USD9.0 trillion economy by 2030 will be a floor and not a ceiling for India.

[1] ‘The boom was a blip’, Foreign Affairs, May/June 2017 (https://www.foreignaffairs.com/articles/world/2017-04-17/boom-was-blip)

[2] ‘Trump’s Trade War On China And Lessons For India’, Swarajya, January 23, 2018 (https://swarajyamag.com/world/trumps-trade-war-on-china-and-lessons-for-india)

[3] ‘Investment and Demographics Key to EM Growth Potential – Medium-Term Growth Potential in Emerging Economies’ Fitchratings, January 2018

[4] ‘The government’s six big economic mistakes’ MINT, September 25, 2017 (http://www.livemint.com/Opinion/sprAUVoQWpbQaSiMCxjMOL/The-six-big-economic-mistakes.html)

[5] ‘Seizing the Demographic Dividend’, Chapter 2, Economic Survey 2012-13, Government of India

[6] See paragraphs 1.27-1.29, Chapter 1, Economic Survey 2017-18, Government of India