What do the financial and
economic crises of the high-income countries mean for
emerging and developing countries? I addressed this
in New Delhi
last week, at a discussion sponsored by the Federation of
Indian Chambers of Commerce and Industry (FICCI), the
Consumer Unity & Trust Society (CUTS) and the Financial
Times. The conclusion I drew was that the crisis is
dangerous. But this is not so much because of its direct
effects. It is far more because of the lessons that might be
drawn. The right lessons have to be drawn, not the wrong
ones.
In the years since the financial
crisis broke upon the high-income countries, the economic
performance of the biggest emerging countries has been
remarkable. Even allowing for the slowdown forecast for 2012
in the International Monetary Fund’s recent
World Economic
Outlook update,
India’s gross domestic product is set to rise by 43 per cent
between 2007 and 2012. This is below China’s rise of 56 per
cent. But it is far superior to the high-income countries’ 2
per cent.
This is a revolution. It also
shows a large measure of decoupling. We learnt in late
2008 that a big shock in high-income countries would
adversely affect developing economies. But the Asian
giants were relatively unaffected. They found ways of
offsetting the shock.
Would that be the case again?
The worst likely shock might be a combination of an
oil-price jump – perhaps following conflict in the Gulf –
with the collapse of the eurozone. The latter would
temporarily disable, if not destroy, the eurozone’s
financial system. That would generate large global shocks,
via trade, remittances, finance and pervasive uncertainty.
One can also identify risks
inside big emerging economies. China, in particular, might
be unable to offset another deep recession in the
high-income countries with a huge rise in credit-financed
investment, as it did three years ago. According to the
economist Andy Xie, fixed asset investment has reached 65
per cent of GDP. It is almost impossible to imagine the
investment rate could be raised further, without risking a
huge overhang of unneeded capital and a subsequent
investment bust.
Another global “bust”, possibly
worse than that of 2008 would also damage the Indian
economy. In its January
Global Economic
Prospects, the World
Bank noted that “conditions today are less propitious for
developing countries than in 2008”. India has high fiscal
deficits and a high rollover rate for public debts. With a
current-account deficit of close to 4 per cent of GDP in
2010, it would be vulnerable to another big global shock.
Yet such direct threats should
not be exaggerated, for two reasons. First, the scenarios
are possible, but far from probable. Downside risks are
large, as the IMF notes, but they are just that: risks. The
eurozone may do the right thing, in the end. Similarly,
conflict with Iran may be avoided. Second, a vast and
relatively poor country, such as India (with GDP per head,
at purchasing power parity, only a 12th of US levels), can
still generate rapid growth by catching up on the world’s
richest countries, almost regardless of the global
environment.
Thoughtful Indian observers are
well aware that the principal obstacles to rapid economic
development are internal, not external. Among obvious
constraints are failures of governance, including wasteful
spending on subsidies at all levels of government, a dire
record on the provision of
education
and health to the bulk of the population, rigid labour laws,
inadequate
infrastructure
and costly restrictions on efficient use of land. Much of
this is laid out in an excellent collection of essays by
Shankar Acharya,
former chief economic adviser to the government of India.
Yet such failings are also opportunities. Given how well
India has performed despite these disadvantages, consider
how well it might do without them.
The biggest danger from a
further global shock would be indirect, not direct. It would
come via backsliding on reforms. I can see two threats.
The first and least important
would be a consequence of global responses. So far, however,
the regulatory response, at least in finance, seems unlikely
to damage India. The Indian financial system would, for
example, be no worse for adopting the emerging global norms,
and probably better. A bigger threat would come from
imitating external protectionism. But so far, nothing too
serious has occurred in that area, though the risks
certainly exist.
The second and far greater
threat would be undiscriminating embrace by Indians of the
“capitalism-in-crisis meme”. In the same way, it might be
remembered, one of the worst consequences of the 1930s Great
Depression was the embrace of anti-trade and anti-market
policies in much of the developing world after the second
world war. It would be a catastrophe if any such response
occurred, when “reform and opening up”, as the Chinese call
it, has begun to work so well, even in India.
The crucial point is that what
has happened is not a crisis of the market economy, but of
mistaken ideas about it. Appropriately supported and
regulated, competitive markets remain incomparably the most
successful means of generating sustained increases in
wealth. This is as close to a proven fact as we are likely
to obtain in social sciences.
For India, where so many markets
are unnecessarily and disastrously distorted by
counterproductive government interventions, this remains
overwhelmingly true. But by doing what they should not do,
Indian governments have too often failed to do what they
should do: to create the conditions for sustained and
broadly shared growth. The reforms listed above remain
essential. Nothing has changed that.
So what should a country such as
India learn from the crisis in forming its own policies? I
suggest two big lessons. First, the financial system is
capable of generating huge instability and needs to be
watched. Second, the integration of India into the global
financial system has to be managed carefully. Huge crises
may be socially and economically manageable for high-income
countries. They would be grossly irresponsible for a country
like India.
What, then, are the conclusions?
First, India’s fate rests mainly in its own hands. Second,
the reforms that made sense before the crisis make as much,
if not more, sense now. Third, India must proof itself
against big macroeconomic risks, particularly from excessive
fiscal deficits, ill-managed integration with the global
financial system and, in the longer run, out-of-control
domestic credit. Last, Indians should resist the notion that
the crisis proves market economies do not work. They should
recall that the adversely affected economies are still the
high-income countries, for a reason. Learn from the
mistakes. Remember the reason
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