Financial times, February 08, 2012
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